Purpose and design of the investee – When assessing control of an investee, an investor shall consider the purpose and design of the investee in order to identify the relevant activities, how decisions about the relevant activities are made, who has the current ability to direct those activities and who receives returns from those activities.
Proportionate voting rights
When an investee’s purpose and design are considered, it may be clear that an investee is controlled by means of equity instruments that give the holder proportionate voting rights, such as ordinary shares in the investee. In this case, in the absence of any additional arrangements that alter decision-making, the assessment of control focuses on which party, if any, is able to exercise voting rights sufficient to determine the investee’s operating and financing policies (see Voting rights in an investee). In the most straightforward case, the investor that holds a majority of those voting rights, in the absence of any other factors, controls the investee.
To determine whether an investor controls an investee in more complex cases, it may be necessary to consider some or all of the other factors in Assessing de facto control.
Voting rights not the dominant factor
An investee may be designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.
In such cases, an investor’s consideration of the purpose and design of the investee shall also include consideration of the risks to which the investee was designed to be exposed, the risks it was designed to pass on to the parties involved with the investee and whether the investor is exposed to some or all of those risks. Consideration of the risks includes not only the downside risk, but also the potential for upside.
How take into account purpose and design?
As a starting point, the standard recommends that preparers of financial statements should consider the purpose and design of the entity in order to assess how decisions relating to relevant activities are made, who currently has the ability to direct these activities, and who has rights to returns from these activities.
In a situation where voting rights (or similar rights) do not have a significant effect on an entity’s returns (as is generally the case for special purpose entities, in the broad sense), it is all the more important to assess whether the investor was involved when the entity was created.
If the investor was involved in creating the entity, this may indicate that the investor had the opportunity to obtain sufficient rights to gain control of the entity (even if this element is not sufficient in itself for the investor to be deemed to have control of the entity).
The same applies in the case of instruments which include potential voting rights, as taking these into consideration will help to shed light on the interests and objectives of the various parties.
Power over relevant activities
Power is based on an assessment of who directs the relevant activities of an investee, i.e. the activities that most significantly affect the investee’s returns. [IFRS 10 10]
The investor needs to have a variable interest in the investee (see below), but its power does not necessarily need to be conveyed through a variable interest. Power may be derived through a management or servicing agreement, or through other agreements.
The assessment of power over a structured entity includes considering the following factors:
- determining the purpose and design of the investee, including: Purpose and design of the investee
- the risk(s) that the investee was designed to create;
- the risk(s) that the investee was designed to pass on to parties involved with the investee); and
- the investorâ€™s role in the purpose and design of the investee;
- identifying the population of relevant activities; and
- considering evidence that the investor has the practical ability to direct the relevant activities, special relationships, and the size of the investor’s exposure to the variability of returns of the investee (see below). [IFRS 10 B3, IFRS 10 B7 – B8]
See also: The IFRS Foundation