involvement with the fund, and the ability to use its power over the fund to affect the amount of its returns.
As third parties invest in the fund and dilute (or acquire) the fund manager’s interest, this would likely result
in a reassessment of whether the fund manager has control. As the third parties invest, they are likely to obtain
rights to direct the relevant activities (that is, the third parties will gain power). In many cases, analysing the
facts and circumstances may indicate that the fund manager is acting as an agent of those third parties (as
discussed at 6 above). Accordingly, the fund manager would deconsolidate the fund upon its determination
that it no longer had control.
9.1
Changes in market conditions
IFRS 10 discusses when a change in market conditions triggers a reassessment of control.
An investor’s initial assessment of control or its status as a principal or an agent does not
change simply because of a change in market conditions (e.g. a change in the investee’s
returns driven by market conditions), unless the change in market conditions changes
one or more of the three elements of control listed in paragraph 7 of IFRS 10 (see 9
above) or changes the overall relationship between a principal and an agent (see 6
above). [IFRS 10.B85].
In response to concerns, the IASB decided to add this guidance to address the
reassessment of control when there are changes in market conditions. The IASB
observed that a change in market conditions alone would not generally affect the
consolidation conclusion, or the status as a principal or an agent, for two reasons. The
first is that power arises from substantive rights, and assessing whether those rights are
substantive includes the consideration of many factors, not only those that are affected
by a change in market conditions. The second is that an investor is not required to have
a particular specified level of exposure to variable returns in order to control an
investee. If that were the case, fluctuations in an investor’s expected returns might result
in changes in the consolidation conclusion. [IFRS 10.BC152].
Accordingly, only a market condition that causes a change in one of the three criteria
would trigger a reassessment (see Example 6.42 below). Evaluating whether a change in
a market condition triggers a reassessment of control should be considered in the
context of the investee’s purpose and design.
As discussed at 5 above, with respect to the second criterion, the focus is on the
existence of an exposure to variable returns, not the amount of the variable returns.
While a change in market conditions often affects the amount of the exposure to
variable returns, it typically does not affect whether the exposure exists.
However, when power has been delegated to a decision-maker, a change in market
conditions could change whether the magnitude and variability of exposures to
variable returns from remuneration and/or other interests are such that they indicate
that the decision-maker is a principal (as discussed at 6.4 and 6.5 above, respectively).
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That is, a change in market conditions could change the evaluation of whether a
decision-maker has the ability to use its power over the investee to affect the amount
of the decision-maker’s returns (the linkage between power and returns). Accordingly,
a change in market conditions may trigger a reassessment of control in principal-
agency evaluations.
As discussed at 4.3.4.A above, when evaluating the exercise price of an option in the
context of whether potential voting rights give control, the evaluation is not solely
based on the nature of the option as of the end of the reporting period. During the
development of IFRS 10, some constituents raised concerns as to whether frequent
changes in the control assessment solely because of market conditions would mean
that an investor consolidates and deconsolidates an investee if potential voting rights
moved in and out of the money. In response, the IASB noted that determining
whether a potential voting right is substantive is not based solely on a comparison
of the strike or conversion price of the instrument and the then current market price
of its underlying share. Although the strike or conversion price is one factor to
consider, determining whether potential voting rights are substantive requires a
holistic approach, considering a variety of factors. This includes assessing the
purpose and design of the instrument, considering whether the investor can benefit
for other reasons such as by realising synergies between the investor and the
investee, and determining whether there are any barriers (financial or otherwise)
that would prevent the holder of potential voting rights from exercising or
converting those rights. Accordingly, a change in market conditions (i.e. the market
price of the underlying shares) alone would not typically result in a change in the
consolidation conclusion. [IFRS 10.BC124].
Example 6.37: Value of option changes from ‘in-the-money’ to ‘out-of-the-
money’
A holds 40% of the voting rights of B, and holds a currently exercisable in-the-money option to acquire a
further 20% of the voting rights of B. Assuming that voting rights give power over B, the option is substantive
and no other facts and circumstances are relevant, A would likely have power over B, because A could
currently exercise its right to obtain a majority of B’s voting shares.
