IFRS 12: Disclosure of Interests in Other Entities

Executive Summary:

IFRS 12 “Disclosure of Interests in Other Entities” is a crucial International Financial Reporting Standard (IFRS) that consolidates and enhances disclosure requirements for an entity’s interests in subsidiaries, joint arrangements, associates, and unconsolidated structured entities. Its primary objective is to improve transparency for users of financial statements, particularly following the 2007 global financial crisis, by providing better information about the nature and risks associated with these interests and their effects on financial position, performance, and cash flows. The standard became effective for annual periods beginning on or after 1 January 2013, with amendments for investment entities coming into effect from 1 January 2014. It replaces previous disclosure requirements found in IAS 27, IAS 28, and IAS 31, aiming for a single, comprehensive disclosure standard.

Key Themes and Important Ideas/Facts:

1. Objective and Scope of IFRS 12:

• Core Objective: IFRS 12 aims to enable users of financial statements to “evaluate: (a) the nature of, and risks associated with, its interests in other entities; and (b) the effects of those interests on its financial position, financial performance and cash flows”.
• Broad Scope: The standard applies to entities with interests in:
• Subsidiaries
• Joint arrangements (joint operations or joint ventures)
• Associates
• Unconsolidated structured entities
• “IFRS 12 addresses the disclosure of a reporting entity’s interests in other entities when the reporting entity has a special relationship with those other entities, i.e. it controls another entity, has joint control of or significant influence over another entity or has an interest in an unconsolidated structured entity.”
• Exclusions: IFRS 12 generally does not apply to post-employment benefit plans (IAS 19), an entity’s separate financial statements (IAS 27, with exceptions for unconsolidated structured entities and investment entities), interests without joint control or significant influence (unless a structured entity), or interests accounted for under IFRS 9 Financial Instruments (with exceptions for fair-valued associates/joint ventures and unconsolidated structured entities).

2. Consolidation and Disclosure Alignment (IFRS 10 & IFRS 12):

• Integrated Approach: IFRS 12 was developed alongside IFRS 10 “Consolidated Financial Statements” to create a single, comprehensive package for consolidation and related disclosures.
• Addressing Diversity: The project aimed to address “diversity in practice related to consolidation, stemming from the definition of control.” Previously, IAS 27 focused on “power to govern financial and operating policies” while SIC-12 focused on “risks and rewards,” leading to inconsistencies.
• Single Control Model: IFRS 10 establishes a single consolidation model that identifies control as the basis for consolidation for all types of entities. This model comprises three elements: “power over an investee; exposure, or rights, to variable returns from an investee; and ability to use power to affect the reporting entity’s returns.”
• Enhanced Disclosures: IFRS 12 enhances and replaces previous disclosure requirements, providing “greater transparency of a reporting entity’s exposure to risks from its involvement with structured entities.”

3. Key Disclosure Requirements under IFRS 12:

• Significant Judgements and Assumptions: Entities must disclose “significant judgements and assumptions it has made (and changes to those judgements and assumptions) in determining: (a) the nature of its interest in another entity or arrangement; (b) the type of joint arrangement in which it has an interest; (c) that it meets the definition of an investment entity, if applicable.” (IFRS 12, para 2(a)). This includes explaining control with less than majority voting rights or lack of control with majority voting rights.
• “The assessment of whether an entity controls another entity sometimes requires judgement.”
• Interests in Subsidiaries:Composition of the Group & NCI: Disclosures enable users to “understand: (i) the composition of the group; and (ii) the interest that non-controlling interests have in the group’s activities and cash flows.” (IFRS 12, para 10(a)). This includes specific information for each material NCI, such as “the name of the subsidiary,” “principal place of business and country of incorporation,” “proportion of ownership interests held by non-controlling interests,” “profit or loss allocated to non-controlling interests,” “accumulated non-controlling interests,” and “summarised financial information about the subsidiary.” (IFRS 12, para 12).
• “Summarised financial information about subsidiaries with material non-controlling interests helps users predict how future cash flows will be distributed among those with claims against the entity including the non-controlling interests.” (IFRS 12 BC, para BC28).
• Restrictions: Disclosure of “significant restrictions… on its ability to access or use assets, and settle liabilities, of the group,” including those due to “protective rights of non-controlling interests.” (IFRS 12, para 13).
• Consolidated Structured Entities: Disclosure of “terms of any contractual arrangements that could require the parent or its subsidiaries to provide financial support to a consolidated structured entity, including events or circumstances that could expose the reporting entity to a loss.” (IFRS 12, para 14).
• Changes in Ownership & Loss of Control: Information on the effects of changes in ownership interest in a subsidiary that do not result in loss of control, and the consequences (gain/loss) of losing control of a subsidiary. (IFRS 12, paras 18-19).
• Interests in Joint Arrangements and Associates:Nature, Extent & Financial Effects: Disclosure of “the nature, extent and financial effects of its interests in joint arrangements and associates,” including contractual relationships. (IFRS 12, para 20(a)). This includes “summarised financial information for the joint venture or associate” (IFRS 12, para B12) on a “100 per cent” basis, reconciled to the carrying amount of the investment (IFRS 12 BC, para BC49).
• Risks: Disclosure of “the nature of, and changes in, the risks associated with its interests in joint ventures and associates.” (IFRS 12, para 20(b)). This includes commitments and contingent liabilities. (IFRS 12, para 23).
• Interests in Unconsolidated Structured Entities:Need for Disclosure: “The global financial crisis that started in 2007 also highlighted a lack of transparency about the risks to which a reporting entity was exposed from its involvement with structured entities, including those that it had sponsored.” (IFRS 12 BC, para BC4).
• Nature & Extent of Interests: Qualitative and quantitative information about the “nature, purpose, size and activities of the structured entity and how the structured entity is financed.” (IFRS 12, para 26).
• Nature of Risks: Summarised information about “carrying amounts of the assets and liabilities recognised… relating to its interests,” “maximum exposure to loss,” and a “comparison of the carrying amounts… and the entity’s maximum exposure to loss.” (IFRS 12, para 29). This includes risks from previous involvement, even without current contractual involvement. (IFRS 12, para 25).
• Non-contractual Support: Disclosure of “type and amount of support provided” and “reasons for providing the support” if financial or other support was provided without contractual obligation to unconsolidated structured entities. (IFRS 12, para 30).
• Complementary to IFRS 7: While there may be overlap with IFRS 7 “Financial Instruments: Disclosures,” IFRS 12 “adopts a different perspective and requires an entity to disclose its exposure to risk from its interest in a structured entity.” (IFRS 12 BC, para BC72).

