CONSOLIDATED AND SEPARATE FINANCIAL STATEMENTS OF GROUP 14.

1
ENTITIES

UNIT 3:
IND AS 110: CONSOLIDATED FINANCIAL STATEMENTS
3.1 OBJECTIVE OF IND AS 110
The objective of Ind AS 110 is to provide principles of when an entity should prepare consolidated financial
statements and how those consolidated financial statements should be prepared. In particular, Ind AS 110
provides following principles for presentation and preparation of consolidated financial statements:
 A parent that controls one or more subsidiaries should prepare consolidated financial statements
 Guidance on how to apply the principles of control evaluation to determine whether an investor has
control over an investee to be able to consolidate that investee
 Principles around accounting requirements for consolidated financial statements
 Definition of an investment entity and consolidation exemptions applicable to them
The principles mentioned above are discussed in this unit except the accounting requirements for
consolidated financial statements which is discussed in Unit 4.
Further, Ind AS 110 does not deal with the accounting requirements for business combinations and their
effects on consolidation, including goodwill arising on a business combination. Hence, such requirements are
also not discussed in this study material. Refer study material ‘Business Combination and Corporate
Restructuring’ for discussion on the same.

3.2 SCOPE OF IND AS 110

Ind AS 110 requires that an entity that is a parent should prepare consolidated financial statements.
However, there are certain exemptions and exceptions to this as follows:
Exemption
As per paragraph 4(a) of Ind AS 110, an parent entity that meets all of the following conditions need not
present consolidated financial statements:
(i) The entity is a wholly owned or partly owned subsidiary of another entity and all the owners of the
entity are informed, and they do not object to the entity not preparing consolidated financial
statements
(ii) The debt or equity instruments of the entity are not traded in a public market (whether domestic or
foreign stock exchange or an over-the-counter market, including local and regional markets)

© The Institute of Chartered Accountants of India

(iii) The entity has not filed nor is it in the process of filing its financial statements with a securities
commission or other regulatory organisation for the purpose of issuing any class of instruments in a
public market
(iv) The entity’s ultimate or any intermediate parent produces financial statements that are available for
public use and comply with Ind AS, in which subsidiaries are consolidated or are measured at fair value
through profit or loss in accordance with Ind AS 110
Illustration 1: Exception to prepare consolidated financial statements
Scenario A:
Following is the structure of a group headed by Company X:
Company X
100%
Company A

100% 100%

Company B Company C

Company X is a listed entity in India and prepares consolidated financial statements as per the
requirements of Ind AS. Company A is an unlisted entity and it is not in the process of listing any
of its instruments in public market. Company X does not object to Company A not preparing
consolidated financial statements. Whether Company A is required to prepare consolidated
financial statements as per the requirements of Ind AS 110?
Scenario B:
Assume the same facts as per Scenario A except, Company X is a foreign entity and is listed in
stock exchange of a foreign country and it prepares its financial statements as per the generally
accepted accounting principles (GAAP) applicable to that country. Will your answer be different in
this case?
Scenario C:
Assume the same facts as per Scenario A except, 100% of the investment in Company A is held
by Mr. X (an individual) instead of Company X. Will your answer be different in this case?
Solution:
Scenario A:
In this case, Company A satisfies all the conditions for not preparing consolidated financial statements i.e. it
is not a listed entity nor it is in the process of listing, the parent of Company A prepares consolidated financial
statements as per Ind AS which is available for public use and parent of Company A does not object
Company A not preparing consolidated financial statements.
Hence, Company A is not required to prepare consolidated financial statements.
Scenario B:
In this case, the consolidated financial statements of parent of Company A are not prepared under Ind AS.
Hence Company A cannot avail the exemption from preparation of consolidated financial statements.
Scenario C:
In this case, Mr. X (an individual) would not be preparing its financial statements as per the requirements of
Ind AS which is available for public use.
Hence Company A cannot avail the exemption from preparation of consolidated financial statements.
*****

Illustration 2: Exception to prepare consolidated financial statements

Scenario A:
Following is the structure of a group headed by Company A.
Company A
100% 60%

Company B Company C
100%
Company X

Company A is a listed entity in India and prepares consolidated financial statements as per the
requirements of Ind AS. Company C is an unlisted entity and it is not in the process of listing any
of its instruments in public market. 60% of the equity share capital of Company C is held by
Company A and balance 40% equity share capital is held by other outside investors. Company A
does not object to Company C not preparing consolidated financial statements. Whether Company
C is required to prepare consolidated financial statements as per the requirements of Ind AS 110?

Scenario B:

Assume the same facts as per Scenario A except, the balance 40% of the equity share capital of
Company C is held by Company B.

State whether C Limited is required to inform its other owner B Limited (owning 40%) of its
intention to not prepare consolidated financial statements as mentioned in paragraph 4(a)(i)?
 Solution:
Scenario A:
Company C is a partly owned subsidiary of Company A. In such case, Company C should inform the other
40% equity shareholders about Company C not preparing consolidated financial statements and if they do not
object then only Company C can avail the exemption from preparing consolidated financial statements.
Scenario B:
In this scenario, Company C is 100% held by Company A (60% direct investment and 40% investment
through Company B). Hence, Company C is not required to inform to Company B of not preparing
consolidated financial statements and can avail the exemption from preparing the consolidated financial
statements.
*****
Exception 1
Ind AS 110 does not apply to post-employment benefit plans or other long-term employee benefit plans to
which Ind AS 19 ‘Employee Benefits’ applies. Therefore, an entity which has set up such plans should not
consolidate them.

he company is a post-employee benefit plan which is accounted as per Ind AS 19 (refer Unit 1 of Chapter 9 for the accountin

Exception 2
An investment entity (explained in section 3.7 of this Unit) that is required to measure all of its subsidiaries at
fair value through profit or loss need not present consolidated financial statements. This exception is further
explained subsequently in this unit.
Note:
It may be noted that the Indian GAAP (i.e. the accounting standards under The Companies (Accounting
Standards) Rules, 2006) contained two exceptions from consolidation, which are no longer applicable:
 When control is intended to be temporary; or
 When the subsidiary operates under severe long-term restrictions
 3.3 CONTROL EVALUATION
As per Ind AS 110, an investor needs to determine whether it controls an investee and if yes then the investor
would be treated as a parent and the investee would be treated as a subsidiary of the parent.
An investor controls an investee if and only if the investor has all of the following three elements:

Ability to use power over the investee to affect the investor’s returns
Exposure, or rights, to variable returns from the investee
Power over the investee Control over the investee

After doing an initial assessment of control over an investee, the investor should reassess the control over the
investee when there are changes to one or more of the three elements of control mentioned above.
Further, there may be situations where the investor is not the only one who control the investee and it
may need to act in co-operation with any other entity. There may also be a situation where there is no investor
who individually controls the investee. In such scenario, the investor would account for the interest in such
investees in accordance with other applicable Ind AS such as Ind AS 111 for joint arrangement (discussed
in Unit 5 of this Chapter), Ind AS 28 for investments in associates (discussed in Unit 6 of this Chapter) or
Ind AS 109 for financial instruments (discussed in Chapter 12).
Each of the elements of control evaluation are explained below.
Power
What is power?
The first criterion of control evaluation is to determine whether the investor has power over the investee. An
investor gets power over an investee if it has three elements:
A. existing rights that give it
B. the current ability
C. to direct the relevant activities of the investee.
In some situations, activities both before and after a particular set of circumstances arises or event occurs may be
relevant activities. When two or more investors have the current ability to direct
 relevant activities and those activities occur at different times, the investors shall determine which investor is
able to direct the activities that most significantly affect those returns consistently with the treatment of
concurrent decision-making rights. The investors shall reconsider this assessment over time if relevant
facts or circumstances change.We will move in a reverse order to understand the meaning of ‘power’ in the
context of Ind AS 110. In other words, we will first learn what are ‘relevant activities’, then we will move
to understand what is intended to be covered within the scope of ‘current ability’ and finally, we will link
this understanding with the concept of ‘rights’.
How to identify the relevant activities and how the decisions about those activities are
made?

Relevant activities are the activities of investee that significantly affect the investee’s returns. For a detailed
understanding of what encompasses ‘returns’, please refer to section 3.3.2.
There may be range of operating and financing activities that would significantly affect the returns of an
investee. Examples of activities related to operating and financing activities that can be relevant activities
include, but not limited to:

Managing financial assets

Selling and purchasing of Selecting, acquiring or
goods and services during their life (including disposing of assets
upon default)

Establishing operating and

Researching and Determining a funding
capital decisions of the
developing new products structure or obtaining
investee, including budgets
or processes funding

Appointing, terminating and

remunerating an investee’s key
management personnel or service
providers

The power to direct the relevant activities can be shared by multiple parties but those rights may not meet
the definition of joint control.

board of directors. All strategic operating and financing decisions (ie decisions in respect of the activities that significantly aff
The five parties do not jointly control entity Z because unanimous consent is not required for decisions relati

There may be another situation where two or more investors have the rights to unilaterally direct different
relevant activities of an investee. In such situation, one has to decide which activities can most significantly
affect the returns of the investee and the investor having the ability to direct those activities would be
considered to have power over the investee. The investors shall reconsider this assessment in case there is
change in the facts or circumstances.

Illustration 3: Different investors have ability to direct different relevant activities

A Ltd. and B Ltd. have formed a new entity AB Ltd. for constructing and selling a scheme of
residential units consisting of 100 units. Construction of the residential units will be done by A Ltd.
and it will take all the necessary decision related to the construction activity. B Ltd. will do the
marketing and selling related activities for the units and it will take all the necessary decisions
related to marketing and selling. Based on above, who has the power over AB Ltd.?

Solution:

In this case, both the investors A Ltd. and B Ltd. have the rights to unilaterally direct different relevant
activities of AB Ltd. Here, investors shall determine which activities can most significantly affect the returns
of the investee and the investor having the ability to direct those activities would be considered to have
power over the investee. Hence, if the investors conclude that the construction related activities would
most significantly affect the returns of AB Ltd. then A Ltd. would be said to have power over AB Ltd.
On the other hand, if it is concluded that marketing and selling related activities would most significantly
affect the returns of AB Ltd. then B Ltd. would be said to have power over AB Ltd.
*****

Illustration 4: Determining the relevant activities

A Ltd. is an asset manager of a venture capital fund i.e. Fund X. Out of the total outstanding units
of the fund, 10% units are held by A Ltd. and balance 90% units are held by other investors.
Majority of the unitholders of the fund have right to appoint a committee which will manage the day
to day administrative activities of the fund. However, the decisions related to the investments /
divestments to be done by Fund X is taken by asset manager i.e. A Ltd. Based on above, who has
power over Fund X?

