Significant influence according IFRS

Significant influence occurs when an entity has the power to intervene in an associate’s financial and operating policy.

When a company acquires a percentage of share in another entity, three events can be presented, which are shown below.

Significant influence co-min

Paragraph 5 of IAS 28 sets out an entity is presumed to exercise significant influence if it owns, directly or indirectly (for example, through subsidiaries), 20 percent or more of the voting power of the investee, unless it can be shown by other means that such influence does not exist.

Thus, if, for example, a company owns less than 20% interest in another entity, but it can be shown that there are any of the following items established in paragraph 6 of IAS 28, it is concluded that there is a significant influence.

The items established in paragraph 6 of this standard are the following:

  • Representation on the board of directors or equivalent governing body of the investee;
  • Participation in policy-making processes, including participation in decisions about dividends or other distributions;
  • Material transactions between the investor and the investee;
  • Interchange of managerial personnel; or
  • Provision of essential technical information
 

When an entity demonstrates significant influence over another company, the company must account for its investment using the equity method.

This method consists of recording the investment initially at cost and subsequently adjusting the investment in the share percentage in the investee’s net assets under the changes that occur after its acquisition.

Now, when an entity owns a percentage higher than 50% of ordinary shares in another company, we must no longer refer to the concept of significant influence, we must refer to the concept of control, and therefore, the investment should no longer be recognized using the equity method.

In this case, the controlling entity must consolidate its financial statements together with those of its subsidiary, using the procedures established in IFRS 10.

Conversely, if an entity cannot demonstrate that it has significant influence over another company and its shareholding is below 20%, it will recognize its investment as a financial instrument.

Before continuing to read the post, put your knowledge into practice.

Significant influence - example 1

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Significant influence examples

Example 1:

Three unrelated entities A, B and C own the following interests in entity Z.

Entity A: 22%

Entity B: 19%

Entity C: 59%

Entity B has a representation on the board of directors of entity Z.

2.Significant influence IFRS

Which of the entities that own an interest in entity Z has significant influence?

Both entity A and entity B have significant influence over entity Z; on the other hand, company C has control over entity Z and therefore must consolidate its financial statements.

Although company B has an interest of less than 20%, this company has a representation on the board of directors of entity Z, and this is evidence that it has significant influence and, therefore, should recognize its investment using the equity method.

Example 2:

Entity A owns a 60% interest in entity B, in turn entity B, has a 40% interest in entity C.

Entity A owns a 20% interest directly over entity C.

Does company A, have significant influence over entity C? 

3.Significant influence IFRS

The answer is NO, for the following reasons:

 Entity A’s interest in entity C is 44%.

This is equivalent to a 20% share direct and a 24% share indirect.

 Entity A’s Indirect interest is determined in the following way: 60% x 40% = 24%

In theory, a 44% share of entity A in entity C would not give rise to control but a significant influence; however, the analysis must go further.

Entity A has control over entity B; for this reason, company A has the 40% voting right over entity C.

Besides, entity A has a 20% share direct over entity C.

In this way, entity A has a 60% share over entity C, giving control over entity C.

A different situation will be if entity A only had a 49% interest over entity B and did not have control of that company; in this case, entity A’s interest in entity C would only be 39.60% (49% * 40% + 20%), which would not lead to control, but significant influence.

Example 3:

Entity A owns a 60% interest in entity B; in turn, company B has a 40% interest in entity C.

Similarly, company A owns a 30% interest directly over entity C.

Does company A, have significant influence over entity C?

4.Significant influence IFRS

The answer is yes, for the following reasons:

Although the interest of entity A over entity C is 54% (30% directly + 24% indirectly (60% x40%) and it could be concluded that there is control, this is not the case since entity A does not control Entity B, and therefore, it is not possible to combine Company B’s 60% interest in Company C, and for this reason, Company A must recognize its interest in Company C, using the equity method, since there is no control of entity A over entity C, but there is a significant influence.

Example 4:

Entity A owns a 10% interest in entity C; on the other hand, entity B has a 30% interest in entity C, and entity A has a 70% interest in entity B.

According to the above information, do entities A and B have significant influence over entity C?

5.Significant influence IFRS

The answer is that both entities A and entity B have significant influence over entity C.

That is, entity B directly owns a 30% interest in company C, which indicates that it must recognize its investment using the equity method.

 On the other hand, because there is control by entity A over entity B, the share of entity A in entity C is as follows; 10% directly and 21% indirectly (70% x30%).

If entity A does not control entity B, entity A should recognize its 10% interest in entity C as a financial instrument.

Significant influence - example 2

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