What are the requirements of IFRS10 for consolidation of financial statements?

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What we’ll be talking about:

  • IFRS10 sets out principles and guidelines for the presentation and preparation of consolidated financial statements
  • While IFRS 10 sets out to clarify the definition of control, the complexity in company structures and agreements still makes it difficult to ascertain whether control exists
  • The growing complexity and internationalisation of companies adds a further challenge to preparing consolidated financial statements, as required under IFRS 10
  • Automation and software uniformity across a group can help minimise the risks and challenges of IFRS 10

IFRS 10 sets out the principles for the presentation and preparation of consolidated financial statements, requiring a parent company to produce a single set of financial statements for all its companies, as a single economic entity. It also sets out the principle of control and how to act on it, and outlines the accounting requirements for the consolidated statement of financial position.

Are you interested in discovering more about financial consolidation and reporting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our CPM software can do for you.

The purpose of consolidated financial statements

Parent companies with multiple subsidiaries and entities must ensure that they present an accurate financial picture of the company to its shareholders and directors. This also means complying with all relevant regulations and requirements for the jurisdictions in which they operate.

However, if the consolidated financial statements included all transactions they would not be accurate. This is mainly because of intercompany transactions, which involve the company buying from and selling to itself via its separate entities, rather than a true picture of the parent company and its current financial health. These intercompany transactions must therefore be identified, matched, and eliminated so they do not show up on the consolidated financial statements.

IFRS 10: When are consolidated financial statements required?

Consolidated financial statements are required when one company – the parent – has control of one other or more companies. In its simplest terms, the controlling company is one which owns more than 50% of the voting stock of a second company. This includes joint ventures, associate companies, and subsidiaries.

However, if that control is only temporary – if the company is about to go into administration, for example – consolidated accounts are not required.

Requirements of IFRS 10 for the consolidation of financial statements: a summary

All accounting professionals involved in the consolidation procedure should have understand the following elements of IFRS 10:

1. Objective

The objective of IFRS 10 is to establish consistent principles for the presentation and preparation of consolidated financial statements. To meet this objective, it:

  • Requires a parent entity (an entity that controls one or more other entities) to present consolidated financial statements
  • Defines the principle of control, and establishes control as the basis for consolidation
  • Sets out how to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee
  • Sets out the accounting requirements for the preparation of consolidated financial statements
  • Defines an investment entity and sets out an exception to consolidating particular subsidiaries of an investment entity.

2. Scope and exemptions

However, under IFRS standards, not all parent companies need to prepare consolidated financial statements. According to Paragraph 4 of IFRS 10, these exemption criteria are:

  • The parent company is a wholly owned subsidiary or is a partially owned subsidiary of another entity and its other owners, including those not entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements
  • The parent company’s debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets
  • The parent company did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market
  • The ultimate or any intermediate parent of the parent produces financial statements available for public use that comply with IFRSs, in which subsidiaries are consolidated or are measured at fair value through profit and loss in accordance with IFRS 10.

Long-term employment benefit plans are also exempt, as are entities which are defined as ‘investment’ entities. This could apply to certain mutual or investment funds.

3. Control

Under IFRS 10, the parent company must be very clear about whether it has ‘control’ of the subsidiary, defined as:

  • Power over the investee: the investor has existing rights that give it the ability to direct the relevant activities (the activities that significantly affect the investee's returns)
  • Exposure, or rights, to variable returns from its involvement with the investee
  • The ability to use its power over the investee to affect the amount of the investor's returns.

If these three elements are present, then the parent company is considered to control the subsidiary. It must therefore prepare consolidated financial statements unless otherwise exempt.

4. Control in application

Applying the definition of control can be complex. The standard therefore gives additional practical guidance and consideration on how the different elements of control interact with company activities, including:

  • The purpose and design of the investee
  • An investee’s relevant activities – what are they?
  • Do the rights of the investor give it the current ability to direct the relevant activities?
  • Is the investor exposed to or have rights over variable returns?

Further complications over control can include agency relationships potential voting rights, control without majority of voting and control over structured entities. IFRS 10 includes guidance on all these aspects of control.

5. Preparation of consolidated financial statements

IFRS 10 lays out best practice in preparation of consolidated financial statements. The framework for this is:

  • Intracompany transactions and investments from the parents must be identified and eliminated from the consolidated financial statement
  • Accounting policies should be consistent and clear across the group in order to reduce the risk of error
  • Financial information upon which the consolidated financial statements are based must have the same reporting date
  • Non-controlling interests must be correctly allocated their comprehensive income and equity
  • Changes in ownership interests without loss of control must be accounted for, as must losing control of a subsidiary.

6. Effective dates and transitions

The International Financial Reporting Standards board created IFRS10 in 2011 and began implementing it for accounting periods beginning 1 January 2013, superseding IAS 27. Companies were allowed to adopt IFRS10 early if they also adopted IFRS 11 and 12 in the consolidation package.

This early adoption also came with certain transitional provisions: notably, where it would be impractical for a company to carry out a fully retrospective consolidation or de-consolidation.

7. Disclosures

There are no disclosure requirements under IFRS10. However, a company which applies IFRS10 must also adopt IFRS 12, which does require disclosures on information that enables users of financial statements to evaluate:

  • The nature of, and risks associated with, the company’s interests in other entities
  • The effects of those interests on its financial position, financial performance, and cash flows.

The challenges of IFRS 10

While IFRS10 was designed to give clear guidance around the issue of control, this guidance can falter in the face of complex agreements between companies, shareholders, stakeholders, and investors.

Making the ‘control call’ still requires judgement on the part of the parent company, which may or may not be correct: grey areas persist. It is therefore key to carry out a careful analysis if that question arises, and ensure that decision-makers fully understand the purpose and design of its subsidiary and the activities it carries out.

It can also be challenging to prepare consolidated financial statements, as required by IFRS 10. Accounting teams must make sure they accurately identify, match, and eliminate all intercompany transactions – which can number in the millions. This becomes even more complex for parent companies with subsidiaries in different time zones and jurisdictions, and with different annual periods and currencies.

Often, these companies follow their own consolidation procedures and use their own systems to prepare their financial statements. This can lead to time-pressed finance teams resorting to risky, manual methods, such as sending additional information on spreadsheets over email or exchanging knowledge verbally. In fact, seven out of ten finance professionals confess to obtaining information this way.

This, in turn, opens the process to errors, which can lead to huge inaccuracies in the consolidated financial statements.

Simplifying the consolidation process

Every forward-thinking CFO is aware of the challenges of IFRS 10 and the risks of getting it wrong. These risks are not just about disseminating inaccurate information: a company that spends vast amounts of time and energy labouring under inefficient consolidation procedures is unlikely to have the resources to spot the next threat or opportunity.

In order to simplify the consolidation process, it should first be standardised and clarified across the parent company and all its entities. It should also harness the power of today’s technology.

Automation is a key part of optimisation: today’s consolidation software can collect and process vast quantities of data to generate financial reports without the risk of human or spreadsheet error, along with a host of other benefits. The same software systems can easily be used across all companies, with data stored in a single, easily accessible place.

Automation, modernisation, and uniform accounting procedures are the key to an efficient consolidation process. Investing in this will save time, human resources, and money, allowing your skilled teams to focus their energies on activities which add genuine value to the organization.

Are you interested in discovering more about financial consolidation and reporting software? If so, please get in touch. We have a team of experts who will be happy to discuss your specific needs and what our CPM software can do for you.