This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board in March, 2009:
Dear Sir,
Exposure Draft ED10 Consolidated Financial Statements
We are pleased to comment on the above Exposure Draft, on behalf of BDO International1. Our detailed comments are set out in the attached Appendix.
We are supportive of the IASB in the action it has taken as a result of the global financial crisis, including the consolidations project, and welcome the enhanced clarity of approach that will result from the elimination of certain inconsistencies between IAS 27 and SIC-12. However, we do have a number of concerns, certain of which we believe need to be addressed before the new standard is issued in final form.
Determination of control
Our principal concern is the basis on which an entity is considered to control another and the extent to which this is operational (that is, the extent to which its application will result in the appropriate boundary being set for the point at which an entity should be consolidated). Although the concept of risk and rewards is explicitly rejected in the Basis for Conclusions (BC33), guidance set out in the standard itself appears to view variations in returns as being an important consideration in determining control.
We note the Alternative View (AV9 – AV12), in which a risk and rewards ‘fall back’ test is suggested. We agree with the analysis set out in the Alternative View, but would go further.
We believe that a risk and rewards test would be complementary to the description of control in paragraph 4, and that there should be an explicit requirement to consider both the power to direct activities of another entity to generate returns for the reporting entity, and risk and rewards. The guidance set out in SIC-12 (a risk and rewards model) has been extremely useful in practice, in that it has resulted in the consolidation of entities that would otherwise have (incorrectly) been excluded from a reporting entity’s consolidated financial statements. We have significant concerns that the apparent inconsistency in the draft guidance which seems to require focus on the power to direct another entity’s activities, but then appears implicitly to require consideration of risk and rewards (variation in returns) even though this is rejected elsewhere, will result in lengthy debates in practice about which entities should properly be included in a reporting entity’s consolidated financial statements. We also believe that the draft guidance could give rise to opportunities for a reporting entity to structure a desired accounting result.
Control where an entity owns less than half of the voting rights
While we welcome the proposed clarification that control might exist although an entity does not have a controlling interest and there are no other arrangements which formally give control, it would be helpful for further guidance to be included. This might include consideration of the extent to which the other shareholdings are in fact widely dispersed (are there 2, 5, 10 or 100 other shareholders and what proportions of share capital do they hold?), and consideration should also be required of the extent to which the widely dispersed shareholders are capable of co-operating when exercising their votes (which would be consistent with the ‘power to control’ model).
Structured entities
We believe that when considering whether a structured entity should be consolidated, it should not be subject to tests that are different from other entities. To do so would perpetuate the current inconsistency between IAS 27 and SIC-12. We believe that if, as we have suggested, the Board requires both the control test (as articulated in the draft standard) and a risk and rewards test in all cases, there would be no need for additional, separate guidance. It may be appropriate for the factors set out in paragraph 31 to be moved to the section ‘Assessing control’ and be described as being indicators, the effect of which should be assessed in the determination of control. If they do not apply, then this assessment will not require significant time and effort.
Disclosures
The disclosure requirements in the draft guidance are extensive, in particular for structured entities and, as noted in our detailed comments, we are doubtful that it will always be possible to obtain the required information. It may be helpful for the proposals to be field tested prior to the new standard being finalised.
We hope that our comments and suggestions are helpful. Should you wish to discuss any of the points we have raised please contact either Tracey-Lee Massey at +32 2 778 01 30 or Andrew Buchanan at +44 (0)20 7893 3300.
Yours faithfully,
BDO Global Coordination B.V.
Question 1
Do you think that the proposed control definition could be applied to all entities within the scope of IAS 27 as well as those within the scope of SIC-12? If not, what are the application difficulties?
Response
No.
We assume that the question is intending to ask whether the proposed control definition would be operational in practice and would capture those entities that should be included in an entity’s consolidated financial statements (although we note that this is a different question from that of whether a definition can be applied). In a number of respects, we do not believe that the proposed control definition would achieve this objective. We have outlined a number of concerns below and in our responses to other questions; we believe that the definition as drafted might result in certain entities, in particular structured entities, that should properly be consolidated being excluded.
