Question Tag: Legal form

Two different approaches to determining a “reporting entity” for financial reporting purposes are:

1. Legal Form Approach:
   • Explanation:
     Under the legal form approach, a reporting entity is determined based on its legal structure. In this approach, the entity is defined by its legal registration, such as a corporation, limited liability company, or partnership. This means that a legally incorporated entity is considered a reporting entity, and its financial statements should reflect the financial activities of that legal entity. This approach is commonly used because it aligns with legal and regulatory frameworks.
   • Advantages:
     The legal form approach provides clear boundaries for what constitutes a reporting entity, making it straightforward to prepare financial statements. It ensures that the financial reporting is aligned with the legal responsibilities of the entity, such as its tax and regulatory obligations.
   • Limitations:
     The legal form approach may not capture the full economic activities of a business, particularly if the entity is involved in a complex group structure with subsidiaries, associates, or joint ventures. As such, legal boundaries may not always reflect the economic reality of how resources are controlled or managed.
2. Control Approach:
   • Explanation:
     The control approach defines a reporting entity based on the concept of control, as outlined in IFRS 10 Consolidated Financial Statements. In this approach, any entity over which another entity has control is considered part of the reporting entity. Control is established when an entity has the power to direct the relevant activities of another entity and can derive benefits from its operations. This approach is used to consolidate financial statements, where a parent company includes all subsidiaries that it controls.
   • Advantages:
     The control approach better reflects the economic reality of a business by including all entities that are controlled by a parent entity, even if they are legally distinct. It ensures that financial reporting provides a holistic view of the financial performance and position of a group of entities under common control.
   • Limitations:
     This approach may be more complex to implement, particularly for large groups with multiple layers of ownership. Additionally, determining control can sometimes be subjective, especially in cases where control is not based solely on ownership percentage but rather on contractual agreements or potential voting rights.