IFRS 12 is basically a set of rules that tells companies what information they need to reveal about the other businesses they’re involved with, like subsidiaries, joint ventures, partners, and other structured entities. It’s like a transparency checklist. Instead of just dumping a ton of details, it breaks down what needs to be shared into clear goals, and then gives instructions on how to meet those goals. So, it’s all about making sure that investors and others who are interested can get a good picture of the company’s connections and how they might affect its overall performance
There have been no modifications to IFRS 12 since 1 September 2017.
The objective of the International Financial Reporting Standards 12 (IFRS 12) is to mandate the disclosure of information in the financial statements of an entity whose purpose is to allow users of those financial statements to evaluate
IFRS 12 disclosures can be classified into the following categories:
If the disclosures outlined within these specified sections of IFRS 12, in conjunction with disclosures provided under other applicable Standards, fail to adequately fulfill the overarching objective of IFRS 12 as stipulated, the reporting entity is obliged to furnish any supplementary information necessary to ensure the fulfillment of the said objective.
To fulfill the objective of IFRS 12 effectively, the reporting entity should carefully consider both the necessary level of detail and the emphasis placed on each disclosure requirement outlined in the Standard. Including excessive insignificant details or grouping together items with diverse characteristics could obscure valuable information. Therefore, disclosures should be organized in a manner that ensures relevant information remains clear and accessible, whether through aggregation or disaggregation.
The degree of aggregation, disaggregation, and emphasis should be customised by each reporting entity to cater to the specific needs of its users. Each entity must strike a balance between providing an adequate amount of information and avoiding overwhelming its audience with unnecessary detail.
Information should be arranged into distinct groups for interests in:
Aggregation is allowed for similar interests within each category, as long as it aligns with the Standard’s main goal and does not make the information unclear. When deciding whether to combine data on specific entities, it is important to analyze both qualitative and quantitative data on the risk and return attributes of each entity, as well as their importance to the reporting entity. IFRS 12 provides examples of potential aggregation levels, including grouping by the nature of operations, industry categorization, or location like country or region.
The financial statements should clearly show the reporting entity’s involvement in other entities.
The financial statements of a reporting entity should include information on how it has combined interests in comparable firms.
At times, the disclosure may be evident from the presentation of the material and may not need further clarification. For instance, when material is arranged by geographical region, it will be clearly indicated in the headers and sub-headings.
An entity must apply IFRS 12 if it has an involvement in any of the following, with several exceptions as outlined below:
Scope – interests held during the period or only at the end of the period?
IFRS 12 does not specify whether ‘has an interest’ refers to the end of the reporting period or at any point during the reporting period. Nevertheless, the Standard mandates various disclosures about events that transpire during the reporting period (such as the loss of control of a subsidiary during the reporting period). Thus, a business entity must adhere to the Standard if it possessed any interest of the kind outlined in IFRS 12 at any point in the reporting period.
IFRS 12 includes a definition of an interest in another entity. But if an entity has already determined, through its application of IFRS 10, IFRS 11 or IAS 28, that it has a subsidiary, joint operation, joint venture or associate, that interest will fall within the scope of IFRS 12.
Exemptions from the disclosure requirements of IFRS 12 fall into two categories:
In addition, investment entities are exempted from certain of IFRS 12’s general disclosure requirements.
Other than what is specified in IFRS 12, the rules of IFRS 12 are relevant to the categories of interests mentioned in IFRS 12:5 when they are categorized (or part of a disposal group that is categorized) as held for sale or discontinued operations as per IFRS 5.
According to IFRS 12, there is no need to disclose summarized financial information for interests classified as held for sale.
IFRS 12 requirements generally do not pertain to an entity’s individual financial statements. Separate financial statements must comply with the disclosure requirements outlined in IAS 27.
Nevertheless, if an organization’s individual financial statements are its sole financial statements, disclosures must be made in accordance with IFRS 12 in the following manner:
(i)If the entity has interests in unconsolidated structured entities, the required disclosures under IFRS 12 regarding unconsolidated structured entities should be provided as outlined in IFRS 12.
(ii) If the organization is an investment entity and all of its subsidiaries are measured at fair value through profit or loss as mandated by IFRS 10, the necessary disclosures for investment entities as per IFRS 12 should be provided.
Application of IFRS 12 by investment entities
Except for those specifically indicated as not applicable to investment firms, all of the disclosure requirements of IFRS 12 are applicable to investment entities (to the extent that the disclosures relate to matters relevant to the investment entity).
