It is easy to assume that control changes when shares change hands.
A parent sells part of a subsidiary. Another investor buys a larger stake. Voting percentages move and the accounting follows.
IFRS 10 is more complicated than that.
Control depends on rights and decision-making power, not simply the percentage printed beside an investor’s name on a share register. A company can therefore own exactly the same number of shares before and after an event and still need to reconsider whether it controls the investee.
That issue has moved back into focus following recent consideration by the IFRS Interpretations Committee.
The question was whether an investor should reassess control when an investee’s governing document is amended in a way that could change its relevant activities and the rights held by different parties.
The answer matters because consolidation is one of the most significant accounting consequences a group can face.
Candidates working with an ACCA SBR tutor should therefore understand the principle rather than relying on a simple ownership percentage test.
Control is not the same thing as ownership
IFRS 10 bases consolidation on control.
An investor controls an investee when three elements are present.
The investor has power over the investee.
It has exposure, or rights, to variable returns from its involvement.
It also has the ability to use its power to affect those returns.
All three matter.
An investor might own a substantial percentage of shares but lack the current ability to direct the activities that significantly affect returns.
Another investor might hold fewer shares but possess contractual rights that give it decisive power.
That is why ownership percentage is evidence rather than the complete answer.
The first question should always be who can actually direct the relevant activities.
Relevant activities sit at the centre of the assessment
Relevant activities are the activities that significantly affect the investee’s returns.
These could include buying and selling goods, managing financial assets, developing products, making investment decisions, setting operating policies or appointing key management.
Different businesses have different relevant activities.
The important decisions in a property investment vehicle may be very different from those in a technology company.
Once the relevant activities have been identified, the accountant needs to determine who has the current ability to direct them.
That requires looking at rights.
Voting rights may provide power.
Contractual rights may provide power.
Rights to appoint or remove key decision makers can be important.
The governing documents of the entity may determine which decisions require approval and which parties can make them.
This is why a change to those documents can matter even when nobody buys or sells a share.
The recent IFRS 10 question is deceptively simple
The fact pattern considered by the Interpretations Committee involved an investor that had been involved in setting the purpose and design of an investee when it was created.
At that time, the investor concluded that it controlled the entity.
Later, the investee’s governing document was amended.
The changes could affect both the relevant activities and the rights of the investor and other parties relating to those activities.
The question was whether the investor had to reassess control.
The conclusion was that, in this type of situation, control should be reassessed.
That does not mean the investor automatically loses control.
It means that the original conclusion cannot simply be carried forward without reconsideration.
Something relevant has changed.
The investor needs to ask whether the three elements of control are still present.
A control assessment is not permanent
This is the wider lesson.
Control is not decided once when an investment is acquired and then left untouched indefinitely.
IFRS 10 requires an investor to consider all facts and circumstances and reassess control when those facts and circumstances indicate that one or more elements of control may have changed.
That could happen even though the percentage ownership remains exactly the same.
Suppose an investor owns 60 per cent of an entity.
At formation, it can appoint most of the board and make the decisions affecting the entity’s main operations.
The governing agreement is later amended.
Major operating decisions now require approval from another shareholder.
Depending on the precise rights created, the original investor may no longer possess unilateral power over the relevant activities.
Its 60 per cent holding has not moved.
Its rights have.
That is the accounting issue.
Governing documents can be commercially important
Legal documents are sometimes treated as background information in financial reporting questions.
They should not be.
Articles of association, shareholder agreements, partnership agreements and other governing documents can establish how decisions are made.
They may determine:
- who appoints directors
- which decisions need majority approval
- which matters require unanimous consent
- whether another party has veto rights
- who controls budgets and strategic plans
- who can direct significant operating decisions
These provisions can alter the control assessment dramatically.
That is why accounting teams involved with complex group structures cannot rely only on organisation charts.
The legal and contractual arrangements matter.
Not every veto right removes control
Care is needed here.
The existence of a veto does not automatically mean another party shares control.
Some rights are protective.
Protective rights are designed to protect the interests of the holder without giving that party power over the investee.
For example, a lender may have rights that restrict unusually risky activity.
A minority investor may need to approve fundamental changes such as winding up the entity.
Those rights may protect the holder without giving it the current ability to direct the activities that significantly affect returns.
