Steven Brice
Steven Brice

IFRS 10 — Consolidation

Why it may cause problems for investment entities.

August 2, 2012
by Steven Brice

FASB and the International Accounting Standards Board have been working on a joint consolidation project for some time now. From the IASB’s perspective, the project has two parts, a general consolidation accounting standard applicable to all entities and a second consolidation standard specifically for investment entities.

FASB is likewise reconsidering its guidance for consolidation of all entities, including entities controlled by voting or similar interests.

The IASB has completed its general consolidation accounting standard IFRS 10—Consolidated Financial Statements, and has started looking at part two of the project, which is the issue of a separate accounting standard Consolidation—Investment Entities. The publication of this accounting standard may cause problems for some entities applying IFRS even in the short term. This is especially so when considering the details of the proposed standard together with the proposals from FASB because to a large extent the boards consider that the concepts are converged even when significant details exist resulting in a GAAP difference.

IFRS 10: Consolidation

IFRS 10 embodies the general principles of consolidation. It requires that an entity control one or more other entities to present consolidated financial statements, and considers a control relationship exists when the investor has all of the following:

  • Power over the investee;
  • Exposure, or rights, to variable returns from its involvement with the investee; and
  • The ability to use its power over the investee to affect the amount of the investor’s returns.

Importantly, IFRS 10 does not refer to “the majority of” in its definition of control. This may be because of its implication that asset managers are in a position of control especially if they have an equity interest in the asset funds they manage. However, before concluding that an asset manager controls a fund, determination needs to be made whether the asset manager holds power over the investee as a principal or simply as an agent.

Careful consideration is therefore required to assess whether an asset manager acts as a principal (therefore needing to consolidate the fund) or as an agent (in which case, it recognizes only its direct interest and its management fee).

The factors that need to be considered include, but are not limited to:

  • Scope of the asset manager’s decision-making authority: Does the asset manager have an unlimited choice of investments or are the choices restricted in some way?
  • Rights held by others: Do the investors have removal rights over the asset manager or are there only protective kick-out rights in relation to breach of contract?
  • Exposure to variability in returns through the remuneration of the asset manager: Is the remuneration of the asset manager linked to portfolio returns or is it a market rate?
  • Variable returns held through other interests: Does the asset manager have an equity holding in the fund?

Therefore, an asset manager who can choose the investment portfolio has the ability to direct the activities of the fund. If that asset manager also has an equity investment in the fund, then the asset manager has the right to variable returns from the performance of the fund. Linking these, the asset manager will have the ability to use its power to affect its own returns and as such key indicators suggest that it may be the principal and therefore be required to consolidate the fund. In IFRS 10, there is a rebuttable presumption that if there is an equity stake of below 20% then this would not be considered to be a “principal” factor for consolidation purposes.

Clearly in the absence of any other guidance, IFRS 10 has some profound implications for asset managers. That other guidance is the proposed Consolidation—Investment Entities accounting standard, details of which are set out below. However, as can be seen from the timeline of application, there appears to be a gap between the effective date of IFRS 10 and when the Consolidation—Investment Entities accounting standard will be available for use.

Consolidation—Investment Entities

Under certain circumstances, the investment entities project permits a consolidation exemption for investment entities.

For the exemption to be applicable, the following strict criteria must be met:

  • The entity’s nature is such that its only substantive activities are investing in multiple entities to achieve capital appreciation, earn investment income, or both.
  • The entity’s business purpose is investing to earn capital appreciation, investment income, or both, and it makes an explicit commitment to investors about this.
  • Investors can own units of investments, such as shares or partnership interests, in the entity.
  • The entity pools the funds it receives from its investors, so that the investors can benefit from professional investment management. The entity has investors that are unrelated to the parent (if any), and in aggregate hold a significant ownership interest in the entity.
  • The entity manages and evaluates the performance of its investments on a fair value basis.
  • The entity provides financial information about its investment activities to its investors.

The exemption from consolidation comes with the stipulation that the entity must be accounted for at fair value. While this is a proposal that the FASB also supports, the difference arises on who may take this exemption.

Under IFRS, only the investment entity may use the fair value exemption. Therefore if the investment entity is controlled by a non-investment entity, consolidation must still be applied at the higher level in the group structure. The FASB proposal is that the fair value exemption can be rolled up through the group structure so that the fund is not consolidated at any level in the group structure.


IFRS 10—Consolidated Financial Statements is effective for accounting periods beginning on or after Jan. 1, 2013. However, European companies may only adopt an accounting standard when the EU endorses it. IFRS 10 is currently scheduled for endorsement in the fourth quarter of 2012, but as awareness of this standard increases and the implications for investment entities become apparent, general opinion is that this standard will not receive EU endorsement this year.

The second part of the consolidation project is Consolidation—Investment Entities. Without this part of the project being developed into an accounting standard and endorsed by the EU, investment companies will be required to use IFRS 10 when it becomes effective. The IASB is targeting the publication of the Consolidation—Investment Entities accounting standard in the second half of this year.

It is generally thought that the EU endorsement of IFRS 10 will be delayed until the accounting standard for consolidation of investment entities is published and debated by the EU, so that they can be endorsed and become effective at the same time. However for those companies applying IFRS that are domiciled in countries outside the EU, there is likely to be a timing difference of effective date.


The existing guidance on consolidation in IFRS is inconsistent and unclear, therefore rationalization of the concepts is welcome news in Europe. However, the mismatch in timing of issuing IFRS 10 and the consolidation for investment entities accounting standard, which is currently only in exposure draft form, has created some consternation. This, along with the seemingly continual “almost the same, but not quite same” as U.S. GAAP, means that Europe is generally in agreement with the consolidation project. That said, there is still considerable disappointment that full convergence on this issue has not been achieved.

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Steven Brice is a technical partner in the financial reporting advisory group for WeiserMazars LLP UK and provides his views on IFRS developments and the proposed creation of the PCSIC.