As a minor point, we note that the proposed control definition appears to place emphasis on one entity controlling another directly. It would be helpful if explicit reference was made to the potential for indirect control (eg a sub – subsidiary). In addition, it is possible within a group that a controlling interest might be held through a number of subsidiaries (which themselves might only have an interest in an associate, or hold a trade investment). The definition might be changed to read:
‘The power of a reporting entity to direct, directly or indirectly through one or more controlled entities, the activities of another entity……..’
Question 2 Is the control principle as articulated in the draft IFRS an appropriate basis for consolidation?ResponseNo. The core principle is based on a definition of control which we believe is flawed. Depending on how control is defined and determined, the core principle might be appropriate as the basis for consolidation.We are supportive of an approach which will eliminate inconsistencies which can arise from the application of IAS 27 and SIC-12. We note that in many cases, the inconsistencies arise principally in determining which entities fall within the scope of IAS 27, and which within the scope of SIC-12 (although differences in the guidance can then result in differences in whether an entity is then consolidated by another).To an extent, the control model set out in the draft standard is consistent with the substance over form principles set out in the Framework (paragraph 35). It is important that entities are (or are not) included within a consolidated group in order that they reflect faithfully the underlying purposes of transactions which have been entered into. The guidance which amplifies the meaning of control to encompass the power to direct the activities of another (whether or not that power is used in practice) removes the focus from legal ownership to a requirement to consider how control is achieved. However, the lack of prescriptive consideration of risks and rewards means that the control model, as drafted, will not capture all entities that should be included by an entity in its consolidated financial statements.It might be considered that, provided all ‘facts and circumstances’ are considered in conjunction with the proposed control definition, an appropriate boundary for entities that should and should not be consolidated would be reached. However, the proposed definition does not achieve this. We have particular concerns about the question of whether all structured entities would be consolidated as appropriate; in particular we do not believe that the proposed definition would necessarily capture those entities that are on so-called ‘autopilot’ as we believe that it would be possible (and straightforward) to structure arrangements in order to avoid consolidation. In this respect, we believe that the proposed definition is a retrograde step from the current IAS 27 / SIC-12 approach.We have included detailed comments on the definition of control in our response to question 3.Question 3 Are the requirements and guidance regarding the assessment of control sufficient to enable the consistent application of the control definition? If not, why not? What additional guidance is needed or what guidance should be removed? ResponseNo.We do not believe that the control definition will be applied consistently in practice. Our most significant concerns are in respect of structured entities, where we believe there will at times be extreme pressure on the part of some entities to exclude certain structured entities from their consolidated group. While the same issues may not arise as frequently in the context of the question of whether certain other entities might be included in the consolidated group, we believe that this highlights a significant deficiency in the proposals.The principal aspect of the draft guidance which we believe will cause difficulties in practice is the link between control and returns. While the draft guidance does cover this at some length, we believe that there are inconsistencies in the approach and a lack of precision in the guidance. In certain respects, the guidance appears to attempt to focus purely on the power to direct the activities of another, rather than looking to the variability of returns (which would arise from a risk and rewards model). Paragraph BC33 notes that the Board: ‘..rejects the risks and rewards model as a basis for consolidation, on the grounds that this model is not conceptually robust.’
However, it is evident from guidance elsewhere in the draft standard that the Board does wish the extent to which an entity might be exposed to variations in return from another to be taken into account (which is a direct link back to risk and rewards arising from such variations). Paragraph 12 of the draft standard notes that:‘When assessing control, a reporting entity shall consider power and returns together, and how a reporting entity can use its power to affect the returns.’
In that context, paragraph BC53 notes that:‘….The Board believes that an entity’s ability to affect the performance of the assets of another entity is correlated with its willingness to be exposed to the variability of returns from its involvement with that other entity. Thus, the Board’s assumption is that the entity that receives the greatest returns from another entity is likely to have the greatest power over that entity.’
