IFRS 12 – if you can think of it, disclose it!

by John Hughes

Since I’ve made some comments on IFRS 10 and IFRS 11 in previous posts, I should probably complete the set and write a few words about IFRS 12 Disclosure of Interests in Other Entities (you can access some CICA resources on the topic here). As you probably know, this now contains all the disclosure requirements for interests in other entities, whether the interest takes the form of control, joint control or significant influence. It also sets out disclosure requirements for structured entities (broadly corresponding to what was previously called “special purpose entities’) that aren’t recognized in the statements, but in which an entity has some kind of interest. It’s tempting to say actually that faced with all the disclosures for unconsolidated structured entities, some preparers may just think it’d be easier to change the structure and consolidate the thing…except that unless they change it into a straightforward 100% owned entity with no other terms or agreements or complexities, they’ll end up disclosing a lot of information regardless. In other words, IFRS 12 wants to make your notes longer; concerns about information overload will have to wait for another day.

In many cases, this’ll consist of providing more detail on matters previously described only vaguely, or of quantifying issues previously addressed only narratively. For example, the standard requires disclosing “information about significant judgments and assumptions” made in assessing that control, joint control or significant influence exists over another entity; such as in concluding control doesn’t exist despite holding more than 50% of the voting shares, or does exist despite holding less than 50%. Of course, there’s always judgment involved in deciding how much information is necessary, but if the assessment was a close call, based for example on reviewing the past actions of other shareholders to determine the likelihood of them ever voting against you in concert (IFRS 10 says it may be relevant to look at voting patterns at past shareholder meetings), it seems you’d have to disclose enough for a reader to get a sense of the factors you looked at and the weight you put on them. This would be especially crucial perhaps if the outcome might change in the future (because IFRS 10 requires revisiting the assessment if the facts and circumstances change). As I wrote before, in some situations, the assessment of control could encompass whether “the investee depends on the investor for critical services, technology, supplies or raw materials” or whether “a significant portion of the investee’s activities either involve or are conducted on behalf of the investor,” so if they’re relevant, these factors would presumably be discussed as well.

On the quantitative side, some of what IFRS 12 prescribes is way overdue. For example, it requires an entity to disclose “significant restrictions (eg statutory, contractual and regulatory restrictions) on its ability to access or use the assets and settle the liabilities of the group, such as: (i) those that restrict the ability of a parent or its subsidiaries to transfer cash or other assets to (or from) other entities within the group, (ii) guarantees or other requirements that may restrict dividends and other capital distributions being paid, or loans and advances being made or repaid, to (or from) other entities within the group.” Although this information should already have been disclosed in some generalized form, analysts and others have often had difficulty figuring out exactly (say) how much of the total cash is effectively locked up within various subsidiaries and isn’t as freely available as the bottom line of the cash flow statement might suggest. IFRS 12 requires disclosing the carrying amounts of the assets and liabilities to which the restrictions apply, which you certainly couldn’t count on getting in the past, and could actually be fundamental to your assessment of a company’s prospects.

In a related vein, although the amount of any non-controlling interests in subsidiaries is usually disclosed plainly enough, it’s often not clear exactly what those interests represent in terms of specific assets and liabilities. For some entities, IFRS 12 will expand the information on this area considerably, including summarized financial information about subsidiaries containing material non-controlling interests. For this and other requirements, the standard does allow some aggregation, while noting the necessity of striking “a balance between burdening financial statements with excessive detail that may not assist users of financial statements and obscuring information as a result of too much aggregation.” In deciding whether to aggregate information, an entity considers “quantitative and qualitative information about the different risk and return characteristics of each entity it is considering for aggregation and the significance of each such entity to the reporting entity,” which could generate some interesting analysis memos in the future (and evokes in a general way the kinds of segment reporting aggregation issues I wrote about here)…

The majority of smaller entities don’t have any of these complexities, and won’t end up disclosing much more than they do now. But plenty of issuers will find themselves saying more. Much of it, no doubt, will be technical boilerplate, but some of it should provide a clearer window on real and relevant risks.

The opinions expressed are solely those of the author