How to Audit Consolidated Financial Statements Under IFRS 10

What IFRS 10 actually requires you to test

The client’s group structure diagram arrives as a hand-drawn chart scanned from the CFO’s notebook. There are seven entities across four countries, two of which the parent owns at 45% and 38% respectively. The CFO says both are consolidated “because we control them.” When you ask what constitutes control, the answer is “we appoint the board.” One of the 45%-owned entities has a shareholder agreement giving the minority veto rights over operating and financial decisions. The other has a put option held by the minority shareholder exercisable in eighteen months. Your file currently treats both as subsidiaries. One of them probably isn’t.

IFRS 10 requires a parent to consolidate all entities it controls, where control is defined as having power over the investee, exposure or rights to variable returns from involvement with the investee, and the ability to use that power to affect those returns (IFRS 10.6–7), with the assessment based on substance over legal form and reassessed whenever facts and circumstances change.

IFRS 10 replaced IAS 27 (as it related to consolidated financial statements) and SIC-12 (on special purpose entities) with a single control model. The standard applies to all entities, including structured entities that were previously assessed under different rules. The core principle sits in IFRS 10.6: a parent shall consolidate an investee when it controls the investee. No option exists to exclude a controlled entity from consolidation, regardless of the nature of its activities, its location, or whether the parent intends to sell it. IFRS 10.4(a)(iv) provides a limited exemption for investment entities meeting the criteria in IFRS 10.27, but this is rare in mid-market audit files.

Your audit work concentrates on two questions. First, is the consolidation scope correct? This means testing whether every entity the parent claims to control actually meets the IFRS 10 control definition, and whether any entities that should be consolidated have been excluded. Second, are the consolidation procedures performed correctly? This means testing the elimination of intragroup balances and transactions, the alignment of accounting policies across group entities, and the treatment of non-controlling interests.

For mid-market European groups, the first question creates more audit risk than the second. Consolidation mechanics (intercompany eliminations, currency translation) follow prescribed rules that can be tested arithmetically. The control assessment is a judgment call that depends on the substance of legal arrangements, governance structures, and contractual rights.

The control assessment: power, returns, and the link between them

IFRS 10.7 defines control through the conjunction of all elements: the investor has power over the investee, has exposure (or rights) to variable returns from its involvement, and has the ability to use its power to affect those returns. All must be present simultaneously. Missing any one means no control under IFRS 10.

Power (IFRS 10.10–14) means having existing rights that give the investor the current ability to direct the relevant activities of the investee. Relevant activities are the activities that significantly affect the investee’s returns (IFRS 10.B11–B13). For most operating entities, the relevant activities are operating and capital expenditure decisions, hiring and compensation policy, and sales and marketing strategy. Power can come from voting rights (majority ownership is the simplest case), but IFRS 10.B34–B46 also addresses situations where an investor has power without a majority of voting rights.

Variable returns (IFRS 10.15–16) must be returns that vary depending on the investee’s performance. Dividends, management fees, returns on investment, and exposure to losses all qualify. A fixed-fee arrangement with no performance linkage does not create variable returns. For most mid-market group structures, the parent’s equity interest in the subsidiary creates obvious variable return exposure.

The link between power and returns (IFRS 10.17–18) requires the investor to have the ability to use its power to affect the amount of the investor’s returns. This element prevents consolidation of entities where an investor has power but is acting as an agent for other parties. IFRS 10.B58–B72 provides the principal-versus-agent analysis. If the investor exercises power primarily for the benefit of other parties and its own economic interest is insignificant relative to theirs, the investor may be an agent rather than a principal.

For the majority of mid-market audit files, the control assessment is straightforward: the parent owns more than 50% of the voting rights, appoints the majority of the board, and receives dividends. But you still need to document the assessment for every consolidated entity. IFRS 10.B80 requires reassessment of control when facts and circumstances change. If the parent sold 10% of a subsidiary during the year, bringing its holding from 80% to 70%, the control assessment needs updating even though 70% is clearly still a majority.

