In May 2011 the IASB simultaneously issued three new standards and two amended standards. This so-called “suite of five” covers all aspects of group accounting and consolidation, joint arrangements, equity accounting and related disclosure of interests in other entities. Disclosure of unconsolidated structured entities is also addressed for the first time in the history of IFRS. The new standards and the replaced standards are:
New IFRS | Replaced IFRS |
IFRS 10, Consolidated Financial Statements. | IAS 27, Consolidated and Separate Financial Statements, and SIC-12, Consolidation Special Purpose Entities. |
IFRS 11, Joint Ventures. | IAS 31, Interest in Joint Ventures, and SIC 13, Jointly Controlled Entities—Non-monetary Contributions by Venturers. |
IFRS 12, Disclosure of Interest in Other Entities. | None. Previously the disclosure requirements relating to interests in other entities were contained in each separate standard. |
IAS 27, Separate Financial Statements. | IAS 27, Consolidated and Separate Financial Statements. |
IAS 28, Investments in Associates and Joint Ventures. | IAS 28, Investment in Associates, and IAS 31, Interests in Joint Ventures. |
IFRS 10, Consolidated Financial Statements, establishes principles for the presentation and preparation of consolidated financial statements when an entity controls one or more other entities, and introduces a single model for identifying control to replace the previous concepts of control contained within the former IAS 27 and SIC-12. IFRS 11, Joint Arrangements, establishes principles for the financial reporting by parties to a joint arrangement. The option to proportionately consolidate joint ventures that was previously available to jointly controlled entities under IAS 31 has been eliminated. IFRS 12, Disclosure of Interest in Other Entities, combines, enhances and replaces the disclosure requirements for subsidiaries, joint arrangements, associates and unconsolidated structured entities. IAS 27 (revised) deals with the presentation of separate financial statements. IAS 28 (revised) identifies associates and deals with equity accounting for both associates and joint ventures.
Associate. An entity over which an investor has significant influence.
Consolidated financial statements. Financial statements of a group in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity.
Control of an investee. An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.
Decision maker. An entity with decision-making rights that is either a principal or an agent of the principal.
Equity method. A method of accounting whereby the investment is initially recorded at cost and adjusted thereafter for the post-acquisition change in the investor's share of the investee's net assets. The investor's profit or loss includes its share of the investee's profit or loss and the investor's other comprehensive income includes its share of the investee's other comprehensive income.
Group. A parent and its subsidiaries.
Interest in another entity. An interest in another entity refers to contractual and non-contractual involvement that exposes an entity to variability of returns from the performance of the other entity.
Investment entity. An entity that obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services; commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both; and measures and evaluates the performance of substantially all of its investments on a fair value basis.
Joint arrangement. An arrangement of which two or more parties have joint control.
Joint control. The contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control.
Joint operation. A joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement.
Joint operator. A party to a joint operation that has joint control of the operation.
Joint venture. A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Joint venturer. A party to a joint venture that has joint control of the joint venture.
Non-controlling interest. Equity in a subsidiary not attributable, directly or indirectly, to the parent.
Parent. An entity that controls one or more entities.
Party to a joint arrangement. An entity that participates in a joint arrangement, regardless of whether that entity has joint control of the arrangement.
Power. Existing rights that give the current ability to direct the relevant activities.
Protective rights. Rights designed to protect the interest of the party holding those rights without giving that party power over the entity to which those rights relate.
Public market. Public market includes a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets.
Relevant activities. Activities of the investee that significantly affect the investee's returns.
Removal rights. Rights to deprive the decision maker of its decision-making power.
Separate financial statements. Financial statements presented by an entity in which the entity could elect to account for its investment in subsidiaries, joint ventures and associates either at cost, in accordance with IFRS 9, Financial Instruments, or using the equity method as described in IAS 28, Investments in Associates and Joint Ventures.
Separate vehicle. A separately identifiable financial structure, including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality.
Significant influence. The power to participate in the financial and operating policy decisions of the investee but it is not control or joint control of those policies.
Structured entity. An entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements.
Subsidiary. An entity that is controlled by another entity.
IAS 27 (2008) defined control as “the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities,” whereas SIC-12 considered both benefits and risks in its assessment of control of special-purpose entities. This subtle but important difference in concepts led to inconsistent application of the principles in practice. IFRS 10 provides a revised definition of control and establishes control as the basis for consolidation, so that a single control model can be applied to all entities.
IFRS 10 sets out related guidance to apply the principle of control to identify whether an investor controls an investee and therefore must consolidate the investee. IFRS 10 also sets out the accounting requirements for the preparation of consolidated financial statements.
IFRS 10 requires that an entity that is a parent must present consolidated financial statements that include all subsidiaries of the parent. Only three exceptions to this rule are available. Firstly, a parent need not present consolidated financial statements if all the following criteria are met:
Secondly, post-employment benefit plans or other long-term employee benefits plans to which IAS 19, Employee Benefits, apply are also excluded from the scope of IFRS 10.
Thirdly, an investment entity need not present consolidated financial statements if it is required to measure those subsidiaries at fair value through profit or loss in accordance with IFRS 9, Financial Instruments. Investment entities are discussed later in this chapter.
Under IFRS 10 an investor shall determine if it is a parent by assessing whether it controls the investee. A subsidiary is defined as “an entity that is controlled by another entity” (IFRS 10 App A). An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. The definition contains three requirements that must be present in order for control to exist:
The three requirements are interrelated. The ability to use power to affect the returns creates a link between the first two requirements. Only when the power could be used to affect the returns is the definition of control met. An investor must assess all facts and circumstances to determine whether it controls an entity. Appendix B to IFRS 10 contains the following factors that investors should use in order to determine if they control a subsidiary: (1) the purpose and design of the investee; (2) what the relevant activities are; (3) how decisions about those activities are made; (4) whether the rights of the investors give it the current ability to direct the relevant activities; (5) whether the investor is exposed, or has the rights to variable returns from its involvement with the investee; and (6) whether the investor has the ability to use its power over the investee to affect the amount of the investor's return.
These facts and circumstances should be continuously monitored, and if there are any changes to the facts or circumstances, control should be reassessed.
Regarding the first requirement, an investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities that significantly affect the investee's returns. Returns will only be affected if the investor can control the activities that generate the returns.
Examples of activities that could, depending on the circumstances, be principal activities include: the purchase and sale of goods or services, the selection, acquisition or sale of assets, research and development for new products or procedures, and the establishment of finance structures or the procurement of funds. If two or more investors currently have the ability to manage the principal activities and these activities take place at different times, the investors must determine which of them has the ability to manage those activities that have the greatest effect on these returns.
Power arises from rights, and could arise in any of the following circumstances: (1) rights in the form of voting rights (or potential voting rights) of an investee; (2) rights to appoint, reassign or remove members of an investee's key management personnel who have the ability to direct the relevant activities; (3) rights to appoint or remove another entity that directs the relevant activities; (4) rights to direct the investee to enter into, or veto any changes to, transactions for the benefit of the investor; and (5) other rights that give the holder the ability to direct the relevant activates. The lower one moves down this hierarchy, the more complex the assessment becomes. In the assessment, all the rights of others must be considered. An investor assessing whether he has decision-making power is only assessing substantive rights. Consequently, an investor that only holds protective rights does not have the power to direct the activities. A right is substantive when the holder has the practical ability to exercise the right. This requires judgement, taking into account all facts and circumstances. The following factors can be used in the assessment:
Usually the substantive rights need to be exercisable when the decision regarding the direction of the relevant activities needs to be made. Rights may, however, also be of a substantial nature even if they cannot be exercised at present. An example for rights which are currently not exercisable but are even then substantive is shown later in this chapter.
Control is presumed if the majority of voting rights is held, unless other factors indicate that the majority of voting rights does not create control. Holding the majority of voting rights normally results in control if:
For a majority of voting rights to result in control, those rights must be substantive. If another party, which is not an agent, has existing rights that provide the other party with the ability to direct the operating activities, the majority of voting rights presumption is rebutted. The test is to determine who has power over the activities.
Control could also exist when a party has less than a majority of voting rights. The following are examples of instances where control could exist even though less than a majority of voting rights is held:
Any combination of the above scenarios could result in an investor having control of an investee. In assessing de facto control, the size of the investor's holdings relative to size and dispersion of other investors are considered, together with the other considerations listed above.