We assume that the use of ‘returns’ in the final sentence of BC53 is in the context of both positive and negative returns.We believe that the lack of clarity and the inconsistencies in the guidance as to whether and when botha reporting entity’s power to direct the activities of another entity; and
the exposure of that reporting entity to variations in returns from another entity
should be taken into account will lead to inconsistency in practice, as entities which do (or do not) wish to consolidate another will look to different parts of the guidance in order to support their position. We note, in the Basis for Conclusions covering control of a structured entity, that the Board has some concerns over the application in practice of FIN46R (which looks to variations in returns), in particular its use of ‘bright line’ thresholds. We agree that the use of ‘bright line’ threshold tests is inappropriate as it will lead to structuring opportunities. However, we are also of the view that a test which looks to an entity’s exposure to variability of returns does not need to contain ‘bright line’ thresholds.Question 8 deals with the question of whether there should be a risks and rewards ‘fallback’ test. As noted in our response to that question, we agree that this would be appropriate in the context of the proposals as drafted. However, we believe that the Board should go further, and require explicitly in all cases that the question of whether an entity controls another requires consideration of both:1. whether a reporting entity has the power to direct the activities of another entity in the context of the guidance set out in the draft standard; and
2. the extent to which a reporting entity is exposed to risk and rewards arising from another entity.
We note that the proposed definition of control by a reporting entity over another entity includes a requirement to consider the extent to which the reporting entity’s control over the other entity’s operations will give rise to returns for the reporting entity. This definition indicates (but is not explicit in doing so) that variations in returns need to be taken into account. This implies some form of risk and rewards analysis; however, we are strongly of the view that it is necessary for the new standard to be explicit and clear on this point. Otherwise, as noted above, the guidance will be open to inconsistent interpretation. The impression given by the draft guidance is that the Board wished to focus purely on control of one entity over another entity’s operations, but consistently found itself drawn back to consideration of risk and rewards.We believe that the definition of control as articulated in the draft standard and a risk and rewards analysis are complementary and not contradictory. This is because economically the entity which is most at risk of benefiting or losing as a result of the gains and losses which are likely to be generated in practice by another entity would be expected to be the entity which controls the operations of that other entity which will give rise to those gains and losses (the Board acknowledges this at paragraph BC53). This control might arise from the manner in which an entity with predetermined activities is set up, or from control over the ongoing operations of an entity. In consequence, we believe that a risk and rewards test could easily (and should) be linked explicitly to the question of control, and not linked implicitly as would appear to be the case in parts of the draft standard.We note that the guidance currently set out in SIC-12 (a risk and rewards model) is extremely useful, in that it frequently captures arrangements which would otherwise, inappropriately, be excluded from an entity’s consolidated financial statements. It would be a significantly retrograde step for this guidance to be eliminated, or for there to be a reduction in the extent to which it is required to be considered.While we agree that it will normally be the case that exposure to risks and rewards will flow from control over another entity, the structure of certain arrangements is such that the controlling party will not always immediately be apparent. We note that it can be particularly difficult to determine which entity has the power to control another (in accordance with the draft guidance) where that power is dispersed among a number of entities. Structuring of arrangements can also result in the true controlling party being disguised. In such cases, the application of a risks and rewards test will be important in identifying the controlling entity, and hence the entity which should consolidate.There is then the question of how the two tests might be structured. We suggest the following:1. the power of one entity to direct the activities of another, in the context of the guidance set out in the draft standard, is considered. If the application of this guidance indicates that control exists, there is an initial presumption that the entity is consolidated subject to the result of the risk and rewards test. The guidance would need to make it clear that this test may not be conclusive, in that either the controlling party may not easily be identifiable or, in certain cases, this test may identify the wrong entity as the controlling entity (this may arise in the context of carefully structured entities).
2. a risk and rewards test is then applied to determine whether: a. the entity that has been identified as controlling another has exposure to risk and rewards that are consistent with control, or whether these in fact are attributable to a different entity; or
b. where it has been difficult to identify the controlling entity, which entity has exposure to risk and rewards that are consistent with control.
The risk and rewards test should include consideration of which entity has the greatest exposure to variations in returns and which entity has residual risk. The analysis of exposure to variations in returns would need to require consideration of the entity’s position in comparison to other individuals or entities from both an individual and collective basis (a collective basis might be necessary when considering agency relationships – see example below).