Solution:

In this case, A Ltd. is able to direct the activities that can most significantly affect the returns of Fund X.
Hence A Ltd. has power over the investee. However, this does not mean that A Ltd. has
control over the fund and consideration will have to be given to other elements of control evaluation as
well i.e. exposure to variable returns and link between power and exposure to variable returns.
*****
Current ability to direct relevant activities
An investor would have current ability to direct relevant activities if that investor were able to make decisions
at the time those decisions need to be taken. An investor can have the current ability to direct the activities of
an investee even if it does not actively direct the activities of the investee.
Having the current ability to direct the activities of an investee is not limited to being able to act today. There
may be steps to be taken in order to act - for example, an investor may need to initiate a meeting before it
can exercise its voting or other rights that give it power. However, such a delay would not prevent the
investor from having power, assuming that there are no other barriers that would prevent the investor from
exercising its rights when it chooses to do so.
For some investees, particularly those with most of their operating and financing decisions predetermined,
decisions that significantly affect the returns of the investee are not made continuously. Such decisions may
be made only if particular events occur or circumstances arise. For such investees, having the ability to make
those decisions if and when they arise is a source of a current ability to direct the relevant activities.
It must be borne in mind that the current ability to direct the activities of an investee would, in all cases, arise
from rights (voting rights, potential voting rights, rights within other arrangements or a combination of
these).
In some situations, activities both before and after a particular set of circumstances arises or event occurs may be
relevant activities. When two or more investors have the current ability to direct relevant activities and those
activities occur at different times, the investors shall determine which investor is able to direct the activities
that most significantly affect those returns consistently with the treatment of concurrent decision-making
rights. The investors shall reconsider this assessment over time if relevant facts or circumstances change.

Illustration 5: Current ability to direct the relevant activities

An investment vehicle (the investee) is created and financed with a debt instrument held by an
investor (the debt investor) and equity instruments held by a number of other investors. The equity
tranche is designed to absorb the first losses and to receive any residual return from the investee.
One of the equity investors who holds 30 per cent of the equity is also the asset manager.
The investee uses its proceeds to purchase a portfolio of financial assets, exposing the investee to the
credit risk associated with the possible default of principal and interest payments of the assets. The
transaction is marketed to the debt investor as an investment with minimal exposure to the credit
risk
 associated with the possible default of the assets in the portfolio because of the nature of these assets
and because the equity tranche is designed to absorb the first losses of the investee.
The returns of the investee are significantly affected by the management of the investee’s asset
portfolio, which includes decisions about the selection, acquisition and disposal of the assets
within portfolio guidelines and the management upon default of any portfolio assets. All those
activities are managed by the asset manager until defaults reach a specified proportion of the
portfolio value (ie when the value of the portfolio is such that the equity tranche of the investee has
been consumed). From that time, a third-party trustee manages the assets according to the
instructions of the debt investor.
Based on the above, who has power over the investment vehicle?
Solution:

Managing the investee’s asset portfolio is the relevant activity of the investee.
The asset manager has the ability to direct the relevant activities until defaulted assets reach the specified
proportion of the portfolio value; the debt investor has the ability to direct the relevant activities when the
value of defaulted assets surpasses that specified proportion of the portfolio value.
The asset manager and the debt investor each need to determine whether they are able to direct the activities
that most significantly affect the investee’s returns, including considering the purpose and design of the
investee as well as each party’s exposure to variability of returns.
*****

Rights that give power to an investor

Power arises from rights. To have power over an investee, an investor must have existing rights that give the
investor the current ability to direct the relevant activities.
The rights that give an investor power over an investee can differ investee by investee. Following are some
of the examples (not an exhaustive list) of various forms of rights that, either individually or in
combination with other rights, can give power to an investor:
Form of right Illustration
Voting rights or potential voting rights of an An investor holding majority of the equity share capital
investee (this is further explained of an investee. Concepts of power through voting or
subsequently in this unit). potential voting rights are further discussed in detail in
section 3.3.1.3 of this unit.
Rights to appoint, reassign or remove An investor having right to appoint majority of the
members of an investee’s key management members of the Board of Director who have power to
personnel who have the ability to direct the take decisions related to relevant activities.
relevant activities.
 Rights to appoint or remove another entity Right with an investor to appoint or remove an asset
that directs the relevant activities. manager who takes decisions related to investments /
divestments by a venture capital fund.

Rights to direct the investee to enter into, Right with an investor to direct the investee to sell all of
or veto any changes to, transactions for the its outputs to a group company of the investor at the
benefit of the investor. price determined by investor

Other rights (such as decision-making rights Right related to relevant activities given to a single
specified in a management contract) that investor by all other investors through a
give the holder the ability to direct the shareholders’ agreement
relevant activities.

In most of the case where the investee has a range of relevant activities and decisions are required to be
taken on a continuous basis for those activities then it will be voting or similar rights that give an investor
power over the investee.
3.3.1.1A Substantive rights vs Protective Rights
For the purpose of determination of power over an investee, an investor shall consider only those rights which
are substantive. Protective rights are not considered for the determination of power. Below table summarises
the difference between substantive rights and protective rights:
Substantive rights Protective rights
Substantive rights can give the Protective rights do not give investor power over the investee.
investor power over the investee.
Substantive rights relate to the Protective rights relate to protect the interest of the party
relevant activities of the investee. holding those rights without giving the holder the right over
the relevant activities of the investee.

Both the above rights are discussed below in detail.

1. Substantive rights
For a right to be substantive, the holder must have the practical ability to exercise that right.
Assessment of whether the rights are substantive requires judgement taking into consideration all the facts and
circumstances. Following are some of the factors (not an exhaustive list) that should be considered while
assessing whether the rights are substantive or not:
a) Whether there are any barriers that prevent the holder from exercising the rights. Example of such
barriers (not an exhaustive list) can be as follows:
 Financial penalties and incentives
 High exercise or conversion price
  Terms and conditions that make it unlikely that the rights would be exercised, like, conditions
that narrowly limit the timing of their exercise
 The absence of an explicit, reasonable mechanism in the founding documents of an investee or in
applicable laws or regulations that would allow the holder to exercise its rights.
 The inability of the holder of the rights to obtain the information necessary to exercise its rights.
 Operational barriers or incentives. For example, in case of a venture capital fund managed by an
asset manager, there is absence of other managers willing or able to provide specialised services or
provide the services and take on other interests held by the existing manager.
 legal or regulatory requirements. For example, where a foreign investor is prohibited from
exercising its rights
b) When the exercise of rights requires agreement of more than one party, or when the rights are
held by more than one party, whether a mechanism is in place that provides those parties with the
practical ability to exercise their rights collectively if they choose to do so. The lack of such a
mechanism is an indicator that the rights may not be substantive.
An independent board of directors may serve as a mechanism for numerous investors to act collectively
in exercising their rights.
c) Whether the party or parties that hold the rights would benefit from the exercise of those rights.
For example, the holder of potential voting rights in an investee shall consider the exercise or
conversion price of the instrument. The potential voting rights are more likely to be substantive
when the exercise price is lower than the market price or when there are other synergies anticipated
between the investor and the investee.
Below are some illustrations that explain the above factors of determining whether the rights held by
investors are substantive or not:
Illustration 5: Voting rights are substantive or not
Scenario A:
Following is the voting power holding pattern of B Ltd.
 10% voting power held by A Ltd.
 90% voting power held by 9 other investor each holding 10%
All the investors have entered into a management agreement whereby they have granted the
decision-making powers related to the relevant activities of B Ltd. to A Ltd. for a period of 5
years.
 After 2 years of the agreement, the investors holding 90% of the voting powers have some
disputes with A Ltd. and they want to take back the decision-making rights from A Ltd. This
can be done by passing a resolution with majority of the investors voting in favour of the
removal of rights from A Ltd. However, as per the termination clause of the management
agreement, B Ltd. will have to pay a huge penalty to A Ltd. for terminating the agreement
before its stated term.
Whether the rights held by investors holding 90% voting power are substantive?
Scenario B:
Assume the same facts as per Scenario A except, there is no penalty required to be paid by
B Ltd. for termination of agreement before its stated term. However, instead of all other
investors, there are only 4 investors holding total 40% voting power that have disputes with
A Ltd. and want to take back decision-making rights from A Ltd.
Whether the rights held by investors holding 40% voting power are substantive?
Solution:
Scenario A:
If the investors holding 90% of the voting power exercise their right to terminate the management
agreement, then it will result in B Ltd. having to pay huge penalty which will affect the returns of B
Ltd. This is a barrier that prevents such investors from exercising their rights and hence such
rights are not substantive.
Scenario B:
To take back the decision-making rights from A Ltd., investors holding majority of the voting power
need to vote in favour of removal of rights from A Ltd. However, the investors having disputes with
A Ltd. do not have majority voting power and hence the rights held by them are not substantive.
*****