An investor is exposed, or has rights to, variable returns when the investor's returns from the involvement have the potential to vary as a result of the investor's performance, whether negative or positive. Variable returns can arise in various forms, for example:
An investor controls an investee if the investor not only has power over the investee and exposure or rights to variable returns from its involvement with the investee, but also has the ability to use its power to affect the investor's return from its involvement with the investee. Therefore, it is important to determine whether the investor is acting as an agent or the principal. If the investor acts as an agent, the investor does not control the investee. The investor will have been delegated power on behalf of another party or parties. An agent is a party primarily engaged to act on behalf or for the benefit of another party or parties (the principal). A decision maker must consider the overall relationship between itself, the investee being managed and other parties involved with the investee, and in particular the following factors to determine whether the decision maker is acting as an agent or principal:
A decision maker founds, markets and manages a fund offering investment opportunities to a number of investors. The decision maker (fund manager) must make decisions in the interests of all investors and in accordance with the contracts that are most important to the fund. Nonetheless, the fund manager has a great deal of discretion where his decisions are concerned. For his services he receives a fee at the normal market level of 1% of assets under management plus 20% of the gains made by the fund once a specified level is reached. The fee is in reasonable proportion to the services provided.
Although the fund manager must make decisions in the interests of all investors, he enjoys wide decision-making authority in the management of the fund's principal activities. The fund manager receives fixed and variable fees at standard market levels. In addition, his remuneration has the effect of aligning the interests of fund managers and those of other investors in a rise in the fund's value. However, this imposes no risk arising from fluctuating returns from fund activities of such a magnitude that the remuneration, when viewed in isolation, might be seen as an indicator that the fund manager is the principal.
Control can also exist through other contractual arrangements. This would usually be the case with structured entities. A structured entity is an entity that has been designed so that voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. The assessment of control in such instances is based on the normal principles discussed above as well as an assessment of the special arrangements and the size of the exposure regarding the variability in returns. In assessing the purpose and design of the structured entity, the risk that was created and passed on to the parties to the arrangement is considered to establish the party's exposure to some or all of the risks. A large exposure to variability in returns might also indicate that the party has power over the entity. Such risk and returns are, however, on their own not conclusive. All facts and circumstances must be considered.
The involvement of the parties and decisions made at the inception of the arrangement are considered to determine whether the transaction terms and features provide the investor with rights that are sufficient to create control. Both explicit and implicit decision-making rights embedded in the contractual arrangement that are closely linked to the investor must be considered. Further contractual rights such as call rights, put rights and liquidation rights are also considered.
Consolidated financial statements shall present fairly the financial position, financial performance and cash flows of the group. IFRS 10 contains only a little guidance on the preparation of consolidated financial statements. A parent shall prepare consolidated financial statements using uniform accounting policies for like transactions and other events in similar circumstances. Consolidation begins from the date the investor obtains control and ceases when the investor loses control.
In preparing consolidated financial statements an entity combines the items presented in the financial statements line by line, adding together like items of assets, liabilities, equity, income and expenses. In order to present financial information about the group as that of a single economic entity, the following procedures are followed:
When less than 100% of the shares of the acquired entity are owned by the acquirer, a complication arises in the preparation of consolidated statements, and a non-controlling interest must be determined and presented. According to IFRS 10.22, non-controlling interests must be presented in the consolidated statement of financial position within equity, separately from the equity of controlling interests (the owners of the parent). If a company holds non-controlling interests in several subsidiaries, the various non-controlling interests can be reported within a single position. This method complies with the economic unit concept that is employed in the world of Anglo-Saxon accounting. The profit or loss and each component of other comprehensive income to the owners of the parent and to the non-controlling interests must be attributed separately. This applies even if this allocation brings about a situation in which the non-controlling interests post or will in future post a negative equity balance. Not even the non-existence of an additional-funding obligation on the part of the non-controlling interests makes any difference to this allocation. In this event a negative share of the non-controlling interests must consequently be reported within equity.
The control concept of IFRS 10 and the economic unit concept can jointly lead to a situation where a parent company, even though it has a minority holding in an entity, controls the relevant activities of the subsidiary—by virtue of other agreements, for example—and hence also controls the subsidiary itself. Since shares in the equity and the profit or loss are determined on the basis of ownership interest (for which see below), this leads to a situation in which consolidation includes 100% of an entity's assets and liabilities while the majority of the equity must be allocated to non-controlling interests. In these cases IFRS 12 requires the disclosure of the nature of the relationship between a parent and a subsidiary when less than 50% of voting rights are owned.
Measurement of non-controlling interests. According to IFRS 3.19 entities have the choice to measure the non-controlling interests at either fair value or at its proportionate share in the recognised amounts of the acquiree's identifiable net assets. This choice can be made on a transaction-by-transaction basis. It is not required for entities to make an accounting policy choice. In the subsequent periods the non-controlling interest is not remeasured to fair value. But, the share of the profit or loss and each component of other comprehensive income is allocated to non-controlling interests as described above.
In the consolidated statement of financial position, non-controlling interest is presented within equity, separately from the equity of the owners of the parent. Changes in a parent's interest in a subsidiary that do not result in the parent losing control are equity transactions and result in transfers to and from the owner's equity to non-controlling interest. The difference between the amount by which the non-controlling interest is adjusted and the fair value of the consideration paid or received is recognised directly in equity attributable to the parent.
There is a presumption that all the members of the consolidated group should use the same accounting principles to account for similar events and transactions. However, in many cases this will not occur, as, for example, when a subsidiary is acquired that uses cost for investment property while the parent has long employed the fair value method. IFRS 10 requires that the policies of the combining entities should be uniform and therefore appropriate adjustments should be made in the consolidated accounts. When a subsidiary of a corporate group is acquired and different accounting policies exist, the principles of IAS 8 permit the subsidiary to alter its accounting policy to that of the group in its individual financial statements. Alternatively the subsidiary may retain its previous principles in its individual financial statements. In this event the group should make appropriate adjustments in the consolidated accounts.
Income and expenses of the subsidiary are included in the consolidated financial statements from the date control is obtained until the date when control is lost. The income and expenses are based on the amounts of assets and liabilities recognised at the acquisition date. The depreciation charges entered in the consolidated income statement after the date of acquisition, for example, are based on the fair value of the associated depreciable assets reported in the consolidated financial statements on the date of acquisition.
A practical consideration in preparing consolidated financial statements is to have information on all constituent entities current as of the parent's year-end. If a subsidiary has a different reporting date, the subsidiary prepares additional financial information as of the date of the consolidated financial statements to enable the parent to consolidate the subsidiary, unless it is impracticable to do so.
If it is impracticable, the subsidiary is consolidated using the most recent financial statements of the subsidiary adjusted for the effect of significant transactions or events that occur between the date of those financial statements and the date of the consolidated financial statements. The difference between the date of the subsidiary's financial statements and the consolidated financial statements is limited to three months and must be applied consistently from period to period. Of course, if this option is elected, the process of eliminating intercompany transaction and balances may become a bit more complicated, since reciprocal accounts (e.g., sales and cost of sales) will be out of balance for any events occurring after the earlier fiscal year-end but before the later one.
In the preparation of consolidated financial statements there is usually a question mark over the share of the profit or loss or changes in the equity of the subsidiary that the parent company must take into account in the preparation of its own consolidated financial statements if, for example, potential voting rights or non-controlling interests exist. IFRS 10 B89 determines that the proportion of profit or loss and changes in equity allocated to the parent and non-controlling interests in preparing consolidated financial statements is determined solely on the basis of existing ownership interests, unless an entity has, in substance, an existing ownership interest as a result of a transaction that currently gives the entity access to the return associated with an ownership interest.
If a parent company has an indirect holding, the treatment of the non-controlling interests is more complicated than in a single-tiered group. Furthermore, the amount of potential goodwill to be reported is contentious. The non-controlling interests in the parent company's consolidated financial statements are calculated by multiplying the fractions applying to the various tiers of the group. The calculation for the purposes of consolidation can be carried out either in a single step, or first at the level of the indirect holding, then at that of the parent company with a corresponding adjustment of the indirect holding (multi-tier consolidation).
If goodwill was revealed in the first consolidation of S2 in S1 in the revaluation process, the question arises as to the level of goodwill that must be included in P's consolidated financial statements.
The treatment of goodwill at the level of P is contentious. On the one hand it is contended that here, too, goodwill should be reported at €30, and that the non-controlling interest is accordingly €4.5 higher (€30 × 15%). This is argued on the grounds that non-controlling shareholders in S1 were part of the S2 acquisition transaction.
The second view is based on net assets from the viewpoint of the group. This holds that P holds only 85% of the goodwill and may thus report only €25.5, while the remaining €4.5 are offset against the non-controlling interest, restoring this to the amount in the original example.
