CBIZ & MHM Executive Education Series™ IFRS: Consolidations

Presented by: Marco Pulido, Shareholder

October 23, 2014

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Before We Get Started…

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This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic participation markers throughout the webinar.

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CPE Credit

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The information in this Executive Education Series course is a brief summary and may not include all

the details relevant to your situation.

Please contact your service provider to further discuss the impact on your business.

Disclaimer

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Today’s Presenters

Marco Pulido, CPA Shareholder 310.268.2746 | mpulido@cbiz.com Marco has 15 years of experience in public accounting working with U.S. GAAP, IFRS and other foreign accounting standards in the U.S., Europe and in Latin America with Big 4 accounting firms. He has experience with SEC filers (foreign and domestic) and private companies. Marco is a CPA certified in California and has IFRS certifications by the Institute of Chartered Accountants in England and Wales (ICAEW) and the American Institute of Certified Public Accountants (AICPA). Technical accounting expertise includes the following industries: Energy (Oil & Gas) - Retail, Distribution & Manufacturing - Technology - Services - Construction/Real Estate - Health Sciences - Agriculture.

Mark Winiarski, CPA Senior Manager, CBIZ MHM 913.234.1656 | mwiniarski@cbiz.com Mark is located in our Kansas City office in an audit and advisory function. In addition to serving his clients which are primarily in the manufacturing, retail and distribution industries, Mark supports MHM’s Professional Standards Group by consulting with clients and engagement teams across the country on accounting and auditing issues in areas including revenue recognition, consolidations and business combinations.

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Question: Please note which principles your company currently uses:

A. IFRS B. U.S. GAAP C. Both IFRS and U.S. GAAP

Survey

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Today’s Agenda

Principles of IFRS 10 1

2

3

4

5 Overview of IAS 27 Consolidated and Separate Financial Statements (2011)

Assessment of Power

Definition of Control

Other Matters

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Principles

IFRS 10 establishes principles that parent entities must consider for preparation of consolidated financial statements.

A subsidiary is defined as an entity that is controlled by another entity. Parent must include all of its subsidiaries in its consolidated financial

statements The standard uses the concept of “control” for determining

whether an investee is a subsidiary. In clear-cut situations, the investor who holds the majority of equity

shares, in the absence of other factors, controls the investee. IFRS is effective for annuals periods beginning January 1, 2013,

supersedes parts of IAS 27. U.S. GAAP may converge certain principles. Although VIE model

will likely not change.

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Principles

• Consolidation was based on control.

• IAS 27: Control to govern operating and financial policies of an entity in order to obtain benefits.

• SIC 12: For SPEs, exposure to the majority of the risks and benefits can be the determining factor for determining control.

• Consolidation is based on control. • Control can be obtained via various

means and not only from the power to direct relevant activities.

• Exposure to the risks and benefits is one of the factors required for control, but never the determinant factor.

IAS 27/SIC 12 IFRS 10

IFRS 10 requires extensive use of judgment. (IFRS 12 requires disclosing judgment areas.)

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Control

An investor controls an investee when the investor “is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.”

“Investor” is not defined. Can result from a management contract if given power to direct activities.

Power

Exposure or rights to variable returns; and

Investor ability to affect returns using their power.

Existing rights to direct relevant activities

Possible variability to positive and negative returns (broad definition)

Necessary to determine who “makes decisions” is an agent or another investor

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Question: Yes or No - Can an investor have control over an investee in scenarios where

there is a zero equity participation?

Example – Control

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Question: Yes or No - Can an investor have control over an investee in scenarios where

there is a zero equity participation? Response: Yes. Equity participation is not a requirement. However, all three of

the requisites for control must be met. Hence, there may be scenarios where an investor has < 50% equity participation, where control requisites are met, and therefore, investor must consolidate the investee.

Unanimous decision-making requirements under shareholder agreements may

signal the presence of a joint venture.

Example – Control

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Determine if There is Control

Power = Existing rights to direct relevant activities

Exposure or rights to variable returns

Investor ability to affect returns using their power.

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What is Power? Power derives from existing rights to direct relevant activities.