4. Investment Entities Amendments (October 2012):

• Business Model Reflection: These amendments require investment entities to “measure certain subsidiaries at fair value through profit or loss account rather than consolidate them.” (European Commission Effects Study, para 2). This reflects their business model of managing investments on a fair value basis.
• Specific Disclosures: IFRS 12 was amended to require specific disclosures about subsidiaries not consolidated by an investment entity. (European Commission Effects Study, para 2).
• An investment entity must disclose the fact that it applies the exception to consolidation. (IFRS 12, para 19A).
• For each unconsolidated subsidiary, it must disclose the name, principal place of business, and proportion of ownership/voting rights held. (IFRS 12, para 19B).
• Disclosure of “significant restrictions… on the ability of an unconsolidated subsidiary to transfer funds to the investment entity.” (IFRS 12, para 19D).
• Disclosure of non-contractual financial support provided to unconsolidated subsidiaries. (IFRS 12, para 19E).
• Cost-Benefit Assessment: The European Commission concluded that “the benefits of the amendments will outweigh the costs of implementation.” (European Commission Effects Study, para 4). EFRAG’s assessment indicated “significant cost savings for investment entity preparers” by eliminating the need to consolidate certain subsidiaries. (European Commission Effects Study, Attachment 1, para 24).

5. Implementation and Practical Considerations:

• Materiality and Aggregation: Entities must “consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the requirements.” (IFRS 12, para 4). Disclosures can be aggregated for similar entities but must be presented separately for subsidiaries, joint ventures, joint operations, associates, and unconsolidated structured entities. (IFRS 12, para B4).
• “It is necessary to strike a balance between burdening financial statements with excessive detail that may not assist users of financial statements and obscuring information as a result of too much aggregation.” (IFRS 12, para B2).
• Materiality is assessed from the perspective of the reporting entity, considering both “quantitative considerations (ie the size of the subsidiary) and qualitative considerations (ie the nature of the subsidiary).” (IFRS IC Staff Paper, September 2014, para 19).
• Transition Relief: Initial application for IFRS 12 was for annual periods beginning on or after 1 January 2013. Amendments provided “additional transition relief in IFRS 12, limiting the requirement to present adjusted comparative information to only the annual period immediately preceding the first annual period for which IFRS 12 is applied.” (IFRS 12, Introduction). For unconsolidated structured entities, comparative information for periods before the first application of IFRS 12 was removed. (IFRS 12, para C2B).
• Challenges: Preparers may face initial costs in gathering and summarising the required information, especially for new disclosures related to structured entities. (EY IFRS 12 Presentation, “Practical issues”). The standard aims to balance the need for detailed information with the practical burden on preparers.
• Consistency with US GAAP: Many disclosure requirements for structured entities align with US GAAP’s variable interest entities. (IFRS 12 BC, para BC121).

Conclusion:

IFRS 12 significantly enhances the transparency of an entity’s interests in other entities, providing users with more relevant and comparable information for decision-making. While the implementation may involve initial costs for preparers, particularly in adapting systems for new disclosure requirements, the benefits in terms of improved financial reporting and investor understanding are deemed to outweigh these costs. The standard’s emphasis on detailed disclosures, particularly for structured entities, reflects a direct response to lessons learned from the global financial crisis.