International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom. Exposure Draft 10: Consolidated Financial Statements

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1 Karl Gadesmann Leiter Konzernrechnungswesen und externe Berichterstattung VOLKSWAGEN AG D Wolfsburg International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom Exposure Draft 10: Consolidated Financial Statements Dear Sir/Madam, Thank you for the opportunity to comment on the IASB Exposure Draft 10: Consolidated Financial Statements. On behalf of the Volkswagen AG, Wolfsburg, we are pleased to provide you with remarks on the proposed Discussion Paper in response to your Invitation to Comment. We apologize for the short delay. In general, Volkswagen agrees on a theoretical basis to most of the conclusions drawn in the exposure draft. Especially we appreciate the incorporation of SIC-12 into the Standard, as the interpretation often was misunderstood in the past. However we can t agree that the proposed guidance becomes a legal requirement, as it often seems to be more a discussion paper, very vague, which gives plenty of opportunities for different interpretations. Especially the paragraphs about factual control are too vague to be applied consistently in practice. Volkswagen has already experienced from the view of a potential subsidiary how difficult it is to decide if there is factual control, two times in the past. In both situations the guidelines proposed in ED 10 would not have been helpful, but it leaves the reporting entity in a substantial legal uncertainty. Further the Draft seems to propose a in dubio pro consolidation rule. With all the discussions about the reasons of the credit crunch this seems to be opportune, but please keep in mind that (1) to include corporations which are not under control into the group is also an easy form of window dressing and that (2) under several legislations subsidiaries have to provide the controlling party with more information than the other shareholders, as this information were needed for the preparation of the group financial

2 statement and therefore there has always to be a fair balance between the information needs of the shareholders of the investor and the needs of the other shareholders of the investment company. The standard should state more clearly that there is very careful consideration need, when control applies and when control not applies. We also disagree to the proposed form of the Standard, because too much guidance is transferred to the appendices. This may be seen as more principle based, but we neither can see the principle when something is stated directly in the standards and when it is transferred to the appendices nor is it easier to read. To your questions in detail Question 1 Do you think that the proposed control definition could be applied to all entities within the scope of IAS 27 as well as those within the scope of SIC-12? If not, what are the application difficulties? We agree to the proposed control definition. However the IASB should elaborate what is meant by the word power in the control definition as it is crucial for assessing control. Power is in our view the factual ability to direct the activities of another entity against the antagonism of all other parties. A legal position is not needed. It is not necessary to use this power to have control; on the other hand directing the activities of an other entity without the power to do so against the antagonism of all other parties is not enough to have control. The IASB states that control is not shareable, what is in line with the definition above, but this means, that a group financial statement at a subgroup level is not possible. If this is really the opinion of the IASB, paragraph 2 of the exposure draft is not needed. Further the IASB should give a clear statement on the rank of the control definition. This questions is crucial to all discussion on the understanding of IAS 27 (at least in Germany) and it is also crucial for the application of ED 10 as there are inconsistencies between the control definition and the paragraphs on how to assess control.

3 Question 2 Is the control principle as articulated in the draft IFRS an appropriate basis for consolidation? We agree. Question 3 Are the requirements and guidance regarding the assessment of control sufficient to enable the consistent application of the control definition? If not, why not? What additional guidance is needed or what guidance should be removed? No, the requirements and guidance regarding the assessment of control are not sufficient to enable a consistent application of the control definition. This is because they are too vague and because they are inconsistent to the control definition. In Paragraph the IASB states that if the appointment or removal of the members of an entity s governing body is determined by voting rights, a reporting entity with more than half of those voting rights controls that governing body and has the power to direct the activities of that entity unless (a) legal requirements, the founding documents of the other entity or other contractual arrangements restrict the power of the reporting entity to the extent that it does not have the power to direct the activities of the entity, or (b) if another party has the power to direct the activities of the entity. First we have to ask if all of the members of the governing body must be appointed by voting rights, what means that the rule is not applicable to all major German entities where half of the board members are appointed by the employee. Second we have to ask if it is sufficient for control to have the majority of voting rights for appointing the members of the governing board without having enough voting rights (e. g. 75 %) needed to replace them. In Germany board members are normally elected for several years. Therefore a party acquiring more than half of the voting rights of an entity can dominate the appointment of new board members, but without removal right, it has to wait until the reelection of the old board members until it has the power to direct the activities of that entity. We would tend to say that in this situation the abstract control definition is not fulfilled. However, as the IASB explicit states in Paragraph 24 that the ability of appointment or removal of the board members is sufficient for control, we are not sure if we have to treat the entity as a subsidiary or if in this case the rule of Paragraph 25 applies, as appointment and removal are normally legal

4 requirements or contractual arrangements. Further we have to ask in which other situations than Paragraph 25 (a) another party than the majority shareholder has control over an entity and if this is possible if it would not be sufficient that this party (for example a group of other shareholders) has the ability to prevent the majority shareholder from directing the activities (but not having joint control as defined by IAS 31). The IASB states in Paragraph 27, that a reporting entity with less than half of the voting rights has the power to direct the activities of another entity if (a) the reporting entity has more voting rights than any other party; and (b) the reporting entity s voting rights are sufficient to give the reporting entity the ability to determine the entity s strategic operating and financing policies. This is inconsistent to the abstract control definition as control is defined as the power to direct the activities of an entity, but Paragraph 27 asks only for the ability to determine the entity s strategic operating and financing policies. Different wording can mean different things. There is an entity with three brothers as shareholders A, B, and C. A having 50 % of the voting rights, and the B and C having only 25 % each. B and C see themselves only as capital providers and normally do not join the election of the board members. Brother A has more voting rights than any other party and his voting rights are sufficient to give him the ability to determine the entity s strategic operating and financing policies. However he has not the power to do so. The wording is also inconsistent to the Paragraphs as it is not clear, what will happen, when a party has the ability to direct activities, but Paragraph 25 applies. Beyond wording it should be without doubt that A has no control; but it is difficult to see, where is the difference between the situation with two other shareholders giving A the ability to direct the activities by not using there voting rights and the situation with two thousand other shareholders giving one party the ability to direct the activities by not going to the annual meeting. Therefore, the principle in which situations one party has factual control must be stated much clearer. Further, the assessment of factual control in practice can often only be done reliable ex post, as it seems more the job of a statistician and every statistic needs either significant differences or a longer observation period to be reliable. Therefore the standard should say clearly for a consistent application that the assessment of factual control is an accounting estimate, that control should be only assessed, if that assessment can be done reliable, that this assessment may take a period of time to be done reliable and that a change in the assessment on factual control as an change in accounting estimates should be applied prospectively in line with IAS 8.

