combination with remaining ownership that is widely dispersed results in an
entity (A) having power.
Applying the concept of de facto control in the absence of ‘bright lines’ will require
significant judgement of the facts and circumstances. For example:
• How large does an investor’s interest need to be relative to others?
• How widely dispersed are the other investors? Could three shareholders easily
act together?
• Are past voting patterns expected to be indicative of future voting patterns? How
much history would be needed to make an assessment?
• Are there other relevant agreements between shareholders?
Generally, the lower the percentage held by one investor (the dominant shareholder, in
Examples 6.9 to 6.13 above), the less likely that investor has de facto control.
Consolidated financial statements 399
Although perhaps rare, an investor could find itself in control of an investee simply
because of circumstances that exist at a point in time, rather than because of deliberate
action (see 9.3 below). In addition, while it may be easy to use hindsight to determine
whether an investor had (or has) control, it might be difficult to apply this principle on
a real-time basis. Information will need to be gathered and analysed (e.g. how widely
dispersed are the other shareholders), so that management can reach a timely
conclusion. It will also be necessary to monitor the changes in the profile of the other
shareholders as this could mean that the investor has gained or lost power over the
investee (see 9.3 below).
The following extract illustrates the disclosure of the significant judgements used in
determining the existence of de facto control.
Extract 6.1: ENGIE SA (2017)
NOTES TO THE CONSOLIDATED FINANICAL STATEMENTS [extract]
NOTE 2
MAIN SUBSIDIARIES AT DECEMBER 31, 2017 [extract]
2.2
Significant judgements exercised when assessing control [extract]
Entities in which the Group does not have the majority of the voting rights [extract]
In the entities in which the Group does not have a majority of the voting rights, judgment is exercised
with regard to the following items, in order to assess whether there is a situation of de facto control:
• dispersion of shareholding structure: number of voting rights held by the Group relative to the
number of rights held respectively by the other vote holders and their dispersion;
• voting patterns at shareholders’ meetings: the percentages of voting rights exercised by the Group at
shareholders’ meetings in recent years;
• governance arrangements: representation in the governing body with strategic and operational
decision-making power over the relevant activities, as well as the rules for appointing key
management personnel;
• contractual
relationships
and material transactions.
The main fully consolidated entities in which the Group does not have the majority of the voting rights
are Compagnie Nationale du Rhône (49.98%) and Gaztransport & Technigaz (40.4%).
Compagnie Nationale du Rhône (“CNR” – France): 49.98%
The Group holds 49.98% of the share capital of CNR, with CDC holding 33.2%, and the balance
(16.82%) being dispersed among around 200 local authorities. In view of the current provisions of the
French “Murcef” law, under which a majority of CNR’s share capital must remain under public
ownership, the Group is unable to hold more than 50% of the share capital of CNR. However, the Group
considers that it exercises de facto control as it holds the majority of the voting rights exercised at
shareholders’ meetings due to the widely dispersed shareholding structure and the absence of evidence
of the minority shareholders acting in concert.
Gaztransport & Technigaz (“GTT” – Others): 40.4%
Since GTT’s initial public offering in February 2014, ENGIE has been the largest shareholder in that
company with a 40.4% stake, the free float representing around 49% of the share capital. The Group
holds the majority of the voting rights exercised at shareholders’ meetings in view of the widely
dispersed shareholding structure and the absence of evidence of minority shareholders acting in concert.
ENGIE also holds the majority of the seats on the Board of Directors. The Group considers that it
exercises de facto control over GTT, based on an IFRS 10 criteria analysis.
400 Chapter
6
4.3.4
Potential voting rights
When assessing whether it has power over an investee, an investor also considers the
potential voting rights that it holds, as well as potential voting rights held by others. Common
examples of potential voting rights include options, forward contracts, and conversion
features of a convertible instrument. Those potential voting rights are considered only if the
rights are substantive (see 4.2.1 above). [IFRS 10.B47]. In the remainder of this section,
reference is made to ‘options’, but the concepts apply to all potential voting rights.
