As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 38 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA last year published some extracts from its confidential database of enforcement decisions on financial statements, covering eight cases arising in the period from December 2021 to December 2023, with the aim of “strengthening supervisory convergence and providing issuers and users of financial statements with relevant information on the appropriate application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while. Here’s one:

• The issuer, a media and entertainment company, was controlled and consolidated by entity A. In addition, the issuer controlled and consolidated entity B, holding 90% of capital and voting rights. During 2021, the issuer (i) sold 20% of the capital of entity B to two external groups, and (ii) distributed 60% of the capital of entity B to its shareholders. Following these two transactions, the share capital structure of entity B was the following: the issuer held 10%, entity A held 28%, two other external groups held 30%, the remaining share capital was held by disparate retail investors.
• The issuer concluded that it had significant influence over entity B given (i) the existence of an agreement between the issuer, parent entity A and the two external groups to act in concert to influence the dividend distribution policy, (ii) the fact that entity B provided the issuer with financial information needed to account for it under the equity method in the issuer’s financial statements, and (iii) that some of the issuer’s key employees were transferred from the issuer to entity B. The issuer had no representation on entity B’s board, nor did it engage in material transactions with entity B. The issuer did not have any contractual rights to appoint a representative to entity B’s board of directors.
• The issuer indicated to the enforcer that a representative of the issuer would be appointed as a member of entity B’s board at the next general meeting.

The enforcer (as ESMA likes to term it) disagreed with the assessment of significant influence, noting that as the issuer owned only 10% of voting rights of entity B, significant influence would have to be clearly demonstrated, and this hadn’t been achieved. The enforcer noted that under IAS 28, the existence of significant influence by an entity is usually evidenced by one or more of 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 entity and its investee, interchange of managerial personnel, or (e) provision of essential technical information. In this case, the financial information exchanged from entity B to the issuer didn’t have the nature of essential technical information; the two managers in entity B that were former employees of the issuer no longer had any contractual relations with the issuer and therefore, the transfer didn’t constitute an interchange of managerial personnel; and the agreement on the dividend payment policy in itself wasn’t sufficient to demonstrate a significant influence over operating policy decisions.

It would be interesting to know why the issuer even bothered trying to make the argument, given the cumbersome nature of equity accounting. The reference to “disparate retail investors” suggests that entity B was publicly traded and that a fair value measurement should have been readily available; maybe they didn’t want to deal with the potential volatility. Maybe the issuer truly believed it had significant influence and that equity accounting was appropriate and meaningful, but it would seem like a stretch, even if some of the facts were different. What if the factors highlighted by the enforcer had swung the other way, and entity B was being regularly supplied with essential technical information, there was a clearer interchange of managerial personnel and so on? Would any of that mean that an entirely different approach to the accounting was warranted and sound? Of course not…

For more along those lines, you can refer back to my old post titled Equity accounting – time to say goodbye, which was published in, um, October 2015, and itself referred back to even older posts along similar lines. It’s long been time to move on from this cumbersome and antiquated mechanism, especially as the use of fair value measurement is now so well-established (whether or not one actually likes it). But will the IASB ever bring itself to take that obvious step? Well, for now they’re doing the exact opposite! Let’s check back in nine or ten years…

The opinions expressed are solely those of the author.