A Ltd, B Ltd and C Ltd owned 60%, 20% and 20%, respectively, of the voting shares of X Ltd. There were ten members on the board of directors of X Ltd.
A shareholder with 10% shareholding is allowed to appoint one board director in X Ltd. These ten directors were responsible for designing and implementing the financial and operating policies of X Ltd.
A Ltd, B Ltd and C Ltd signed a shareholders’ agreement which gave B Ltd the option to acquire more shares at any time for a fixed price. If B Ltd exercised these share options, it would increase its equity interest and voting rights in X Ltd to 60%. Consequently, the equity interest and voting rights of A Ltd and C Ltd would be reduced to 30% and 10%, respectively.
Explain the concept of control according to financial reporting standards and discuss whether A Ltd, B Ltd, or C Ltd has control of X Ltd.
As per Financial Reporting standards Control by one entity on another entity can be obtained in the following ways-
1- If it holds voting power of another entity of more than 50%
2- it has the power to compose a board of directors
3- it has the ability to direct the relevant activity of another company.
An investor determines whether it is a parent by assessing whether it controls one or more investees. An investor considers all relevant facts and circumstances when assessing whether it controls an investee.
A parent prepares consolidated financial statements if it has control over other entities using uniform accounting policies for like transactions and other events in similar circumstances.
Initially, A Ltd. held more than 50% of voting power of X Ltd. Hence, it has control over X Ltd.
If B Ltd exercised these share options, it would increase its equity interest and voting rights in X Ltd to 60%. Consequently, it will become the holding company of X Ltd., and A & C Ltd. will have a minority Interest in X Ltd.