Common control scenarios in mid-market files

Less than 50% ownership with de facto control

IFRS 10.B38–B46 addresses situations where an investor holds less than 50% of voting rights but may still control the investee. De facto control arises when the remaining voting rights are widely dispersed among many shareholders who are unlikely to act together, giving the largest single shareholder practical ability to direct the relevant activities. IFRS 10.B42 lists factors to consider: the size of the investor’s holding relative to others, the number and dispersion of other shareholders, potential voting rights, contractual arrangements, and historical voting patterns at shareholder meetings.

A 45% holding where the remaining 55% is split among twelve shareholders (each holding 2–8%) is a plausible de facto control scenario. A 45% holding where one other shareholder holds 40% is not. The assessment depends on specific facts. When auditing a de facto control assertion, obtain the full shareholder register, review the attendance and voting records of recent shareholder meetings, and assess whether any shareholder agreements exist that could create a voting block.

Protective rights versus substantive rights

Not all rights held by minority shareholders defeat control. IFRS 10.B26–B28 distinguishes between protective rights and substantive rights. Protective rights are designed to protect the interest of the holder without giving that holder power over the entity. Examples include approval rights over fundamental changes (amendments to the articles of association, issuance of new shares, liquidation) and rights to approve transactions above a very high threshold. These do not prevent the majority shareholder from having power.

Substantive rights give the holder actual ability to participate in decisions about the relevant activities. A veto right over the operating budget, the power to appoint or remove key management, or the right to approve capital expenditure above a level that covers most normal business spending are substantive rights. When a minority shareholder holds substantive participating rights, the majority holder may not have power as defined by IFRS 10. This is the most common reason a majority-owned investee should not be consolidated.

Potential voting rights and options

IFRS 10.B47–B50 requires you to consider potential voting rights (options, convertible instruments, warrants) when assessing power. Only potential voting rights that are currently exercisable are considered (IFRS 10.B48). A call option that allows the parent to acquire the remaining 55% of an investee’s shares is relevant only if that option can be exercised now, not if it becomes exercisable in two years.

For mid-market files, the most common potential voting right is a call option in a shareholder agreement. If the parent holds 40% of voting rights plus a currently exercisable call option over another 20%, the control assessment considers the parent as holding 60%. But the option must be currently exercisable and the entity must consider whether the purpose and design of the instrument indicate it gives the holder power (IFRS 10.B49–B50). An out-of-the-money option with no economic incentive to exercise may exist on paper but carry no substance.

Consolidation procedures: what to check in the numbers

Once you have confirmed the consolidation scope, the procedural audit work follows IFRS 10.B86–B99 and ISA 600 (for group audits involving component auditors).

IFRS 10.B87 requires the parent and subsidiaries to use uniform accounting policies for like transactions and events. If a German subsidiary applies a different depreciation method than the Dutch parent for similar assets, one set of financial statements must be adjusted. Obtain the group accounting policy manual and test compliance at each material subsidiary. For entities with IAS 16 property, plant and equipment, depreciation methods and useful lives are the most common area where policy alignment fails.

Intragroup balances and transactions must be eliminated in full under IFRS 10.B86(c). This includes intercompany receivables and payables, intercompany revenue and cost of sales, intercompany loans and interest, dividends paid by subsidiaries to the parent, and unrealised profits on intragroup asset transfers. The most common elimination error in mid-market files is incomplete elimination of intercompany trading margins. If the parent sells inventory to a subsidiary at a 20% markup and the subsidiary still holds €500K of that inventory at year-end, the unrealised profit of €100K (€500K × 20/120) must be eliminated from inventory and from consolidated profit.

Non-controlling interests are presented in consolidated equity separately from the parent’s equity (IFRS 10.22). Profit or loss attributable to non-controlling interests is allocated even if the result is a deficit balance for the NCI (IFRS 10.B94). Changes in ownership interest that do not result in a loss of control are accounted for as equity transactions under IFRS 10.23. Verify the NCI calculation: opening NCI plus share of profit plus share of OCI plus contributions less distributions equals closing NCI. Reconcile this for each subsidiary with non-controlling interests.

