Case 05-6Centcom Inc.Centcom Inc., a telephone company, entered into an agreement to manage Britel, a telecommunications company based in Italy. Britel is a wholly-owned subsidiary of TTL Group LLC. The terms of the management agreement are as follows: Centcom would manage Britel for a period of five years. Centcom would be entitled to receive a variable management fee that would allow Centcom to receive 80 percent of Britels EBTIDA during the agreement period. However, payment of the management fee is contingent on sufficient cash being generated from Britels operations. Centcom would select one member on the six-member board of directors and TTL Group would select the remaining five. Major expansion transactions (i.e., acquisitions, joint ventures, issuance of capital or debt, etc.) would require unanimous approval of the board. Centcom would manage the administrative and operational activities of Britel, including hiring and terminating employees.o Centcom plans to integrate Britels activities into its own operations, through consolidating finance, accounting and customer services departments, by terminating the majority of Britels employees. Centcom would be able to provide additional services to Britels customers that Britel did not provide as of the date of the management agreement. In the event that Britels operations do not generate the required cash flow to satisfy Britels debt obligations, Centcom will be required to fund any shortfall. Such shortfalls are not reimbursable by Britel or TTL Group. TTL Group has no responsibility to fund Britels operations as a result of the agreement. TTL Group received a premium of 6 million for writing a call option to Centcom that, if exercised, would allow Centcom to purchase 100 percent of Britels outstanding common shares, as of the date of the agreement, at a strike price of 1 million. The option is exercisable at each anniversary date and expires five years from the date of the agreement.Additional Information Britel is highly leveraged, and its balance sheet contains a deficit in shareholders equity. Centcom estimates that under its management of Britel, economies of scale benefits will be realized, and, thus, will reduce Britels operating costs. Below is Britels summary Balance Sheet as of the date of the agreement.Assets(in Thousands)Total current assets 11,500Fiber optic cable70,500Other assets3,500Total assets 85,500LiabilitiesProvision and payables 5,000Deferred liabilities10,500Long-term debt100,000Total liabilities115,500Total shareholders deficit 30,000Assume for discussion purposes that Britel meets the definition of a business in Appendix A of IFRS 3.Required:On the basis of your analysis of the factors presented in the case, determine whether Centcom, TTL Group, or neither party should consolidate Britel under International Financial Reporting Standards (IFRS). Be certain to discuss the relevant factors in the case that would support consolidation by either entity.
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