The approach suggested deliberately leaves the analysis open to some interpretation (for example, it sets a minimum risk and rewards test that is to be applied but does not restrict the extent to which the analysis could be extended). It also excludes ‘bright line’ thresholds. This is in order that complex group structures, and arrangements that can be deliberately structured to achieve a particular result, are as far as possible eliminated.The risk and rewards test would therefore be capable of overriding the first, ‘power to direct’ test. This would be consistent with the approach required by the draft standard for agency relationships. For example, a fund manager might have wide discretion over the activities of a fund and have remuneration which is linked directly to the performance of that fund (say, 5% of the fund’s performance). However, the risk and rewards attaching to the investment returns to be derived from that fund are principally for the investors (on a collective basis) even though all the investors have an individual interest in the fund of less than 3%. In this case, the fund manager would have the power to direct the activities of the fund to generate returns for itself, but would not consolidate the fund as the fund manager would fail the risk and rewards test.Other detailed comments in respect of question 3 are as follows:We note that paragraph 16 states that:‘if the reporting entity ceases to receive returns from its involvement with that entity, it does not control that entity.’
The draft guidance indicates that for a reporting entity to control another entity it must have the power to direct the activities of that entity to generate a return (whether positive or negative). This might be taken to imply that in the event that the entity under consideration breaks even, it would no longer be consolidated, which may often be inappropriate. It is necessary to require the analysis to look to both the current and future reporting periods. In some cases, an entity may have operations in a country where there are certain political or other restrictions which limit the extent to which the entity might be able to derive returns from those operations. Nevertheless, the entity continues to invest in and direct those operations as it believes that the restrictions are likely to be lifted at some point in the future. It would appear inappropriate for such entities to be excluded from consolidation.A similar issue arises in respect of entities controlled within a group where their activities have become dormant – the guidance would suggest that a dormant subsidiary should be excluded from consolidation, which we believe is inappropriate. We suggest that the guidance is clarified. Both paragraph 22 and BC71 refer to an entity’s ability to determine the ‘strategic operating and financial policies’ of another as being the factor which determines control. This would appear contrary to the principle as articulated in the draft standard, and is inconsistent with paragraph B9 which identifies this factor as an indicator, not a determinant, of control. We suggest that the wording in paragraph 22 is amended.We understand the reasons why the Board might wish to provide clarity that so-called ‘defacto control’ might exist (ie one entity controls another even though it does not have a controlling shareholder interest, and there are no other arrangements which formally give it control). However, the guidance in paragraph 28 would appear to bring the potential for an entity (say, with a 45% dominant shareholder where the remaining 55% holding is widely dispersed) to be consolidated or deconsolidated each time a strategic or operating decision is made, depending on the extent to which the widely dispersed shareholders agree with the dominant shareholder (and hence choose whether to organise their votes in order to defeat a particular proposal). In addition, the guidance as drafted does not extend to consideration of whether the widely dispersed shareholders are capable of combining their votes (and therefore have the power to combine their voting power to defeat the dominant shareholder).We also note that there is some inconsistency between the guidance in paragraph 28 which requires the application of judgement in determining whether a widely dispersed majority shareholding precludes a dominant shareholder from having control, and the presumed control of a majority but passive shareholder in paragraph 8.We consider that this may give rise to confusion in application, and diversity in practice. This might be reduced if a further sentence were to be added to the existing guidance at paragraph 28:‘……more voting power than the reporting entity. In determining whether this is the case, the dominant shareholder will consider whether the other shareholders are capable of organising their votes in such a way that they actively co-operate when they exercise their votes so as to have more voting power than the reporting entity and, if so, the extent to which that organisation might occur in practice.’