Illustration 6: Potential voting rights are substantive or not

Scenario A:
An investor is holding 30% of the voting power in ABC Ltd. The investor has been granted
an option to purchase 30% more voting power from other investors. However, the exercise
price of the option is too high compared to the current market price of ABC Ltd. because
ABC Ltd. is incurring losses since last 2 years and it is expected to continue to incur losses
in future period as well. Whether the right held by the investor to exercise purchase option
is substantive?
Scenario B:
Assume the same facts as per Scenario A except, the option price is in line with the current
market price of ABC Ltd. and ABC Ltd. is making profits. However, the option can be
 exercised in next 1 month only and the investor is not in a position to arrange for the require
amount in 1 month’s time to exercise the option. Whether the right held by the investor to
exercise purchase option is substantive?
Scenario C:
Assume the same facts as per Scenario A except, ABC Ltd. is making profits. However, the
current market price of ABC Ltd. is not known since the ABC Ltd. is a relatively new
company, business of the company is unique and there are no other companies in the
market doing similar business. Hence the investor is not sure whether to exercise the
purchase option. Whether the right held by the investor to exercise purchase option is
substantive?
Solution:
Scenario A:
The right to exercise purchase option is not substantive since the option exercise price is too high
as compared to current market price of ABC Ltd.
Scenario B:
The right to exercise purchase option is not substantive since the time period for the investor to
arrange for the requisite amount for exercising the option is too narrow.
Scenario C:
The right to exercise purchase option is not substantive. This is because the investor is not able to
obtain information about the market value of ABC Ltd. which is necessary in order to compare the option
exercise price with market price so that it can decide whether the exercise of purchase option would
be beneficial or not.
*****
Illustration 7: Removal rights are substantive or not
A venture capital fund is managed by an asset manager who has right to take the
investment and divestments decisions related to the fund corpus. The asset manager is
also holding some stake in the fund. The other investors of the fund have right to remove
the asset manager.
However, in the present scenario, there is absence of other managers who are willing or
able to provide specialised services that the current asset manager is providing and
purchase the stake that the current asset manager is holding in the fund. Whether the
removal rights available with other investors are substantive?
 Solution:
If the other investors exercise their removal rights, then it will impact the operations of the fund and
ultimately the returns of the fund since there is no substitute of the current asset manager available
who can manage the corpus of the fund. Hence the removal rights held by other investors are not
substantive.
*****

For a right to be substantive, it should be exercisable when decisions about the direction of the relevant
activities need to be made. In most of the cases a right, to be a substantive right, rights need to be currently
exercisable. However, there may be some situations where a right can be substantive, even though it may
not be currently exercisable.

olding scheduled to be held after 30 days to take decision about relevant activities of the company. In such case, even though

An investor may be directing relevant activities of an investee and the evidence of that can help determine
whether the investor has power. However, such evidence is not, in itself, conclusive in determining whether
the investor has power over an investee.
While assessing the power, an investor should also consider the substantive rights held by other investors. The
other investors may not be able to initiate the decisions about relevant activities on their own, but the rights
held by them to approve or block any decision may prevent the investor from taking decision about relevant
activities.

e in favour of calling the meeting. However, to pass any decision in the meeting, unanimous consent of all investors is requi

2. Protective rights
Protective rights are the rights designed to protect the interest of the party holding those rights
without giving that party power over the entity to which those rights relate.
 Such rights mainly relate to fundamental changes to the activities of an investee or apply in exceptional
circumstances. However, not all the rights that apply in exceptional circumstances or are contingent on future
events are protective rights. Protective rights do not give its holder power or prevent another party from
having power over an investee. The examples of protective rights include, but not limited to, following:

A right exercisable by an investor only in the event of a fraud or default by other investors having power to take decisions about relevant activities

*A lender’s right to appoint its nominee director in the Board of a borrower to ensure the borrower do not engage in any activities that significantly increase the credi

Rights held by minority shareholders to approve decisions related to capital expenditure greater than required in normal course of business or to approve issue of equity

A lender’s right to seize the assets of a borrower if the borrower defaults in repayment of loan instalments

rove or block decisions related to change in the name of the investee, amendment to constitutional documents of the investee to enter into a new business, change in th

*Note: The 2nd right (illustrated above) is not protective in all circumstances. So far as the nomination doesn’t
result in majority control over the Board, it can be considered protective.
The effect of substantive and protective rights is summarised below:

Type of rights held by investor Type of rights held by other parties Conclusion on ‘power’?

Substantive Protective Investor has power

Other parties have power

Protective Substantive

Further evaluation needed

Substantive Substantive
Franchises

Apart from the examples of protective rights mentioned above, one more example can be of rights of a
franchisor in a franchise agreement. In a franchise agreement, the investee i.e. the franchisee usually give the
franchisor the rights that are related to protect the franchise brand. Following are some of the salient features
of a franchise arrangement which indicates that the rights of a franchisor in a franchise agreement are
protective rights:

Salient features of a franchise agreement that indicate that rights of

franchisor are protective rights

Franchisor's right do Other parties have Franchisor's rights do

not give it ability to current ability to direct not affect the rights of Franchisee operates
direct the relevant the relevant activities others to take decisions the business for its
activities of of the franchisee about relevant activities own account
franchisee

Note: Control over fundamental decisions as the legal form of the franchisee and its funding structure may be
determined by parties other than the franchisor and may significantly affect the returns of the franchisee. The
lower the level of financial support provided by the franchisor and the lower the franchisor’s exposure to
variability of returns from the franchisee the more likely it is that the franchisor has only protective
rights.

Illustration 8: Protective rights of a franchisor

ABC Ltd. is a manufacturer of branded garments and is the owner of Brand X. PQR Ltd. has
entered into a franchise agreement with ABC Ltd. to allow PQR Ltd. to set up a retail outlet to sell
the products of Brand X.
As per the agreement, PQR Ltd. will set up the retail outlet from its own funds, decide the capital
structure of the entity, hire employees and their remuneration, select vendors for acquiring capital
items, etc. However, ABC Ltd. will give certain operating guidelines like the interior of the retail
outlet, uniform of the employees and other such guidelines to protect the brand name of ABC Ltd.
Whether the rights held by ABC Ltd. protective or substantive?
Solution:
The activities that most significantly affect the returns of PQR Ltd. are the funding and capital structure of
PQR Ltd., hiring of employees and their remuneration, vendors for capital items, etc.
 which are exercisable by PQR Ltd. Further, the retails outlet is being set up by PQR Ltd. without any
financial support from ABC Ltd. The rights available with ABC Ltd. are to protect the brand name of
ABC Ltd. and such rights do not affect the ability of PQR Ltd. to take decisions about relevant activities.
Hence, the rights held by ABC Ltd. are protective rights.
*****
Voting rights
Generally, an investor gets power over an investee by way of voting rights that allow it to direct the relevant
activities.
However, there can be situations where voting rights (even if the investor holds majority of them) do not
give investor power over the investee. This can be in the following situations:
 Voting rights are not substantive (as discussed above).
 If another entity has existing rights that provide that entity with the right to direct the relevant activities
and that entity is not an agent of the investor, the investor does not have power over the investee

Even if the voting rights do not give power to an investor, there can be other rights which would give an
entity power over the investee. In this section we will discuss various scenarios of power through voting
rights and power other than through voting rights.
Power through voting rights
In the most straightforward cases, the investor that holds a majority of voting rights has power over an
investee. However, there can be certain cases where an investor can have power even if it holds less than a
majority of the voting rights of an investee.
A. Power with a majority of the voting rights
An investor that holds more than half of the voting rights of an investee has power in the following situations:

A majority of the members of the governing body that directs the relevant activities are appointed by a vote of the
nt activities are directed by a vote of the holder of the majority of the voting rights
OR

For example, in case of a company where the decisions related to relevant activities are taken by Board of
Directors of the company and the Board members are appointed by shareholder holding majority of the voting
rights. Then the shareholder holding majority of the voting rights has power over the company.
B. Power without a majority of voting rights
There can be certain cases where an investor can have power even if it holds less than a majority of the
voting rights of an investee. Following are the examples of power without majority voting rights:

Contractual Rights from other

The investor's voting
arrangement with other contractual rights
vote holders arrangements

Combination of all of
Potential voting rights above

Contractual arrangement with other vote holders

An investor, who is not holding voting rights that are sufficient to given it power over the investee, may enter
into a contract with other vote holders to give the investor rights to exercise voting rights which are
sufficient to have power over the investee. In such case, the investor would direct the other vote
holders on how they should vote whereby the investor gets power to direct the decision related to relevant
activities.
Rights from other contractual arrangements
Apart from holding voting rights, an investor might be having decisions-making rights related to relevant
activities of the investee pursuant to a contractual arrangement. Such contractual rights in
combination with voting rights may give investor power to direct the relevant activities like
manufacturing process of the investee or other operating and financing activities of the investee.
However, in the absence of any other rights, economic dependence of an investee on the investor (such as
relations of a supplier with its main customer) does not lead to the investor having power over the investee.
The investor's voting rights
There may be certain situations where even though an investor is not holding majority of the voting rights, but
the voting rights held by it are sufficient to give it practical ability to have power over the investee
unilaterally. Generally, this is termed as de-facto control.
In assessing the sufficiency of the voting rights of an investor, one should consider the size of the
investor’s holding of voting rights relative to the size and dispersion of holdings of the other vote
holders. This is interpreted as follows:
Particulars Higher number or size Lower number or size
Number of voting rights held by More likely to have power Less likely to have power
investor
Size of investor’s voting rights relative More likely to have power Less likely to have power
to voting rights held by other holders

Number of parties required to More likely to have power Less likely to have power
outvote the investor

Illustration 9: Voting rights of investor are sufficient to give it power

An investor holds 45% of the voting rights of an investee. The remaining voting rights are held by
thousands of shareholders, none individually holding more than 1% of the voting rights. None of
the shareholders has any arrangements to consult any of the others or make collective decisions.
Whether the investor holding 45% voting right have power over the investee?

