NAGIL's Investments Report Paper Example

Purpose and Method of this Report

The following is a report relating to four of NAGIL's investments. In each scenario, AASB 10 principles for the presentation and preparation of consolidated financial statements are utilized to decide whether or not to include these investments in NAGIL's consolidated accounts.

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The report takes on the format of a commentary on the control and power requirements, for each for the four individual cases, as dictated by the provisions of AASB 10.

Each commentary ends with a recommendation on what action to take when preparing consolidated financial statements.

Recommendations and Conclusions

I recommend that Bill Handy only include investment C and D in NAGIL's final consolidated accounts. MSCL and CROCsRUs are the only investee that NAGIL controls. In scenario B, NAGIL is essentially an agent and does not control the investment in question. Whereas in Scenario A, it is obvious NAGIL has failed to meet the control requirements of AASB 10, and that NAGIL neither has power nor control in Struggle Ltd

Scenario A

Paragraph B7 of AASB 10 explicitly states that an investor controls an investee if and only if the investor has all the following: (a) power over the investee (b) exposure, or rights, to variable returns from its involvement with the investee and (c) the ability to use its power over the investee to affect the amount of the investor's returns (Australian Accounting Standards Board (AASB), 2011, 18)

How well does NAGIL fulfill this criterion?

Is NAGIL exposed, or does it have rights, to variable returns from its involvement with Struggle? Yes.

Does NAGIL have the ability to use its power over Struggle to affect the amount of the investor's (NAGIL) returns? No.

Paragraph B9 of AASB 10, on the topic of the criteria for assessing power, clearly states that only substantive rights and rights that are not protective shall be considered (Australian Accounting Standards Board (AASB), 2011, 18).

Paragraph B10 of AASB 10 states that an investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, i.e. activities that significantly affect the investee's returns (Australian Accounting Standards Board (AASB), 2011, 18). And in this particular scenario, there seems to be an arrangement which has rendered voting rights NOT the dominant factor in deciding who controls the investee.

NAGIL is never involved in personnel appointments; neither does NAGIL take part in any operational nor capital decisions. Going by the power requirements of paragraphs B10 - B12 (Australian Accounting Standards Board (AASB), 2011, 19), it is clear that NAGIL does NOT direct Struggle Ltd.'s relevant activities.

Paragraph B14 explicitly states that power arises from rights. For a right to be substantive, the holder must have the practical ability to exercise that right. In an ideal and straightforward scenario, the rights granted by the 70% stake that NAGIL owns in Struggle Ltd would have been substantive rights; rights enabling NAGIL to direct the activities of Struggle Ltd without the co-operation of the others.

However in this particular case, NAGIL's rights in Struggle seem to be only protective at best. NAGIL does not enjoy any rights that, either individually or in combination, can give an investor power; such as those listed from Paragraphs B15 (a) to B15 (e) (Australian Accounting Standards Board (AASB), 2011, 22). The debt-to-equity conversion almost serves as mere 'insurance' to NAGIL that Struggle Ltd will repay its loan provided the latter continues as a going concern.

Verdict: Do not include

NAGIL neither has power nor control in Struggle Ltd. As such, NAGIL fails to meet the control requirements of AASB 10 and should not include the investee, Struggle Ltd, in his consolidated books.

Scenario B

In this particular scenario VBCL delegated to NAGIL all decision-making regarding the former's finances. NAGIL'S deputy chief finance officer is now acting as an agent, transacting on behalf of VBCL's investors.

Relevant activities are defined by paragraph B11 and B12 of AASB 10 as 'operating and financing activities that significantly affect a company's returns' (Australian Accounting Standards Board (AASB), 2011, 19). It is important to note that NAGIL's deputy chief finance officer is heavily involved in VBCLs operational, financial budgeting and capital decisions. Nothing gets done without his approval.

This implies that NAGIL exercises a certain degree of power and control over VBCL since finance, the lubricating oil of all other relevant activities, is still very much in the hands of NAGIL. Of all the relevant activities listed from paragraph B11 (A) to B11 (e) none of them can proceed without NAGIL's approval. All sales, purchases, decisions on funding, management of capital assets as well as financial assets must have CFO approval, which is testament to the NAGIL's power in this situation.

The principal's power may be held and exercisable by an agent, but only on behalf of the principal. Despite the fact that NAGIL's deputy CFO enjoys decision-making rights, he is still just an agent of VBCL shareholders, who still retain the right to appoint board members. Furthermore, NAGIL has no board representation.