Investment entities are free from IFRS 12 and IFRS 12, respectively, from the IFRS 12 standards that are specifically mentioned as not applying to them. These requirements relate to stakes in joint arrangements and associates and unconsolidated structured businesses.
Thus, apart from the particular mandates included in IFRS 12 and 19, which are exclusive to investment entities, an investment entity must furnish the disclosures mandated by the subsequent general requirements found in IFRS 12:
- IFRS 12, which addresses important conclusions and presumptions;
- IFRS 12, which addresses important limitations on the transfer of funds from joint ventures and associates, material joint arrangements and affiliates, and risks related to stakes in joint ventures and associates, respectively; and
- Only with regard to entities that the investment entity does not control (and which are not, therefore, covered by the exemption in IFRS 12) would IFRS 12 apply with regard to interests in unconsolidated structured entities.
An investment entity that values all subsidiaries at fair value through profit or loss does not need to provide the information outlined in:
- IFRS 12 about interests in subsidiaries (because these either have to do with consolidation accounting that investment entities don’t use or are repeated by IFRS 12’s specific rules; or
- IFRS 12 about the equity method of accounting (which investment entities don’t use either because IFRS 10 says they have to choose the exemption from using the equity method in IAS 28).
If an investment company merges with a service-provider subsidiary, as required by IFRS 10, IFRS 12’s disclosure rules apply to the new financial records (see IFRS 12). After thinking about the things mentioned in the previous lines, the disclosures that should be made are then chosen. Besides that, the information needed by IFRS 12 (about important decisions made to decide that the investment entity controls the service-providing subsidiary) and IFRS 12 (about interests in subsidiaries) should be given if they apply to the service-providing subsidiary’s facts and circumstances.
IFRS 12 does not require disclosures to be provided about the following interests:
When you look at the last bullet point, IAS 28 says that an investment-linked insurance fund, a venture capital firm, a mutual fund, a unit trust, or a similar company can use profit or loss to figure out how much their interest in an associate or a joint venture is worth. These kinds of interests are covered by the disclosure rules in IFRS 12.
Scope – employee share trusts
“Post-employment benefit plans or other long-term employee benefit plans to which IAS 19 applies” are not covered by IFRS 12. Entities like employee share trusts set up to help with equity compensation plans are not exempt from this rule. These fall under IFRS 2 instead of IAS 19, so they are not required to follow the full disclosure rules of IAS 19. Some of these kinds of organizations are covered by IFRS 12.
An interest in another entity, for the purpose of applying IFRS 12, refers to contractual and non-contractual involvement that exposes an entity (the reporting entity) to variability of returns from the performance of the other entity. An interest can be evidenced by the holding of debt or equity instruments as well as other forms of involvement including (but not limited to) the provision of funding, liquidity support, credit enhancement and guarantees. An interest encompasses the means by which an entity has control of, joint control of, or significant influence over another entity. A typical customer-supplier relationship alone does not necessarily give rise to an interest in another entity for the purpose of applying IFRS 12.
If the reporting entity is exposed, or has rights, through contractual or non-contractual involvement, to variability of returns from the performance of another entity, the reporting entity has an interest in that other entity for the purpose of applying IFRS 12.
Variability of returns is key to the meaning of control in IFRS 10 and is widely defined.
Typically, an entity will already have determined, through its application of IFRS 10, IFRS 11 and IAS 28, the extent to which it has interests in subsidiaries, joint arrangements and associates. In addition, for the purpose of applying IFRS 12, a reporting entity will need to determine the extent to which it has interests in unconsolidated structured entities.
A structured entity is defined in IFRS 12 as “an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements”.
The term ‘structured entity’ is not used in IFRS 10. The background to this definition, and to IFRS 12’s requirement to provide disclosures about unconsolidated structured entities, is that the Board was asked by, among others, the G20 leaders and the Financial Stability Board to improve disclosure requirements relating to ‘off balance sheet’ activities. Unconsolidated structured entities, particularly securitization vehicles and asset-backed financings, are seen as part of such activities.
A structured entity that is controlled by the reporting entity will meet the definition of a subsidiary and be consolidated (and thus ‘on balance sheet’). Specific disclosures are required in respect of subsidiaries that are structured entities.
Appendix B to IFRS 12 states that a structured entity often has some or all of the following features or attributes:
In response to the third bullet point, just because a company needs subordinated financial support doesn’t mean it is automatically a structured entity. For instance, companies may choose to fund their subsidiaries with a mix of stock and subordinated debt. However, if the subsidiaries are run by the voting rights that come with the equity instruments, they will not be considered a structured entity.