Solution:
On the basis of the absolute size of its holding by the investor and the relative size of the voting rights held by
other shareholders, it is more likely that the investor would have power over the investee.
*****
Illustration 10: Voting rights of investor are sufficient to give it power
ABC Ltd. holds 40% of the voting rights of XYZ Ltd. The remaining voting rights are held by 6 other
shareholders, each individually holding 10% each. Whether the investor holding 40% voting right
have power over the investee?
Solution:
In this case, it is less likely that ABC Ltd. will have power over XYZ Ltd. since the size of the number
of shareholders required to outvote ABC Ltd. is not so high. Additional facts and circumstances should
also be considered to determine whether ABC Ltd. has power or not.
*****
Apart from the size of the investor’s voting rights, one should also consider the i) potential voting rights held
by investor or other vote holders or parties (discussed subsequently in this section) and
ii) rights arising from other contractual arrangements (already discussed above) to determine whether the
investor’s voting rights are sufficient to give it power over the investee.
Ind AS 110 provides that when the decisions related to relevant activities of an investee are taken by
majority vote holders and the investor holds sufficiently more voting rights compared to other vote
holders and the other shareholdings are widely dispersed then it may be clear from the above factors i.e. i)
size of the investor’s voting rights, ii) potential voting rights and iii) other contractual
arrangements that investor has power over the investee. In such case, there is no need to consider other
factors to evaluate who has power over the investee.
 For examples, in the illustration 9 discussed above, the investor holding 45% of voting rights may, on
the basis of the absolute size of its holding and the relative size of the other shareholdings,
conclude it has power over the investee without the need to consider any other evidence of
power.
 However, in illustration 10 above, the absolute size of the ABC Ltd.’s holding and the relative size of
the other shareholdings alone are not conclusive in determining whether ABC Ltd. has power over the
investee and hence additional facts and circumstances need to be considered.
When it is not clear from the three factors of sufficiency of voting rights of an investor discussed above, the
investor should consider additional facts and circumstances such as the voting patterns at previous
shareholders’ meetings to determine whether investor has power over the investee.
Solution:
Illustration 11: Voting patterns at previous shareholders’ meetings
An investor holds 35% of the voting rights of an investee. Three other shareholders each hold 5%
of the voting rights of the investee. The remaining voting rights are held by numerous other
shareholders, none individually holding more than 1% of the voting rights. None of the
shareholders has arrangements to consult any of the others or make collective decisions.
Decisions about the relevant activities of the investee require the approval of a majority of votes
cast at relevant shareholders’ meetings—75% of the voting rights of the investee have been cast
at recent relevant shareholders’ meetings.
Whether the investor’s voting rights are sufficient to give it power to direct the relevant activities of
the investee?

In this case, the active participation of the other shareholders at recent shareholders’ meetings indicates that
the investor would not have the practical ability to direct the relevant activities unilaterally, regardless of
whether the investor has directed the relevant activities because a sufficient number of other shareholders
voted in the same way as the investor.
*****
Ind AS 110 provides that if it is not clear from the above factors of sufficiency of voting rights of an investor
that investor has power then the investor does not control the investee.
Potential voting rights
Potential voting rights are rights to obtain voting rights of an investee, such as those arising from
convertible instruments or options or forward contracts. Those potential voting rights are
considered only if the rights are substantive as per the guidance discussed earlier.
When considering potential voting rights, an investor shall consider the purpose and design of the instrument
giving those rights as well as any other benefits that the investor would get from the exercise of those rights.
Potential voting rights are to be considered in combination with voting or other decisions-making rights that
the investor might have to assess whether investor has power or not.
Illustration 12: Potential voting rights
Investor A and two other investors each hold a third of the voting rights of an investee. The
investee’s business activity is closely related to investor A. In addition to its equity instruments,
investor A also holds debt instruments that are convertible into ordinary shares of the investee at
any time for a fixed price. The conversion rights are substantive. If the debt were converted,
investor A would hold 60% of the voting rights of the investee. Investor A would benefit from
realising synergies if the debt instruments were converted into ordinary shares. Whether investor A
has power over the investee?
Solution:
Investor A has power over the investee because it holds voting rights of the investee together with substantive
potential voting rights that give it the current ability to direct the relevant activities.
*****
Power other than through voting rights
When voting rights cannot have a significant effect on an investee’s returns, such as when voting rights relate
to administrative tasks only the investor shall consider following factors to determine whether it has power
over the investee:
 Purpose and design of the investee
 Contractual arrangements
 Special relation between investor and investee
Purpose and design of the investee
Evaluation of purpose and design of the investee helps in:
 identification of relevant activities of the investee,
 how decisions about the relevant activities are made,
 who has the current ability to direct those activities, and
 who receives returns from those activities.
In assessing the purpose and design of an investee, an investor shall consider its involvement and
decisions made at the time of design of the investee and evaluate whether such involvement
provide the investor with rights that are sufficient to give it power. Being involved in
the design of an investee alone is not sufficient to give an investor control. However, involvement in the
design may indicate that the investor had the opportunity to obtain rights that are sufficient to give it
power over the investee.
Illustration 13: Purpose and design of the investee
PQR Ltd. has entered into a contract with a state government to construct a power plant and
distribute the electricity generated from the plant to the households of the state. For this, PQR Ltd.
has set up a new entity XYZ Ltd. PQR Ltd. was involved in the design of XYZ Ltd. The decisions
related to the relevant activities of XYZ Ltd. i.e. how much electricity to generate or the price at
which units of electricity to be sold to customers, etc. are not determined by the voting rights.
Whether PQR Ltd. has power over XYZ Ltd.?
Solution:
PQR Ltd. was involved in the design of XYZ Ltd. Accordingly, its involvement in the design may indicate
that the investor had the opportunity to obtain rights that are sufficient to give it power over the
investee. However, being involved in the design of XYZ Ltd. alone is not sufficient to give PQR Ltd. control
over XYZ Ltd. and hence other facts and circumstances, such as other contractual arrangements, should
also be considered.
*****
Contractual arrangements
An investor shall consider contractual arrangements such as call rights, put rights and liquidation rights that
give it explicit or implicit decision-making rights that are closely related to the relevant activities of the
investee even though they may occur outside the legal boundaries of the investee.
For some investees, decisions about relevant activities are required to be taken only when particular
circumstances arise or events occur. The investee may be designed so that the direction of its activities and
its returns are predetermined unless and until those particular circumstances arise or events occur. In this case,
only those decisions that are required to be taken when those circumstances or events occur would
significantly affect its returns and thus be relevant activities. However, it is not necessary for those
circumstance or events to actually occur to establish that investor has power over the investee. The fact that
the investor has rights to take those decisions whenever required is sufficient to establish power.

Illustration 14: Rights contingent upon future events

An investee’s only business activity, as specified in its founding documents, is to purchase
receivables and service them on a day-to-day basis for its investors. Following is the relevant fact
pattern:
 The servicing on a day-to-day basis includes the collection and passing on of principal and
interest payments as they fall due.
  Upon default of a receivable the investee automatically puts the receivable to an investor as
agreed separately in an agreement between the investee and the investor.
 The only relevant activity is managing the receivables upon default because it is the only
activity that can significantly affect the investee’s returns.
 Managing the receivables before default is not a relevant activity because the activities
before default are predetermined and amount only to collecting cash flows as they fall due
and passing them on to investors.
Whether the investor has power over the investee?
Solution:
In this question, the design of the investee ensures that the investor has decision-making power only in
case of default of a receivable. The terms of the agreement between investee and investor are integral to the
overall transaction and the establishment of the investee. Therefore, the terms of the agreement together
with the founding documents of the investee lead to the conclusion that the investor has power over the
investee even though the investor takes ownership of the receivables only upon default and manages the
defaulted receivables outside the legal boundaries of the investee.
*****
An investor may have an explicit or implicit commitment to ensure that an investee continues to operate as
designed. Such a commitment may increase the investor’s exposure to variability of returns and thus increase
the incentive for the investor to obtain rights sufficient to give it power. Therefore, a commitment to ensure
that an investee operates as designed may be an indicator that the investor has power, but does not, by itself,
give an investor power, nor does it prevent another party from having power.
Solution:
Illustration 15: Commitment to ensure that an investee operates as designed
A Ltd. is a manufacturer of pharmaceutical products. A Ltd. has invested in share capital of B Ltd.
which is a manufacturer of packing material for pharmaceutical products. A Ltd.’s requirements of
packing materials for its products are entirely supplied by B Ltd. A Ltd. is not purchasing the
packing materials from any other vendors because the materials supplied by other vendors are of
inferior quality. Whether A Ltd. has power over B Ltd.?
A Ltd. would be the most affected by the operations of B Ltd. since it is dependent on B Ltd. for the supply of
packing materials. Therefore A Ltd. would be committed to ensure that B Ltd. operates as designed. This
can be an indicator of A Ltd. having power over B Ltd. But it has to consider other facts and circumstances
as well to conclude whether it control B Ltd. or not.
*****
Special relation between investor and investee

Ind AS 110 recognises that the control assessment process described above will not always yield a clear
conclusion. To assist in reaching a conclusion in marginal situations, the Standard includes guidance on:
 Evidence of possible power
 Indicators of possible power
 Incentives to obtain power
In some circumstances it may be difficult to determine whether an investor’s rights are sufficient to give it
power over an investee. In such cases, paragraph B18 of Ind AS 110 provides guidance to enable the
assessment of power whereby the investor shall consider evidence of whether it has the practical
ability to direct the relevant activities unilaterally. Following are some of the examples of such evidences:
Evidence Illustration
The investor can appoint or approve the An investor holds 40% of the voting rights of an
investee’s key management personnel investor. However, the investor has right to appoint
who can direct the relevant activities majority of the board members of investee and the
decisions of relevant activities of investee are taken by its
board.
The investor can direct the investee to enter A Ltd. and B Ltd. both holds 50% each of voting
into, or can veto any changes to, significant rights of an investee and also have right to appoint 2
transactions for the benefit of the investor members each in board of investee. The decision of
relevant activities of investee are taken in board meetings
by majority members. A Ltd. also has right to appoint a
chairman of the board who will have a casting vote in
case of a deadlock situation.
The investor can dominate either the X Ltd. has invested in the share capital of P Ltd. Apart
nominations process for electing from A Ltd. there are 4 other investors in P Ltd. Each
members of the investee’s governing body investor has right to appoint one member on the board of
or the obtaining of proxies from other P Ltd. who will have right to direct the relevant
holders of voting rights. activities of P Ltd. Out of the 4 other investors, 2
investors are related parties of X Ltd. and hence X Ltd.
can direct them to appoint their representative on the
board as per X Ltd.’s choice. Accordingly, X Ltd. can
appoint majority of the members of the board of P Ltd.

The investee’s key management The chief executive officer of the investee and the chief
personnel are related parties of the executive officer of the investor are the same person.
investor
 The majority of the members of the The majority of the board members of the investee are also
investee’s governing body are related the board members of the investor.
parties of the investor.

As per paragraph B19 of Ind AS 110, sometimes there will be indications that the investor has a special
relationship with the investee, which suggests that the investor has more than a passive interest in
the investee. The existence of any individual indicator, or a particular combination of indicators, does not
necessarily mean that investor has power over an investee. However, having more than a passive interest in
the investee may indicate that the investor has other related rights sufficient to give it power over an investee.
For example, the following suggests that the investor has more than a passive interest in the investee and, in
combination with other rights, may indicate power:

Investee's key management personnel who can direct the relevant activities are current or previous employees of the investor

Investee's operations are dependent on the investor such as in following situations:

•Dependence to fund a significant portion of its operations.

