How is the term “control” defined in a business combination? There are two perspectives to the definition of control: one is based on presumption, and the other is based on the business combination’s underlying substance or reality. It is presumed that an entity controls another entity if the formal has more than 50% voting right in the latter. A voting right is a right of a shareholder of a corporation to vote on corporate policy matters, including decisions on the board of directors’ makeup, issuing new securities, initiating corporate actions like mergers or acquisitions, approving dividends, etc. However, this is not often the case when we look at the substance or reality of the arrangement over the legal form. Hence, new evidence has shown that the underlying reality may depict that control does not exist even if an Investor owns more than 50% voting right. The following are the critical criteria to assess whether control exists: 

• If the investor can exercise Power over the Investee.
• If the investor is exposed to variable returns from it’s involvement with the Investee.
• If there is a link that establishes that the investor can use its Power over the Investee in such a manner that affects the amount of returns it gets from the Investee. 

All three criteria must be present to ascertain the presence of control in a business combination. In essence, the entity in which Power lies invariably prepares the group or consolidated account at the end of the reporting period. We can use the family settings to explain this concept. 

Traditionally, one would expect that the man should have control over the family. Sometimes, the economic reality may put the control in the hand of the wife or even the children. In most cases, the person who calls the shot will exercise control over the home’s affairs.

However, in the absence of any information to the contrary, we would assume that having more than 50% voting right sufficiently show that control does exist. The other shareholders with less than 50% voting right are referred to as the Non-Controlling Interest.

There are certain circumstances when two or more entities have existing rights which give them the independent ability to direct the different relevant activities of the Investee. In such a situation, the entity having the current ability to direct the relevant activities that most substantially affect the returns from Investee will be deemed to have control over the Investee. Also, when two entities have equal control over an investee, this gives rise to a joint venture, and it is covered under IFRS 11: Joint Arrangement. 

 The presence of control gives rise to the preparation of the consolidated financial statements. The consolidated financial statements represent the group financial statements as if it is a single economic entity. Hence, the Parent must exclude every form of inter-company transactions such as transfer of assets, inventory or loans from the consolidated account.

There are, however, instances whereby control is established, but the Parent may not prepare consolidated financial statements. 

• If the Parent entity itself has a Parent (i.e. grand Parent) and the Parent’s Parent prepares a group account. In such a situation, a Parent may choose not to prepare a consolidated account. However, the grand Parent’s consolidated account must be in line with the International Financial Reporting Standards. 
• A Parent entity may choose not to prepare a consolidated account if it is not quoted or in the process of being quoted. However, where an entity is quoted, or its securities are listed in the capital market, the company must prepare and present a group account.
• A parent entity may elect not to prepare a group account if it is not required to file returns with a security agency.
•  The Parent is not required to preapre consolidated account if , as of the reporting date, the Parent no longer possesses control over the Investee. This can happen by way of disposal of investment or bankruptcy or court administration of the subsidiary. For example, when the government or a creditor takes over a subsidiary’s operations, control would be lost, and in this situation, the Parent cannot prepare a consolidated account.

Finally, even if a Parent entity meets the conditions not to prepare a consolidated account, it must comply fully with the requirements of IAS 27: Consolidated and Separate Financial Statements. 

Please note that a Parent who is an Investment entity is not required under IFRS 3: Business Combination to prepare a consolidated account. Investment entities include Pension Fund Administrators, Mutual Funds, Hedge Funds, Unit Trust Funds, Exchange Traded Funds etc. Investment entities are characterised as having more than one investment, more than one investor and the investors are not related parties of the entity. IFRS 3 grants this exemption for the following reasons:

• It obtains funds for providing investment management services to one or more investors.
• Its business objective is to invest funds only for returns from capital appreciation, investment income or both for the investors
• It measures and evaluates the performance of all its investments on a fair value basis.

Accounting treatment in the case of loss of control

Generally, control is deemed to be lost when the Parent entity disposes of all or part of its investment in the subsidiary to such an extent that it no longer owns more than 50% voting right in the subsidiary. As I stated earlier, this could also result from court actions instituted against the subsidiary that hampers the Parent’s control over the subsidiary. However, the below accounting treatment is necessary for the event of loss of control. The Parent will:

• De-recognize the assets, liabilities, goodwill and non-controlling interest relating to the Investee from the consolidated financial statements, from the date it ceases to have control over Investee
• Recognise the resulting gain on loss on disposal of interest in Investee in the statement of profit or loss
• Recognise any interest retained investment in the Investee after the disposal in line with IFRS 9: Financial Instruments or IAS 28: Investment in Associates and Joint Ventures.
• Reclassify to statement of profit or loss, any items related to the Investee that are recognised in the other comprehensive income.

Next time, we would dive deep into accounting for goodwill from a business combination and gain on bargain purchase.