WHEN TO CONSOLIDATE AND HOW TO FAIR VALUE Presented by Kashif Zafar Di Director t KPMG

KPMG I NTERNATIONAL S TANDARDS G ROUP F OR I NTERNAL U SE O NLY

Agenda
Introduction

Red Flag 1: Potential Voting Rights Red Flag 2: De Facto Control Red Flag 3: Supplier Relationships g 4: Structured Entities Red Flag Red Flag 5: Disclosures Conclusion

Learning objectives 2) Identify key factors in assessing de facto

By completing this module, power. you will be able to:

1) Explain how to assess potential voting rights.

3) Explain how supplier relationships can lead

to control. 4) ) Identify y key y factors in assessing g whether an investee is a structured entity. 5) Describe the new disclosure requirements.

Why is consolidation relevant?

Outside of financial sector, probably no changes in consolidation conclusion in most cases. But there are some key areas to watch for in the minority of cases you also need to assess whether previous conclusions remain valid valid. Model contains fewer bright lines and the use of professional judgement is essential. Red flags identified based on discussions with DPPs / engagement teams to date.

Old vs new requirements

2008 standards Exemptions from f preparing consolidated financial statements

IFRS 10

Similar requirements IAS 27 control model SIC-12 R&R model

Determination of investees to be consolidated

New single control model

Consolidation procedures

Similar requirements

The model in one slide

Power

Exposure p to variability in returns

Link between power and returns

Consolidation

To have power, it is necessary for investor to have existing rights that give it current ability to direct activities that significantly affect investee investees s returns (i.e. the relevant activities).

Power over relevant activities: Gating question

Voting rights are relevant Majority of voting rights Consider Rights held by others Less than a majority Consider Agreements with other vote holders Other contractual agreements Potential voting rights De facto power

Rights other than voting rights are relevant

Consider Purpose and design Evidence of practical ability to direct Special relationships Exposure to variability of returns

Consider only substantive rights

Agenda

Introduction
Red Flag 1: Potential Voting Rights

Red Flag 2: De Facto Control Red Flag 3: Supplier Relationships Red Flag g 4: Structured Entities Red Flag 5: Disclosures Conclusion

Potential voting rights

Y has option to purchase further 20% voting rights in Coffee Co from Java Group. Group Option is currently exercisable. Option is currently in the money. If Y exercises option, it must sell its stake in Cuppa pp Ltd ( (which is unrelated to Java Group) due to anti-competition rules. pp Ltd p Cuppa provides 3x return on investment compared to Coffee Co.
Q1: Who should consolidate Coffee Co?

Java Group
40% 60%

Coffee Co

Assessing potential voting rights

Whether potential voting rights are currently

exercisable is not necessarily y determinative and in some cases may not be a necessary condition.

Whether those rights are substantive is key:

Barriers that prevent holder from exercising. exercising Whether several parties need to agree. How holder would benefit from exercise. Purpose and design of potential voting rights rights.

Agenda

Introduction Red Flag 1: Potential Voting Rights

Red Flag 2: De Facto Control

Red Flag 3: Supplier Relationships Red Flag g 4: Structured Entities Red Flag 5: Disclosures Conclusion

De facto control

There are no contractual arrangements that exist between shareholders of the widely held interest (the 50%). Shareholder X has historically voted t d in i line li with ith J Java G Group. All substantive decisions need majority approval.

Java Group
10% 40%

Man y
50%

Espresso Co

Q2: Does Java Group control Espresso Co?

Does your conclusion change?

WHAT IF?
Java Group has currently exercisable potential voting rights to purchase Xs 10% voting p g rights. g

WHAT IF?

Total shareholder meeting

attendance is usually 75%.

When de facto control may exist

Investor considers all facts and circumstances STEP 1

Size of voting rights compared to others

Potential
voting rights
Not conclusive

Other contractual arrangements

Consider additional facts and circumstances

Number of active voters at previous meetings Evidence of power Special relationships Level of exposure to variable returns

STEP 2

Not clear

The investor does not consolidate

Agenda

Introduction Red Flag 1: Potential Voting Rights Red Flag 2: De Facto Control
Red Flag 3: Supplier Relationships

Red Flag g 4: Structured Entities Red Flag 5: Disclosures Conclusion

Supplier relationships

Bean Co, an entity controlled by voting rights, is a Coffee coffee bean producer in Ethiopia. Co Coffee C ff C Co h has d developed l d a new coffee ff plant l t proven to grow beans with long-lasting freshness. Supplier Under a 10-year non-cancellable licence, Bean Co 30% will grow coffee beans according to Coffee Cos programme. Bean Co: Bean Co
Does not have capacity to grow any other coffee plants. Has a Coffee Co manager supervising the growing season. Grows beans according to Coffee Cos specifications. Sells substantially all of its production to Coffee Co. Does not have its own Research & Development function.