We prefer the second view, because this reflects the goodwill commercially acquired by the group shareholders at its correct level. Also this does not result in any blending with the full goodwill method as in the first view. If the full goodwill method is applied as per IFRS 3.32, accounting is unambiguous. At the level of S1, goodwill of €40 is detected (full goodwill = €30 (S1 goodwill)/75%). Of this, €10 are allocated to S2's non-controlling shareholders and €4.5 to those of S1. In total, non-controlling interests of €110.75 (equity share of €96.25 plus €14.5 as a share of goodwill) must be reported in P's consolidated financial statements.
Subsidiaries that were acquired with a view to resale or are to be sold, where these meet the definition of an asset held for sale in accordance with IFRS 5, are not excluded from the consolidation. They must continue to be consolidated, and furthermore their results, assets and liabilities must be reported separately. These subsidiaries are presented in a single amount in the statement of comprehensive income comprising the total of:
The assets of the subsidiaries classified as held-for-sale must be separately presented from other assets in the statement of financial position. The same is true for the liabilities of the subsidiaries classified as held-for-sale.
The provisions of IFRS 5 are dealt with in detail in Chapter 13.
If a parent company ceases to have a controlling financial interest in a subsidiary, the parent is required to deconsolidate the subsidiary as of the date on which its control ceased. Examples of situations that can result in a parent being required to deconsolidate a subsidiary include:
Should the parent's loss of controlling financial interest occur through two or more transactions, management of the former parent is to consider whether the transactions should be accounted for as a single transaction. In evaluating whether to combine the transactions, management of the former parent is to consider all of the terms and conditions of the transactions as well as their economic impact. The presence of one or more of the following indicators may lead to management concluding that it should account for multiple transactions as a single transaction:
Obviously, this determination requires the exercise of sound judgement and attention to economic substance over legal form.
When control of a subsidiary is lost and a non-controlling interest is retained, consistent with the approach applied in step acquisitions, the parent should measure that retained interest at fair value and recognise, in profit or loss, a gain or loss on disposal of the controlling interest. The gain or loss is measured as follows:
FVCR | = | Fair value of consideration received, if any |
FVNIR | = | Fair value of any non-controlling investment retained by the former parent at thederecognition date (the date control is lost) |
DISTRoS | = | Any distribution of shares of the subsidiary to owners |
CVNI | = | Carrying value of the non-controlling interest in the former subsidiary on thederecognition date, including any accumulated other comprehensive incomeattributable to the non-controlling interest |
CVAL | = | Carrying value of the former subsidiary's assets (including goodwill) and liabilitiesat the derecognition date |
(FVCR + FVNIR + DISTRoS + CVNI) − CVAL = Gain (Loss) |
If a parent loses control of a subsidiary, it must recognise all amounts that were previously reported for the relevant subsidiary in other comprehensive income. Recognition takes place on the same basis as would have been prescribed by the parent company for a direct disposal of the corresponding assets or liabilities. Example: Subsidiary X is sold by parent company A. The previous consolidated balance sheet contained other comprehensive income reserves pursuant to IFRS 9 and actuarial losses pursuant to IAS 19 resulting from subsidiary X. At the time of the loss of control of X, A must reclassify the reserve to profit or loss, and leave the remeasurements of the net defined benefit liability (asset) recognised in other comprehensive income under IAS 19 in the consolidated equity of A. This is because, under IAS 19.122, remeasurements shall not be reclassified to profit or loss in a subsequent period, and under IFRS 9 the reserve must be reclassified on the sale of the securities.
Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27), issued in October 2012, introduced an exception to the principle that required all subsidiaries to be consolidated. These amendments came into effect for reporting periods beginning after January 1, 2014, a full year after the effective date of the original versions of the standards. The amendments define an investment entity and require a parent that is an investment entity to measure its investments in particular subsidiaries at fair value through profit or loss in accordance with IFRS 9 instead of consolidating those subsidiaries in its consolidated and separate financial statements. However, as an exception to this requirement, if a subsidiary provides investment-related services or activities to the investment entity, it should be consolidated.
A parent of an investment entity has to consolidate all entities that it controls, even those subsidiaries who are controlled by an investment entity, unless the parent itself is an investment entity.
Example: Vehicle manufacturer X is the parent company of investment entity B. B has holdings in various companies that are not active in the automotive sector. Whereas X is not an investment entity pursuant to IFRS 10, B is classed as an investment entity pursuant to IFRS 10. For the purposes of this example it should be assumed that both X and B must prepare consolidated financial statements. Solution: Since B is an investment entity, it must report companies in which it holds a controlling interest at fair value through profit or loss. X, conversely, must fully consolidate all its subsidiaries, including B.
IFRS 10 requires a parent to determine whether it is an investment entity. An investment entity is defined as an entity that:
The standard explains that an investment entity will usually display the following typical characteristics, which entities should consider in determining whether the definition is met:
Although these typical characteristics are not essential factors in determining whether an entity qualifies to be classified as an investment entity, the standard does require an investment entity that does not have all of these typical characteristics to provide additional disclosure regarding the judgement made in arriving at the conclusion that it is in fact an investment entity.
From the point of view of the IASB one of the essential activities of an investment entity is that it obtains funds from investors in order to provide those investors with investment management services. Even though detailed guidance is not given about the first criteria of the definition, the IASB notes that this provision differentiates investment entities from other entities.
The purpose of an investment entity should be to invest solely for capital appreciation, investment income (such as dividends, interest or rental income) or both. This would typically be evident in documents such as the entity's offering memorandum, publications distributed by the entity and other corporate or partnership documents. Further evidence may include the manner in which the entity presents itself to other parties (such as potential investors or potential investees).
An investment entity may provide investment-related services (for example, investment advisory services, investment management, investment support and administrative services), either directly or through a subsidiary, to third parties as well as to its investors, even if those activities are substantial to the entity. However, such services should not be offered to investees, unless they are undertaken to maximise the entity's investment return. In addition, if these services to investees represent a separate substantial business activity or a separate substantial source of income to the entity, it would not be able to classify itself as an investment entity in the context of IFRS 10.
A common characteristic of investment entities is that they would not plan to hold investments indefinitely. The standard requires an investment entity to have an exit strategy documenting how the entity plans to realise capital appreciation from substantially all of its equity investments and non-financial asset investments. An investment entity would also be required to have an exit strategy for any debt instruments that have the potential to be held indefinitely, for example perpetual debt investments. Although it is not necessary to document specific exit strategies for each individual investment, an investment entity should at least be able to identify different potential strategies for different types or portfolios of investments, including a substantive time frame for exiting the investments. For the purposes of this assessment, it would not be sufficient to consider exit mechanisms that are only put in place for default events, such as breach of contract or non-performance.
Examples of exit strategies for private equity securities could include:
Examples of exit strategies for publicly trade equity securities could include:
Examples of exit strategies for real estate investments include:
An entity would not be investing solely for capital appreciation, investment income or both, if the entity or another member of the group to which the entity belongs obtains, or has the objective of obtaining, other benefits from the entity's investments that are not available to other parties that are not related to the investee.
Examples of benefits which would usually result in disqualification from investment entity status include:
Can Select Biotechnology Fund be considered as an investment company? Although Select Biotechnology Fund has the business purpose to invest for capital appreciation and it provides investment management services to its investor, Select Biotechnology Fund is not an investment entity for two reasons: (1) Pharma Ltd., the parent of Select Biotechnology Fund, holds options to acquire investments in investees held by Select Biotechnology Fund if the assets developed by the investees would benefit the operations of Select Biotechnology Fund. This provides a benefit in addition to capital appreciation or investment income; and (2) the investment plans of Select Biotechnology Fund do not include exit strategies for its investments, which are equity investments. The options held by Pharma Ltd. are not controlled by Select Biotechnology Fund and do not constitute an exit strategy.
An essential element of the definition of an investment entity is that it measures and evaluates the performance of substantially all of its investments on a fair value basis. An investment entity would ordinarily be expected to provide investors with fair value information and measure substantially all of its investments at fair value in its financial statements whenever fair value is required or permitted in accordance with IFRS Standards. Investment entities would typically also report fair value information internally to the entity's key management personnel (as defined in IAS 24), who use fair value as the primary measurement attribute to evaluate the performance of substantially all of its investments and to make investment decisions. Areas where fair value would be expected to feature as the accounting policy of choice for accounting for investments include:
These choices would be expected for all investment assets, but an investment entity would not be expected to measure any non-investment assets at fair value. Thus, there would be no requirement for non-investment assets (such as property, plant and equipment, or intangible assets) or liabilities to be measured at fair value.
In determining whether it meets the definition of an investment entity the following typical characteristics could be used. The absence of any of these characteristics may indicate that an entity does not meet the definition of an investment entity. If an entity does not meet one or more of the typical characteristics, additional judgement is necessary in determining whether an entity is an investment entity.