Under the subsection on 'delegated power', Paragraph B58 of AASB 10 defines an agent as a 'party primarily engaged to act on behalf and for the benefit of another party or parties (the principal(s)) and therefore does not control the investee when it exercises its decision-making authority' (Australian Accounting Standards Board (AASB), 2011, 38).

Verdict: Do Not Include

NAGIL still does not enjoy any rights that, either individually or in combination, can give an investor power; such as those listed from Paragraphs B15 (a) to B15 (e). These aforementioned rights include but are not limited to voting rights; the right to appoint, reassign or remove personnel or other entities directing relevant activities etc.

Substantive removal rights and can remove the decision maker without cause, this, in isolation, is sufficient to conclude that the decision maker is an agent

Therefore, Bill Handy should not include this investment in the consolidated books because NAGIL is simply an agent - it has neither control nor power over VBCL. NAGIL fails to meet the control requirements of AASB 10 and should not include VBCL in its consolidated books.

Scenario C

In this scenario both NAGIL and SPL are equals with regard to equity invested and voting rights.

Paragraph 13 of AASB 10 states that if two or more investors each have existing rights that give them the unilateral ability to direct different relevant activities, the investor that has the current ability to direct the activities that most significantly affect the returns of the investee has power over the investee (Australian Accounting Standards Board (AASB), 2011, 19).

If all the activities in this example-providing finance on a standard commercial basis and providing the necessary managerial and entrepreneurial expertise-are relevant activities, each investor needs to determine whether it is able to direct the activities that most significantly affect the investee's returns. Both NAGIL and SPL ought to choose between providing finance on a standard commercial basis and providing the necessary managerial and entrepreneurial expertise - which is the activity that most significantly affects MSCL's returns? Are either NAGIL or SPL able to direct that activity?

In this particular investment, the tiebreaker is exposure, risk and uncertainty. As paragraph B20 puts it, "The greater an investor's exposure, or rights, to variability of returns from its involvement with an investee, the greater is the incentive for the investor to obtain rights sufficient to give it power. Therefore, having a large exposure to variability of returns is an indicator that the investor may have power" (Australian Accounting Standards Board (AASB), 2011, 24).

Furthermore, advancing credit to the investee exposes NAGIL to credit risk associated with possible default of principal and interest payments of MSCL. NAGIL, being the more exposed investor here, has rights, to partake in variable returns from its involvement with the investee (MSCL Ltd). These returns may potentially vary as a result of the investee's performance.

Verdict: Include in Consolidated Accounts

If NAGIL's debt were converted, NAGIL would own a majority of the voting rights of MSCL (the investee). NAGIL would benefit immensely from realizing synergies if the debt were converted into equity. NAGIL therefore has power over MSCL because it holds voting rights of the investee (50%) together with substantive potential voting rights that could potentially give it the ability to direct MSCL's relevant activities.

Additionally, NAGIL enjoys top priority when profits are distributed whereas SPL's interests take a back seat. NAGIL gets paid even before preferred shareholders since the secured loan is treated as a liability.

Verdict: NAGIL controls MSCL through both equity and debt therefore Bill Handy ought to include investment C within its consolidated accounts.

Scenario D

Paragraph B58 of AASB 10 under the subsection "Delegated Power" states that when an investor with decision-making rights (a decision maker) assesses whether it controls an investee, it shall determine whether it is a principal or an agent. An agent is a party primarily engaged to act on behalf and for the benefit of another party (the principal(s)) and therefore does not control the investee when it exercises its decision-making authority (Australian Accounting Standards Board (AASB), 2011, 38).

Verdict: Do not Include in Consolidated Accounts

According to Paragraph B59, an investor may delegate its decision-making authority to an agent on some specific issues or on all relevant activities. In this particular instance, Tom and Marjory Legless have chosen to delegate all relevant activities to NAGIL. This gives NAGIL power. Nevertheless, since Tom and Marjory own 60%, and every major decision passes. through them, it would be inaccurate to say that NAGIL has control. Although the principals' power is held and is exercisable by an agent, it is done only on behalf of the principal.

Tom and Marjory's substantive removal rights and can also remove NAGIL from the decision maker role without cause. This, in isolation, is sufficient to conclude that the decision maker is an agent.

Conclusio...