Rights

Substantive

Relevant activities

• Depends on the nature of the activities, legal and decision-making structure

• Voting rights, potential voting rights and contractual rights • Should evaluate the potential impact of rights

• Practical ability to exercise rights • Actual capacity to direct relevant activities • It is not necessary for rights to be actively exercised (a passive majority

shareholder may have the power)

• Activities that have a considerable effect on the profitability of the entity • For examples, purchases/sales, management of financial assets, debt,

etc. • Decisions over relevant activities: budget, personnel decisions,

investment decisions.

Note: Protective rights do not provide power, nor do they preclude ability for a third party to have power.

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Principles

IFRS 10 establishes principles that parent entities must consider for preparation of consolidated financial statements.

A subsidiary is defined as an entity that is controlled by another entity. Parent must include all of its subsidiaries in its consolidated

financial statements. The standard uses the concept of “control” for determining

whether an investee is a subsidiary. In clear-cut situations, the investor who holds the majority of

equity shares, in the absence of other factors, controls the investee.

IFRS is effective for annuals periods beginning January 1, 2013, supersedes parts of IAS 27.

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Power = Existing rights to direct

relevant activities

Exposure or rights to variable returns

Investor ability to affect returns using their power.

Determine if There is Control

1. What are the relevant activities? 2. How are decisions made with respect to

relevant activities?

Votes Other

> 50% < 50%

Should consider rights

of minority shareholders

Control via “de facto power,” substantive (potential) voting rights and other contractual rights

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Question: An example of a substantive right is the right for an investor to acquire

additional shares which would give them majority voting rights. Which of the following factors must an investor consider in assessing these rights? A) Barriers (economic or otherwise) that may prevent the holder (or holders) from

exercising the rights B) Whether the exercise of rights require the agreement of more than one party C) Whether the party or parties that hold the rights would benefit from the exercise of

those rights D) All of the above

Example – Substantive Rights

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Question: An example of a substantive right is the right for an investor to acquire

additional shares which would give them majority voting rights. Which of the following factors must an investor consider in assessing these rights? A) Barriers (economic or otherwise) that may prevent the holder (or holders) from

exercising the rights B) Whether the exercise of rights require the agreement of more than one party C) Whether the party or parties that hold the rights would benefit from the exercise of

those rights D) All of the above

Response: D. All of the above. All of the factors noted are critical to assessing

the substantive rights of an investor and whether this results in the power to direct the relevant activities of an entity.

Example – Substantive Rights

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Power = Existing rights to direct

relevant activities

Exposure or rights to variable returns

Investor ability to affect returns using their power.

Determine if There is Control

1. What are the relevant activities? 2. How are decisions made with respect to

relevant activities?

Votes Other

> 50% < 50%

Should consider rights

of minority shareholders

Control via “de facto power,” substantive (potential) voting rights and other contractual rights

• Contractual rights • Practical abilities • Special relationships • Role of variable returns

(e.g. debt and purchase/sale arrangements)

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Evaluating Power

Evaluate all contractual rights, e.g. selection of key personnel, right to direct specific activities, administration contracts.

• Practical ability (when no contractual arrangement exists) to unilaterally direct relevant activities. ‒ Capacity to appoint key management ‒ Capacity to make significant decisions ‒ If key management is a related party to the investor.

• Special relationship with the entity. ‒ Key management also is a key employee with the investor ‒ Key dependence: economic, technology, human resources ‒ Significant transactions between entity and investor ‒ Proportion of variable returns on investment is disproportionate with voting rights.

If it is difficult to determine power based on available rights, should consider the following:

Priority

• The significance of exposure to variable returns on investment.

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Question: All of the following represent significant factors that may indicate an investor’s

ability to unilaterally direct relevant activities of an investee except for: A) Capacity to appoint key management B) Capacity to make significant decisions C) Non-significant transactions between both parties D) Key management at investee is a related party to the investor

Example – Evaluating Power

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Question: All of the following represent significant factors that may indicate an investor’s

ability to unilaterally direct relevant activities of an investee except for: A) Capacity to appoint key management B) Capacity to make significant decisions C) Non-significant transactions between both parties D) Key management at investee is a related party to the investor

Response: C. Non-significant transactions between the investor and investee is

not an indicator of the investor’s ability to unilaterally direct the relevant activities of the investee.