When considering potential voting rights, an investor considers the purpose and design
of the entity, including the rights associated with the instrument, as well as those arising
from any other involvement the investor has with the investee. This includes an
assessment of the various terms and conditions of the instrument as well as the investor’s
apparent expectations, motives and reasons for agreeing to those terms and conditions.
[IFRS 10.B48].
If the investor also has voting or other decision-making rights relating to the investee’s
activities, the investor assesses whether those rights, in combination with potential
voting rights, give the investor power. [IFRS 10.B49].
Substantive potential voting rights alone, or in combination with other rights, may
provide an investor the current ability to direct the relevant activities. [IFRS 10.B50]. For
example, if an investor has less than a majority of voting rights, but holds a substantive
option that, if exercised, would give the investor a majority of voting rights, that investor
would likely have power. [IFRS 10.B42, B50]. Example 6.14 below illustrates when holding
an option would likely give an investor power.
Example 6.14: Potential voting rights (1)
A holds 40% of the voting rights of B, and holds a currently exercisable in-the-money option to acquire a
further 20% of the voting rights of B.
A
40% voting
rights
Option for 20%
voting rights
B
Assuming that voting rights give power over B, the option is substantive and no other facts and circumstances
are relevant to this assessment, A would likely have power over B, because A can currently exercise its right
to obtain a majority of B’s voting shares at any time.
Consolidated financial statements 401
The opposite is also true. If an investor holds a majority of the voting rights, but those
voting rights are subject to a substantive option held by another investor, the majority
shareholder would likely not have power.
Another example provided by IFRS 10 of a situation where substantive potential voting
rights, in combination with other rights, can give an investor the current abi
lity to direct
the relevant activities is reflected in Example 6.15 below.
Example 6.15: Potential voting rights (2)
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 that is out of
the money (but not deeply out of the money). 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. 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. [IFRS 10.B50 Example 10].
IFRS 10 is silent on whether the intention of the holder (i.e. whether the holder intends
to exercise the option or not) is considered in the assessment of potential voting rights.
However, IFRS 10 is clear that power arises from rights per se and the ability those rights
give the investor to direct the relevant activities. [IFRS 10.B14]. Therefore, an option is
only considered in the assessment of power if it is substantive (i.e. the holder has the
practical ability to exercise the option when decisions about the direction of relevant
activities need to be made). [IFRS 10.B22, B24, B47]. As discussed at 4.2.1 above, whether an
option is substantive depends on facts and circumstances. Common factors to consider
when evaluating whether an option is substantive include:
• exercise price or conversion price, relative to market terms;
• ability to obtain financing; and
• timing and length of exercise period.
These factors are each discussed in more detail below, and their implications are
indicated in the table below. The evaluation of whether an option is substantive
should consider all the factors discussed at 4.2.1 above, rather than limited to only
one of the factors.
Figure 6.5:
Evaluating whether potential voting rights are substantive
Evaluation Non-substantive Depends
on
facts Substantive
and circumstances
Exercise price
Deeply-out-of-
Out-of-the-money or
In-the-money
the-money
at market (fair value)
Financial ability
Holder has no
Holder would have
Holder has cash or
to exercise
financial ability
to raise financing
financing readily available
Exercise period
Not exercisable
Exercisable before decisions
Currently
need to be made
exercisable
402 Chapter
6
4.3.4.A
Exercise price or conversion price
IFRS 10 is clear that the exercise price (or conversion price) can and should be
considered, in evaluating whether an option can give power, because it might represent
a barrier to exercise. [IFRS 10.B23(a)(ii)]. Factors to consider are:
• deeply-out-of-the-money – Generally, these would be considered non-substantive;
• out-of-the-money (but not deeply) – Judgement will be needed to assess whether
the cost of paying more than fair value is worth the potential benefits of exercise,
including the exposures to variable returns that are associated with exercising that
option (see 5 below for examples of exposures to variable returns);
• at market (fair value) – Consideration should be given as to whether the option
conveys rights that differ from those that would be available to third parties in an
open market; or
• in-the-money – Generally, in-the-money options would be considered substantive.