•Guarantee a significant portion of the investee’s obligations.
•Dependence for critical services, technology, supplies or raw materials.
•Assets such as licences or trademarks that are critical to investee’s operations are controlled by investor
•Dependence on for key management personnel, such as when the investor’s personnel have specialised
knowledge of the investee’s operations.

A significant portion of the investee’s activities either involve or are conducted on behalf o

Investor’s exposure, or rights, to returns from its involvement with the investee is disproportionately greater th

•For example, there may be a situation in which an investor is entitled, or exposed, to more than half of the
returns of the investee but holds less than half of the voting rights of the investee.

Further, paragraph B20 of Ind AS 110 provides that the greater an investor’s exposure, or rights, to
variability of returns from its involvement with an investee, the greater is the incentive for the investor to
obtain rights sufficient to give it power. Therefore, having a large exposure to variability of returns is an
indicator that the investor may have power. However, the extent of the investor’s exposure does not, in itself,
determine whether an investor has power over the investee.
When the factors set out in paragraph B18 and the indicators set out in paragraphs B19 and B20 of Ind AS
110 are considered together with an investor’s rights, greater weight shall be given to the evidence of power
described in paragraph B18.
Exposure, or rights, to variable returns from an investee
When assessing whether an investor has control of an investee, the investor determines whether it is
exposed, or has rights, to ‘variable returns’ from its involvement with the investee.
Variable returns are returns that are not fixed and have the potential to vary as a result of the
performance of an investee. Variable returns can be only positive, only negative or both positive and
negative. It should be noted that the term used is ‘returns’ and not ‘benefits’ which are often interpreted as
implying only positive returns.
An investor assesses whether returns from an investee are variable and how variable those returns are on the basis
of the substance of the arrangement and regardless of the legal form of the returns.
 For example, an investor can hold a bond with fixed interest payments. The fixed interest payments are
variable returns for the purpose of control evaluation because they are subject to default risk and they
expose the investor to the credit risk of the issuer of the bond. The amount of variability (i.e. how
variable those returns are) depends on the credit risk of the bond.
 Similarly, fixed performance fees for managing an investee’s assets are variable returns because they
expose the investor to the performance risk of the investee. The amount of variability depends on the
investee’s ability to generate sufficient income to pay the fee.
 However, a non-refundable income received from the investee which is not impacted by the credit risk
or performance of the investee can be considered as a fixed return.
It must also be noted that the term ‘returns’ includes within its scope both (a) direct returns (which are mostly
financial returns), as well as (b) synergistic returns, which are more indirect.
Following are some of the examples of variable returns:

Variable returns from an investee

Returns that are not available to other

Remuneration for servicing an interest holders
Dividends, other distributions of investee’s assets or liabilities
For example, an investor might use its
economic benefits from an Fees and exposure to loss from assets in combination with the assets of
investee (eg interest from debt providing credit or liquidity support the investee, such as combining operating
securities)
Residual interests in the investee’s functions to achieve economies of scale,
Changes in the value of the assets and liabilities on liquidation cost savings, sourcing scarce products,
investor’s investment in that gaining access to proprietary knowledge or
investee. Tax benefits Access limiting some operations or assets, to
to future liquidity enhance the value of the investor’s other
assets.
Exposure to variable returns is not in itself enough to conclude the assessment of control. An investor should
have power over the investee and the ability to use its power to affect the amount of the investor’s returns
from its involvement with the investee. For example, it is common for a lender to have an exposure to variable
returns from a borrower through interest payments that it receives from the borrower, that are subject to credit
risk. However, the lender would not control the borrower if it does not have the ability to affect those
interest payments (which is frequently the case).
Although only one investor can control an investee, more than one party can share in the returns of an
investee. For example, holders of non-controlling interests can share in the profits or distributions of an
investee.
Reputational risk
During the financial crisis, some financial institutions provided funding or other support to securitisation or
investment vehicles because they established or promoted those vehicles. Rather than allowing them to fail
and facing a loss of reputation, the financial institutions stepped in, and in some cases took control of the
vehicles. Having reputational risk in isolation is not an appropriate basis for consolidation. The term
'reputational risk' relates to the risk that failure of an investee would damage an investee's reputation and,
therefore, that of an investor or sponsor, compelling the investor or sponsor to provide support to an
investee in order to protect its reputation, even though the investor or sponsor has no legal or contractual
requirement to do so.
Reputational risk is part of an investor's exposure to risks and rewards, albeit a risk that arises from
non-contractual sources. Therefore, when assessing control, reputational risk is a factor to consider along with
other facts and circumstances. It is not an indicator of power in its own right, but may increase an investor's
incentive to secure rights that give the investor power over an investee.
Link between power and returns
An investor controls an investee if the investor not only has power over the investee and exposure or
rights to variable returns from its involvement with the investee, but also has the ability to use its power
to affect the investor’s returns from its involvement with the investee.
Thus, an investor with decision-making rights shall determine whether it is a principal or an agent.
An investor shall also determine whether another entity with decision-making rights is acting as an agent for
the investor. An agent is a party primarily engaged to act on behalf and for the benefit of another party or
parties (the principal(s)). An investor that is an agent does not control an investee when it exercises
decision-making rights delegated to it.
An investor may delegate its decision-making authority to an agent on some specific issues or on all
relevant activities. When assessing whether it controls an investee, the investor shall treat the decision-
making rights delegated to its agent as held by the investor directly.
 A decision maker shall consider the overall relationship between itself, the investee being managed
and other parties involved with the investee, in particular all the factors below, in determining whether
it is an agent:
The scope of the Remuneration Exposure to variable returns
Rights held by
decision-making from the from other interests in the
other parties
authority investee investee
Different weightings shall be applied to each of the factors on the basis of particular facts and circumstances.
The scope of the decision-making authority
The scope of a decision maker’s decision-making authority is evaluated by considering:
(a) the activities that are permitted according to the decision-making agreement(s) and specified by law,
and
(b) the discretion that the decision maker has when making decisions about those activities.
A decision maker shall consider the purpose and design of the investee, the risks to which the investee was
designed to be exposed, the risks it was designed to pass on to the parties involved and the level of
involvement the decision maker had in the design of an investee. For example, if a decision maker is
significantly involved in the design of the investee (including in determining the scope of decision-making
authority), that involvement may indicate that the decision maker had the opportunity and incentive to obtain
rights that result in the decision maker having the ability to direct the relevant activities.
Rights held by other parties
Substantive removal or other rights may indicate that the decision maker is an agent.
Removal rights
Removal rights are rights to deprive the decision-maker of its decision making authority. The
removal rights held by other should be considered as follows:

ntive removal rights and can remove the decision maker without cause, this, in isolation, is sufficient to conclude that the

ndividual party can remove the decision maker without the agreement of other parties) those rights are not, in isolation, conc

nd the greater the magnitude of, and variability associated with, the decision maker’s other economic interests (ie remune
 Other substantive rights
If other parties hold substantive rights that can restrict the decision maker from exercising its discretion shall
be considered in similar manner to removal right when evaluating whether the decision maker is an agent.
For example, a decision maker that is required to obtain approval from a small number of other parties for
its actions is generally an agent.
Consideration of the rights held by other parties shall include an assessment of any rights exercisable by
an investee’s board of directors (or other governing body) and their effect on the decision-making authority.
For example, if board of directors (which is appointed by other investors) of an investee has right to
remove the decision maker without cause than the decision maker is an agent.
Remuneration from the investee
The relationship between the remuneration of a decision maker and it being an agent is explained below:

Decision maker is a principal

Higher

ariability associated with, the decision maker’s remuneration relative to the returns expected from the activities of the

Lower

Decision maker is an agent

For example, if a variation in investee’s returns by 1% causes variation in decision maker’s remuneration
from investee by less than 1% then the decision maker can be an agent. However, if a variation in investees
returns by 1% causes variation in decision maker’s remuneration from investee by more than 1% then the
decision maker can be a principal.
Further, in determining whether it is a principal or an agent the decision maker shall also consider following
conditions:
 The remuneration of the decision maker is comme

Yes

The remuneration agreement includes only terms, conditions or amounts that are customarily presen
No

No

More likely to be an agent but oth

Not an agent

Exposure to variable returns from other interests in the investee

A decision maker that holds other interests in an investee (like investments in the investee or provides
guarantees with respect to the performance of the investee), shall consider its exposure to variability of
returns from those interests in assessing whether it is an agent. Holding other interests in an investee
indicates that the decision maker may be a principal.
In evaluating the exposure to variability of returns, the decision maker shall consider the magnitude of
variability as follows:

Decision maker is a principal

Higher

, and variability associated with, its economic interests, considering its remuneration and other interests in aggregate