An investment entity typically holds several investments to diversify risk and maximise returns. An investment entity may hold a portfolio of investments directly or indirectly, for example by holding a single investment in another investment entity that itself holds several investments. There may be times when the entity holds a single investment. However, holding a single investment does not necessarily prevent an entity from meeting the definition of an investment entity. For example, an investment entity may hold only a single investment when the entity is in its start-up period, or has not yet made other investments to replace those it has disposed of. In some cases, an investment entity may be established to pool investors' funds to invest in a single investment when that investment is unobtainable by individual investors (for example, when the required minimum investment is too high for an individual investor). In such a situation, the entity with a single investment could still meet the definition of an investment entity, but these circumstances would have to be explained in the judgements applied by management.
An investment entity would typically have several investors who pool their funds to gain access to investment management services and investment opportunities that they might not have had access to individually. Having several investors would make it less likely that the entity, or other members of the group containing the entity, would obtain benefits other than capital appreciation or investment income. Alternatively, an investment entity may be formed by, or for, a single investor that represents or supports the interests of a wider group of investors (for example, a pension fund, government investment fund or family trust). The standard also explains that the entity's investors would typically be unrelated to one another, again making it less likely that there would be any other benefits to investors besides capital appreciation or investment income.
An investment entity normally has various investors who are not related to the company or to other members of the company. The existence of unrelated parties is an indication that the companies or members of the company derive advantages from the investment mostly through increases in value or capital returns. Even if the investors are related to one another, however, the possibility of qualifying the company as an investment entity exists. An investment entity may, for example, set up a separate parallel fund for a group of its employees in order to reward them.
Since the determination of investment entity status is dependent on an assessment of the relevant facts and circumstances at a point in time, an entity's status may change over time. If facts and circumstances indicate changes to one or more of the three elements that qualify an entity to be an investment entity, a parent needs to reassess whether it is an investment entity. If an entity's status changes due to a change in circumstances, the effects of the change are accounted for prospectively. When an entity that was previously classified as an investment entity ceases to be an investment entity, it applies IFRS 3, Business Combinations, to any subsidiary that was previously measured at fair value through profit or loss. The date of the change of status is the deemed acquisition date for the purposes of applying the acquisition method, and the fair value of the subsidiary at the deemed acquisition date represents the transferred deemed consideration when measuring any goodwill or gain from a bargain purchase that arises from the deemed acquisition. The entity consolidates its subsidiaries with effect from the deemed acquisition date until control is lost.
If an entity becomes an investment entity, it deconsolidates its subsidiaries at the date of the change in status. The deconsolidation of subsidiaries is accounted for as though the investment entity has lost control of those subsidiaries at that date, and any difference between the fair value of the retained investment and the net asset value of the former subsidiary is recognised in profit or loss.
Exemplum Reporting PLC Financial Statements For the Year Ended 31 December 20XX |
||||||||
19. Investment in subsidiaries | ||||||||
Composition of the Group | ||||||||
Name | Country of incorporation |
Proportion of ownership interest |
Proportion owned by subsidiary companies |
Principal activities |
Wholly or non-wholly owned subsidiary |
IFRS12p10 p4, B4, B5, B6 |
||
20XX | 20XX-1 | 20XX | 20XX-1 | |||||
Subsidiary A | UK | 48% | 48% | – | – | Distributionof widgets | Non-wholly | |
Subsidiary B | UK | 90% | 100% | Manufacturingof widgets | Non-wholly | |||
Subsidiary C | France | – | – | 90% | 90% | Retail of widgets | Non-wholly | |
Company A | UK | 100% | 100% | – | – | Manufacturingof widgets | Wholly | |
Company B | France | 100% | 100% | – | – | Distributionof widgets | Wholly |
Details of non-wholly owned subsidiaries that have material non-controlling interests | |||||||
Name of subsidiary | Proportion of ownership interest held by non- controlling interest |
Profit or loss allocated to non- controlling interest |
Accumulated non- controlling interests |
IFRS12 p10 p12 B11 | |||
20XX | 20XX-1 | 20XX | 20XX-1 | 20XX | 20XX-1 | ||
Subsidiary A (a) | 52% | 52% | X | X | X | X | |
Subsidiary B | 10% | 0% | X | – | X | – | |
Subsidiary C | 10% | 10% | X | X | X | X | |
Total | X | X |
(a) The group owns 48% equity shares of Subsidiary A. The remaining 52% is widely held by thousands of unrelated shareholders. An assessment of control was performed by the group based on whether the group has the practical ability to direct the relevant activities unilaterally and it was concluded that the group had a dominant voting interest to direct the relevant activities of Subsidiary A and it would take a number of vote holders to outvote the group, therefore the group has control over Subsidiary A and Subsidiary A is consolidated in these financial statements. |
IFRS12 p9 |
Summarised financial information | |
Summarised financial information in respect of each of the Group's subsidiaries that has material non-controlling interests is set out below. The summarised financial information below represents amounts before intragroup eliminations. |
IFRS12 p12 B10, B11 |
Subsidiary A | Subsidiary B | Subsidiary C | ||||
20XX | 20XX-1 | 20XX | 20XX-1 | 20XX | 20XX-1 | |
Current assets | X | X | X | – | X | X |
Non-current assets | X | X | X | – | X | X |
Current liabilities | (X) | (X) | (X) | – | (X) | (X) |
Non-current liabilities | (X) | (X) | (X) | – | (X) | (X) |
Equity attributable to owners of the company | X | X | X | – | X | X |
Non-controlling interests | X | X | X | – | X | X |
Revenue | X | X | X | – | X | X |
Expenses | (X) | (X) | (X) | – | (X) | (X) |
Profit or loss for the year | X | X | X | – | X | X |
Profit or loss attributable to owners of the company | X | X | X | – | X | X |
Profit or loss attributable to the non-controlling interests | X | X | X | – | X | X |
Profit or loss for the year | X | X | X | – | X | X |
Other comprehensive income attributable to owners of the company | X | X | X | – | X | X |
Other comprehensive income to the non-controlling interests | X | X | X | – | X | X |
Other comprehensive income for the year | X | X | X | – | X | X |
Total comprehensive income attributable to owners of the company | X | X | X | – | X | X |
Total comprehensive income to the non-controlling interests | X | X | X | – | X | X |
Total comprehensive income for the year | X | X | X | – | X | X |
Dividends paid to non-controlling interests | – | – | – | – | – | – |
Net cash in/(out) flow from operating activities | X | X | X | – | X | X |
Net cash in/(out) flow from investing activities | (X) | X | X | – | (X) | X |
Net cash in/(out) flow from financing activities | (X) | X | (X) | – | (X) | (X) |
Net cash in/(out) flow | X | X | X | – | X | X |
Change in the group's ownership interest in a subsidiary 10% of the group's interest in Subsidiary B was disposed of during the year, reducing its continuing interest to 90%. The difference between the consideration received of X and the increase in the non-controlling interest of X has been credited to retained earnings. |
IFRS12 p18 |
Significant restrictions There are no significant restrictions on the company's or subsidiary's ability to access or use the assets and settle the liabilities of the group. |
IFRS12 p13 |
Financial support The group has not given any financial support to a consolidated structured entity. |
IFRS12 p14 p15, p16, p17 |
IFRS 11, Joint Arrangements, deals with financial reporting by parties to a joint arrangement. IFRS 11 replaced IAS 31, Interest in Joint Ventures, and SIC 13, Jointly Controlled Entities—Non-monetary Contributions by Venturers, and sets principles for the accounting for all joint arrangements. Joint arrangements are classified in two types: joint operations and joint ventures. The party to a joint arrangement must determine the type of joint arrangement it is involved in by assessing its rights and obligations created by the arrangement.
A joint arrangement is defined as an arrangement of which two or more parties have joint control and has two characteristics: (1) the parties must be bound by contractual arrangement, and (2) the contractual arrangement must give two or more of the parties joint control over the arrangement. Therefore, not all parties need to have joint control. IFRS 11 distinguishes between parties that have joint control and parties that participate in the joint arrangement but do not have joint control. Judgement is applied to assess whether parties have joint control by considering all the facts and circumstances. If the facts and circumstances change, joint control must be reassessed.
Enforceable contractual arrangements are normally created through a written contract or other documented discussions between the parties. However, statutory mechanisms (articles of association, charters, bylaws and similar mechanisms) can also create enforceable arrangements on their own or in conjunction with the written documentation. The contractual arrangement normally deals with activities such as:
Joint control is defined as the contractually agreed sharing of control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control. The parties must assess whether the contractual arrangement gives them control collectively. Parties control the arrangement collectively when they must act together to direct the activities that significantly affect the returns of the arrangement (the relevant activities). The collective control could be created by all the parties or a group of parties.