Q3: Should Coffee Co consolidate Bean Co?

When supplier relationships are considered

Of itself, economic dependence of a supplier on a customer consolidation. But ...

Power to direct the relevant activities.

Other contractual agreements.

Exposure to variable returns.

Agenda

Introduction Red Flag 1: Potential Voting Rights Red Flag 2: De Facto Control Red Flag 3: Supplier Relationships
Red Flag g 4: Structured Entities

Red Flag 5: Disclosures Conclusion

From SICSIC-12 ... to IFRS 10

SIC-12 tests
Activities on behalf of the entity according to business needs needs. Entity has decision-making powers to obtain the majority of the benefits. Has rights to benefits and is exposed to risks. Retains majority of residual or ownership hi risks. i k

IFRS 10 factors
Purpose and design. Evidence of practical ability to direct direct. Special relationships. Exposure to variability in returns returns.

Involvement with structured entities

Espresso Co has decided to start operating partly through a franchise network network. To help start operations, a structured entity is nominally capitalised (Lend Co h no real has l equity), it ) 80% b by B Bank k and d 20% by Espresso Co, and debt financed by Bank. Lend Co provides loans to franchisees based on their business needs as determined by Espresso Co. Bank services the loans on a day-to-day basis.
Q4: Who consolidates Lend Co?

Espresso Co
20%

Bank
80%

Lend Co

Espress1

Espress2

When rights other than voting rights are relevant

Purpose and design

Involvement and decisions made at i inception. ti Contractual arrangements. Investor Investors s commitment to continued operation of investee.

Evidence of practical ability to direct

Appointing key management personnel l (KMP) (KMP). Directing investee to enter into significant transactions for i investors t b benefit. fit

Special relationships
Investees KMP are current or previous employees. Investees operations depend on investor (funding, technology etc). Disproportionate exposure to returns compared to voting rights.

Exposure to variability of returns

Relative exposure to variability of returns due to investors involvement in investee investee.

Agenda

Introduction Red Flag 1: Potential Voting Rights Red Flag 2: De Facto Control Red Flag 3: Supplier Relationships Red Flag g 4: Structured Entities
Red Flag 5: Disclosures

Conclusion

IFRS 12 might be challenging

Interests in subsidiaries. Disclosures are much

broader.

Interests in joint arrangements

and a d assoc associates. ates

Interests in unconsolidated
structured entities entities.

Consider increased disclosures and whether systems are designed to provide such information.

Agenda

Introduction Red Flag 1: Potential Voting Rights Red Flag 2: De Facto Control Red Flag 3: Supplier Relationships Red Flag g 4: Structured Entities Red Flag 5: Disclosures
Conclusion

Overview of the red flags

IAS 27 / SIC-12 Potential voting rights D f De facto t control t l Supplier relationships Structured entities Disclosures Currently exercisable P li election Policy l ti Ownership benefits (narrow) SIC-12 tests (SPEs) Limited

IFRS 10/ 12 Substantive B i f Basis for control t l Returns (broad) Broader analysis Might be more challenging

Key points to remember!

Substantive rights are key. Control may be achieved with less th a majority than j it of f voting ti rights. i ht Certain relationships could give power. Existing structured entities need to be re-assessed and the analysis is different than under SIC-12. Dont underestimate the disclosures required under IFRS 12.

JOINTLY CONTROLLED OPERATIONS AND JOINT VENTURES

KPMG I NTERNATIONAL S TANDARDS G ROUP F OR I NTERNAL U SE O NLY

Agenda

Introduction

Point 1: Separate Vehicle Point 2: Unlimited Liability Vehicles Point 3: Obligations for Liabilities Point 4: Other Facts and Circumstances Point 5: Disclosures Conclusion

1) Explain what constitutes a separate vehicle. 2) Describeobjectives situations in which the parties have rights to Learning

the assets / obligation for the liabilities of the joint By completing this module, arrangement.
you will be able to:

3) Describe situations in which the parties have rights to

the assets and obligations for the liabilities of the joint arrangement. 4) Describe situations in which the contractual arrangement reverse or modify the rights and obligations conferred by the legal form of the separate vehicle. vehicle 5) Explain when other facts and circumstances drive classification as a joint operation. 6) Describe the new disclosure requirements.