Lower

Decision maker is an agent

It is to be noted that here the decision maker needs to consider the remuneration and other interests in
aggregate. Hence, even though in case the decision maker had concluded in the initial assessment about
remuneration that it is an agent, it needs to again consider remuneration in the assessment of exposure to
variable returns.
Apart from the magnitude of exposure to variable returns, decision maker shall also consider whether its
exposure to variability of returns is different from that of the other investors. If yes, then
whether this might influence its actions. For example, this might be the case when a decision maker holds
subordinated interests in, or provides other forms of credit enhancement to, an investee.
The decision maker shall evaluate its exposure relative to the total variability of returns of the investee.
This evaluation is made primarily on the basis of returns expected from the activities of the investee but
shall not ignore the decision maker’s maximum exposure to variability of returns of the investee
through other interests that the decision maker holds.
For example, if a variation in investees returns by 1% causes variation in decision maker’s returns from
investee by less than 1%. However, a variation in investee’s returns by ` 100 causes variation in decision
maker’s returns from investee by ` 150 because of significant variation in the market price of the equity
shares of the investee.
Illustration 16: Link between power and returns
A decision maker (fund manager) establishes, markets and manages a publicly traded, regulated
fund according to narrowly defined parameters set out in the investment mandate as required by
its local laws and regulations. The fund was marketed to investors as an investment in a diversified
portfolio of equity securities of publicly traded entities. Following is the relevant fact pattern related
to fund manager:
 Within the defined parameters, the fund manager has discretion about the assets in which to
invest.
 The fund manager has made a 10% pro rata investment in the fund and receives a market-
based fee for its services equal to 1% of the net asset value of the fund.
 The fees are commensurate with the services provided.
 The fund manager does not have any obligation to fund losses beyond its 10% investment.
The fund is not required to establish, and has not established, an independent board of directors.
The investors do not hold any substantive rights that would affect the decision-making authority of
the fund manager but can redeem their interests within particular limits set by the fund.
Whether the fund manager controls the fund?
Solution:
Although operating within the parameters set out in the investment mandate and in accordance with the
regulatory requirements, the fund manager has decision-making rights that give it the current ability to direct
the relevant activities of the fund—the investors do not hold substantive rights that could affect the fund
manager’s decision-making authority. The fund manager receives a market-based fee for its services that is
commensurate with the services provided and has also made a pro rata investment in the fund. The
remuneration and its investment expose the fund
manager to variability of returns from the activities of the fund without creating exposure that is of such
significance that it indicates that the fund manager is a principal.
In this case, consideration of the fund manager’s exposure to variability of returns from the fund together with
its decision-making authority within restricted parameters indicates that the fund manager is an agent. Thus,
the fund manager concludes that it does not control the fund.
*****
Illustration 17: Link between power and returns
A decision maker establishes, markets and manages a fund that provides investment opportunities
to a number of investors. The decision maker (fund manager) must make decisions in the best
interests of all investors and in accordance with the fund’s governing agreements. Nonetheless,
the fund manager has wide decision-making discretion. The fund manager receives a market-
based fee for its services equal to 1% of assets under management and 20% of all the fund’s
profits if a specified profit level is achieved. The fees are commensurate with the services
provided.
Although it must make decisions in the best interests of all investors, the fund manager has
extensive decision-making authority to direct the relevant activities of the fund. The fund manager
is paid fixed and performance-related fees that are commensurate with the services provided. In
addition, the remuneration aligns the interests of the fund manager with those of the other
investors to increase the value of the fund, without creating exposure to variability of returns from
the activities of the fund that is of such significance that the remuneration, when considered in
isolation, indicates that the fund manager is a principal.
The above fact pattern and analysis applies to various scenarios described below. Each scenario
is considered in isolation. Determine whether the fund manager control the fund?
Scenario A
The fund manager also has a 2% investment in the fund that aligns its interests with those of the
other investors. The fund manager does not have any obligation to fund losses beyond its 2%
investment. The investors can remove the fund manager by a simple majority vote, but only for
breach of contract.
Scenario B
The fund manager has a more substantial pro rata investment in the fund but does not have any
obligation to fund losses beyond that investment. The investors can remove the fund manager by a
simple majority vote, but only for breach of contract.
Scenario C
The fund manager has a 20% pro rata investment in the fund but does not have any obligation to
fund losses beyond its 20% investment. The fund has a board of directors, all of whose members
are independent of the fund manager and are appointed by the other investors. The board
 appoints the fund manager annually. If the board decided not to renew the fund manager’s
contract, the services performed by the fund manager could be performed by other managers in
the industry.
Solution:
Scenario A
The fund manager’s 2% investment increases its exposure to variability of returns from the activities of the
fund without creating exposure that is of such significance that it indicates that the fund manager is a
principal. The other investors’ rights to remove the fund manager are considered to be protective rights
because they are exercisable only for breach of contract. In this example, although the fund manager has
extensive decision-making authority and is exposed to variability of returns from its interest and remuneration,
the fund manager’s exposure indicates that the fund manager is an agent. Thus, the fund manager concludes
that it does not control the fund.
Scenario B
In this scenario, the other investors’ rights to remove the fund manager are considered to be protective rights
because they are exercisable only for breach of contract. Although the fund manager is paid fixed and
performance-related fees that are commensurate with the services provided, the combination of the fund
manager’s investment together with its remuneration could create exposure to variability of returns from the
activities of the fund that is of such significance that it indicates that the fund manager is a principal. The
greater the magnitude of, and variability associated with, the fund manager’s economic interests (considering
its remuneration and other interests in aggregate), the more emphasis the fund manager would place on those
economic interests in the analysis, and the more likely the fund manager is a principal.
For example, having considered its remuneration and the other factors, the fund manager might consider a
20% investment to be sufficient to conclude that it controls the fund. However, in different
circumstances (i.e. if the remuneration or other factors are different), control may arise when the level of
investment is different.
Scenario C
Although the fund manager is paid fixed and performance-related fees that are commensurate with the
services provided, the combination of the fund manager’s 20% investment together with its remuneration
creates exposure to variability of returns from the activities of the fund that is of such significance that it indicates
that the fund manager is a principal. However, the investors have substantive rights to remove the fund
manager—the board of directors provides a mechanism to ensure that the investors can remove the fund
manager if they decide to do so.
In this scenario, the fund manager places greater emphasis on the substantive removal rights in the analysis.
Thus, although the fund manager has extensive decision-making authority and is exposed to variability of
returns of the fund from its remuneration and investment, the substantive
rights held by the other investors indicate that the fund manager is an agent. Thus, the fund manager
concludes that it does not control the fund.
*****
Illustration 18: Link between power and returns
An investee is created to purchase a portfolio of fixed rate asset-backed securities, funded by fixed
rate debt instruments and equity instruments. The equity instruments are designed to provide first
loss protection to the debt investors and receive any residual returns of the investee.
The transaction was marketed to potential debt investors as an investment in a portfolio of asset-
backed securities with exposure to the credit risk associated with the possible default of the
issuers of the asset-backed securities in the portfolio and to the interest rate risk associated with
the management of the portfolio.
On formation, the equity instruments represent 10% of the value of the assets purchased. A
decision maker (the asset manager) manages the active asset portfolio by making investment
decisions within the parameters set out in the investee’s prospectus. For those services, the asset
manager receives a market-based fixed fee (i.e. 1% of assets under management) and
performance-related fees (i.e. 10% of profits) if the investee’s profits exceed a specified level. The
fees are commensurate with the services provided. The asset manager holds 35% of the equity in
the investee. The remaining 65% of the equity, and all the debt instruments, are held by a large
number of widely dispersed unrelated third-party investors. The asset manager can be removed,
without cause, by a simple majority decision of the other investors.
Does the asset manager control the investee?
Solution:
The asset manager is paid fixed and performance-related fees that are commensurate with the services
provided. The remuneration aligns the interests of the fund manager with those of the other investors to
increase the value of the fund. The asset manager has exposure to variability of returns from the activities of
the fund because it holds 35% of the equity and from its remuneration.
Although operating within the parameters set out in the investee’s prospectus, the asset manager has the
current ability to make investment decisions that significantly affect the investee’s returns - the removal rights
held by the other investors receive little weighting in the analysis because those rights are held by a large
number of widely dispersed investors. In this example, the asset manager places greater emphasis on its
exposure to variability of returns of the fund from its equity interest, which is subordinate to the debt
instruments. Holding 35% of the equity creates subordinated exposure to losses and rights to returns of the
investee, which are of such significance that it indicates that the asset manager is a principal. Thus, the asset
manager concludes that it controls the investee.
*****
Following table summarises the above illustrations on link between power and returns by highlighting each of
the factors for evaluating link between power and returns:
Illustration Scope of the Removal Remuneration Variable Conclusion
decision- rights held from the returns from
making by others investee other interests
authority
16 Narrowly No such 1% of the net 10% Agent
defined rights asset value of investment in
the fund the fund
17 (A) Extensive Removal for 1% of assets 2% investment Agent
decision- cause by under in the fund
17 (B) making simple management 20% Principal
authority majority and 20% of all investment in
the fund’s the fund
profits if a
17 (C) Removal specified profit 20% Agent
without level is investment in
cause by achieved the fund
board
18 Decisions Removal 1% of assets 35% of equity in Principal
within the without under the investee
parameters set cause by management
out in the simple and 10% of
investee’s majority of profits if the
prospectus widely profits exceed a
dispersed specified level
investors
Illustration 19: Link between power and returns
A decision maker (the sponsor) sponsors a fund, which issues short-term debt instruments to
unrelated third-party investors. The transaction was marketed to potential investors as an
investment in a portfolio of highly rated medium-term assets with minimal exposure to the credit
risk associated with the possible default by the issuers of the assets in the portfolio. Various
transferors sell high quality medium-term asset portfolios to the fund. Each transferor services the
portfolio of assets that it sells to the fund and manages receivables on default for a market-based
servicing fee. Each transferor also provides first loss protection against credit losses from its asset
portfolio through over-collateralisation of the assets transferred to the fund. The sponsor
establishes the terms of the fund and manages the operations of the fund for a market-based fee.
The fee is commensurate with the services provided. The sponsor approves the sellers permitted
to sell to the fund, approves the assets to be purchased by the fund and makes decisions about
the funding of the fund. The sponsor must act in the best interests of all investors.
 The sponsor is entitled to any residual return of the fund and also provides credit enhancement
and liquidity facilities to the fund. The credit enhancement provided by the sponsor absorbs losses
of up to 5% of all of the fund’s assets, after losses are absorbed by the transferors. The liquidity
facilities are not advanced against defaulted assets. The investors do not hold substantive rights
that could affect the decision-making authority of the sponsor. Whether the sponsor has control
over the fund?
Solution:
Even though the sponsor is paid a market-based fee for its services that is commensurate with the services
provided, the sponsor has exposure to variability of returns from the activities of the fund because of its rights
to any residual returns of the fund and the provision of credit enhancement and liquidity facilities (i.e. the
fund is exposed to liquidity risk by using short-term debt instruments to fund medium-term assets). Even
though each of the transferors has decision-making rights that affect the value of the assets of the fund, the
sponsor has extensive decision-making authority that gives it the current ability to direct the activities that
most significantly affect the fund’s returns (i.e. the sponsor established the terms of the fund, has the right to
make decisions about the assets (approving the assets purchased and the transferors of those assets) and the
funding of the fund (for which new investment must be found on a regular basis)). The right to residual
returns of the fund and the provision of credit enhancement and liquidity facilities expose the sponsor to
variability of returns from the activities of the fund that is different from that of the other investors.
Accordingly, that exposure indicates that the sponsor is a principal and thus the sponsor concludes that it
controls the fund. The sponsor’s obligation to act in the best interest of all investors does not prevent the
sponsor from being a principal.
*****