Should the conclusion reached by the dominant shareholder subsequently be proved incorrect, consolidation (or deconsolidation) would then be required from the point at which that additional evidence became available.Question 4 Do you agree with the Board’s proposals regarding options and convertible instruments when assessing control of an entity? If not, please describe in what situations, if any, you think that options or convertible instruments would give the option holder the power to direct the activities of an entity.ResponseYes, in principle we agree with the proposals.We note that the current provisions of IAS 27 in respect of potential voting rights, while clear, are unsatisfactory in that they permit particular accounting approaches to be chosen depending on the legal form of contractual arrangements. We therefore support the Board in a move away from the existing approach.The wording of paragraph B13 suggests that the criteria set out in subparagraphs a), b) and c) are an exhaustive list, and that the application is binary (ie if one of these criteria is met then control exists). We suggest that it would be more appropriate for these criteria to be badged as indicators or examples so that the list is not exhaustive, with these indicators giving rise to a rebuttable presumption of control.If this approach is taken, the introductory wording of paragraph B13 should be redrafted. We suggest that this might read:‘When assessing control, a reporting entity considers the effect of any instruments that could enable the reporting entity to obtain additional voting rights, including options or convertible instruments, whether or not these are currently exercisable. The effects of those instruments are taken into account in the determination of whether the reporting entity has control over another, taken in conjunction with all other facts and circumstances. The following are examples of indicators of control, which give rise to a rebuttable presumption of control, where the indicators result from instruments held by a reporting entity that could enable it to obtain additional voting rights:
In order that this guidance is linked clearly to the definition of control, we suggest that sub-paragraph c) is extended to read:‘…..reporting entity to have the power to direct the activities of the entity so as to generate returns.’
Question 5 Do you agree with the Board’s proposals for situations in which a party holds voting rights both directly and on behalf of other parties as an agent? If not, please describe the circumstances in which the proposals would lead to an inappropriate consolidation outcome.Yes.We agree with the proposals, and note that it is helpful for guidance to be included, as this represents a substantial gap in the guidance currently provided in IAS 27 and SIC-12. We believe that it would be helpful for the guidance to be clarified further as noted below.We note that there is a reference in paragraph B8 to an agent being paid a non refundable fee in return for services provided, with this being used to demonstrate that there is a difference between an agency arrangement and a shareholder’s exposure to reductions in the value of the entity in which the shareholder has invested. However, we note that a shareholder who has received a dividend is unlikely to be asked to return that dividend in the event that the trading performance and financial position of the investee entity deteriorates. We suggest that this paragraph is revised.Although paragraph B4 provides helpful guidance where there are removal rights, this guidance is not linked to the guidance in paragraph 28 of the draft standard. It would be helpful for consideration to be given to circumstances where removal rights are widely dispersed through a large number of principals to ensure consistency of approach. Although guidance has been included in paragraphs B5 – B8 for circumstances where an entity acts as agent for another, this guidance does not extend to cover circumstances where an entity has a dual role. This might arise where an entity provides investment management services and, in addition to providing investment management services, holds an interest in the investment fund. We suggest that the conclusions set out in paragraph BC95 are incorporated into the standard itself.Question 6 Do you agree with the definition of a structured entity in paragraph 30 of the draft IFRS? If not, how would you describe or define such an entity?ResponseNo.While we understand why the Board has sought to define a structured entity in the manner set out in the ED, we believe that it would be helpful to enhance the guidance in order to clarify what is believed to be a structured entity. We note from paragraph BC99 that:‘The type of entity that the Board envisages being characterised as a structured entity is unlikely to differ significantly from an entity that SIC-12 describes as a special purpose entity.’
The Basis for Conclusions then goes on to describe aspects of SIC-12 that the Board felt needed to be improved or clarified. While it may be that improvements are appropriate, it would also be helpful for certain of the guidance in SIC-12 to be replicated in order to clarify what the new standard means by the term ‘structured entity’. As drafted, the guidance is not sufficiently precise.The existing guidance in the ED might be expanded to read:30. A structured entity is an entity whose activities are restricted to the extent that those activities are not directed as described in paragraphs 23-29. A structured entity might take a variety of forms, including a company, corporation, trust, partnership or unincorporated entity. Structured entities are often created with legal arrangements that impose strict and sometimes permanent limits on the decision-making powers of their governing board, trustee or management over the operations of the structured entity.