Even if collective control is established, joint control exists only when decisions about the relevant activities require the unanimous consent of all the parties that control the arrangement collectively. This can either be explicitly agreed or implicit in the arrangement. For instance, two parties may each hold 50% of the voting rights, but the arrangement states that more than 50% of the voting rights are needed to make decisions about the relevant activities. Because the parties must agree in order to make decisions, joint control is implied.
When the minimum required proportion of rights required to make decisions can be achieved by different combinations of parties agreeing, joint control is normally not established.
The requirement of unanimous consent means that any party with joint control can prevent any of the other parties from making unilateral decisions about the relevant activities. However, clauses on the resolving of disputes, such as arbitration, do not prevent the arrangement from being a joint arrangement.
Identifying a joint arrangement is based on answering the following two questions positively:
Joint arrangements are classified as either joint operations or joint ventures. A joint operation is defined as a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement. A joint venture is defined as a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. The classification is thus dependent on the rights and obligations of the parties to the arrangements:
Type | Rights and Obligations |
Joint operation | Rights to the assets, and obligations for the liabilities, relating to the arrangement. |
Joint venture | Rights to the net assets of the arrangement |
A joint operator has rights and obligations directly in the assets and liabilities, while a joint venturer has rights in the net assets.
Judgement is applied in assessing whether a joint arrangement is a joint operation or a joint venture. Rights and obligations are assessed by considering the structure and legal form, the terms agreed by the parties and other facts and circumstances. The joint arrangement could be structured through a separate vehicle. IFRS 11 specifically states that a joint arrangement that is not structured through a separate vehicle is a joint operation. This is because no rights and obligations in the net assets are created.
If a joint arrangement is structured through a separate vehicle, an assessment must be made to establish whether it is a joint operation or a joint venture, based on the rights and obligations created. A separate vehicle does not automatically indicate a right in the net assets. Specifically, in the case of a separate vehicle, the assessment is based on the legal form, the terms of the contractual arrangement and other relevant facts and circumstances.
The legal form could create a separate vehicle that is considered in its own right. The separate vehicle holds the assets and liabilities and not the parties to the arrangement. By implication the parties have only indirect rights in the net assets, which indicates a joint venture. In contrast, the legal form will create a joint operation, when the legal form does not create a separation between the parties and the separate vehicle.
However, when a separation is created between the parties and the separate vehicle, a joint venture is not automatically assumed. The terms of the contractual arrangement and, if relevant, other factors and circumstances can override the assessment of the rights and obligations conferred upon the parties by the legal form. The contractual arrangement could be used to reverse or modify the rights and obligations conferred by the legal form of the separate vehicle. When the contractual arrangement specifies that the parties have rights to the assets and obligations for the liabilities, the arrangement is a joint operation and other facts and circumstances do not need to be considered. IFRS 11 includes the examples set out in the table below to identify when the contractual arrangements created a joint operation or joint venture.
Other facts and circumstances are assessed to classify the joint arrangement when the terms of the arrangement are not conclusive. IFRS 11 provides one situation when other facts and circumstances override the legal form and contractual arrangement. When the activities of the arrangement are designed to provide output mainly to the joint parties and the arrangement is limited in its ability to sell to third parties, it is an indication that the joint parties have rights to substantially all the economic benefits of the arrangement. The effect of such an arrangement is that the liabilities incurred by the arrangement are, in substance, settled by the cash flows received from the joint parties for their share of the output. Since the joint parties are substantially the only contributor to the cash of the joint arrangement, they indirectly assume responsibility for the liabilities.
A joint arrangement through a separate vehicle is not automatically a joint venture. Only if the answers to all three of the questions identified below are negative would the separate vehicle be classified as a joint venture.
The principle established in IFRS 11 is that joint operations should be accounted for by following the contractual arrangement established between the parties to the joint arrangement. In its own financial statements, a joint operator will account in accordance with IFRS 11.20 for the following:
It is clear that in a joint operation, a joint operator could either have an interest in the assets or incur the liabilities or expenses, directly as its own assets, liabilities and expenses, or the joint operator could have a shared interest. If a shared interest exists, the terms of the contractual arrangement will determine each operator's share. Once a joint operator's direct or shared interest in the assets, liabilities, income and expenses is determined, the joint operator accounts for them by following the IFRS applicable in each instance.
Special guidelines are also provided for transactions, such as the sale, contribution or purchase of assets between the entity of the joint operator and the joint operations. The joint operator only recognises gains and losses resulting from sales and contributions to the joint operation to the extent of other parties' interest in the joint operations. Therefore, if a joint operator has a 40% interest in the joint operation it will only recognise 60% of the profit or losses on the transactions attributable to the other joint operators. The logic is that a portion of the profit has in fact been realised. As a further example, if venturers A, B and C jointly control joint operation D (each having a 1/3 interest), and A sells equipment having a book value of €40,000 to the operation for €100,000, only 2/3 of the apparent gain of €60,000 or €40,000 may be realised. However, if the transaction provides evidence of an impairment or reduction in the net realisable value of the assets sold or contributed, the joint operator must recognise the loss fully.
Similarly, if joint operators purchase assets from the joint operation, it may not recognise its share of gains and losses until the assets are resold to other parties. Again, if such transaction provides evidence of an impairment or reduction in the net realisable value of the assets purchased, the joint operator must recognise its full share of the losses.
A party to an arrangement that is a joint operation that does not have joint control, but has rights to the assets and obligations for the liabilities of the joint operation, accounts for its interest by following the principle established in IFRS 11. However, if the participating party does not have rights to the assets and obligations for the liabilities, it accounts for its interest in the joint operation by applying the applicable IFRS.
In May 2014 the IASB issued the amendments to IFRS 11 “Accounting for Acquisitions of Interests in Joint Operations” ruling the accounting for acquisitions of interests in joint operations in which the activity constitutes a business. Those amendments, which are explained below, shall be applied prospectively in annual periods beginning on or after January 1, 2016. Earlier application is permitted. If an entity applies those amendments in an earlier period it shall disclose that fact. The IASB had noted that it was unclear how acquisitions of interests in joint operation, in which the activities constitute a business, were to be reported and thus the need for the amendment to IFRS 11. It has now been clarified that when an entity acquires an interest in a joint operation in which the activity of the joint operation constitutes a business, as defined in IFRS 3, it shall apply, to the extent of its share in the assets, liabilities in a joint operation, all of the principles on business combinations accounting in IFRS 3, and other IFRS, that do not conflict with the guidance in IFRS 11 and disclose the information that is required in those IFRS in relation to business combinations. This applies to the acquisition of both the initial interest and additional interests in a joint operation in which the activity of the joint operation constitutes a business. According to IFRS 11, the principles on business combinations accounting that do not conflict with the guidance in IFRS 11 include but are not limited to:
These principles also apply to the formation of a joint operation if, and only if, an existing business, as defined in IFRS 3, is contributed to the joint operation on its formation by one of the parties that participate in the joint operation. However, these principles do not apply to the formation of a joint operation if all of the parties that participate in the joint operation only contribute assets or groups of assets that do not constitute businesses to the joint operation on its formation. These principles also do not apply on the acquisition of an interest in a joint operation when the parties sharing joint control, including the entity acquiring the interest in the joint operation, are under the common control of the same ultimate parent. A joint operator might increase its interest in a joint operation in which the activity of the joint operation constitutes a business, as defined in IFRS 3, by acquiring an additional interest in the joint operation. In such cases, previously held interests in the joint operation are not remeasured if the joint operator retains joint control.
Entity D recognises in its financial statements its share of the assets and liabilities resulting from the contractual arrangement. It applies the principles on business combinations accounting in IFRS 3 and other IFRS for identifying, recognising, measuring and classifying the assets acquired, and the liabilities assumed, on the acquisition of the interest in joint operation X. This is because entity D acquired an interest in a joint operation in which the activity constitutes a business. However, entity D does not apply the principles on business combinations accounting in IFRS 3 and other IFRS that conflict with the guidance in IFRS 11. Consequently, in accordance with IFRS 11.20, entity D recognises, and therefore measures, in relation to its interest in joint operation X, only its share in each of the assets that are jointly held and in each of the liabilities that are incurred jointly, as stated in the contractual arrangement. Entity D does not include in its assets and liabilities the shares of the other parties in joint operation X. Due to IFRS 3, entity D has to measure the identifiable assets acquired and the liabilities assumed at their acquisition-date fair values with limited exceptions; for example, deferred tax assets and deferred tax liabilities are not measured at fair value but are measured in accordance with IAS 12. Such measurement does not conflict with this IFRS and thus those requirements apply.
