Learning Outcomes
After reading this article, you will be able to determine when an investor controls an investee under IFRS 10, apply the three-pronged test for control (power, variable returns, and the link), and use judgement in complex scenarios, such as those involving dispersed shareholders, potential voting rights, or agency arrangements. You will also recognise when consolidation is appropriate and justify your reasoning effectively for the ACCA SBR exam.
ACCA Strategic Business Reporting (SBR) Syllabus
For ACCA Strategic Business Reporting (SBR), you must understand how group financial statements are prepared and when control requires consolidation under IFRS 10. You should revise:
- The three elements required for control in IFRS 10 (power, exposure to variable returns, link between them)
- How power can be obtained by voting rights, contractual arrangements, or substantive potential voting rights
- Identification and assessment of variable returns from involvement with an investee
- How the ability to use power affects variable returns
- Judgement in scenarios with less than majority holdings or passive shareholders
- The implications of rights being substantive or protective
- The impact of agency/principal relationships in group accounting
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What three conditions must all be met for an investor to have control under IFRS 10?
- True or false? An investor owning 35% of voting shares can control an investee if the remaining shares are widely held and inactive.
- Briefly explain when potential voting rights are considered in the assessment of control.
- Explain why an asset manager, as an agent rather than a principal, does not consolidate an investment fund despite having decision-making rights.
Introduction
IFRS 10 requires consolidated financial statements when an investor controls an investee. Although owning the majority of voting rights is the most obvious route to control, significant judgement is often needed where shareholdings are smaller, rights are held by contract, or agency relationships exist. Properly analysing control is essential to ensure group accounts reflect the single economic entity concept.
Key Term: control
Control exists when an investor has power over an investee, exposure or rights to variable returns, and the ability to use that power to affect those returns.
The Three Elements of Control
An investor controls an investee only if all of the following are present:
- Power over relevant activities of the investee
- Exposure or rights to variable returns from involvement with the investee
- The practical ability to use power to affect those returns
Failing any element means no control—so no consolidation is required.
Key Term: power
The current ability to direct the relevant activities of an investee—those that most significantly affect the investee's returns.Key Term: variable returns
Returns (positive or negative) from involvement with an investee that are not fixed—such as dividends, changes in asset value, management fees, cost savings, or residual interests.Key Term: link between power and returns
The ability of the investor to use its power over the investee to influence the amount of its own variable returns.
Power Over Relevant Activities
Power is most obvious where the investor holds a majority of voting rights. However, IFRS 10 requires substance over form. Actual decision-making ability is key, not merely legal rights on paper.
Power may arise through:
- Holding more than 50% of voting rights
- Contracts giving decision power over budgets, strategies, or management appointments
- Rights to appoint or remove the majority of the governing body
- Potential voting rights (e.g., options or convertible instruments), if substantive
Relevant activities are those that have a significant impact on returns, such as setting sales policy, approving significant investments, or appointing senior management.
Exposure or Rights to Variable Returns
The investor must benefit from performance highs and be exposed to losses or lower performance. Variable returns go beyond mere dividends—they include profits, capital growth, management fees, synergies, cost savings, or any benefit that is not fixed or guaranteed.
The Link Between Power and Returns
Even with power and exposure to returns, there must be a genuine connection: the investor must have both the ability and the incentive to use its power to influence its own economic outcomes. If power must be exercised primarily for another party’s benefit, the investor is acting as an agent, not as a principal.
Key Term: agent
A party that exercises decision-making power on behalf of another (the principal) and does not control the investee for its own benefit.Key Term: principal
The party that delegates power to an agent while retaining the main exposure to variable returns and overall control.
Assessing Power: Less Than Majority Holding, Contracts, and Potential Rights
Majority voting rights are strong evidence of power, but not always necessary. Control may exist with a smaller shareholding if:
- Other investors are passive, widely dispersed, and unlikely to coordinate
- Contracts assign sole or dominant decision-making rights
- Substantive potential voting rights (e.g., currently exercisable or in-the-money options) give the practical ability to direct activities
Potential voting rights must be considered only if:
- They can be currently exercised in practice
- Exercising them is economically rational (not deeply out-of-the-money)
- There are no significant barriers to use
Rights that are protective (for example, vetoing fundamental changes only) do not grant power—they are designed only to safeguard an investor’s interests.
