The decision on whether a reporting entity can consolidate another entity under GAAP and IFRS should is based on control. IFRS favors a model of control in consolidation, whereas the risk and reward model is preferred for the U.S GAAP.
However, differences exist in the control of definition.
The following are the main provisions of the new IASB consolidation guidance under IFRS:
- Every entity is subject to a single model of control
- A reporting entity can only control another entity if only it has the rights to some variable returns and is normally involved with the entity and by virtue of its power, it must have the ability of affecting these returns
- A reporting entity is deemed to have power over the entity if it has the present ability of directing the activities which mainly affect the returns of the entity
- In certain cases, the reporting entity has power over another entity if it holds less than majority of voting rights
- In some instances, a reporting entity has got power over an entity through holding the potential voting rights like convertible instruments and options
- A decision maker acting on behalf of a different party is considered as an agent and doesn’t have any control. The decision maker acting in its capacity may have power and is deemed as a principal
- As circumstances and facts changes, control is continuously assessed
There are two primary models of consolidation that exist in the US GAAP; one for voting interest’ entities and the other for VIES. A VIE is that entity where the investors of equity have got no characteristic of controlling the holders’ of financial interest. That entity that isn’t a VIE is in most cases referred to as an entity of voting interest. The ancient voting consolidation model is considered if only an entity is established as not a VIE.
Controlling a VIE only occurs if a reporting entry has got both:
- Power of directing activities of that VIE which impacts significantly the economic performance of the VIE
- The obligation of absorbing losses of the VIE which could be possibly significant to the VIE or the right of receiving benefits from that entity which possibly could be quite significant to the VIE
In general, the control of an entity of voting interest normally results from that reporting entity that is holding the majority of voting rights of the entity. Nonetheless, for the limited partnerships and other similar entities like some particular companies that are limited liability which are not VIES, it is assumed that the general partner usually controls the entity in spite of the percentage ownership.
However, these general rules (that is exceptions of whether the general presumption of the partner and majority of ownership) and when other holders of equity have decision making rights to participate or in situations of limited partnerships, the general partner can be kicked out or removed.
In the new consolidation guideline of IASB, the control principle is largely consistent with the VIES control principle in the US GAAP. IASB and FASB have also indicated that they expect the requirements for VIES consolidation in the US GAAP to be substantially converged with the new guidance of IASB.
Both IASB and FASB have got a project agenda in the convergence of an investment company definition. In case it is finalized, the investment companies can record all the investments in the entities at fair value under both the IFRS and US GAAP. Nonetheless, there could be differences in GAAP and IFRS in terms of accounting by the parent’s investment company. This means that in IFRS, the investment company’s parent does not necessarily have to retain the fair value of the investment company in controlled entities’ consolidation.