Substantive rights are different.
If another party gains genuine decision-making rights over relevant activities, the control conclusion may change.
Candidates therefore need to analyse what the right actually does.
The label “veto” is not enough.
Purpose and design still matter
IFRS 10 also requires consideration of the purpose and design of the investee.
This can be particularly important where voting rights do not provide a complete picture of power.
Some entities are designed so that important decisions are predetermined.
Others may have narrow objectives or contractual arrangements that allocate decision-making rights in unusual ways.
Understanding why the entity exists can help identify its relevant activities and the parties capable of directing them.
This also explains why an amendment to the governing structure can be so important.
If the entity was originally designed around one decision-making arrangement and that arrangement changes, the original control assessment may no longer reflect reality.
The accountant cannot simply say:
“We controlled it when it was created, so we still control it.”
The current facts matter.
Control can also change because another party gains rights
The investor itself does not always have to lose a right directly.
Another party may gain rights that change the balance of power.
Imagine an investor controls an entity because it has the unilateral ability to approve significant operating decisions.
The shareholders later amend their agreement so that those decisions require the consent of a second investor.
The first investor may still retain all its original shares.
It may even retain most of its original rights.
However, the new requirement for another party’s consent could mean it no longer has the current ability to direct the relevant activities alone.
Whether control has actually been lost depends on the exact terms.
But the change clearly requires reassessment.
That distinction is important.
A triggering event creates the need to reconsider control.
It does not predetermine the result.
Losing control has major accounting consequences
This is not a technical classification with little financial effect.
If a parent loses control of a subsidiary, consolidation stops.
The parent derecognises the subsidiary’s assets and liabilities from the consolidated financial statements.
Any non-controlling interests relating to the former subsidiary are removed.
The parent recognises consideration received where relevant and measures any retained investment in accordance with the applicable accounting requirements.
Amounts previously recognised in other comprehensive income may also need to be treated in accordance with the relevant standards.
A gain or loss on loss of control can arise.
The effect on the group accounts can therefore be substantial.
Revenue may fall because the former subsidiary is no longer consolidated line by line.
Assets and liabilities disappear from the consolidated statement of financial position.
The retained investment may instead be accounted for as an associate, joint arrangement or financial asset depending on the remaining relationship.
That is why control must be assessed carefully.
The opposite can happen too
The same principle works in the other direction.
An investor may gain control without acquiring additional shares.
Suppose an investor previously needed another shareholder’s consent to direct relevant activities.
The governing arrangement is changed and the investor now has unilateral decision-making rights.
Its shareholding does not move.
Its power may have changed.
This could create control.
Again, the precise facts matter.
The key idea is that IFRS 10 follows the substance of the decision-making arrangement rather than assuming that control moves only when shares are transferred.
Board appointment rights deserve careful attention
The right to appoint or remove key management can be particularly significant.
Imagine an investor owns 45 per cent of the shares but has the contractual right to appoint most of the board.
If the board directs the activities that significantly affect returns, that appointment right may be important evidence of power.
Now suppose the shareholder agreement changes.
Appointments are shared equally between two investors and strategic decisions require agreement from both sides.
The voting percentage may remain 45 per cent.
The decision-making structure has changed considerably.
An SBR candidate should therefore avoid beginning and ending the analysis with ownership.
Ask who directs the relevant activities after the amendment.
A change in control can expose management bias
Control decisions may also create uncomfortable incentives.
Management may prefer to continue consolidating an entity because consolidation increases reported revenue or assets.
In another situation, management may prefer deconsolidation because the subsidiary carries substantial debt.
That does not mean every judgement is biased.
It does mean the assessment deserves scrutiny where the accounting outcome is significant.
A professional accountant should examine the amended agreements, identify the relevant activities and assess the substantive rights held by each party.
The conclusion should follow the evidence.
It should not follow the accounting result management would prefer.
This creates a strong professional scepticism point in SBR.
Legal advice may be needed but accounting judgement remains
Complex agreements may require legal interpretation.
An accountant may need advice on whether a contractual right is enforceable or what a particular amendment legally permits.
That does not outsource the accounting decision.
Legal advisers can explain the rights.
The finance team still needs to determine what those rights mean under IFRS 10.
Does the right give the investor the current ability to direct relevant activities?
