by John Hughes
“At long last – a single model for consolidation!” proclaims IASB member Patrick Finnegan in his latest Investor perspectives piece on the IASB website, describing how the new IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosure of Interests in Other Entities will “make the approach to consolidation accounting more understandable, comparable and consistent, and, we hope…ensure that what you see on the balance sheet is a complete picture of what is under the control of a parent company and its management” (just as an aside, if an IASB member isn’t intuitively drawn to that new-fangled “statement of financial position” terminology, then why should we be?!) Now, you know, standard-setters like holding up concepts like “single model,” I suppose because it conveys an impression of coherence and integrity – having multiple models for something can only mean fuzzy thinking at best, and caving to special interests at worst. But in truth, it generally means little more than you want it to mean. Put it this way, human life on earth is all governed by a “single model” in that it shares the common experiences of being born and dying, usually with some form of consciousness in between (please feel free to insert your own accounting-related joke at this point). But these points of commonality, of course, tell you nothing about the immense diversity of life experiences as they’re actually lived: it’s really an individual moral judgment whether you think the “single model” of our common humanity counts for anything at all, beyond lip service.
In other words, it’s not clear to me the new single model carries much guarantee of comparability and consistency, in the marginal situations where these concepts will be most tested. Maybe there’s no way that it could. I do wish though the standard did a bit more to explore those margins. The main medium for doing that, in theory, would be the illustrative examples it contains, but it’s in this respect that it appears most unhelpful. Consider the illustration Finnegan includes in his investor perspectives piece:
ABC Company is a marketer, producer and distributor of consumer products. As of 31 December, 2010, the company owned 45 per cent of the outstanding common shares of XYZ Company. The remaining common shares are held by numerous other institutional and retail investors, none of which own more than 3 per cent of XYZ individually. In addition, none of the remaining shareholders have an arrangement to consult or make decisions collectively as a group.
Decisions about the relevant activities of XYZ require the approval of a majority of votes cast at relevant shareholders’ meetings. Less than a majority of the other shareholders are active, as is shown by voting patterns at previous shareholders’ meetings. In addition, there are no signs of shareholder activism and the shareholder composition has been relatively stable over the recent years. Most recently, 60 per cent of the voting rights of XYZ have been cast at the last shareholders’ meeting.
In addition to owning 45 per cent of the outstanding common shares of XYZ, ABC provides XYZ with essential management personnel and specialized industry knowledge. Furthermore, ABC is the sole customer of XYZ’s products and ABC controls XYZ’s licences and trademarks, which are critical to XYZ’s operations.
Given this blizzard of green lights, the conclusion comes as little surprise:
Even though ABC owns less than a majority of the outstanding common shares, ABC controls XYZ. This is because ABC is exposed to variable returns from the investee through its equity investment and has the ability to affect its returns through its power. ABC has power because it has the practical ability to direct unilaterally the relevant activities of XYZ as evidenced by holding the majority of votes required at the most recent shareholders’ meeting; in addition, ABC provides XYZ with essential management personnel and specialized industry knowledge.
But you know, it’s such a one-sided example that Finnegan might as well have said all the other shareholders were deceased. The last bit, about the essential management personnel and controlling the licences and trademarks and all, seems especially gratuitous, raising an unnecessary question about whether the answer might have been different otherwise. Obviously, the scenarios in the standard itself cast a wider net. But they still seem to me to steer clear of the territory where these things will actually get tough. The standard includes an example where a 35% interest doesn’t provide control, but that example includes three other holdings of 5% each and emphasizes “the active participation of the other shareholders at recent shareholders’ meetings.” Absent that, it seems to suggest a 35% interest might (or would?) provide control, if dealing with a sufficiently diverse and apathetic shareholder group. What about 30% then? 25%? Of course, one understands the desire to avoid those deadly “bright lines.” But the scope for inconsistency seems considerable here, no matter how much diligence and integrity practitioners bring to the exercise. And I’m only addressing one aspect of the standard: other elements of the model present much the same kind of challenge.
No doubt the new standard is a step forward. But whether anything about it deserves the “At long last!” banner will remain to be seen I think.
The opinions expressed are solely those of the author.