The relevant activities of an investee – Don’t get fooled, relevant activities for financial reporting and consolidation purposes does not mean that the activities of an investee are the same as the activities of other entities (parent entity and subsidiary entities) consolidated into that one group. No…….. it is about whether the activities significantly affect the investee’s returns. In other words can the parent entity earn from the relevant activities.
Let that be clear!!
IFRS 10 introduces the concept of ‘relevant activities’. This is a critical part of the model. This concept clarifies which aspects of an investee’s activities must be under the direction of an investor for that investor to have control for consolidation purposes.
Examples of activities that, depending on the circumstances, can be relevant activities include, but are not limited to:
- selling and purchasing of goods or services; The relevant activities of an investee
- managing financial assets during their life (including upon default); The relevant activities of an investee
- selecting, acquiring or disposing of assets; The relevant activities of an investee
- researching and developing new products or processes; and The relevant activities of an investee
- determining a funding structure or obtaining funding. The relevant activities of an investee
Questions sometimes arise as to whether an investee whose activities are largely pre-determined (such as some special purpose and structured entities) really has any relevant activities. In general, practice and theory show it is very rare (although not impossible) that an investee has no relevant activities at all.
Illustration of relevant activities for traditional business structures: The relevant activities of an investee
For many investees, returns depend on a wide range of financial and operating activities. Most entities with traditional ownership and governance structures that operate a business are in this category.
In such cases it is not normally necessary to identify the relevant activities in detail. This is because directing the investee’s financial and operating policies (either directly or by appointing the majority of the Board of Directors or other senior management body) encompasses all or most of the underlying activities – and therefore confers power.
However, a more specific and detailed analysis of relevant activities is required in less straightforward situations. This will often be the case for special purpose or structured entities. The example illustrates one such situation: The relevant activities of an investee
Specific relevant activity
Bank A establishes Entity B – a limited life entity with a narrow and well-defined purpose to acquire a portfolio of Bank A’s originated mortgage loans. Entity B funds the purchase by issuing loan notes to various third party investors. Once these initial transactions have been completed, Entity B will not undertake any further investing or financing activities. The only continuing activities relate to:
The set-up activities that occurred in the past are not directly relevant since no further decisions are be taken about them. However, in assessing Entity B’s purpose and design, Bank A should consider its involvement and decisions made at inception. This may indicate Bank had the opportunity to obtain rights that confer power, such as rights to manage the loans (including on default).
In this case, Entity B’s relevant activity is likely to be managing the loans. Bank A should therefore consider:
Some investees are structured such that two or more investors have the current ability to direct relevant activities but those activities occur at different times. In this situation the investors again determine which investor is able to direct the activities that most significantly affect the returns. This assessment is re-evaluated if relevant facts or circumstances change. The example illustrates two situations in which different relevant activities are directed by different investors: The relevant activities of an investee
An entity with two investors (A and B) is designed to research, develop, and produce a new drug. In this entity, Investor A will make the significant decisions until a new drug candidate receives regulatory approval, and Investor B will make all decisions on manufacturing, marketing, and distribution of that drug. The relevant activities of an investee
Analysis: The relevant activities of an investee
The production and sales period may be expected to be longer than the research phase of the entity, which could be an indicator that the manufacturing, marketing, and distribution activities would have a more significant effect on the investee’s returns over the life of the entity. However, significant uncertainty about the ultimate outcome of the research might indicate that the research activities are more significant to the investee’s returns until that uncertainty is reduced or eliminated.
Over time, the investors would need to reconsider this assessment as the manufacturing and marketing activities become more significant. Once regulatory approval is obtained (and no further drugs are developed) then there are no further activities or decisions associated with this phase. The only activities then relate to manufacturing and marketing activities so these must now be the relevant activities.
In this type of situation a change of control (from one investor to another) is possible, following reassessment of the investee’s relevant activities. This is consistent with IFRS 10’s continuous assessment requirement. The ‘relevant activities’ of an investee
Scenario 2: Construction of a facility
In contrast to the research and development example, consider an entity designed to construct and operate a facility. For this entity, Investor A has the ability to make the significant decisions only during the construction of the entity’s operating facility; thereafter, Investor B manages all operating activities of the entity. Over the expected life of the entity, the operating period is expected to be significantly longer than the initial construction period. In addition, there may be little uncertainty about the entity’s ability to complete the construction and begin operations.
Analysis: The relevant activities of an investee
The operating activities of the entity may be determined to have the most significant impact on the investee’s returns over the life of the entity, even during the construction period. If so, Investor B has power from the outset. The ‘relevant activities’ of an investee
Relevant activities can include future activities, and are not necessarily limited to current activities. However, once a one-off activity (such as the construction phase in this example) has been completed it can no longer be a relevant activity. The ‘relevant activities’ of an investee
See also: The IFRS Foundation