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Control determines whether to consolidate, or not

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Steve Bradby


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Control determines whether to consolidate, or not

Control can be a deceptively simple concept but in practice it can be very complicated.

Earlier in the year ASIC (Australian Securities and Investments Commission) brought the issue of control to light in requiring ASX (Australian Stock Exchange) listed Kalina Power Ltd to restate its most recent financial report to correct the outcome of its assessment of whether control over an investee existed. Kalina had reduced its ownership interest in a subsidiary to 49% and in doing so, believed that it no longer controlled the subsidiary. Accordingly it was deconsolidated, before a restructure of the group saw Kalina increase its ownership in the subsidiary, requiring reconsolidation. This led to ASIC questioning the transactions and specifically whether the parent maintained control throughout, not by virtue of the quantum of the holding, but due to other factors evidencing continuance of control.

So, what is control?

The Oxford English Dictionary defines control as the power to influence or direct people’s behaviour or the course of events.

The Australian Accounting Standards relate the definition in terms of an investor and investee. An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and can affect the amount of those returns through its power over the investee. Note that an investee need not be a company; it may be a unit trust for example.

Exposure or rights to variable returns is relatively straight forward however, an assessment of whether an investor’s power is sufficient to affect the variable returns may be more difficult.

In the situation observed by ASIC, Kalina’s ability to exercise power was key to the conclusion that control continued throughout the relationship. Kalina impacted restructure outcomes despite holding less than a 50% interest in the subsidiary, and its subsequent reconsolidation. All of the principles of control remained intact throughout and consequently a $4m intangible booked on reconsolidation had to be reversed.

Control remains topical with the recent release of Harvey Norman Holdings Limited’s 30 June 2017 financial report, in which it notes as a significant accounting judgement, the assessment by directors of whether Harvey Norman, as franchisor, should consolidate the results of franchisees.

The notes to the financial report point out that the conclusion is determined by whether the franchisor has control over the franchisee, and involves, “Significant judgement in assessing whether the franchisor has sufficient power through its rights under arrangements with franchisees and through the practical application of those arrangements, to direct the relevant activities of the franchisee that most significantly affect the returns of the franchisee.”

The significance of the judgements – which result in non-consolidation of franchisees – has received critical press coverage. The critics argue that notwithstanding Harvey Norman’s declared constructive obligation to support a stressed franchisee’s ability to honour obligations to suppliers, such obligation is an element of control that arguably should result in consolidation under the Australian Accounting Standards.

Harvey Norman’s auditors also regard control judgements as significant, highlighting this as a ‘Key Audit Matter’.

We agree, to consolidate or not on the basis of power as a significant element of control, is a significant judgement in the preparation of consolidated financial statements.

We will be pleased to advise in respect of your particular circumstances. 



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