Consider a situation in which the in-the-money option changed to being slightly (but not deeply) out-of-the-
money, due to a change in market conditions (and this change was not previously expected to occur, as
discussed at 4.3.4 above). This would probably not trigger reassessment, because the option is likely to remain
substantive, and therefore there is no change in how power over B is evaluated.
Consider a second situation in which the option changed to being deeply-out-of-the-money due to a change
in market conditions (and this change was not previously expected to occur and it was now expected to remain
deeply-out-of-the-money for the remainder of the option period, as discussed at 4.3.4 above). This would
likely trigger reassessment, since the option would no longer be substantive, and the fact that the option was
previously a substantive right was a critical factor in assessing whether A had power over B.
Example 6.38: Structured entity reassessments
There are two investors in a structured entity; one holds the debt, and the other holds the equity. In the initial
assessment, the investors concluded that the equity holder had control because it had the power to direct the
relevant activities, exposure to variable returns through its equity interests, and the ability to use its power
over the structured entity to affect the equity holder’s returns. Due to a change in market conditions, the value
of the equity diminishes. This fact, by itself, would probably not trigger reassessment, because the equity
holder continues to have exposure to variable returns (i.e. it continues to be exposed to further decreases in
Consolidated financial statements 441
equity, and has potential upside if market conditions improve). Accordingly, the conclusion that the equity
holder had control of the structured entity would proba
bly not change.
However, if, concurrently with the deterioration of the equity, there are other changes in facts and
circumstances (e.g. the equity holder loses its ability to direct the relevant activities), this might trigger
a reassessment. In this case, the trigger is actually the other change in facts and circumstances, not the
decrease in equity itself. In this case, whether the debt holder has control depends on whether it has
rights that give it the current ability to direct the relevant activities, and the ability to affect its exposure
to variable returns.
Example 6.39: Investee loses money due to change in market conditions
C holds 100% of the voting rights of D, which is a profitable entity. In its initial assessment, C concludes that
it controls D.
Due to a change in the market conditions, D begins to lose money and is no longer profitable (e.g. due to a
decrease in demand for its products). This would probably not trigger reassessment, because the change in
market conditions would likely not change the identification of the relevant activities, how those activities
are directed, the investors’ exposure to variable returns, or the linkage between power and returns.
However, at some point, D might become so unprofitable as to consider restructuring its debt, or filing for
bankruptcy. This situation is discussed at 9.2 below.
9.2
Bankruptcy filings and troubled debt restructurings
Filing for bankruptcy or restructuring a debt will usually trigger reassessment as to which
investor, if any, controls the investee (see 4.3.2 above). While control should be
reassessed at such triggering points, it does not necessarily mean the conclusion as to
which entity consolidates will change. Examples 6.40 and 6.41 below illustrate
situations when the control conclusion might change, and possibly result in a bank
consolidating an entity that it had previously concluded it did not control.
Example 6.40: Bankruptcy filing
A made a loan to B. Because of A’s position as a senior creditor, if B defaults on the loan, A has the right to
direct B to sell certain assets to repay the loan to A. In its initial assessment of control, A concluded that this
right was a protective right, because it concluded that defaulting on the loan would be an exceptional
circumstance. Consequently, this right did not give A power over B, and therefore, A did not control B. A
concluded that the voting rights, which are held by the equity investors, give the equity investors power
over B.
B later defaults on the loan and files for bankruptcy, giving A the right to direct B to sell certain assets to
repay the loan to A. Upon B filing for bankruptcy, A would need to evaluate whether having this right, which
was previously protective, gives A power.
Before concluding which investors, if any, control B once it files for bankruptcy, consideration would also
be given to what rights the equity investors have, if any, to direct the relevant activities of B, and also to
whether A and the equity investors have exposure to variable returns from B.
Example 6.41: Troubled debt restructuring
Consider the same facts as Example 6.40 above, except that A and B agree to restructure the loan, rather than
B filing for bankruptcy. During the restructuring, A determines which assets will be sold to repay the loan,
with management and the equity investors agreeing to this plan. In addition, management agreed to an
incentive scheme under which payments are based on asset sale and loan repayment targets.
Upon restructuring the loan, A would need to evaluate whether determining which assets should be sold to
repay the loan gives A power. This might be the case if voting rights do not give power over B, because
management is required to comply with the asset sale plan mandated by A.