Is the right substantive?
Is another party’s right merely protective?
Do several parties now need to act together?
Those are accounting questions informed by legal facts.
A board-ready recommendation might therefore involve obtaining legal advice while keeping responsibility for the control assessment with management.
Joint control may become the next question
Losing sole control does not necessarily mean the investment falls all the way into IFRS 9.
The amended arrangement might create joint control.
Joint control exists where decisions about the relevant activities require unanimous consent of parties sharing control.
That could bring IFRS 11 into the analysis.
The arrangement would then need to be classified as either a joint operation or joint venture according to the parties’ rights and obligations.
Alternatively, the investor may retain significant influence and account for the investment using IAS 28.
This is why a loss-of-control question often becomes a classification question immediately afterwards.
The accountant needs to ask what relationship remains.
How this could appear in SBR
Imagine a parent owns 65 per cent of a technology subsidiary.
When the subsidiary was created, the parent had the right to appoint four of five directors and approve the operating budget.
A new strategic investor later enters into a revised shareholder agreement.
No shares are transferred by the parent.
However, the agreement changes the board structure so that major product development, financing and budget decisions require the approval of both investors.
Management argues that the subsidiary should continue to be consolidated because the parent still owns 65 per cent.
That answer is too simplistic.
The first question is whether the amended agreement changes the rights relating to relevant activities.
If it does, the parent must reassess control.
The next step is to identify the activities that significantly affect returns and determine whether the parent can still direct them unilaterally.
If both parties must agree, the arrangement may instead involve joint control.
The conclusion should then explain the accounting consequences.
That is much stronger than simply quoting the parent’s ownership percentage.
The timing of the reassessment matters
A change in control affects accounting from the date control changes.
That means finance teams need to identify the effective date of amended rights accurately.
If a revised agreement takes effect halfway through the reporting period, the group cannot simply use the year-end structure for the entire year.
There may be one accounting relationship before the amendment and another afterwards.
This can affect consolidation, profit attribution and disclosures.
The implementation challenge therefore extends beyond deciding whether control exists.
Management also needs evidence showing when the change became effective.
Disclosure becomes important where judgement is significant
Control assessments can involve substantial judgement.
Where management’s conclusion has a material effect on the financial statements, users may need information explaining the judgement.
A company should not leave investors wondering why an entity with an apparently large ownership interest is not consolidated, or why an entity with a smaller holding is.
Useful disclosure should explain the nature of the relationship and the important factors behind the conclusion.
This becomes particularly important after amendments to shareholder agreements or governing documents.
The ownership percentage may appear unchanged from the previous year while the accounting treatment changes completely.
Without explanation, that can be confusing.
Finance teams should monitor contractual changes
One practical lesson from the current IFRS 10 discussion is that control assessment cannot sit only within the year-end accounts process.
Legal teams may renegotiate shareholder agreements.
Corporate development teams may bring in new strategic investors.
Boards may restructure governance.
Lenders may acquire new contractual rights.
These changes need to reach the financial reporting team.
Otherwise, management could continue consolidating an entity using an assessment based on outdated documents.
Businesses with complicated group structures should therefore have controls that identify changes to governing arrangements and trigger an accounting review where necessary.
The question should not be:
“Did we buy or sell any shares?”
It should be:
“Did anything change the rights or decisions that determine control?”
What candidates should remember
The technical lesson is straightforward.
Control under IFRS 10 depends on power, variable returns and the ability to use power to affect those returns.
Ownership percentage can be important, but it does not replace that assessment.
When governing documents, contractual arrangements or decision-making rights change, control may need to be reassessed.
The result may be that control continues.
It may be lost.
It may become joint control.
The investor may retain only significant influence.
The facts decide.
Candidates using a structured ACCA SBR course should therefore practise control questions by identifying relevant activities and rights before jumping to the ownership percentages.
What to do next
When you see a consolidation scenario, do not begin with the percentage.
Begin with power.
Identify the relevant activities.
Identify who can direct them.
Look at voting rights, contractual rights, board appointment rights and the purpose and design of the entity.
Then ask whether anything has changed.
That final question matters because yesterday’s correct control assessment can become today’s wrong answer without a single share being sold.
Control follows rights and decision-making power.
The share register is only part of the story.