Why are we discussing this topic?

Lots of publicity about proportionate consolidation being dead. Key K question ti becomes b under d what h t circumstances i t aj joint i t operation exists. To answer that, need to understand some of the key points in the analysis that apply across all sectors. Areas identified based on discussions with DPPs / engagement g g teams to date.

Old vs new requirements

IAS 31 Line-by-line accounting

JCO/ JCA

IFRS 11

No separate vehicle
A separate vehicle, but separation overcome by y form, , contract or other facts and Separate vehicle circumstances A separate vehicle with separation maintained

JO

Choice: equity accounting or proportionate consolidation

Line-by-line accounting accou go of the underlying assets and liabilities

JCE

JV

Equity accounting

Joint venture vs joint operation

Structure

Is the arrangement structured through a vehicle

that is separate from the parties? Y

Legal form Contractual

arrangement

assets and obligations for the liabilities of the arrangement?

N 3

Do the contractual arrangements give the parties rights to the

assets and obligations for the liabilities of the arrangement?

Other facts
and circumstances

Do the parties have rights to substantially all the economic

benefits of the assets of arrangement? Y Does the arrangement depend on the parties on a continuous basis for settling its liabilities?

N
Joint Venture

Jo oint Operat tion

Does the legal form of the vehicle give the parties rights to the

Agenda

Introduction
Point 1: Separate Vehicle

Point 2: Unlimited Liability Vehicles Point 3: Obligations for Liabilities Point 4: Other Facts and Circumstances Point 5: Disclosures Conclusion

IFRS 11: Separate vehicle

A joint arrangement that is not structured through a separate vehicle is a joint operation.

1
Structure

Is the arrangement structured through a vehicle that is separate from the parties? Y More questions

Joint Oper J ration

MiniMini -case 1: Separate vehicle Entities by y statute

Accounting records
Operating segment Circumscribed Ci ib d area of business

Bank account

Q1: Which of these examples is a separate vehicle?

Solution: Separate vehicle

1 Entities by statute

Accounting records

Bank B k account

Circumscribed area of business

Operating segment

Learning points: A separately identifiable financial structure, including entities recognised by statute, regardless of having legal personality. Needs at least some sort of legal form.

Agenda

Introduction Point 1: Separate Vehicle

Point 2: Unlimited Liability Vehicles

Point 3: Obligations for Liabilities Point 4: Other Facts and Circumstances Point 5: Disclosures Conclusion

IFRS 11: Legal form

A joint operation is a joint arrangement whereby the parties that have joint control have rights to the assets, and obligations for the liabilities liabilities, relating to the arrangement arrangement. Joint Oper J ration

2
Legal form

Does the legal form of the vehicle give the parties rights to the assets and obligations for the liabilities of the arrangement?

N
More questions

MiniMini -case 2: Legal form

A and B set up Unlimited Co. A and B have unlimited liability for the liabilities of Unlimited Co.

Partner A
50% equity interest

Partner B
50% equity interest

Unlimited Co: separate legal personality

Q2: Does the legal form of the arrangement give the parties rights to the assets and obligations for the liabilities of the arrangement?

Solution: Legal form

Answer: No. Learning points: The separate vehicle has a separate legal personality and therefore a primary obligation for its liabilities. liabilities The unlimited nature of the parties is essentially a guarantee and this does not cause the arrangement to be a joint operation. Rights to the assets are also required for joint operation classification.

Agenda

Introduction Point 1: Separate Vehicle Point 2: Unlimited Liability Vehicles

Point 3: Obligations for Liabilities

Point 4: Other Facts and Circumstances Point 5: Disclosures Conclusion

IFRS 11: Contractual arrangements

the parties use the contractual arrangement to reverse or modify the rights and obligations conferred by the legal form of the separate vehicle.

3 Contractual
arrangement

Do contractual arrangements give the parties rights to the assets and obligations for the liabilities of the arrangement?

N
More questions

Joint Oper J ration

MiniMini -case 3: Contractual arrangements A and B each sell their defence contracting b i businesses t to a new, jointly controlled, legally separate vehicle vehicle, Defence Co, for fair value. Defence Co funds the payment with bank debt g yA guaranteed by and B.

Partner A
50% equity interest

Guarantee

Partner B
50% equity interest

Bank
Loan

Defence Co

Q3: Do the contractual arrangements give A and B rights to the assets and obligations for the liabilities of the arrangement?