3.4 RELATIONSHIP WITH OTHER PARTIES

When assessing control, an investor shall consider the nature of its relationship with other parties and whether
those other parties are acting on the investor’s behalf i.e. they are ‘de facto agents’ of the investor. The
determination of whether other parties are acting as de facto agents requires judgement, considering not only
the nature of the relationship but also how those parties interact with each other and the investor.
A de factor agent relationship does not require a contractual arrangement between the investor and the
de facto agent.
A party is a de facto agent when the investor has, or those that direct the activities of the investor have, the
ability to direct that party to act on the investor’s behalf.
An investor shall consider its de facto agent’s decision-making rights and its indirect exposure, or rights, to
variable returns through the de facto agent together with its own when assessing control of an investee.
 Further, having a de facto agent does not necessarily mean that the investor controls the investee. The investor
still needs to perform the control evaluation as per the detailed guidance discussed above.
When assessing control, an investor would consider its de facto agent’s decision-making rights and
exposure (or rights) to variable returns together with its own as if the rights were held by the investor
directly.

estor may conclude that the fellow subsidiary is a de facto agent of the investor. Accordingly, investor would be able to contr

Following are the examples of other parties that, by the nature of their relationship, might act as de facto agents
for the investor:

Investor’s related parties

A party that received its interest in the investee as a contribution or loan from the
investor

A party that has agreed not to sell, transfer or encumber its interests in the investee
without the investor’s prior approval (except in case investor and other party have right
of prior approval and rights are based on mutually agreed terms)

A party that cannot finance its operations without subordinated financial support from
the investor

Investee for which the majority of the members of board or similar body are the same as
those of the investor

A party that has a close business relationship with the investor, such as the relationship between a professiona
Parties mentioned above are not necessarily de facto agents of the investor. However, the investor needs to
evaluate whether the parties following in the above categories are the de facto agents or not.
An investor shall consider whether it treats a portion of an investee as a deemed separate entity and, if so,

3.5 CONTROL OF SPECIFIED ASSETS

whether it controls the deemed separate entity. A deemed separate entity is often called a ‘silo’.
An investor shall treat a portion of an investee as a deemed separate entity if and only if the following
condition is satisfied:

Determination of whether a portion of an investee is a deemed separate entity

In substance, none of the returns

Specified assets of the investee (and
Parties other than those with the from the specified assets can be used
related credit enhancements, if any)
specified liability do not have rights by the remaining investee and none
are the only source of payment for
or obligations related to the specified of the liabilities of the deemed
specified liabilities of, or specified
assets or to residual cash flows from separate entity are payable from the
other interests in, the investee.
those assets. assets of the remaining investee.

Thus, in substance, all the assets, liabilities and equity of that deemed separate entity are ring- fenced from
the overall investee.
For example, an investee is a mutual fund and under the investee there are multiple sub-funds
established with different investment objectives like debt-oriented funds, equity-oriented funds, etc.
In such case, an assessment should be made as to whether the sub-funds are deemed separate
entities as per the conditions mentioned above.
When the conditions mentioned above are satisfied, an investor shall assess whether it controls the silo
by applying the guidance of control evaluation i.e. whether the investor has power over the silo, exposure
or rights to variable returns from involvement with silo and whether it can use that power to affect the
returns of the silo.
If the investor controls the silo, the investor shall consolidate that silo. In that case, other parties exclude that
silo when assessing control of, and in consolidating, the investee.
 For example, continuing with the above example on identification of a silo, if one of the sub-funds is
treated as a silo then the investor that controls that silo will consolidate that sub-fund. Other
parties who control other sub-funds will exclude the sub-fund controlled by the investor in their
control evaluation and consolidation.

3.6 CONTINUOUS ASSESSMENT

An investor shall reassess whether it controls an investee if facts and circumstances indicate that
there are changes to one or more of the three elements of control i.e. power, exposure or rights to
variable returns and link between power and variable returns.
An investor should reassess the control over an investee in following situations:
Situation Example
A change in how power over an investee can Changes to decision-making rights whereby the relevant
be exercised activities are no longer directed through voting rights,
but instead other agreements, like contracts, give
another party or parties power over the investee

An event can cause an investor to gain or An investor can gain power over an investee because
lose power over an investee without the decision-making rights held by another party or parties
investor that previously prevented
being involved in that event the investor from controlling an investee have lapsed

Changes affecting exposure, or rights, to An investor that has power over an investee can lose
variable returns from involvement with an control of an investee if the investor ceases to be
investee entitled to receive variable returns or to be exposed to
obligations (e.g. if a contract to receive performance-
related fees is terminated).
Assessment to act as an agent or principal If changes to the rights of the investor, or of other
has changed. Changes in the overall parties, occur, the investor shall reconsider its status as
relationship between the investor and other a principal or an agent.
parties can mean that an investor no
longer acts as an agent, even though it has
previously acted as an agent, and vice
versa.
An investor’s initial assessment of control or its status as a principal or an agent would not change simply
because of a change in market conditions (e.g. a change in the investee’s returns driven by market conditions),
unless the change in market conditions changes one or more of the three elements of control or changes the
overall relationship between a principal and an agent.
 3.7 INVESTMENT ENTITIES

Determining whether an entity is an investment entity

A parent shall determine whether it is an investment entity. An entity is an investment entity if it fulfils all
the following conditions:

Obtains funds from one or Commits to its investor(s) that

Measures and evaluates
more investors for providing its business purpose is to
the performance of
those investor(s) with invest funds solely for
substantially all of its
investment returns from capital
investments on a fair
management services appreciation, investment
value basis
income, or both

In assessing whether an entity meets the definition of investment entity as above, the entity shall consider
whether it has the following typical characteristics of an investment entity:

More than one investment More than one investor

Typical characteristics of an investment entity

Entity has ownership interests in the form of equity or similar interests

Investors are not related parties of the entity
The absence of one or more of these typical characteristics does not necessarily disqualify an entity
from being classified as an investment entity but indicates that additional judgement is required in
determining whether the entity is an investment entity.
If facts and circumstances indicate that there are changes to one or more of the three elements that
make up the definition of an investment entity or the typical characteristics of an investment entity, a parent
shall reassess whether it is an investment entity.
Following is the detailed discussion on two of the three elements of the definition of an investment entity
(business purpose and fair value measurement) and the typical characteristics of an investment entity. As
regards the first element, i.e. provision of investment management services, that essentially differentiates an
investment entity from other entities.
Business Purpose
The definition of an investment entity requires that the purpose of the entity is to invest solely for capital
appreciation, investment income (such as dividends, interest or rental income), or both.
Documents or other evidence that indicate the entity’s investment objectives are include:
 offering memorandum of the entity
 publications distributed by the entity and other corporate
 partnership documents of the entity
 manner in which the entity presents itself to other parties (such as potential investors or
potential investees)
For example, an entity may present its business as providing medium-term investment for capital
appreciation. In contrast, an entity that presents itself as an investor whose objective is to jointly develop,
produce or market products with its investees has a business purpose that is inconsistent with the business
purpose of an investment entity, because the entity will earn returns from the development, production or
marketing activity as well as from its investments.
Apart from the business purpose of investing for capital appreciation and investment income, an investment
entity may provide investment-related services (e.g. investment advisory services, investment
management, investment support and administrative services), to third parties as well as to its investors,
even if those activities are substantial to the entity, subject to the entity continuing to meet the definition
of an investment entity.
An investment entity may also participate in the following investment-related activities if these activities
are undertaken to maximise the investment return (capital appreciation or investment income) from
its investees and do not represent a separate substantial business activity or a separate substantial source of
income to the investment entity:
a) providing management services and strategic advice to an investee; and
b) providing financial support to an investee, such as a loan, capital commitment or guarantee.
Illustration 20: Business purpose of an investment entity
An asset manager has set up and investment fund for the purpose of acquiring capital
contributions from various investors (by issuing them units in the fund) and investing those
contributions in the equity share capital of various entities for the purpose of earning capital
appreciation on those investments. Following is the existing structure of the fund.

Various investors

Investment Fund
Strategic Advisory Services and
financial support

Investment in
equity shares of
various entities

Apart from the investments in various entities, the investment fund also provides its investee the
strategic advisory services so that it can result in increase in the capital appreciation from
investments in those investees. It also provides its investees financial support in the form of loan
to provide them with funds for acquiring capital assets. The investment fund does not hold such
investments for a period longer than 5 years. The investment fund measures and evaluate the
performance of the investments on fair value basis.
Whether the investment fund can be treated as an investment entity?
Solution:
Out of the three elements of the definition of an investment entity, the investment fund fulfils the two
elements very clearly i.e. it obtains fund from more than one investor for providing investment management
services and measures and evaluates its investments on fair value basis.
The typical characteristics of an investment entity are also present in the structure of the investment fund
i.e. more than one investment, more than one investor, investors are unrelated and investment fund issues
units in the fund to the investors.
With respect to the business objective of the investment fund, the objective is to earn capital appreciation from
its investments. The strategic advisory services and financial support provided to investees are extended with the
intention of earning higher capital appreciation from the investees.
However, judgement should to be applied that these do not represent substantial business activity or a
separate substantial source of income for the investment fund. If the investment fund concludes that these
services and financial support to investees are not substantial business activity and substantial source of
income for the investment fund, then only the investment fund can be treated as an investment entity.
*****
Exit strategies
One feature that differentiates an investment entity from other entities is that an investment entity does
not plan to hold its investments indefinitely; it holds them for a limited period. Because equity
investments and non-financial asset investments have the potential to be held indefinitely, an investment
entity shall have an exit strategy documenting how the entity plans to realise capital appreciation from
substantially all of its equity investments and non-financial asset investments.
An investment entity shall also have an exit strategy for any debt instruments that have the potential to be held
indefinitely, for example perpetual debt investments. The entity need not document specific exit strategies for
each individual investment but shall identify different potential strategies for different types or
portfolios of investments, including a substantive time frame for exiting the investments. Exit
mechanisms that are only put in place for default events, such as a breach of contract or non-performance, are
not considered exit strategies for the purpose of this assessment.
Exit strategies can vary by type of investment.
 For investments in private equity securities , examples of exit strategies include an initial public
offering, a private placement, a trade sale of a business, distributions (to investors) of ownership
interests in investees and sales of assets (including the sale of an investee’s assets followed by a
liquidation of the investee).
 For equity investments that are traded in a public market , examples of exit strategies include
selling the investment in a private placement or in a public market.
 For real estate investments, an example of an exit strategy includes the sale of the real estate
through specialized property dealers or the open market.
An investment entity may have an investment in another investment entity that is formed in
connection with the entity for legal, regulatory, tax or similar business reasons. In this case, the investment
entity investor need not have an exit strategy for that investment, provided that the investment entity
investee has appropriate exit strategies for its investments.