Consequently, entity D determines the fair value, or other measure specified in IFRS 3, of its share in the identifiable assets and liabilities related to joint operation X. The following table sets out the fair value or other measure specified by IFRS 3 of entity D's shares in the identifiable assets and liabilities related to joint operation X:
Fair value or other measure specified by IFRS 3 for Company X's shares in the identifiable assets and liabilities of joint operation |
€ |
Property, plant and equipment | 145,000 |
Intangible assets (excluding goodwill) | 83,000 |
Accounts receivable | 78,000 |
Inventory | 60,000 |
Retirement benefit obligations | (18,000) |
Accounts payable | (55,000) |
Contingent liabilities | (60,000) |
Deferred tax liability | (45,000) |
Net assets | 188,000 |
In accordance with IFRS 3, the excess of the consideration transferred over the amount allocated to entity D's shares in the net identifiable assets is recognised as goodwill:
Consideration transferred | €500,000 |
Company E's shares in the identifiable assets and liabilities relating to its interest in the joint operation | €188,000 |
Goodwill | €312,000 |
Acquisition-related costs of €70,000 are not considered to be part of the consideration transferred for the interest in the joint operation. In accordance with IFRS 3.53 they are recognised as expenses in profit or loss in the period that the costs are incurred and the services are received.
A joint venturer recognises its interest in a joint venture as an investment by applying the equity method of accounting as described in IAS 28, Investment in Associates and Joint Ventures. The proportionate consolidation method of accounting that was previously permitted for jointly controlled entities under IAS 31 is no longer available to joint ventures. Any participating party in the joint venture that does not have joint control accounts for its interest by applying IFRS 9, unless it has significant influence over the joint venture. If the participating party has significant influence, it too will apply equity accounting in accordance with IAS 28.
The accounting for a joint operation in the consolidated and separate financial statements is the same. A party that participates in a joint operation that does not have joint control must also apply the same principles as discussed above to account for its interest.
Equity accounting is not only applied in the consolidated financial statements of the joint venture. In the separate financial statements, IAS 27, Separate Financial Statements, does also allow the application of equity accounting. For further details, please see below.
An associate is an entity over which an investor has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not in control or joint control of those policies.
In defining the concept of significant influence, there was recognition that the actual determination of the existence of significant influence could be difficult and that, to facilitate such recognition, there might be a need to set out a bright line against which significant influence would be measured. To this end, a somewhat arbitrary, refutable presumption of such influence was set at a 20% (direct or indirect) voting power in the investee. This has been held out as the de facto standard on assessing significant influence, and thus an investor accounts for such an investment as an associate unless it can prove otherwise. If the investor holds less than 20% voting power, it is presumed that significant influence is not applicable, unless such influence can be clearly demonstrated. Specifically, a substantial or majority ownership from another party does not preclude significant influence.
No top bright line (such as 50%) is set to identify significant influence. In difficult situations control must first be considered. The reason is that control could be achieved with a voting power of less than 50%. If control is not applicable and the voting power is above 20%, significant influence is assumed, unless it can be demonstrated otherwise.
In assessing significant influence, all facts and circumstances are assessed, including the term of exercise of potential voting rights and any other contractual arrangements. The following factors are indicators of significant influence:
Only the existence and effect of potential voting rights that are currently exercisable or convertible are considered in the assessment. Potential voting rights exist in the form of options, warrants, convertible shares or a contractual arrangement to acquire additional shares. In making the assessment, all facts and circumstances, such as the terms of exercise and other contractual arrangements that affect potential rights, must be considered. Potential voting rights held by others must also be considered. Intentions of management and the financial ability to exercise or convert are, however, not considered.
An entity recognises its interest in an associate by applying the equity method of IAS 28, Investment in Associates and Joint Ventures, except if an exception is applicable.
The equity method of accounting is applied to investments in associates and joint ventures.
The cost method for accounting for associates would simply not reflect the economic reality of the investor's interest in an entity whose operations were indicative, in part at least, of the reporting entity's (i.e., the investor's) management decisions and operational skills. Thus, the clearly demonstrable need to reflect substance, rather than mere form, made the development of the equity method highly desirable. This is in keeping with the thinking that is currently driving IFRS that all activities that have a potential impact on the financial position and performance of an entity must be reported, including those that are deemed to be off-balance-sheet-type transactions.
The equity method is applied to an investment in a joint venture since the investor has an interest in the net assets of the joint venture. The investor has no direct interest in the underlying assets or liabilities of the venture and can therefore not recognise such assets or liabilities.
An exception is applicable to investments in associates or joint ventures held (directly or indirectly) by a venture capital organisation or a mutual fund, unit trust or similar entity, including unit-link insurance funds. Such entities may elect to measure the investment at fair value through profit and loss in accordance with IFRS 9. When those investments are measured at fair value, changes in fair value are included in profit or loss in the period of the change. This election may also be applied to a portion of investment in associates or joint ventures held indirectly through such exempted entities. The other portion of the investment in the associate or joint venture should still be equity accounted.
IFRS 5 is applied to an investment (or a portion) in an associate or joint venture that meets the requirements to be classified as held-for-sale (see Chapter 13). The portion of the investment that is not classified as held-for-sale must still be equity accounted until disposal of the held-for-sale portion takes place. After the disposal, the remaining portion must be reassessed to determine whether it is still an investment in associate or joint venture, and if not, recorded in terms of IFRS 9.
Specifically, an entity that has control over a subsidiary and is exempt from consolidating the subsidiary because its ultimate or intermediate parent does prepare financial statements, is not required to apply the equity method.
The equity method permits an entity (the investor) controlling a certain share of the voting interest in another entity (the investee) to incorporate its pro rata share of the investee's operating results into its profit or loss. However, rather than include its share of each component of the investee's revenues, expenses, assets and liabilities into its financial statements, the investor will only include its share of the investee's profit or loss as a separate line item in its statement of profit or loss and comprehensive income. Similarly, only a single line in the investor's statement of financial position is presented, but this reflects, to a degree, the investor's share in each of the investee's assets and liabilities.
Initially under the equity method the investment in the associate or joint venture is recognised at cost, and the carrying amount is increased or decreased to include the investor's share of the profit or loss of the investee after the acquisition date. The investor's share of the profit or loss is recognised in the investor's profit and loss. The carrying amount is also adjusted for the investor's share of other comprehensive income, and the contra entry is recognised in other comprehensive income. Distributions received from the investee reduce the carrying amount of the investment.
When determining the entity's share in the associate or joint venture, potential voting rights or other derivatives containing potential voting rights are ignored. The entity's share is solely based on the existing ownership interest. However, if an entity has, in substance, existing ownership because a transaction currently gives it access to the returns associated with an ownership interest, this right to returns is taken into account to determine the entity's share in profits. Such instruments that are included in the determination of the entity's share in the associate or joint venture are specifically excluded from IFRS 9, even if they meet the definition of a derivative.
Many of the procedures applicable to equity accounting are similar to the consolidation procedures discussed above.
The principles regarding the acquisition of business combinations (Chapter 15) are also adopted in the acquisition of associates and joint ventures.
The equity method starts from the date an associate or joint venture is acquired. On the acquisition date, any positive difference between the cost of the investment and the entity's share of the net fair value of the investee's identifiable assets and liabilities is identified as goodwill and included in the carrying amount of the investment. Amortisation of the goodwill is not allowed. Any excess of the entity's share of the net fair value of the investee's identifiable assets and liabilities over the cost of the investment is recognised as income and included in the entity's share of the associate's or joint venture's profit or loss for the year.
Adjustments are made to the entity's share of profit and losses of the associate or joint venture after acquisition to account for the effect of the fair value on acquisition, such as adjusted depreciation.
Transactions between the investor and the investee may require that the investor make certain adjustments when it records its share of the investee earnings. In terms of the concept that governs realisation of transactions, profits can be recognised by an entity only when realised through a sale to outside (unrelated) parties in arm's-length transactions (sales and purchases). Similar problems can arise when sales of property, plant and equipment between the parties occur. In all cases, there is no need for any adjustment when the transfers are made at carrying amounts (i.e., without either party recognising a profit or loss in its separate accounting records).
In preparing consolidated financial statements, all intercompany (parent-subsidiary) transactions are eliminated. However, when the equity method is used to account for investments, only the profit component of intercompany (investor-investee) transactions is eliminated. This is because the equity method does not result in the combining of all statement of comprehensive income accounts (such as sales and cost of sales) and therefore will not cause the financial statements to contain redundancies. In contrast, consolidated statements would include redundancies if the gross amounts of all intercompany transactions were not eliminated.