31. An interest in a structured entity may, for example, take the form of a debt instrument, and equity instrument, a participation right, a residual interest or a lease. Some interests may simply provide the holder with a fixed or stated rate of return, while others give the holder rights or other access to returns of the structured entity. In most cases, the entity which either created the structured entity, or on whose behalf the structured entity was created, retains a significant interest in those returns which may be subject to variation in practice which arise from the structured entity’s activities even though it may own little or none of the structured entity’s equity.
Question 7 Are the requirements and guidance regarding the assessment of control of a structured entity in paragraphs 30–38 of the draft IFRS sufficient to enable consistent application of the control definition? If not, why not? What additional guidance is needed? ResponseNo.We assume that the question is whether the guidance would result in the appropriate consolidation (or not) of structured entities. While there is some focus on returns arising from structured entities, we do not believe that it is sufficiently robust to avoid the risk of arrangements being structured to achieve a particular accounting result. We believe that our suggested approach, of applying both a control test (as defined in the draft standard) and a risk and rewards test would be likely to deal with the deficiencies of the guidance as drafted.As noted above, we have found the guidance in SIC-12 extremely useful in practice, in that it frequently captures arrangements which would otherwise, inappropriately, be excluded from an entity’s consolidated financial statements. We consider that the guidance at paragraph 37 for related arrangements might be clarified further, by extending the first sentence to read:‘…by means of related arrangements (see paragraphs 17 and 18), where the presence of such related arrangements may result in the entity being exposed to a variability of returns that are potentially significant in comparison with the total variability of returns arising from the structured entity, and the reporting entity’s exposure to that variability is greater than that of any other party.’Question 8 Should the IFRS on consolidated financial statements include a risk and rewards ‘fall back’ test? If so, what level of variability of returns should be the basis for the test and why? Please state how you would calculate the variability of returns and why you believe it is appropriate to have an exception to the principle that consolidation is on the basis of control.ResponseOn the basis of the guidance as drafted, we believe that a risk and rewards fall back test is essential. However, as noted above, we believe that all assessments of control should include a risk and rewards test. We believe that this approach would minimise the risk of arrangements being capable of being structured to achieve a particular accounting result, and would assist in eliminating inconsistency in the application of the standard.If the Board considers that a mandatory risk and rewards test should not be included in the final standard, then we believe that it is of critical importance for a risk and rewards ‘fall back’ test to be included. We agree with the Alternative View articulated at paragraphs AV9 – AV12.We agree that there may be instances were it will be extremely difficult (if not impossible) correctly to determine which entity has the power to direct the activities of a structured entity. However, we do not agree that the combination of the guidance in the draft standard would be undermined by the addition of a risk and rewards test, nor do we believe that the two approaches (of control – as set out in the draft standard – and risk and rewards) are inconsistent. Paragraph 33 of the draft standard appears to be attempting to reconcile the control (as defined) and risk and rewards models, as it acknowledges that:‘…..the more a reporting entity is exposed to the variability of returns from its involvement with an entity, the more power the reporting entity is likely to have to direct the activities of that entity that cause the returns to vary.’
This view is repeated in paragraph 35, which states that:‘In this example, the party with the power to direct how any defaulting receivables are managed, and in having that power can affect its returns from its involvement with that entity, controls that entity.’
It would therefore appear that, although not stated in the draft standard, the Board is implicitly requiring consideration of both control, and a risk and rewards analysis. This introduces inconsistency into the guidance in that the Board appears first to indicate that only control (as defined) is relevant, but then adds – without any clear guidance – consideration of risk and rewards. If issued in this form, we believe that this will serve only to cause confusion about which entities should be included within a consolidated group, give rise to inconsistency of approach, and assist entities which do not wish to consolidate another entity in the ability to structure arrangements to achieve that accounting result.The Board has requested suggestions of how the variability of returns should be calculated. We believe that it would be inappropriate to set precise requirements, as these would inevitably give rise to ‘bright line’ arguments (eg if the test was which entity had the greatest exposure to variation in residual returns), resulting in structuring to achieve a desired accounting result. In consequence, we would suggest a number of key indicators which should be considered in combination.We believe that the standard should set minimum tests which should be applied, but should not restrict the extent to which the analysis should be extended. Consequently, there should be a requirement for the risks and rewards test to include at a minimum consideration of: which entity has the greatest exposure to variations in returns; and
which entity has residual risk.
