1.       Practical considerations when determining significant influence

1. Do all the examples listed in paragraph 6 of IAS 28 have to be met to evidence significant influence?

No.

Any one of the examples could evidence the existence of significant influence; it is not necessary for all of the examples to apply. It is important to note that it is having the power to be able to participate in the policy decisions that matters, and not the actual exercise of that power. An entity might be on the board of the investee, but elect to be passive by not actively participating at meetings or abstaining from voting (although, in practice, this might be difficult to demonstrate). It is the power that comes with this board representation that matters, and not the fact that the entity is not participating in the policy-making process.

2. How should one assess significant influence on initial acquisition of an investment?

A practical problem might arise in judging the amount of influence that the entity has over its investment where the investment has only just been made. In these circumstances, the actual relationship usually becomes clear fairly soon after an investment is acquired. It is the power to exercise significant influence that matters. If the actual relationship were to develop differently, it might be necessary subsequently to change the way in which the investment is accounted if, in practice, the entity was not able to exercise significant influence.

3. How should active opposition of significant influence be accounted for?

Significant influence might be called into question if the entity has failed in an attempt to gain board representation or to obtain timely financial information from the investee, or if the investee is actively opposing the entity’s attempts to exercise influence over it. This is demonstrated by the following example.

Entity A owns 20% of the voting rights in entity B and is entitled to appoint one director to the board, which consists of five members. The remaining 80% of the voting rights are held by two entities, each of which is entitled to appoint two directors A quorum of four directors and a simple majority of those present are required to make decisions. The other shareholders frequently call board meetings at short notice and make decisions in the absence of entity A’s representative. Entity A has requested financial information from entity B, but this information has not been provided. Entity A’s representative has attended board meetings, but suggestions for items to be included on the agenda have been ignored, and the other directors oppose any suggestions made by entity A. Despite the fact that entity A owns 20% of the voting rights and has representation on the board, the existence of other shareholders holding a significant proportion of the voting rights prevents the entity from exerting significant influence.

Whilst it appears that entity A should have the power to participate in the financial and operating policy decisions, the other shareholders prevent entity A’s efforts and stop entity A from actually having any influence. In this situation, entity B would not be an associate of entity A. In the above example, the other entities were able to achieve a majority vote by working together. This enabled them to actively oppose entity A’s attempts to exert influence and thereby removed its power. However, the standard says that: “… a substantial or majority ownership by another entity does not necessarily preclude an entity from having significant influence”. [IAS 28 para 5]. The facts of each case will need to be examined closely.

2.       Practical considerations regarding board representation

Representation on the board is usually essential, in demonstrating that an entity has the power to participate in the financial and operating policy decisions and therefore have significant influence, unless it is clear that there are other arrangements in place that give the entity the power to participate in policy-making decisions. The nomination of board members and the proposed decision-making process, including the voting rights of those directors at meetings, are indicators in determining whether an entity has significant influence. Certain entities in some countries are required to have a supervisory board and a management board. Power to participate on either board should be considered. The supervisory board generally appoints the management board, so power to participate on the supervisory board is also relevant. Entity P holds 10% of the voting shares in entity A.

Entity A’s board comprises eight members, and two of these members are appointed by entity P. Each board member has one vote at meetings. Entity A is an associate of entity P, because significant influence is demonstrated by the presence of directors on the board and the relative voting rights at meetings. It is presumed that an entity has significant influence where it holds 20% or more of the voting power of the investee; but it is not necessary to have 20% representation on the board to demonstrate significant influence, because this will depend on all of the facts and circumstances. One board member might represent significant influence, even if that board member has less than 20% of the voting power. But, for significant influence to exist, it would be necessary to show (based on the specific facts and circumstances) that this is the case, because significant influence would not be presumed.

3.       Practical considerations regarding participation in the policy-making process

An associate relationship will exist if it can be demonstrated that the entity has the power to participate in the direction of its investee through representation in the policy decisions covering aspects of policy relevant to the entity, including decisions on strategic issues, dividends and other distributions. Participation in the policy-making process means being involved in strategic decisions, such as:

1. expansion or contraction of the business;
2. participation in other entities;
3. changes in products, markets and activities; and
4. determining the balance between dividend and reinvestment.

Such participation will be with a view to gaining economic benefits from the entity’s activities, although the entity will also be exposed to the risk that those activities might be loss-making.

For example, this would be accomplished by representation on the board of directors, because a director has power to participate in decision-making, where voting is often carried out by a show of hands. A single shareholder with less than 20% of the voting rights has significant influence and the power to participate in policy-making decisions if, for example, it has board representation. A shareholder with the same percentage shareholding and no board representation would not have the equivalent influence or power to participate. A fund manager might have significant influence, regardless of the percentage shareholding, and needs to make an assessment of whether or not it does, based on the specific facts and circumstances.

