A new financial reporting standard (FRS) affecting the consolidation of financial statements will become effective for annual periods beginning on or after Jan 1, 2014, the Singapore Exchange (SGX) reminded investors

PUBLISHED OCTOBER 23, 2013

SGX reminds investors of new consolidation rule

MICHELLE QUAH MICHQUAH@SPH.COM.SG

A NEW financial reporting standard (FRS) affecting the consolidation of financial statements will become effective for annual periods beginning on or after Jan 1, 2014, the Singapore Exchange (SGX) reminded investors yesterday. The new standard, FRS 110, issued by the Accounting Standards Council, could change the entities that consolidated into the group’s consolidated financial statements. “FRS 110 . . . makes control the basis for determining the entities to be included in consolidated financial statements. More entities will be included in the consolidated financial statements if the issuer is able to establish control over them,” SGX said in a mailer, sent via its investor education portal My Gateway, yesterday. “This means the assets, liabilities, income, and expenses of these ‘investees’, or subsidiaries, will be reflected in the consolidated financial statements as if they were part of the issuer group, likely affecting the final figures,” SGX’s report added.It used the example of IHH Healthcare Bhd, which is cross-listed in Malaysia and Singapore, to show how FRS 110 could affect the consolidated assets and liabilities of the controlling entity.

For its 2012 financial year, IHH Healthcare consolidated its 35.8 per cent- owned Parkway Life Reit and its 50 per cent-owned Khubchandani Hospitals Pte Ltd into its financial statements, by applying an identical consolidation standard. This brought its restated total assets, net of total liabilities, to RM19.2 billion from RM18.2 billion for that year.

Broken down, the restatements for IHH Healthcare’s 2012 financial year were as follows:

  • Non-current assets restated to RM22.9 billion from RM20.6 billion
  • Current assets restated to RM2.75 billion from RM2.67 billion
  • Non-current liabilities restated to RM4.6 billion from RM3.2 billion
  • Current liabilities restated to RM1.9 billion from RM1.8 billion.

As the example illustrates, the effect of FRS 110 on the reported financial position of the parent will depend on the financial circumstances of the investee.

The new standard supersedes two others: FRS 27 Consolidated and Separate Financial Statements and INT FRS 12 Consolidation – Special Purpose Entities.

FRS 110 defines the principle of control, stating that “an investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee”.

It also requires the parent, or investor, to reassess whether it controls a subsidiary, or investee, if there are any changes to any of the elements of control defined in the standard.

FRS 110 also sets out the accounting requirements for the preparation of consolidated financial statements.

New consolidation accounting rule may pose some challenges for companies

Business Times

07 Nov 2013

Michelle Quah

[SINGAPORE] The impending new financial reporting standard (FRS) on consolidation, FRS 110, claimed its first victim recently, when United Overseas Bank (UOB) took steps at the end of last month to wind up its associate, United International Securities (UIS).

Under the new standard, which redefines the entities to be consolidated, UIS would need to be consolidated into UOB’s accounts; the move would incur additional costs that the group would prefer to avoid.

FRS 110 will become effective for annual periods beginning on or after Jan 1, 2014. The looming adoption date begs the questions: Are companies fully prepared for the change? And just how will the new standard affect financial statements and the companies they belong to?

The Accounting Standards Council (ASC), which issues the standards here, actually held back the implementation of FRS 110 by a year, after receiving feedback that this and other FRSs due to be introduced at the same time were posing a greater challenge to stakeholders than anticipated.

Accounting experts agree that, given the extra preparation time, FRS 110 should not present that much of a challenge to most companies on its own. But they also agree that the increased complexity of the new standard and the greater judgment needed to apply it will present some issues.

Sim Hwee Cher, Assurance leader at PwC Singapore, points out: “For example, in the case of the option to purchase further shares, such as warrants – before FRS 110, the assessment of whether these options lead to consolidation was less complex and focused mainly on whether the option holder has the current power to exercise his option.

“Under FRS 110, the assessment will be much more complex, involving the consideration of a melting pot of factors including whether and how far the option is in the money, the purpose and design of the option, an assessment of the wider arrangement that led to the acquisition of the option, etc.”

Reinhard Klemmer, partner and head of Accounting Advisory Services at KPMG in Singapore, says the initial adoption of the standard where market practices have not been set will prove difficult. “For example, does a company with shares of less than 50 per cent control another company when the former is by far the largest shareholder? Such decisions are hard to make without historical precedent.

“Another requirement of the FRS 110 is to determine the significant activity of a company that may require consolidation – which was not something that the accounting standards required previously. The activity may not be straightforward enough to determine, which makes it hard for the finance function to judge on its own.”

There are also operational issues a company will face in applying FRS 110. Shariq Barmaky, Assurance and Advisory partner at Deloitte Singapore, believes one of the biggest challenges will be the need for the parent company or investor to continually assess if it controls an investee when facts and circumstances indicate there are changes to the elements of control defined by the standard. “We anticipate challenges in executing the assessment continually, particularly where very often the assessment of control is one that requires consideration of other market factors as well as other parties to the investee.”

Mr Sim points out that other operational issues include “managing stakeholders with regard to the impact on capital ratios, key performance indicators (KPIs), effects on key items such as revenue – due to consolidating additional revenue or vice versa – training finance teams to understand the new approach, implementing internal controls to identify judgmental areas of consolidation, and so on”.

The adoption of the standard will also be trickier for certain types of companies or entities.

Tan Seng Choon, Assurance partner at EY, says: “Companies that will face significant challenges in adopting FRS 110 would likely be those who invested in special-purpose entities and fund/asset managers who are directing the activities of the fund that they manage, as these are the areas where (the) judgment involved would be significant.”

Mr Barmaky points out that “Reits (real estate investment trusts) and business trust structures need to exercise judgment in determining if they are principal or agent to the structure”.

“Among others, the assessment of principal-agent, and whether the rights are substantive or protective in nature, may not be a straightforward assessment,” he adds.

Mr Klemmer believes two distinct categories of companies will face the greatest challenges: large conglomerates with a wide variety of relationships and operations in a number of foreign countries; and smaller companies that may lack the manpower to dedicate their most knowledgeable resources to deal with the adoption issues.

He adds: “The other group that may struggle are some of the users of financial instruments, for example, lenders who have financial ratios they monitor; such ratios may significantly change if additional companies are being consolidated into the borrower . . . (Also,) as consolidation has an implication not just on one or a few line items on the financial statements, analysing its impact will require significant effort.”

Still, despite these, it is important not to lose sight of the fact that FRS 110 was introduced to improve on the current situation. It is meant to deal with the current diversity in practice in applying FRS 27, and with off-balance sheet vehicles, such as the securitisation vehicles that posed such a risk during the global financial crisis.

Mr Barmaky says: “The debate continues as to whether FRS 110 will bring about more or less consolidation but, in essence, the new standard is intended to bring about more appropriate consolidation that better reflects the relationship between a reporting entity and an investee.”

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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