Reporting dates must be aligned. IFRS 10.B92–B93 permits a difference of no more than three months between the subsidiary’s reporting date and the parent’s. If a subsidiary reports at 30 September and the parent at 31 December, adjustments are required for significant transactions and events between those dates. In practice, most mid-market groups require all subsidiaries to prepare reporting packages at the parent’s year-end.

Foreign currency translation of subsidiaries

For subsidiaries with a functional currency different from the parent’s presentation currency, IAS 21.39 requires translation of the subsidiary’s financial statements before consolidation. Assets and liabilities translate at the closing rate, income and expenses at the exchange rate at the date of the transaction (or an average rate if it approximates actual rates). The resulting exchange differences go to OCI and accumulate in the foreign currency translation reserve within equity.

Verify the exchange rates used by management against published rates (ECB reference rates for eurozone entities). Recalculate the translation reserve movement for the period: opening balance plus exchange differences on the subsidiary’s net assets during the year plus any exchange differences on intragroup monetary items that form part of the net investment (IAS 21.32). This calculation is frequently wrong in mid-market consolidation files because management translates the income statement at the closing rate rather than the average rate, or omits the OCI component entirely.

Loss of control during the period

If the parent lost control of a subsidiary during the period (through disposal or dilution of its holding, or through changes in contractual terms or governance), IFRS 10.25–26 prescribes the accounting. The parent derecognises the subsidiary’s assets and liabilities, derecognises the carrying amount of any NCI, recognises the fair value of consideration received, recognises any retained interest at fair value at the date control is lost, and reclassifies amounts previously recognised in OCI to profit or loss (or retained earnings, as required by other standards). The gain or loss on deconsolidation goes to profit or loss.

For mid-market groups, partial disposals that result in loss of control create the most complexity. If Houtman sold 30% of a previously wholly-owned subsidiary, reducing its holding to 70%, it retains control and accounts for the change as an equity transaction (IFRS 10.23). But if it sold 60%, reducing its holding to 40%, it loses control and must deconsolidate, recognising a gain or loss on the full subsidiary (not just the 60% disposed). The retained 40% interest is then remeasured at fair value at the disposal date. That fair value remeasurement is often the most judgmental element of the transaction.

Worked example: auditing a Dutch group with a disputed subsidiary

Client: Houtman Holding B.V., a Dutch construction group. €89M consolidated revenue, December 2025 year-end. The group holds 100% of two operating subsidiaries (Houtman Bouw B.V. and Houtman Infra B.V.) and 45% of Gebr. Franken Projecten B.V., a project development entity. The remaining 55% of Franken is held by the Franken family (two individuals, holding 30% and 25% respectively). Management consolidates all entities.

1. Assess control over the wholly-owned subsidiaries

Houtman holds 100% of voting rights in Houtman Bouw and Houtman Infra. It appoints all board members. Variable returns exist through dividends and equity exposure. Control is unambiguous under IFRS 10.7. No further analysis required beyond documenting the holding and the governance structure.

2. Assess control over the 45%-owned entity

Houtman claims de facto control over Gebr. Franken Projecten B.V. You need to test this claim against IFRS 10.B38–B46.

Obtain the shareholder agreement. Review the governance provisions. The agreement gives Houtman the right to appoint two of four board members. The Franken family appoints two. Decisions require a simple majority. Board deadlocks are resolved by mediation, not by a casting vote.

Assess the voting structure: Houtman’s 45% is less than a majority. The remaining 55% is held by two related individuals (the Franken brothers) who are likely to vote together as a block. This is not a dispersed shareholding. IFRS 10.B42’s de facto control indicators do not support Houtman’s position.

Review the shareholder agreement for substantive participation rights. The agreement gives the Franken family veto rights over capital expenditure above €250K, operating budgets, management appointments, and new project commitments. Gebr. Franken Projecten’s typical project size is €1.5M–€4M. A €250K capital expenditure threshold covers virtually every material spending decision. These are substantive participating rights, not protective rights.