4.       Practical considerations regarding material transactions between an entity and its investee.

Entity A manufactures clothing for a leading clothing retailer. The retailer provides all designs for the clothes and participates in scheduling, timing and quantity of production. The majority (that is, 90%) of entity A’s sales are made to the retailer. The retailer has a 10% shareholding in the entity, which it acquired many years ago at the start of their relationship. Entity A is highly dependent on the retailer for the continued existence of business. Despite having only, a 10% interest in entity A, the retailer has significant influence.

5.       Practical considerations regarding interchange of managerial personnel

Where one entity seconds managerial personnel to another entity, it might have the power to participate in the financial and operating policies and practices of that other entity. The entity sending the personnel is in a position to select who is sent, and so it can provide personnel who will promote the sending entity’s interests. Where it can be evidenced that the interchange of managerial personnel has resulted in the management of one entity having significant influence over the other, that entity will be an associate. Entities A and B operate in the same industry, but in different geographical regions. Entity A acquires a 10% shareholding in entity B as part of a strategic alliance. A new production process is key to instigating a fundamental change in the strategic direction of entity B. The terms of the alliance provide for entity B to implement a new production process under the supervision of two managers from entity A.

The managers seconded from entity A, one of whom is on entity A’s board, will oversee the selection and recruitment of new staff, the purchase of new equipment, the training of the workforce and the negotiation of new purchase contracts for raw materials. The two managers will report directly to entity B’s board as well as to entity A’s The secondment of a board member and a senior manager from entity A to entity B gives entity A a range of powers over the new production process, and it might evidence that entity A has significant influence over entity B. This assessment takes into account the key financial and operating policies of entity B and the influence that this gives to entity A over those policies.

6.       Practical considerations regarding provision of essential technical information

A high degree of reliance on technology sourced from the investor entity might result in that entity having significant influence over the investee. Entity B has a 15% interest in entity A. Entity A manufactures mobile telephone handsets, using technology developed by entity B. Entity B licenses the technology to entity A and updates the licence agreement for new technology on a regular basis. The handsets are sold by entity A and represent substantially all of entity A’s sales. Entity A is dependent on the technology that entity B supplies, since a high proportion of entity A’s sales are based on that technology. Entity A is likely to be an associate of entity B, because of the provision of essential technical information.

7.       Practical considerations in calculating recoverable amount

The carrying amount of an investment in an associate or joint venture is not automatically written down to the current share price. The price decline is an indicator and also establishes the ‘fair value less costs of disposal’ of the associate or the joint venture. IAS 36 requires that the recoverable amount using the ‘value in use’ method should also be calculated before recording an impairment loss. If the value in use is higher than the carrying amount of the investment, there is no impairment to recognise. Calculating the value in use of an associate or a joint venture might entail obtaining cash flow forecasts from the associate’s or the joint venture’s management. The future expected dividend streams from the investment in the associate or the joint venture could also be used in measuring the associate’s or the joint venture’s value in use. [IAS 28 para 42].

8.       Practical considerations regarding loss of significant influence

1. Can an investor continue to have significant influence over an associate operating under restrictions?

An associate might operate under the following restrictions: Insolvency or administration procedures in progress Government restrictions on the transfer of currency out of the country. Significant international sanctions against the country that have a direct impact on the entity’s ability to trade and/or remit profits out of the country. Significant government regulation. In these circumstances, the entity might or might not continue to have significant influence. An investor entity might still have significant influence over an associate, despite restrictions on the associate’s ability to transfer funds to the investor entity. Such restrictions on the transfer of funds should be considered when assessing an investor entity’s ability to exercise significant influence over an entity. Such restrictions, independently, do not preclude the existence of significant influence.

2. Can a contractual arrangement not to interfere in the associate’s ongoing business result in loss of significant influence?

An entity that has significant influence over an associate might enter into a contractual agreement not to interfere with the associate’s ongoing business. It would be necessary to consider carefully the facts and circumstances to determine whether the contractual arrangement means that the entity has lost its significant influence over the associate. This would depend on, for example, the contract’s legal enforceability and how severe the penalty is for not meeting its contractual terms. It might also be a different situation where the contract is between the shareholders themselves rather than between the company and its shareholders.

9.       Practical situation requiring adjustment for different accounting policies

An entity and its associate or joint venture have inconsistent accounting policies if the entity prepares its financial statements under IFRS whilst the associate or joint venture prepares its financial statements under local GAAP. In order to comply with the requirements of IAS 28, the results of the associate or joint venture should be adjusted to comply with the entity’s IFRS-based policies.