5 We can not agree to the proposals in paragraph B9, as they describe the mechanics to direct the activities of another entity, but giving no answer to the question, how control is established. According to our understanding, it is not enough to have the ability to direct the activities of another entity because the other shareholders do not object. Therefore, there should be no consolidation without explanation about the locus of control (meaning the way the power to direct the activities is established). The indicators in Paragraph B9 are misleading and therefore should be abandoned. We agree to the proposals on related arrangements; however these proposals are not specific for assessing control. Therefore we believe these proposals should be better stated in IAS 1. We are missing proposals about control, when the allowance by an antitrust authority or other regulation authority is not given at the balance sheet date, as this can be very important in practice. Though normally it is agreed by contract that the closing date is after the approval was reached, but in some situations this it not possible. From our point of view keeping the legal consequences of gun jumping in mind control without approval is factual not possible. Question 4 Do you agree with the Board s proposals regarding options and convertible instruments when assessing control of an entity? We do not agree. We do not see how the requirement in Paragraph B13(a) fits to the requirement that a reporting entity need not have exercised its power to direct the activities of an entity to control that entity or to the other requirements in B13. We also don t see how this principle should be applied in practice. Question 5 Do you agree with the Board s proposals for situations in which a party holds voting rights both directly and on behalf of other parties as an agent? If not, please describe the circumstances in which the proposals would lead to an inappropriate consolidation outcome. We agree to the principle, but we see no sense in the list in B12. Either these parties or any other party not on the lists act as described in B3-B8 and therefore are agents of the reporting entity, or they are not. The list is not helpful at all, but we fear, that the phrase examples of parties that often act for a reporting entity can be misunderstood.

6 Question 6 Do you agree with the definition of a structured entity in paragraph 30 of the draft IFRS? If not, how would you describe or define such an entity? Although we can not find a definition of a structured entity, we principally agree to the distinction drawn between entities controlled via a governing body and entities that are not. However, we believe that structured entities are only a special form of agency relationship with the shareholders of the entity acting as agent for the controlling party and wonder if the complicated distinction between (normal) entities and structured entities is needed. Question 7 Are the requirements and guidance regarding the assessment of control of a structured entity in paragraphs of the draft IFRS sufficient to enable consistent application of the control definition? If not, why not? What additional guidance is needed? We agree. Question 8 Should the IFRS on consolidated financial statements include a risks and rewards fall back test? If so, what level of variability of returns should be the basis for the test and why? Please state how you would calculate the variability of returns and why you believe it is appropriate to have an exception to the principle that consolidation is on the basis of control. As stated above, we believe that structured entities are a special form of agency relationships. An agency relationship is identified by showing that the agent receives beyond his fee no reward from the relationship. Therefore the question of reward is already part of the control test. But we do not agree to use risk and reward as a fall back test. The outcome will be very different if instead of control risk and reward would be the principle for consolidation. For example we would have to consolidate some major joint ventures, where we provide more than fifty percent of the capital and therefore bear more than fifty percent of the risks and receive more than fifty percent of the reward, but by agreement join control; on the other hand we may not consolidate a subsidiary where we hold less than 50 % of the cumulative voting and non-voting stock. It would lead therefore to inconsistencies to use it as fall back test.

7 Question 9 Do the proposed disclosure requirements described in paragraph 23 provide decision-useful information? Please identify any disclosure requirements that you think should be removed from, or added to, the draft IFRS. We do not agree in the form the disclosure requirements are described as this leads to many discussions in practice. E. g. the requirement to evaluate the basis of control and the related accounting consequences is very broad and could be understood in different ways. Also B32 to B34 seems to indicate, that there is no substantial change to IAS 27, we wonder, if the requirements in IAS 27 were not much clearer to understand and easier to read. We do not agree to the disclosure requirements about structured entities at least because most of this information can normally not be provided, if there is no control. Further, we believe that in formations about risks not included in the balance sheet are already in the scope of IAS 37 and IFRS 7. Question 10 Do you think that reporting entities will, or should, have available the information to meet the disclosure requirements? Please identify those requirements with which you believe it will be difficult for reporting entities to comply, or that are likely to impose significant costs on reporting entities. See 9. Question 11 (a) Do you think that reputational risk is an appropriate basis for consolidation? If so, please describe how it meets the definition of control and how such a basis of consolidation might work in practice. (b) Do you think that the proposed disclosures in paragraph B47 are sufficient? If not, how should they be enhanced? Yes to both. Question 12 Do you think that the Board should consider the definition of significant influence and the use of the equity method with a view to developing proposals as part of a separate project that might address the concerns raised relating to IAS 28?

8 We believe that the equity method is a measurement method that measures the equity of the investment company from the view sight of the investor. We therefore see no inconsistency. Best Regards, Karl Gadesmann