Monday, April 25, 2011

The Concept of Significant Influence

Based on IAS 24 : Related Party Disclosures, entities are considered to be related parties when one of them either :

  1. has the ability to control the other entity
  2. can exercise significant influence over the other entity in making financial and operating decisions
  3. has joint control over the other
  4. is a joint venture in which the other entity is a joint venturer
  5. functions as key management personnel of the other entity
  6. is a close family member of any individual having the ability to control or influence the entity or is a key management member thereof

Significant Influence

The existence of the ability to exercise significant influence is an important concept in relation to this standard. It is one of the two criteria stipulated in the definition of a related party, which when present would, for the purposes of this standard, make one party related to another. In other words, for the purposes of this standard, if one party is considered to have the ability to exercise significant influence over another, then the two parties are considered to be related.

The existence of the ability to exercise significant influence may be evidenced in one or more of the following ways :

  1. By representation on the board of directors of the other entity;
  2. By participation in the policy-making process of the other entity;
  3. By having material intercompany transactions between two entities;
  4. By interchange of managerial personnel between two entities; or
  5. By dependence on another entity for technical information

Significant influence may be gained through agreement, by statute, or by means of share ownership. Under the provisions of IAS 24, similar to the presumption of significant influence under IAS 28, an entity is deemed to possess the ability to exercise significant influence if it directly or indirectly through subsidiaries  holds 20% or more of the voting power of another entity (unless it can be clearly demonstrated that despite holding such voting power the investor does not have the ability to exercise significant influence over the investee).

Conversely, if an entity, directly or indirectly through subsidiaries, owns less than 20% of the voting power of another entity, it is presumed that the investor does not possess the ability to exercise significant influence (unless it can be clearly demonstrated that the investor does have such an ability despite holding less than 20% of the voting power).

Further, while explaining the concept of significant influence, IAS 28 also clarifies that “a substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence” (emphasis added).

Source of this article : WILEY – 2010 Interpretation and Application of International Financial Reporting Standards, by Barry J.Epstein and Eva K.Jermakowicz

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