Having identified an investee’s relevant activities, the next step is to determine how those activities are directed. IFRS 10 breaks this down into the following two steps (although in practice these steps are normally combined with the identification of relevant activities):
- understanding the decisions about relevant activities [IFRS 10 B12]
- identifying rights that confer ability to direct those decisions [IFRS 10 B14-B17].
IFRS 10 envisages two types of rights that may confer ability to direct these decisions (ie power):
- voting rights granted by equity instruments for example, ordinary shares
- contractual rights [IFRS 10 B16-B17].
The control assessment will typically be more straightforward when power is conferred through voting rights. In most cases involving conventional operating entities and governance structures, power is conferred by voting rights. For investees that would have been considered special purpose entities or structured entities however, power arises from more specific contractual rights.
The diagram below highlights how the direction of relevant activities differs for normal (Non-structured entities) and structured or special purpose entities:
In some cases voting rights might exist but, in practice, confer an ability to direct only administrative-type tasks with little or no effect on returns. The example below illustrates one such situation:
Voting versus contractual rights Directing relevant activities Directing relevant activities Directing relevant activities
Bank A establishes a special purpose vehicle, Entity B, and owns 100% of its shares. Entity B simultaneously enters into a trade receivables factoring agreement with Company C. The agreement sets out the terms on which Entity B will purchase Company C’s receivables, and the terms of financing provided by Bank A for that purpose. The agreement provides that Company C will continue to be responsible for collecting and managing the receivables, including in the event of default. Company C is also required to provide a guarantee that losses on the transferred receivables will not exceed a specified percentage.
Entity B’s articles of association restrict its activities to this specific factoring programme.
The shares held by Bank A confer the general range of voting rights associated with shares but cannot override the restriction on Entity B’s activities, or invalidate the contract with Company C.
What is it?
Although Bank A owns 100% of the shares of Entity B, it is unlikely that the associated voting rights confer the ability to direct the relevant activities. This is due to the combined effect of: