Question

ABC Ltd has gained control of XYZ Ltd by purchasing 80% of the share capital, while only gaining some significant influence over Wan Ltd due to only holding a 20% share of the capital. Your Financial Controller has asked you to evaluate critically the differences between control and significant influence relating to the consolidation of financial statements and explain how a company may still control another entity even though it may not own a majority of the ordinary shares.

Answer 1

In order to apply consolidation method the parties involved has to identify the acquirer i.e the entity that obtains the control of other entity.The other entity on whom the control is established is is termed as acquiree.this is because the acquiree's assets and liabilities is what is  accounted as per the recognition and measurement principles of the standard.

Control:

An iinvestor controls an investee if and only if the investor has all the following

a)Power over the investee

b)Exposure,or rights,or variable returns from its involvement with the investee:and

c)The ability to use its power over the investee to affect the amount of the investors return

The above definition is very wide and control assessment does not depend only on voting rights instead it depends on the following as well

1)Potential voting rights

2)Rights of non-controlling shareholders:and

3)other contractual right of the investor if those are substantive in nature

Indicators of control:

More than 50% voting rights

Power to appoint and remove board of directors

Investor have currently exercisable potential voting rights

Significant influence:

If an entity holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the entity does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence.

The existence of significant influence by an entity is usually evidenced in one or more of the following ways:

(a) representation on the board of directors or equivalent governing body of the investee;

(b) participation in policy-making processes, including participation in decisions about dividends or other distributions;

(c) material transactions between the entity and its investee;

(d) interchange of managerial personnel; or

(e) provision of essential technical information

An entity may own share warrants, share call options, debt or equity instruments that are convertible into ordinary shares, or other similar instruments that have the potential, if exercised or converted, to give the entity additional voting power or to reduce another party’s voting power over the financial and operating policies of another entity (ie potential voting rights). The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities, are considered when assessing whether an entity has significant influence. Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until a future date or until the occurrence of a future event.

In assessing whether potential voting rights contribute to significant influence, the entity examines all facts and circumstances (including the terms of exercise of the potential voting rights and any other contractual arrangements whether considered individually or in combination) that affect potential rights, except the intentions of management and the financial ability to exercise or convert those potential rights.

An entity loses significant influence over an investee when it loses the power to participate in the financial and operating policy decisions of that investee. The loss of significant influence can occur with or without a change in absolute or relative ownership levels. It could occur, for example, when an associate becomes subject to the control of a government, court, administrator or regulator. It could also occur as a result of a contractual arrangement.

SO from this we understood that eventhough an entity is not holding not more than 50% of voting rights or share capital ,the company can control the other by it's significant influence by any of these way mentioned above.