Answer – Business Combination and Equity Investments
This is the answer for Quiz – Business Combination and Equity Investments.
For each of the following consider whether there is a controlled entity and if so who should consolidate it.
Scenario 1
A owns 100% of the equity share capital of B, giving it rights to receive dividends that vary with B‘s performance. A holds all the equity voting rights in B. Voting rights are the means by which B‘s management board is appointed.
Answer: A controls B
A has exposure, or rights, to variable returns from its involvement with B in the form of dividends and changes in the value of its investment.
A also has the ability to affect those returns through its power over B. it can use its voting rights to appoint B’s management board which directs B’s relevant activities.
Scenario 2
Both C and D own 50% of the equity share capital of E, giving them rights to receive dividends that vary with E‘s performance. C and D share voting rights equally. C and D make a contractual agreement under which C appoints E‘s management board. The management board directs E‘s relevant activities.
Answer: C controls E
Both C and D have exposure, or rights, to variable returns from their involvement with E in the form of dividends and changes in the value of their investments.
However, as a result of the contractual arrangement permitting C to appoint the management board of E, only C has the power to direct the relevant activities that significantly affect E‘s returns.
Scenario 3
H is a retail company. With support from Bank B, H sets up Special Purpose Entity J. H transfers pools of receivables to J in exchange for cash; receivables transferred must satisfy certain criteria in relation to credit quality. Under this revolving structure, when transferred receivables are settled, further receivables are transferred to J.
J‘s funding comprises interest-bearing debt securities secured on the receivables. There are senior (Tranche 1) securities which are owned by Bank B and other market investors and which give holders priority in the event of default by J. H holds Tranche 2, the junior securities, which are exposed to the majority of expected risks (slow payment, default) relating to the receivables.
H maintains the customer relationships with the counterparties to the receivables who are unaware of the securitisation. H retains responsibility for managing the receivables, including renegotiating terms with counterparties who are experiencing financial difficulties.
A third-party servicer is employed to collect the receivables and pass on the cash to J.
Answer: H controls J.
This scenario involves an entity whose relevant activities are not directed through voting rights. H has exposure, or rights, to variable returns from its involvement with J through its holding of Tranche 2 securities which bear the expected credit risk. it can also use its power to direct the relevant activities which affect the investee’s (J’s) returns.
Relevant activities include determining which receivables are transferred to J and what happens on default of those receivables. H maintains the client relationships and can take action to prevent default through negotiating terms and determining which receivables are transferred to J.
The third-party servicer’s activities are not ‘relevant’ because they do not require decisions that significantly affect J‘s returns. it simply collects and transmits cash.
J is SPE of H. J should be consolidated into H because H still maintains the customer relationships and decision making.
Scenario 4
In 2010, A had a 50% equity interest in B and had key management representation on the board of directors. The remaining 50% of equity interests in B were listed on the KLSE. How should A have treated their investment?
Answer: B is associate of A. Investments in B is accounted for using equity method.
Scenario 5
X holds just 44.6% of Z. Z made a huge loss in FY2016. That lack of a majority has allowed X not to include Z in X’s consolidated financial statements. But in FY2016, Alan, a veteran in X, has been appointed to be President of Z. In this case, should X include the unprofitable firm in its consolidated financial statements?
Answer: According to IFRS 10, an investor can control an investee with less than 50 per cent of the voting rights of the investee. IFRS 10 provides a single consolidation model that identifies control as the basis for consolidation for all types of entities. The key consideration here is whether X influenced Z to appoint Alan (the veteran in X) as the President. If yes, X would seem to fulfil the IFRS definition of control.
Collection of Guides
[pt_view id=”bcd3b2cq2d”]