Worked Example 1.1
Sigma Ltd owns 37% of Zulu plc. No other shareholder owns more than 9%, and attendance at annual meetings is low. Sigma appoints the full board and is the main supplier. Does Sigma control Zulu?
Answer:
Yes. Though Sigma holds less than 50% of shares, the remainder are dispersed and disengaged. Sigma can unilaterally direct relevant activities and is exposed to variable returns (through dividends and trading benefits). Principles of power, returns, and the link are satisfied.
Worked Example 1.2
Mercury Inc holds 20% of Rapide Ltd, plus options (currently exercisable, in-the-money) for 30% more. The remaining shares are widely held. Should Mercury consolidate Rapide?
Answer:
Yes. Mercury’s options are substantive—they are exercisable now and have clear value. Mercury effectively can secure majority voting rights and direct relevant activities. Combined with exposure to returns, Mercury controls Rapide Even with less than 50% holding at present.
Worked Example 1.3
Blue Asset Mgmt manages a fund for outside investors. It appoints directors and earns fees based on asset value, but 95% of returns go to investors. Is Blue required to consolidate the fund?
Answer:
No. Blue is acting as an agent. Although Blue directs the fund, it does so primarily for the benefit of the principal investors. Blue’s own exposure to variable returns is insignificant. Without the link to its own significant variable returns, control does not exist.
Exam Warning
In the exam, candidates often overlook whether rights are truly substantive, especially with potential voting rights or contracts. Always state explicitly whether a right is currently exercisable, practical to use, and allows real control of relevant activities at decision time.
Substantive Rights and Judgement
Assessing whether rights are substantive requires attention to detail:
- Can the rights be exercised whenever a decision is needed?
- Is exercising them realistic and economically sensible?
- Are they more than just protective (vetoes over major changes only)?
Judgement is essential. Rights held by an investor in-the-money options, contracts, or board appointment powers must be carefully examined for timing, conditions, and ability to influence returns.
Agent Versus Principal
Where power is exercised for another’s benefit (for example, investment managers acting for fund investors), the party with power is deemed an agent. Indicators that a decision-maker is an agent include:
- Remuneration is mainly fixed or a small performance bonus
- Other parties can remove the decision-maker with minimal barriers
- Most returns (benefits and risks) flow to other investors
Agents do not consolidate the investee. The principal (with the real variable returns and removal rights) is assessed for control instead.
Linking Power to Returns
Having power and exposure to returns is not enough if the investor cannot use power to benefit itself. Contractual arrangements or agency restrictions may mean power can only be used for others’ advantage.
If any of the three elements for control—power, variable returns, or the link—are missing, consolidation is not required.
Revision Tip
For borderline scenarios, work through each of the three control elements in turn. Do not assume that a large shareholding alone is decisive. Cite evidence to justify your conclusion on each element.
Summary
To require consolidation under IFRS 10, an investor must have:
- Power over relevant activities (via shareholding, contracts, or substantive potential rights)
- Exposure or rights to variable returns
- The ability to use power to affect its own returns
Complex cases, such as those with low shareholdings, options, or agency relationships, demand careful application of judgement. Each element of control must be examined and justified individually.
Key Point Checklist
This article has covered the following key knowledge points:
- Define "control" and identify the three IFRS 10 conditions for consolidation
- Recognise power via majority rights, contracts, or substantive potential rights
- Recognise variable returns and when exposure is sufficient
- Explain the requirement for a link between power and returns
- Distinguish between principal and agent relationships and their effect on consolidation
- Apply careful judgement in scenarios with dispersed ownership, rights, or potential voting instruments
Key Terms and Concepts
- control
- power
- variable returns
- link between power and returns
- agent
- principal