Where, following the application of these tests, there is any doubt about whether an entity should be consolidated by another, the standard should mandate that further analysis be carried out to assist in determining the appropriate approach.
While this might lead to a small degree of inconsistency at the edges (as a degree of judgement would need to be applied), we believe that these tests would result in an appropriate accounting approach being adopted in the vast majority of cases where, under the proposals in the ED, entities that should be consolidated by a reporting entity could easily be excluded through careful structuring of contractual conditions and concentration on certain aspects of the guidance.
Question 9
Do the proposed disclosure requirements described in paragraph 23 provide decision-useful information? Please identify any disclosure requirements that you think should be removed from, or added to, the draft IFRS.
Response
For entities other than structured entities that are excluded from consolidation, we consider that the disclosure requirements set out in paragraph 48 – 50 are appropriate.
We acknowledge the focus in recent months on structured entities, in particular those which were not previously consolidated but which have now been consolidated by certain reporting entities, and are sympathetic to the Board’s concern that full and comprehensive disclosures are made in future where structured entities are not consolidated. However, we believe that there is a danger that the extent of disclosure will be so great that the most important aspects of a reporting entity’s exposure to one or more structured entities will be obscured. While none of the disclosures can be described as being unnecessary (as they may or may not be applicable, depending on the precise contractual arrangements), it would be helpful for the standard to emphasis that the disclosure should concentrate on key aspects which may give rise to subsequent exposure.
An additional disclosure that would be helpful is, where it is considered that a reporting entity does not control one or more structured entities where it has involvement, an explanation is given of why this is the case.
Question 10
Do you think that reporting entities will, or should, have available the information to meet the disclosure requirements? Please identify those requirements with which you believe it will be difficult for reporting entities to comply, or that are likely to impose significant costs on reporting entities.
We note that extensive disclosures are required for structured entities where an entity has involvement with, but does not control, the structured entity. While we believe that it is appropriate for clear and transparent disclosures to be made such that the reader of financial statements can understand clearly the extent of unconsolidated structured entities, we are concerned that it will not be possible to obtain certain of the information requested in paragraph B44 – B47. In particular, paragraph B44 c) requires the disclosure of ‘the reported amount of assets held by structured entities….measured at the date of the reporting entity’s consolidated financial statements’. If the reporting entity does not control the structured entity, it may not be able to obtain this information at its reporting date.
We also note that an entity which have involvement with a structured entity may not prepare consolidated financial statements, and suggest that the drafting of the guidance is amended.
Question 11
(a) Do you think that reputational risk is an appropriate basis for consolidation? If so, please describe how it meets the definition of control and how such a basis of consolidation might work in practice.
(b) Do you think that the proposed disclosures in paragraph B47 are sufficient? If not, how should they be enhanced?
Response
We do not consider that reputational risk by itself is an appropriate basis for consolidation. However, it might be appropriate to require further analysis of an entity’s interest in another if the arrangements indicate the existence of reputational risk, as this might suggest the existence of other factors which would give rise to control.
We note that consideration of reputational risk is similar to the issue of so-called ‘economic compulsion’ that the Board has previously discussed in the context of IAS 32 and the classification of certain financial instruments as debt or equity.
We consider that the proposed disclosures in paragraph B47 are sufficient.
Question 12
Do you think that the Board should consider the definition of significant influence and the use of the equity method with a view to developing proposals as part of a separate project that might address the concerns raised relating to IAS 28?
Response
While we agree that the Board might revisit significant influence and the use of the equity method, we do not consider this sufficiently important to require a separate project in the short term.
1BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country.
The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the International Executive Office is located.
Exposure Draft - Consolidated Financial Statements, Comments due 20 March 2009:
ED 10 Consolidated Financial Statements.pdf