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6
Before concluding which investors, if any, control B, consideration would also be given to what rights the
equity investors have, if any, to direct the relevant activities of B, and also to whether A and the equity
investors have exposure to variable returns from B.
In some jurisdictions, it is possible that a trustee or court administrator may have power
(and possibly control) over an investee that files for bankruptcy. In such situations,
consideration needs to be given not only to whether the trustee has power, but also
whether it has an exposure to variable returns from the investee, and if so, whether it has
the ability to use that power to affect its exposure to variable returns. In many cases, a
trustee or court administrator might have power, but this power is held as an agent (see 6
above). However, a determination will need to be made as to whether the trustee or court
administrator is an agent for a specific lender, or for the creditors as a group. This will
depend on individual facts and circumstances for the jurisdiction.
In the situations in Examples 6.40 and 6.41 above, it might be determined that the
lender obtained control over the investee. In this case, judgement will also be
needed to determine the date at which the lender obtained control over the
investee. Is it the date that the investee filed for bankruptcy or restructured the debt?
Or, did the lender obtain control over the investee before the actual filing, or
restructuring, when it became evident that the investee would likely have to file for
bankruptcy or restructure the debt?
9.3
Control reassessment as a result of action by others
An investor may gain or lose power over an investee as a result of action by others (i.e.
without direct involvement in the change in circumstances). For example, an investor
can gain power over an investee because decision-making rights held by another party
or parties that previously prevented the investor from controlling an investee have
elapsed. [IFRS 10.B82].
Alternatively, actions of others, such as a government, could cause an investor to
lose the ability to make key operational decisions and therefore direct the relevant
activities of the investee. However, IFRS 10 does not include any consolidation
exception when the functional currency of an investee is subject to a long-term
lack of exchangeability. As explained in the Basis for Conclusions, when issuing
IAS 27 (2003) the Board decided to remove from the previous version the
exclusion of a subsidiary from consolidation when there are severe long-term
restrictions that impair a subsidiary’s ability to transfer funds to the parent. It did
so because such circumstances may not preclude control. The Board decided that
a parent, when assessing its ability to control a subsidiary, should consider
restrictions on the transfer of funds from the subsidiary to the parent. In
themselves, such restrictions do not preclude control. [IFRS 10.BCZ21].
Another example would be where other investors acquire rights of other parties. In such
cases, it might be more difficult to determine whether an event has happened that would
cause an investor to reassess control, because the information might not be publicly
available. Consider the situation in Example 6.42 below.
Consolidated financial statements 443
Example 6.42: Control reassessment without being involved
52% widely dispersed
11 investors hold 52%
A
/>
B
A
B
48%
48%
A holds 48% of the voting rights of B, with the remaining 52% being widely dispersed. In its initial assessment,
A concludes that the absolute size of its holding, relative to the other shareholdings, gives it power over B.
Over time, some of the shareholders begin to consolidate their interests, such that eventually, the 52%
is held by a much smaller group of shareholders. Depending on the regulatory environment, and rights
held by A regarding the right to receive information when shareholders acquire other interests in B, it
is possible, although perhaps unlikely, that A would not be aware of this occurrence. Nonetheless, it
would seem that IFRS 10 would require A to re-evaluate whether it has control over B, because the
other shareholders are no longer widely dispersed, and thus A may not have the current ability to direct
the relevant activities of B.
While the situation in Example 6.42 above might be uncommon, management should
consider what systems and processes are needed to monitor external events for changes
that could trigger reassessment. Without knowledge of such events, and a process for
gathering this information, it may be difficult to determine the date when the other
voters became sufficiently concentrated to conclude that the investor no longer has
control. The same might apply where an investor has determined that it does not have
control due to there being a relatively small number of other shareholders, but the other
voters become sufficiently dispersed or disorganised such that the investor now has
control. Depending on the facts and circumstances, there could be a lag in the period
between when the facts and circumstances actually change, and when management is
able to conclude that the investor has control.
10 INVESTMENT
ENTITIES
In October 2012, the IASB issued Investment Entities (Amendments to IFRS 10,
IFRS 12 and IAS 27). This introduces an exception to the principle that all
subsidiaries shall be consolidated. The amendments define an investment entity and
require a parent that is an investment entity to measure its investments in particular
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 88