Illustration 21: Exit strategies of an investment entity

ABC Ltd. Is established with primary objective of investing in the equity shares of various entities
across various industries based on the detailed research about each industry and entities within
that industry being done by the investment manager of the company.
The investment manager decides the timing as to when the investments should be made considering
the current market situation. Sometimes, the investment manager decides to invest the idle funds into
short-term to medium-term debt instruments with fixed maturity. The exit strategies are in place for the
investments done in equity shares but the same is not there for investments done in debt instruments.
Determine whether the entity fulfils the exit strategy condition of being classified as investment entity?
Solution:
The exit strategies are in place for investments done in equity shares. But not in place for investments
done in debt instruments. However, it should be noted that the debt instruments have fixed maturity period
and they cannot be held for indefinite period. Hence, there is no need for having exit strategies for such
instruments. Accordingly, the exit strategy condition is fulfilled for being classified as investment entity.
*****
Earnings from investments
To be an investment entity, an entity must commit to its investors that its business purpose is to invest funds
solely for returns from capital appreciation, investment income, or both.
An entity is not an investment entity if the entity, or another member of the group containing the entity
obtains, or has the objective of obtaining, other benefits from the entity’s investments that are
not available to other parties unrelated to the investee.
Such other benefits include following:
Acquisition, use, exchange or exploitation of Joint arrangements or other
the processes, assets or technology of an agreements between the entity or another
investee. This would include the entity or another group member and an investee to develop,
group member having disproportionate, or produce, market or provide products or
exclusive, rights to acquire services;
assets, technology, etc. of any investee

Financial guarantees or assets provided by an

investee for borrowing arrangements of the entity or An option held by a related party of the
another group member (however, an investment entity entity to purchase, from that entity or
would still be able to use an investment in an investee another group member, an ownership
as collateral for any of its borrowings) interest in an investee of the entity;

Transactions (except as mentioned in next paragraph) between the

entity or another group member and an investee that are
•on terms that are unavailable to unrelated parties; or
•not at fair value; or
•represent a substantial portion of the investee’s or the entity’s or other
group entities' business
An investment entity may have a strategy to invest in more than one investee in the same industry, market or
geographical area in order to benefit from synergies that increase the capital appreciation and
investment income from those investees. An entity is not disqualified from being classified as an investment
entity merely because such investees trade with each other.

Illustration 22: Earnings from investments of an investment entity

PQR Ltd. Is established with primary objective of investing in the equity shares of various
pharmaceutical companies which are involved in the research and development of medicine for a
critical illness. DEF Ltd. Is a follow subsidiary of PQR Ltd. And DEF Ltd. Has entered into
contractual arrangements with all the investees of PQR Ltd. That in case they are successful in
developing the medicine then they will transfer the patent and distribution rights for that medicine
to DEF Ltd. At less then market price. This arrangement is explained in following diagram:

Fellow subsidiaries
PQR Ltd. DEF Ltd.

Contractual
arrangements
Investment in equity shares
of pharmaceutical
companies

Determine whether PQR Ltd. Can be classified as investment entity?

Solution:

PQR Ltd. And DEF Ltd. Are part of same group. Further, DEF Ltd. Have exclusive right to acquire the patent
and distributions rights from the investees of PQR Ltd. And that too at less then the market price. Hence, the
related party of PQR Ltd. Is in position to obtain benefits other than capital appreciation and
investment income from the investees that are not available to other parties unrelated to the investee.
Accordingly, PQR Ltd. Cannot be classified as investment entity.

*****
Fair value measurement
An essential element of the definition of an investment entity is that it measures and evaluates the performance
of substantially all of its investments on a fair value basis, because using fair value
 results in more relevant information than, for example, consolidating its subsidiaries or using the
equity method for its interests in associates or joint ventures. In order to demonstrate that it meets this
element of the definition, an investment entity:
ion internally to the entity’s key management personnel, who use fair value as the primary measurement attribute to evaluate th
sures substantially all of its investments at fair value whenever fair value is required or permitted in accordance with Ind

AND

In order to meet the requirement of measuring investments at fair value, an investment entity would:
a) elect the exemption from applying the equity method in Ind AS 28 for its investments in associates and
joint ventures (exemptions from applying the equity method is discussed in detail in unit 6); and
b) measure its financial assets at fair value using the requirements in Ind AS 109.
An investment entity may have some non-investment assets, such as a head office property and related
equipment, and may also have financial liabilities. The fair value measurement element of the definition of
an investment entity applies to an investment entity’s investments. Accordingly, an investment entity need not
measure its non-investment assets or its liabilities at fair value.
More than one investment
An investment entity typically holds several investments to diversify its risk and maximise its returns.
An entity may hold a portfolio of investments directly or indirectly, for example by holding a single
investment in another investment entity that itself holds several investments.
There may be times when the entity holds a single investment. However, holding a single investment does
not necessarily prevent an entity from meeting the definition of an investment entity. For
example, an investment entity may hold only a single investment when the entity:

is in its start-up period and has not yet identified suitable investments and, therefore, has
not yet executed its investment plan

has not yet made other investments to replace those it has disposed of

is established to pool investors’ funds to invest in a single investment when that investment is un

is in the process of liquidation

More than one investor

An investment entity would have several investors who pool their funds to gain access to investment
management services and investment opportunities that they might not have had access to individually.
Having several investors would make it less likely that the entity, or other members of the group containing
the entity, would obtain benefits other than capital appreciation or investment income.
Alternatively, an investment entity may be formed by, or for, a single investor that represents or
supports the interests of a wider group of investors (e.g. a pension fund, government investment
fund or family trust).
There may also be times when the entity temporarily has a single investor. For example, an
investment entity may have only a single investor when the entity:
(a) is within its initial offering period, which has not expired and the entity is actively identifying
suitable investors;
(b) has not yet identified suitable investors to replace ownership interests that have been
redeemed; or
(c) is in the process of liquidation
Unrelated investors
An investment entity has several investors that are not related parties of the entity or other members
of the group containing the entity. Having unrelated investors would make it less likely that the entity, or
other members of the group containing the entity, would obtain benefits other than capital
appreciation or investment income.
However, an entity may still qualify as an investment entity even though its investors are related to the entity.
For example, an investment entity may set up a separate ‘parallel’ fund for a group of its employees
(such as key management personnel) or other related party investor(s), which mirrors the investments of the
entity’s main investment fund. This ‘parallel’ fund may qualify as an investment entity even though all of
its investors are related parties.
Ownership interests
An investment entity is typically, but is not required to be, a separate legal entity. Ownership interests in an
investment entity are typically in the form of equity or similar interests (e.g. partnership interests), to
which proportionate shares of the net assets of the investment entity are attributed. However, having
different classes of investors, some of which have rights only to a specific investment or groups of
investments or which have different proportionate shares of the net assets, does not preclude an
entity from being an investment entity.
 Example 6
An entity has issued two types of equity shares to its investors i.e. class A shares and class B shares. Holders

In addition, an entity that has significant ownership interests in the form of debt that, in
accordance with other applicable Ind ASs, does not meet the definition of equity, may still qualify as an
investment entity, provided that the debt holders are exposed to variable returns from changes in
the fair value of the entity’s net assets.

nancial liability in accordance with Ind AS 32 ‘Financial Instruments: Presentation’. The compulsorily convertible bonds expo

Exemptions to investment entities

An investment entity shall
 not consolidate its subsidiaries or apply Ind AS 103 ‘Business Combinations’ when it obtains
control of another entity; and
 measure an investment in a subsidiary at fair value through profit or loss in accordance
with Ind AS 109.
If an investment entity has a subsidiary that is not itself an investment entity and whose main purpose
and activities are providing services related to the investment entity’s investment activities, it shall
consolidate that subsidiary and apply the requirements of Ind AS 103 to the acquisition of any such
subsidiary. If the subsidiary that provides the investment-related services or activities is itself an investment
entity then the investment entity parent shall measure that subsidiary at fair value through profit or loss.
A parent of an investment entity shall consolidate all entities that it controls, including those
controlled through an investment entity subsidiary, unless the parent itself is an investment entity. This is
explained in following diagram form:
e Investment Entity A and susidiaries controlled through InvestmentParent
Entity of
A Investment Entity A

ated financial statements and measure its investments at fair value through profit or loss
Investment Entity A

Investment in X Ltd.Investment in Y Ltd.

Illustration 23
HTF Ltd. Was formed by T Ltd. To invest in technology start-up companies for capital appreciation. T Ltd.
Holds a 70 percent interest in HTF Ltd. And controls HTF Ltd. The other 30 percent ownership interest
in HTF Ltd. Is owned by 10 unrelated investors. T Ltd. Holds options to acquire investments held by HTF
Ltd., at their fair value, which would be exercised if the technology developed by the investees would
benefit the operations of T Ltd. No plans for exiting the investments have been identified by HTF Ltd.
HTF Ltd. Is managed by an investment adviser that acts as agent for the investors in HTF Ltd.
Determine whether HTF Ltd. Is an investment entity or not.

Solution:
Even though HTF Ltd.’s business purpose is investing for capital appreciation and it provides investment
management services to its investors, HTF Ltd. Is not an investment entity because of the following
arrangements and circumstances:
(a) T Ltd., the parent of HTF Ltd. Holds options to acquire investments in investees held by HTF
Ltd. If the assets developed by the investees would benefit the operations of T Ltd. This provides a
benefit in addition to capital appreciation or investment income; and
(b) the investment plans of HTF Ltd. Do not include exit strategies for its investments, which are equity
investments. The options held by T Ltd. Are not controlled by HTF Ltd. And do not constitute an exit
strategy.
*****