Even if an organization controlled by voting rights gets money from outside sources after being restructured, that doesn’t mean it is now a structured entity.
If you look at IFRS 12, it lists structured companies like securitization vehicles, asset-backed financings, and some investment funds.
For IFRS 12, if a reporting company owns a piece of a joint venture or an associate that is a structured entity, that piece of the joint venture or associate is also an unconsolidated structured entity. Because of this, the reporting company should give details about that interest that meet both sets of disclosure rules: those for interests in joint ventures and associates and those for interests in unconsolidated structured entities.
The Board thought about this problem and agreed with the last paragraph’s conclusion. In coming to this decision, the Board said that a company should provide most, and sometimes all, of the information needed for interests in unconsolidated structured entities by doing so for interests in joint ventures and associates. As a result, the Board did not believe that this finding should make the amount of information that an entity had to give much bigger.
This part talks about how to use IFRS 12 to figure out if a business has an interest in another business.
A contractual or non-contractual interest in another entity (such as an unconsolidated structured business) exposes the reporting entity to a range of returns depending on how well the other entity performs. When determining whether the reporting entity has an interest in the other entity, it may be helpful to take into account the other entity’s goals and design, as well as the risks that the other entity was intended to create and transfer to the reporting entity and other parties.
Generally, holding instruments (such as debt or equity instruments issued by the other entity) or having some other participation that absorbs variability exposes a reporting organization to returns that can vary depending on how well the other entity performs. Think about a structured entity that owns a portfolio of loans. The structured entity may engage in a credit default swap with the reporting entity to safeguard itself against the failure to make interest and principal payments on the loans. The reporting entity would be exposed to return variability from the structured entity’s performance by entering into the credit default swap, as the structured entity’s return variability is absorbed by the credit default swap.
However, concluding that the counterparty has an interest in the structured organization is not as simple as entering into a credit default swap, or any other instrument, with it. The structured entity’s returns must be variable, and as will be shown later, this will not always happen to the counterparty.
Specific instruments are made to move risk from one reporting entity to another. These instruments produce return variability for the other entity, but they usually shield the reporting entity from return variability resulting from the other entity’s performance. Imagine an entity (Entity A) that is organized and designed to offer investment opportunities to investors who want to be exposed to the credit risk of another entity (Entity Z), which is independent of all the parties. Investors receive cash-linked notes from Entity A that are tied to the credit risk of Entity Z. The money that Entity A receives is invested in low-risk financial instruments. Furthermore, Entity A engages in a credit default swap (CDS) with Entity X, whereby Entity X pays Entity A a fee in exchange for Entity A being exposed to Entity Z’s credit risk. The return to the investors is determined by adding the Entity X charge to the return from the asset portfolio. If Entity Z’s creditworthiness does not decline, they will receive their entire principal amount back at the conclusion. In order to protect Entity X from the unpredictability of returns resulting from Entity A’s performance, the credit default swap transmits variability to Entity A rather than absorbing it. For IFRS 12, Entity X in this example does not have an interest in Entity A as a result.
Investment manager’s interest in an unconsolidated investment fund
According to IFRS 12, an investment manager’s fee from an investment fund that it runs but does not consolidate is a “interest in an unconsolidated structured entity” that needs to be disclosed. This is the case if the fund fits the definition of a structured entity.
“Interest in another entity” means “contractual and non-contractual participation that exposes an entity to variability of returns from the performance of the other entity,” as was already said. IFRS 10 says that variable returns are “returns that are not fixed and have the potential to change depending on how well the investee does.”
In addition, IFRS 10 states as follows.
“Variable returns can be only positive, only negative or both positive and negative. An investor assesses whether returns from an investee are variable and how variable those returns are on the basis of the substance of the arrangement and regardless of the legal form of the returns…. Similarly, fixed performance management fees for managing an investee’s assets are variable returns because they expose the investor to the performance risk of the investee. The amount of variability depends on the investee’s ability to generate sufficient income to pay the fee.”
An investment manager should therefore consider an investment fee received from a fund it oversees as a “interest in another entity” because it puts the manager at risk of losing money depending on the value of the assets under administration.
As noted, a structured entity is “an entity that has been designated so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements”.
“Some investment funds” are examples of structured entities, according to IFRS 12, which states that this concept. In the context of an investment fund, it is necessary to evaluate the extent to which decisions regarding investment strategy are made by the votes of unit holders (either directly or, as was previously mentioned, through a substantive right to vote to remove the fund manager) rather than through the administration contract of the fund.