Only the percentage held by the investor is eliminated and this applies to unrealised profits and losses arising from both “upstream” and “downstream” transactions (i.e., sales from investee to investor, and from investor to investee), which should be eliminated to the extent of the investor's interest in the investee.
Elimination of the investor's interest in the investee, rather than the entire unrealised profit on the transaction, is based on the logic that in an investor-investee situation, the investor does not have control (as would be the case with a subsidiary), and thus the non-owned percentage of profit is effectively realised through an arm's-length transaction. For purposes of determining the percentage interest in unrealised profit or loss to be eliminated, a group's interest in an associate is the aggregate of the holdings in that associate by the parent and its subsidiaries (excluding any interests held by non-controlling interests of subsidiaries). Any holdings of the group's other associates (i.e., equity-method investees) or joint ventures are ignored for the purpose of applying the equity method. When an associate has subsidiaries, associates or joint ventures, the profits or losses and net assets taken into account in applying the equity method are those recognised in the associate's consolidated financial statements (including the associate's share of the profits or losses and net assets of its associates and joint ventures), after any adjustments necessary to give effect to the investor's accounting policies.
In the example above, the tax currently paid by Radnor Co. (34% × €25,000 taxable gain on the transaction) is recorded as a deferred tax benefit in 20XX-1 since taxes will not be due on the book gain recognised in the years 20XX through 20XX+4. Under provisions of IAS 12, deferred tax benefits should be recorded to reflect the tax effects of all deductible temporary differences. Unless Radnor Co. could demonstrate that future taxable amounts arising from existing temporary differences exist, this deferred tax benefit might be offset by an equivalent valuation allowance in Radnor Co.'s statement of financial position at year-end 20XX-1, because of the doubt that it will ever be realised. Thus, the deferred tax benefit might not be recognisable, net of the valuation allowance, for financial reporting purposes unless other temporary differences not specified in the example provided future taxable amounts to offset the net deductible effect of the deferred gain.
This is discussed more fully in Chapter 26. When downstream transactions provide evidence of a reduction in the net realisable value of asset to be sold or contributed, or of an impairment loss, the investor must recognise the full loss. Similarly, when upstream transactions provide evidence of a reduction in the net realisable value of the asset to be purchased, or of an impairment loss, the investor shall recognise its share in those losses.
If an investee makes a contribution of non-monetary assets that do not constitute a business, as defined in IFRS 3, to an associate or joint venture in exchange for an equity interest, the fair value of the asset is in principle capitalised as part of the investment. However, fair value gains and losses are only recognised by the investor to the extent of the unrelated investors' interest in the associate or joint venture. Any fair value profit or loss regarding the investee's share in the associate or joint venture is not recognised.
This section covers the accounting issues that arise when the investor either sells some or all of its equity or acquires additional equity in the investee. The consequence of these actions could involve discontinuation of the equity method of accounting, or resumption of the use of that method.
Significant influence is lost when an investee loses the power to participate in the financial and operating policy decisions of the investee. The loss of significant influence does not always occur with a change in absolute or relative ownership levels. The associate may for instance be subjected to the control of a government, court, administrator or regulator. Contractual arrangements could also change significant influence.
The equity method is discontinued from the date when the investment ceases to be an associate or joint venture. Different situations may arise. If the investment changes to a subsidiary, IFRS 3, Business Combinations, is applied for the initial recognition of the subsidiary (Chapter 15).
If the retained interest becomes a financial instrument (not classified as a subsidiary, joint arrangement or associate) the retained interest should be measured at fair value and the fair value change recognised in profit or loss. The fair value on the date of discontinuance of the equity method becomes the initial recognition value of the financial instrument. The profit or loss is the difference between:
When the equity method is discontinued, any equity share of the associate or joint venture recognised in other comprehensive income must be removed by regarding this as part of the sale of the transaction. The effect is that the gain and loss previously recognised in other comprehensive income is reclassified (as a reclassification adjustment) to profit or loss.
If an associate changes to a joint venture or a joint venture changes to an associate, the equity method is continued without any remeasurement of the retained interest.
If the interest in an associate or joint venture is reduced, but the equity method is still applied, a profit and loss is calculated on the portion sold as the difference between the proceeds received and the carrying value of the portion sold. Any proportionate profit or loss recognised in other comprehensive income that relates to the portion of the investment sold must also be reclassified to profit or loss.
The gains (losses) from sales of investee equity instruments should be reported in the investor's profit or loss as a separate line item after the line of its share of those joint ventures or associated profit or loss from continuing operations.
An entity may hold an investment in another entity's ordinary share that is below the level that would create a presumption of significant influence, which it later increases so that the threshold for application of the equity method is exceeded. The guidance of IAS 28 would suggest that when the equity method is first applied, the difference between the carrying amount of the investment and the fair value of the underlying net identifiable assets must be computed (as described earlier in the chapter). Even though IFRS 9's fair value provisions were being applied, there will likely be a difference between the fair value of the passive investment (gauged by market prices for publicly-traded instruments) and the fair value of the investee's underlying net assets (which are driven by the ability to generate cash flows, etc.). Thus, when the equity method accounting threshold is first exceeded for a formerly passively held investment, determination of the “goodwill-like” component of the investment will typically be necessary.
When an entity increases its stake in an existing associate continuing to have significant influence but not gaining control, the cost of acquiring the additional stake (including any directly attributable costs) is added to the carrying value of the associate. Goodwill that arises from the purchase of the additional stake is calculated based on the fair value information at the date of the acquisition of the additional stake. The previously held interest may not be stepped up because the status of the investment has not changed. The same applies, for example, when existing stakes are reduced, thus resulting in an increased stake in an existing associate (e.g., where the investee purchases treasury shares from outside shareholders (i.e., owners other than the reporting entity)).
A stake in an associate or joint venture may decrease, for example, following a capital increase on the part of the investee in which the investor does not take part. This constitutes a partial disposal of an entity's interest in an associate. Investor accounting for investee capital transactions that dilute the share of the investor's investment is not addressed by IAS 28. Although due to IFRS 10.B96, changes in the proportion held by non-controlling interests shall be recognised directly in equity, we feel that this principle is not applicable in this instance as the investor only accounts for his stake in the investee in his equity accounting and has not entered into a transaction with the associate. Accounting adjustments such as these therefore do not constitute transactions with owners, and any profit or loss must be recognised in the income statement.
Exemplum Reporting PLC Financial Statements For the Year Ended 31 December 20XX |
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20. Investments accounted for using the equity method | ||||||||
Name | Country of incorporation |
Proportion of ownership interest |
Proportion owned by associates and joint venture |
Principal Activities |
IFRS12 p20 p21 |
|||
20XX | 20XX-1 | 20XX | 20XX-1 | |||||
Associate A (a) | UK | 16% | 16% | – | – | Marketing of widgets | ||
Associate B (b) | UK | – | – | 32% | 32% | Property holding | ||
Joint Venture C | UK | 33.3% | 33.3% | – | – | Distribution |
a)Associate A is an associate of the group even though the group only owns 16% interest in Associate A. Significant influence arises by virtue of the groups' contractual right to appoint three out of the seven board of directors of Associate A. |
IFRS12 p9 |
b)Associate B has a year end of 30 November. This reporting date was established when the company was incorporated. The reporting date cannot change as it is not permitted by the government in the UK. |
IFRS12 p21p22 |
Associate A's financial statements for the year ended 30 November 20XX have been used and appropriate adjustments have been made for the effects of any significant transactions that occurred between Associate A's year end and the group's year end. This was necessary so as to apply the equity method of accounting. |
IFRS13 p97 |
Based on the quoted market price available on the UK stock exchange as at 31 December 20XX, the fair value of the group's interest in Associate A was €X. |
An entity applies IFRS 9, Financial Instruments, to determine if any investment in an associate or joint venture is impaired. IFRS 9 is also used to determine if other interests in the associate or joint venture should be impaired. Since goodwill is included in the carrying value of the investment, it is not separately assessed for impairment. The total value of the investment is assessed in terms of IFRS 9 and the goodwill portion is not assessed in terms of IAS 36, Impairment (see Chapter 13). However, if IFRS 9 indicates that an impairment is applicable, the total carrying value of the investment is compared to its recoverable amount (higher of value in use or fair value) determined in terms of IAS 36. Specifically, the impairment loss is not allocated to any individual asset, including goodwill. Instead, the total investment is impaired.
A reversal of an impairment loss is only applied when the recoverable amount of the investment increases.
In determining the value in use, an entity should consider:
Under appropriate assumptions (given a perfectly functioning capital market), both methods give the same result.
IAS 28 provides that in the separate financials of the investor, the investment in the associate or joint venture may be carried at either cost, in terms of IFRS 9, or using the equity method as described in IAS 27. This is an accounting policy choice that the investor must make and apply consistently across each category of investments.
