How Is Control Defined Under IAS 27?
Understand the modern definition of control over an investee and its specific implications for how a parent entity accounts for its investments.
International Accounting Standard 27 (IAS 27) establishes rules for how companies account for their investments in other companies. Understanding the concept of “control” is necessary to apply this standard, as it determines how a company reports its investments.
The Definition of Control Under IFRS 10
The definition of “control” is located in International Financial Reporting Standard 10 (IFRS 10), Consolidated Financial Statements. An investor controls an investee when it has all three of the following: power over the investee; exposure to variable returns; and the ability to use its power to affect those returns.
Power arises from rights that give the investor the ability to direct “relevant activities”—those that significantly affect the investee’s returns, such as operating and financial policies. While owning more than half of the voting shares typically confers power, it can also exist through contractual arrangements.
The second element is exposure to variable returns, meaning the investor’s returns can vary based on the investee’s performance. These returns can be positive or negative and include dividends or changes in the investment’s value. An investor with only fixed returns would not meet this criterion.
Finally, the investor must have the ability to use its power to affect its returns. This ability to actively influence the returns received distinguishes a controlling party from a passive investor.
The Current Scope of IAS 27
The revised IAS 27, titled Separate Financial Statements, now prescribes the accounting and disclosure rules for investments in subsidiaries, joint ventures, and associates when an entity prepares separate financial statements. An entity might be required by local regulations to present these statements or may choose to do so voluntarily for purposes such as statutory reporting, where the focus is on the parent’s performance as a standalone entity.
These statements are presented in addition to consolidated financial statements. The distinction is that in separate financial statements, investments are not consolidated line-by-line but are instead reported as individual investments on the parent company’s balance sheet.
Accounting for Investments in Separate Financial Statements
When an entity prepares separate financial statements, IAS 27 allows it to account for its investments in subsidiaries, joint ventures, and associates using one of three methods. The entity must apply the same policy for each category of investments. The choices are accounting for the investments at cost, in accordance with IFRS 9 Financial Instruments, or using the equity method as described in IAS 28 Investments in Associates and Joint Ventures.
Under the cost method, an investment is initially recorded at its purchase price. The carrying amount of the investment does not change unless it is impaired. The investor recognizes income from the investment, such as dividends, only when its right to receive the payment is established.
Alternatively, an entity can account for its investments in accordance with IFRS 9. This typically means measuring the investments at fair value, which is the price that would be received to sell an asset. Changes in fair value are usually recognized in profit or loss each reporting period.
The third option is to use the equity method from IAS 28. With this method, the investment is initially recorded at cost and is subsequently adjusted to reflect the investor’s share of the investee’s post-acquisition profits or losses. Dividends received from the investee reduce the carrying amount of the investment.