Solution: Contractual arrangement

Answer: No. Learning points: A guarantee does not, in itself, determine that the parties have obligations for the liabilities of a separate vehicle vehicle. In this example, the recourse of the bank to the parties is only in the event of a default of the loan by Defence Co. Only a primary, not a secondary obligation, would meet the obligation for the liabilities criterion. Rights to the assets are also required for joint operation classification. classification

Agenda

Introduction Point 1: Separate Vehicle Point 2: Unlimited Liability Vehicles Point 3: Obligations for Liabilities
Point 4: Other Facts and Circumstances

Point 5: Disclosures Conclusion

IFRS 11: Other facts and circumstances

Other facts
and circumstances

Do the parties have rights to substantially all the economic

benefits of the assets of arrangement? Y Does the arrangement depend on the parties on a continuous basis for settling its liabilities?

N
Joint Venture

Joint Oper J ration

IFRS 11: Other facts and circumstances

Asset side

Liability side

Joint Operation

JA must give parties rights to substantially all economic benefits relating to arrangement ( (asset t side) id ).

JA must cause arrangement to depend on parties on a continuous basis for settling its li biliti (liability liabilities (li bilit side) id ).

MiniMini -case 4: Other facts and circumstances

Contracted to purchase output 50/50

JA Partner 1
50% equity interest Cost price Cost price

JA Partner 2
50% equity interest

Joint Arrangement No access to external funding

Q4: Do the parties have rights to substantially all the economic benefits of the assets; does the arrangement depend on the parties for settling its liabilities?

Solution: Other facts and circumstances

Answer: Yes. Learning points: The parties have contractual rights to all of the output and therefore have rights to substantially all economic benefits of the assets; and The parties have an obligation for the arrangements liabilities, as there is exclusive dependence on the parties (payment for output) for the generation ti of f cash h flows. fl

Agenda

Introduction Point 1: Separate Vehicle Point 2: Unlimited Liability Vehicles Point 3: Obligations for Liabilities Point 4: Other Facts and Circumstances
Point 5: Disclosures

Conclusion

IFRS 12 might be challenging

Significant judgements / assumptions

In determining joint control over another th entity. tit In determining classification of joint arrangements in separate vehicles.

Summarised financial information

Several new line items required. Amounts in investees financial statements adjusted to reflect group measures. Reconciliation to investors financial statements.

Specific requirements
Name / place of business. Relationship with investor. Proportion owned. Accounting model.

Aggregation
Possible aggregation of similar entities, but JVs and associates cant can t be aggregated aggregated.

Agenda

Introduction Point 1: Separate Vehicle Point 2: Unlimited Liability Vehicles Point 3: Obligations for Liabilities Point 4: Other Facts and Circumstances Point 5: Disclosures
Conclusion

Key points to remember!

A separate vehicle needs to have at least some sort of legal form. Joint J i t operation ti classification l ifi ti requires direct rights to the assets and direct obligation (primary obligation) bli ti ) f for th the li liabilities. biliti In spite of legal form and contractual arrangements, certain facts and circumstances may result in joint operation classification. Dont underestimate the disclosures required under IFRS 12.

Fair Value: One Size Fits All?

KPMG I NTERNATIONAL S TANDARDS G ROUP F OR I NTERNAL U SE O NLY

Agenda

Introduction

Scope and FV Definition Selected Application Issues Conclusion

Learning objectives
By completing this module, 1) Describe the nature you will be able to:

and scope of IFRS 13. 2) Explain the implications of IFRS 13s FV definition. 3) Identify changes from current practice. 4) Apply IFRS 13 to selected issues.

Why are we discussing this topic? IFRS 13 is pervasive and impacts most IFRSs that require or permit FV measurement or disclosure. IFRS 13 introduces new and changed guidance for measuring FV and related disclosure requirements. New or changed guidance that is addressed in this module includes: Changed FV definition, including: Exit price and transfer notion. New guidance on: Unit of valuation. valuation Valuation adjustments. Valuation premise for non-financial assets. Significant decrease in volume or level of activity.

Background

Why

Consolidate FV measurement guidance into single g g standard. Increase convergence with US GAAP. Defines FV. Sets out single framework for FV measurement. Requires R i specific ifi FV measurement disclosures. Annual periods beginning on or after 1 January 2013. Early application permitted.

What When

Agenda

Introduction
Scope and FV Definition

Selected Application Issues Conclusion

Which of these is in the scope of IFRS 13?