IFRS 10 does not define ‘deeply-out-of-the-money’ or provide a list of indicators for
management to consider when exercising judgement in determining whether an option
is deeply-out-of-the-money (as opposed to merely out-of-the-money). A call option
with a strike price significantly above the value of the underlying interest is normally
considered to be deeply-out-of-the-money.
When evaluating the exercise price, consideration is given as to whether the nature of the
exercise price (e.g. deeply-out, out, or in-the-money) is expected to remain so for the
entire exercise period, or whether the nature of the exercise price may change in the
future. That is, the evaluation is not solely based on the nature of the option at inception
or as of the end of the reporting period. This is because to convey power, an option must
give an investor the current ability to direct the relevant activities when the decisions
need to be made. Thus, for example, if an option was deeply-out-of-the-money at the
reporting date, but the exercise price was subject to decrease such that the option was
expected to become in-the-money before the relevant activities of the investee need to
be directed, then the option may be substantive (or vice versa). This evaluation will
require the exercise of judgement based on all relevant facts and circumstances. As noted
above, the evaluation is not solely based on the nature of the option as of the end of the
reporting period, i.e. whether a potential voting right is substantive is not based solely on
a comparison of the strike or conversion price of the instrument and the then current
market price of its underlying share. Although the strike or conversion price is one factor
to consider, determining whether potential voting rights are substantive requires a holistic
approach, considering a variety of factors. This includes assessing the purpose and design
of the instrument, considering whether the investor can benefit for other reasons such as
by realising synergies between the investor and the investee, and determining whether
there are any barriers (financial or otherwise) that would prevent the holder of potential
voting rights from exercising or converting those rights. Accordingly, a change in market
conditions (i.e. the market price of the underlying shares) alone would not typically result
in a change in the consolidation conclusion. [IFRS 10.BC124].
Example 6.16 below reflects an example from IFRS 10 of an option that is currently
exercisable, but is deeply-out-of-the-money and is expected to remain so for the whole
of the exercise period. [IFRS 10.B50 Example 9].
Consolidated financial statements 403
Example 6.16: Potential voting rights (3)
Investor A holds 70% of the voting rights of an investee. Investor B has 30% of the voting rights of the
investee as well as an option to acquire half of investor A’s voting rights. The option is exercisable for the
next two years at a fixed price that is deeply out of the money (and is expected to remain so for that two-year
period). Investor A has been exercising its votes and is actively directing the relevant activities of the investee.
In such a case, investor A is likely to meet the power criterion because it appears to have the current ability
to direct the relevant activities. Although investor B has currently exercisable options to purchase
additional
voting rights (that, if exercised, would give it a majority of the voting rights in the investee), the terms and
conditions associated with those options are such that the options are not considered substantive.
4.3.4.B Financial
ability
The financial ability of an investor to pay the exercise price should be considered when
evaluating whether an option is substantive, because this could be an ‘economic barrier’
as contemplated by IFRS 10. [IFRS 10.B23(a)]. For example, if there is evidence that an
investor cannot obtain financing to exercise an in-the-money option, this might indicate
that the option is not substantive. However, financial ability is generally considered to
be linked to the exercise price, because an investor should be able to obtain financing
for an in-the-money option. As such, instances in which an investor would be unable to
obtain financing for in-the-money options are expected to be uncommon.
In contrast, it is probably more common that the holder has the financial ability to
exercise an option that is out-of-the-money (but not deeply so) and would consider
exercising that option to benefit from synergies. This might be the case when the
investee has strategic importance to the option holder.
4.3.4.C Exercise
period
To have power over an investee, an investor must have existing rights that give the
investor the current ability to direct an investee’s relevant activities. [IFRS 10.10]. This
would imply that an option needs to be currently exercisable to give power. However,
under IFRS 10, an option can give an investor the current ability to direct an investee’s
relevant activities even when it is not currently exercisable. Although ‘current’ often
means ‘as of today’ or ‘this instant’ in practice, the IASB’s use of the term in IFRS 10
broadly refers to the ability to make decisions about an investee’s relevant activities
when they need to be made. [IFRS 10.B24]. This is illustrated in Example 6.17 below.
Example 6.17: Potential voting rights (4)
An investee holds annual shareholder meetings, at which decisions to direct the relevant activities are made.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 80