Example – Evaluating Power

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Power = Existing rights to direct

relevant activities

Exposure or rights to variable returns

Investor ability to affect returns using their power.

Determine if There is Control

1. What are the relevant activities? 2. How are decisions made with respect to

relevant activities?

Votes Other

> 50% < 50%

Should consider rights

of minority shareholders

Control via “de facto power,” substantive (potential) voting rights and other contractual rights

• Contractual rights • Practical abilities • Special relationships • Role of variable returns

(e.g. debt and purchase/sale arrangements)

• What are the variable returns of the entity?

• How variable are the returns as a result of the performance of the entity?

• To what degree is each investor exposed to variations?

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Other Matters

Consolidation of “silos” or “cells”

• Silos or Cells = a group of assets and liabilities that should be treated as one single entity for purposes of determining consolidation. Must determine if portion of an entity is “ring-fenced” from the overall investee.

Continuous evaluation of control

• Investors should revaluate control when facts and circumstances indicate changes in one or more elements of control.

Capacity to influence returns using power • Determine if party that makes decisions is principal or agent.

De facto agent

• An investor is required to consider the nature of its relationships with other parties and whether those other parties are acting on the investor's behalf – i.e. they are acting as de facto agents.

• Investor should consider its de facto agent's decision-making rights and its indirect exposure, or rights, to variable returns through the de facto agent together with its own when assessing control of an investee.

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IFRS 10 effective date was for periods beginning on or after January 1, 2013, with earlier application permitted. Replaced IAS 27/SIC 12.

Use of judgment is extensive. Should consider a number of indicators and factors.

It is necessary to reconsider the consolidation evaluation performed under IAS 27/SIC 12, principally when the following indicators exist: Rights to potential voting rights Special purpose entities De facto control Different parties with rights over different activities Related parties.

Principal Changes in IFRS 10

Professional judgment is critical.

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Summary

• Consolidation is based on control • Single model applicable to all entities • Control = Exposed or have rights to variable returns

derived from its involvement with the investee and the ability to affect those returns through the power over the investee

Fundamental principles

• Must consider substantive rights to direct the relevant activities of the entity

• Requires identifying the relevant activities of the entity and how significant operational decisions are made

Power

• Broad definition • Must consider all returns on investment that can vary as

a result of the business of the entity Variable returns

Professional judgment is critical.

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IFRS vs. U.S. GAAP – Key Differences

U.S. GAAP IFRS

• VIE model- All consolidation decisions must first be evaluated using this model.

• Qualitative model- Criteria for control focuses on the following criteria:

• Power to direct activities of the VIE that most significantly impact the VIE’s economic performance (power criterion)

• Obligation to absorb losses from or right to receive benefits of the VIE that could potentially be significant to the VIE (loss/benefits criterion)

• No VIE model- Focus is on who has control in determining whether parent-subsidiary relationship exists.

• Control Assessment- An investor controls an investee when it has all of the following:

• Power

• Exposure, or rights to variable returns

• Ability to use its power over the investee to affect returns

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IAS 27 scope changed in 2011 to address how individual financial statements should be presented for “Investments in Subsidiaries,” “Joint Ventures” and “Investments in Associates” Use of equity method is no longer an option or not permitted for

these type of investments when preparing individual financial statements.

Cost method is used for accounting purposes Establishes criteria for NOT presenting consolidated F/S

May not present individual F/S if criteria are not met

Overview of IAS 27 Consolidated and Separate Financial Statements (2011)

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Questions?

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Join us for the last IFRS course of the year: Nov. 20: The Impact of IFRS on Income Taxes

Other upcoming webinars: Oct. 29, Nov. 11 & 12: Eye on Washington - Quarterly

Business Tax Update Nov. 13: Revenue Recognition for the Technology Industry Nov. 18 & Dec. 3: Individual Year-End Tax Planning for

2014 and Beyond We want your input on IFRS topics to consider for

2015!

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