In scope of FV measurement requirements Y: Initial and subsequent measurement Y: Initial measurement and FV disclosure Y: Subsequent measurement based on revaluation model N: Subsequent measurement based on cost model Y: Measurement of revenue In scope of FV disclosure requirements Y: Subsequent FV measurement Y: FV disclosure

Item Interest rate swap

Loan measured at a amortised o t sed cost Property plant and equipment

Y: Subsequent measurement based on revaluation model N: Subsequent measurement based on cost model N: Item not recognised in the statement of financial position Y FV disclosure Y: di l

Revenue Investment property t (cost model)

Y FV disclosure Y: disclos re

General IFRS 13 requirements on scope

Oth her IFRS permits s /require es?

Initial measurement (based on) FV Subsequent measurement (based on) FV Disclosure about measurement (based on) FV

Apply IFRS 13 FV measurement requirements if not explicitly scoped out

Apply IFRS 13 disclosure requirements if not explicitly scoped out

Implications of IFRS 13s FV definition

The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.

Pre IFRS 13

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

IFRS 13

Exit p price notion Liabilities: transfer vs settlement Market participant vs entity specific measurement Measurement date

Agenda

Introduction Scope and FV Definition

Selected Application Issues

Conclusion

Unit of account and unit of valuation NEW Is the unit of valuation provided in IFRS 13? No Determine unit of account in accordance with IFRS that requires or permits FV measurement Yes Unit of valuation may be different from unit of account

Unit of valuation = unit of account

Premiums, discounts and blockage factors

NEW No Premium or discount not permitted e.g. Bl k Blockage factors

Is premium or discount consistent with unit of account? Yes Is unit of account aggregation of identical individual assets/liabilities? Yes Is a Level 1 input p available for the individual asset/liability? Yes Application issue No

No

Yes

Is a Level 1 input p available for unit of account? No

Premium or discount may be allowed

Highest and best use of a nonnon-financial asset

NEW

Do market or other factors suggest that different use by market participant maximises assets value? Yes Identify other uses that are physically possible, legally permissible AND financially feasible either on: Stand-alone basis; or In I combination bi ti with ith other th assets t or assets t and d liabilities.

FV is based on assets current use.

Measure FV based on use that maximises the assets value = highest and best use.

No

Significant decrease in volume or level of activity and transactions that are not orderly

Area of Factors that may indicate significant decrease in judgement volume or level of activity include, for example: Few recent transactions; Quoted price not based on current information; or Quoted prices vary substantially over time or among market makers.

In case of I f a significant i ifi td decrease i in volume l or level l l of f activity, ti it f further th analysis l i of transactions or quoted prices is needed.

Circumstances that may indicate that a transaction is not orderly include e.g.: Inadequate exposure to allow usual and customary marketing activities Seller is near bankruptcy p y or receivership. p

Od l Orderly...

N t orderly... Not d l

Not known to be orderly...

NEW

Transactions that are (not) orderly

NEW Nature of transaction Weight placed on transaction price Depends on, for example: ...Orderly Volume Comparability to item being measured and Proximity to measurement date Little if any weight

...Not orderly

...Not known to be orderly

Less weight than on those known as orderly

Sufficient information may not be available to determine whether a transaction is orderly if entity is NOT party to transaction.

Area of judgement

MiniMini -case: Valuation techniques

To measure the FV of CGU X, the following valuation techniques are available to Company Z:
a) ) b) c) EBITDA multiple; multiple is based on EBITDA and enterprise value of f listed entities that have businesses similar to CGU X. Based on the recent sale price for a business similar to CGU X. Discounted estimated cash flows for the next five years with a terminal value.

Q: Arrange g the valuation techniques in the order of appropriateness for FV measurement purposes.

MiniMini -case solution 3: Valuation techniques

Q3: Arrange the valuation techniques in the order of appropriateness for FV measurement purposes. Valuation techniques are selected based on: their appropriateness in the circumstances, availability of sufficient data to measure FV, and maximisation of relevant observable inputs. Depending p g on the circumstances the use of a single g or multiple p valuation technique(s) may be appropriate. Whether an EBITDA multiple or sales price of a similar business is an observable input depends on adequate disclosure of purchase price and operating data as well as the necessity for adjustment of differences. Valuation based on discounted cash flows is not based on observable inputs.

It depends

Agenda

Introduction Scope and FV Definition Selected Application Issues

Conclusion

Key points to remember!

New requirements and principles introduced have a broad scope. Highest g and best use of a non-financial asset should be consistent with a market participants view. Use valuation technique that maximises use of observable inputs inputs.

Agenda

CONTACT DETAILS Kashif Zafar

Director, Audit KPMG Al Fozan & Al Sadhan

kashifzafar@kpmg.com