3. Conclude on the consolidation scope

Houtman does not control Gebr. Franken Projecten B.V. under IFRS 10.7. The entity lacks power over the investee because substantive participating rights held by the Franken family prevent Houtman from unilaterally directing the relevant activities. Additionally, the remaining shares are not dispersed (concentrated in a related block of 55%).

The correct accounting treatment is equity method under IAS 28 (significant influence exists through the 45% holding and two board seats). The impact of deconsolidating Franken on Houtman’s group financial statements: revenue reduces by approximately €18M (Franken’s standalone revenue), total assets decrease by €12M, and the investment is presented as a single line at €4.2M (equity-method carrying amount). This is a material scope change. Discuss with the engagement partner before communicating to management.

4. Test the consolidation mechanics for the two confirmed subsidiaries

Verify intercompany eliminations: Houtman Bouw invoiced €3.1M to Houtman Infra during 2025 for subcontracted construction work. At 31 December 2025, €440K of receivable/payable remains outstanding. Verify the elimination of €3.1M revenue and cost, €440K intercompany balance, and assess whether any unrealised margin exists on work in progress transferred between entities.

Verify uniform accounting policies: compare the depreciation methods and useful lives for construction equipment across both subsidiaries and the parent. Houtman Infra uses a 10-year life for heavy machinery while the parent uses 8 years. Quantify the difference. If material, adjust to the group policy.

Conclusion: The completed file shows that the consolidation scope was assessed entity by entity, with a detailed IFRS 10 control analysis for the disputed investee and documented consolidation procedures for the confirmed subsidiaries.

Practical checklist for your engagement file

1. Obtain the full group structure with ownership percentages, and for each consolidated entity, document the IFRS 10.7 control assessment (power, variable returns, link) even if control appears obvious from a majority holding
2. For any investee held below 50%, prepare a detailed analysis against IFRS 10.B38–B46 (de facto control factors) and obtain shareholder agreements to classify minority rights as protective or substantive under IFRS 10.B26–B28
3. Identify all potential voting rights (options, convertibles, warrants) per IFRS 10.B47–B50 and assess whether they are currently exercisable and carry economic substance
4. Test intercompany elimination completeness: agree intercompany revenue, receivables, payables, loans, and interest to the counterpart entity’s records, and verify unrealised profit eliminations on any intragroup inventory or asset transfers
5. Verify accounting policy alignment across group entities per IFRS 10.B87, with particular attention to depreciation methods, revenue recognition policies, and provision methodologies
6. Reconcile non-controlling interests: opening balance plus NCI share of profit plus NCI share of OCI plus contributions less distributions equals closing balance, tested for each subsidiary with minority shareholders

Common mistakes

• Consolidating without testing control for less-than-majority holdings: when the parent holds less than 50%, the control assessment under IFRS 10.B38–B46 must be documented. Consolidating a 40% investee “because we always have” is not a control analysis. The AFM flagged insufficient IFRS 10 control documentation in its 2023 thematic inspection of group audits, particularly for entities with complex governance arrangements.
• Incomplete intercompany eliminations: the most frequent mechanical error is eliminating intercompany revenue and receivables but missing the unrealised margin on transferred inventory still held at the reporting date. For groups where operating subsidiaries trade with each other at a markup, this margin elimination requires a separate calculation.
• Ignoring substantive participating rights held by minorities: protective rights (veto over liquidation, constitutional changes) do not prevent consolidation, but substantive rights (veto over operating budgets, management appointments, capital allocation) do. Many mid-market files fail to distinguish between the two when a minority shareholder agreement exists.

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Further reading and source references

• IFRS 10, Consolidated Financial Statements – the primary standard governing consolidation scope, control assessment, and consolidation procedures.
• IAS 28, Investments in Associates and Joint Ventures – the equity method standard applicable when an entity has significant influence but not control.
• IAS 21, The Effects of Changes in Foreign Exchange Rates – governs currency translation of foreign subsidiaries before consolidation.
• ISA 600, Special Considerations – Audits of Group Financial Statements – the audit standard for group engagements involving component auditors.