New standards may change deal structures and increase transparency for investors

LONDON, 20 May 2011 –Two new standards released yesterday by the International Accounting Standards Board (IASB), IFRS 10 Consolidated Financial Statements and IFRS 12 Disclosure of Interest in Other Entities, will fundamentally change how companies identify controlled entities and will increase understanding of control relationships for users of financial statements.In addition, the IASB released IFRS 11 Joint Arrangements, which will change how many companies account for such arrangements. Going forward, the manner in which deal structures are put together could also be severely impacted, in light of these new standards.

Ernst & Young’s Global IFRS Leader, Ruth Picker says, “IFRS 10 includes a new definition of control and consequently, may change which companies are included in consolidated financial statements. Management will now have to exercise significant judgment to determine whether another entity is controlled, and may have to gather data about other shareholders and past voting patterns to make those judgments.”

Ruth Picker adds, “For private equity funds, asset managers, even certain insurance companies, IFRS 10 will help them to assess whether they are ‘principals’ or ‘agents’ and therefore whether they have to consolidate. Other companies, particularly where there are options to acquire additional voting interests, or less than a majority of voting rights, will also need to consider the new rules and assess whether they have control.”

The objective of IFRS 12 is for an entity to disclose information that helps users of its financial statements evaluate both the nature of its involvement with other entities and the financial effects of that involvement on its financial position.

Ruth Picker comments, “The disclosure standard will increase the amount of information in financial statements about one company’s relationship with another. Even if a company makes a judgment that it does not control another entity, management has to disclose the information that it considered in reaching that decision, so that judgment becomes more transparent. The new disclosures will help users of the financial statements to make their own assessment of the financial impact if management had made a different decision by providing more information about unconsolidated entities.”

IFRS 11 deals with joint arrangements where there is joint control. Whereas previously joint ventures were accounted for based on their legal form, the new principles consider the rights and obligations of the arrangement.
Ruth Picker adds, “Companies in the mining, extractive, oil, and gas industries, and also in real estate and construction, where joint arrangements are common, may feel the biggest impact from adopting IFRS 11. Entities that have investments in jointly controlled entities that are classified as joint ventures under IFRS 11 will now be required to apply equity accounting, which will fundamentally change both their balance sheets and income statements. However, some former jointly-controlled entities might now be classified as joint operations, in which case the joint operator will recognize its share of assets, liabilities, revenues, and expenses. This often looks similar to proportionate consolidation, but is in fact different.”

"IFRS 10 will have important implications for many companies in Russia and other CIS countries. They will need to revise their consolidation perimeter, which could lead to including additional subsidiaries in it. Because the new standard is effective from 2013, companies should start assessment of the impact of the new standard now", - says Dmitry Weinstein, Partner, Head of Financial Reporting in the CIS.

Ruth Picker concludes, “All companies operating under IFRS should assess how they will be affected and begin planning for adoption of the new standards as soon as possible. We could see management change how they structure deals and joint arrangements going forward, in light of these changes.”

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