Financial statements should be prepared using uniform accounting policies. If the accounting policies of the associate or joint venture differ from the reporting entity, adjustments should be made to the financial statements of the associate or joint venture to conform to those of the reporting entity.
The most recent available financial statements of the associate or joint venture are used to apply the equity method. If the reporting dates of the entity and the associate or joint venture differ, financial statements on the reporting date of the entity are prepared for the associate or joint venture, unless it is impracticable to do so. If the reporting dates differ, adjustments are required for the effect of significant transactions that occur between the dates. IAS 28 requires that a reporting date difference of no more than three months is permissible. The length of the reporting period and difference in reporting dates must be applied consistently from year to year.
If an associate has outstanding cumulative preferred shares, held by parties other than the investor that are classified as equity, the investor computes its share of the profits or losses after deducting dividends due to the preferred shareholders, whether or not declared.
If an entity's share of losses exceeds its interest in the associate or joint venture, the recognition of its share of future losses is discontinued. The interest in the associate or joint venture is the carrying amount of the equity accounted investment and other long-term interests that are regarded as part of the entity's net investment in the associate or joint venture. Long-term items for which settlement is neither planned nor likely to occur are deemed to be an extension of the investment. Losses incurred after the investment in the associate or joint venture is reduced to zero are applied to other interests in reverse order of seniority (i.e., priority in liquidation).
If the entity's interest is reduced to zero, any further losses are only recognised as a liability to the extent that the entity has incurred legal or constructive obligations or made payments on behalf of the associate or joint venture. If the associate or joint venture is again profitable, the entity only resumes recognising its share of profits after the share of losses not recognised are eliminated.
IAS 27, Separate Financial Statements, addresses issues related to accounting for investments in subsidiaries, joint ventures and associates when the entity elects or is required by local regulations to prepare separate financial statements in accordance with IFRS. Separate financial statements are financial statements that are presented in addition to consolidated financial statements and financial statements of companies without subsidiaries but which have investments in associates or joint ventures which are required by IAS 28 to be accounted by applying the equity method. Individual financial statements prepared by companies that do not have subsidiaries, associates or joint ventures are not separate financial statements. However, entities that are exempted from preparing consolidated financial statements or from applying equity accounting may present separate financial statements as their only financial statements. In addition, an investment entity that is required to apply the exception to consolidation for all of its subsidiaries by measuring these at fair value presents separate financial statements as its only financial statements.
An entity preparing its separate financial statements may account for investments in subsidiaries, joint ventures and associates either:
The possibility of using the equity method in separate financial statements was introduced by the amendments to IAS 27 (“Equity Method in Separate Financial Statements”) in August 2014. An entity shall apply those amendments for annual periods beginning on or after January 1, 2016 retrospectively in accordance with IAS 8. Earlier application is permitted. If this option is chosen by the entity, it shall be disclosed.
The same accounting should be applied for each category of investments presented in the separate financial statements. Investments accounted for at cost or using the equity method and classified as held-for-sale (or included in a disposal group that is classified as held-for-sale) are accounted for in accordance with IFRS 5, Non-current Assets Held for Sale and Discontinued Operations (measured at fair value less costs to sell). Investments accounted for at fair value in accordance with IFRS 9 are excluded from IFRS 5's measurement requirements. Consequently, an entity should continue to account for such investments in accordance with IFRS 9 even if they meet the held-for-sale criteria in IFRS 5. If an entity that is a venture capital or similar organisation elects to account for its investments in associated and joint ventures at fair value in its consolidated financial statements, it must also use fair value in its individual financial statements.
An entity should recognise a dividend from a subsidiary, jointly controlled entity, or associate in profit or loss in its separate financial statements when it has the right to receive the dividend. The dividend is recorded in the profit or loss unless the equity method has been used. In this case the dividend has to be reduced from the carrying amount of the investment.
Special guidance is provided to determine cost in certain reorganisations if the cost option is applied in the separate financial statements. The guidance is applicable when a new entity is established meeting the following requirements:
Although investment entities present separate financial statements as their only financial statements, the cost option is not available to investment entities, since these would have to measure their investments at fair value through profit or loss. When an entity ceases to be an investment entity, it is required to consolidate any subsidiaries under IFRS 10. Should it continue to present separate financial statements in addition to consolidated financial statements, the cost option or the equity method will become available to it as with any other entity, subject to the requirements discussed above. The date of the change of status shall be the deemed acquisition date. The fair value of any subsidiary at the date of change in status becomes the deemed consideration of the subsidiary in the separate financial statements, when accounting for the investments in accordance with the options shown above. If an entity becomes an investment entity, the difference between the previous carrying amount of the subsidiary and its fair value at the date of the change of status of the entity is recognised as a gain or loss in profit or loss. The cumulative amount of any gain or loss previously recognised in other comprehensive income in respect of those subsidiaries must be treated as if the investment entity had disposed of those subsidiaries at the date of change in status.
All applicable IFRS are applied in the separate financial statements. Additionally, when a parent (because of the exemption in IFRS 10) elects not to prepare consolidated financial statements and instead prepares separate financial statements, the following should be disclosed in those separate financial statements:
When a parent (other than a parent covered by the above-mentioned exemption) or an investor with joint control of, or significant influence over, an investee prepares separate financial statements, the parent or investor is required to identify the financial statements prepared in accordance with IFRS 10, IFRS 11 or IAS 28 to which they relate. The parent or investor must also disclose the following in its separate financial statements:
IFRS 12, Disclosure of Interest in Other Entities, combines the disclosure about an entity's interest in subsidiaries, joint arrangements, associates and unconsolidated “structured entities” in one standard. IFRS 12 does not apply to employee benefit plans, separate financial statements (except in relation to unconsolidated structured entities), participants in joint ventures that do not share in joint control, and investments accounted for in accordance with IFRS 9, except for interests in associates, joint ventures or unconsolidated structured entities measured at fair value.
IFRS 12 specifically provides disclosure requirements for structured entities that are not consolidated to identify the nature and risk associated with them. A structured entity is an entity that has been designated so the voting or similar rights are not the dominant factor in deciding who controls the entity, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. The main features or attributes of structured entities could include:
The disclosures in IFRS 12 are presented as a series of objectives, with detailed guidance on satisfying those objectives. The objectives are listed below and entities need to consider the level of detail needed to meet these objectives. For annual periods beginning on or after 1 January 2017 the amendments to IFRS 12 clarify, that the disclosure requirements in the standard, except for those in paragraphs B10–B16, apply to an entity's interests listed in paragraph IFRS 5.5 that are classified as held for sale, as held for distribution or as discontinued operations in accordance with IFRS 5.
The objective of IFRS 12 is to require the disclosure of information that enables users of financial statements to evaluate:
Where the disclosures required by IFRS 12, together with the disclosures required by other IFRS, do not meet the above objectives, an entity is required to disclose whatever additional information is necessary to meet the objectives.
An entity discloses information about significant judgements and assumptions it has made (and changes in those judgements and assumptions) in determining whether:
An entity must disclose information that enables users of its consolidated financial statements to:
An entity must disclose information that enables users of its financial statements to evaluate:
An entity must disclose information that enables users of its financial statements to:
An investment entity that measures all its subsidiaries at fair value should provide the IFRS 12 disclosures related to investment entities.
An investment entity is required to disclose information about significant judgements and assumptions it has made in determining that it is an investment entity. If the investment entity does not have one or more of the typical characteristics of an investment entity, it must disclose its reasons for concluding that it is nevertheless an investment entity. In addition, an investment entity is required to disclose the following information, in addition to any disclosures required by other standards (such as IFRS 7 or IAS 24):
The suite of five standards (IFRS 10, IFRS 11, IFRS 12, IAS 27 [amended] and IAS 28 [amended]) is applicable for periods beginning on or after January 1, 2013. For entities preparing financial statements in accordance with IFRS as adopted by the EU, the suite of five is effective for periods beginning on or after January 1, 2014. Earlier application is permitted provided that the fact is disclosed and all five standards are applied simultaneously. These standards are applied retrospectively, except for the relief provided as discussed below. Entities are only required to provide disclosure of the quantitative information required by IAS 8 for the immediately preceding reporting period.
At the date of initial application (the beginning of the annual period IFRS 10 is applied for the first time) no adjustments are required to the previous accounting for entities that are consolidated based on the old IAS 27 and, in terms of IFRS 10, will still be consolidated. Relief is also provided for an investor's interest in investees that were disposed of during the previous reporting period resulting in non-consolidation in terms of both the old IAS 27 and IFRS 10.
If the consolidation conclusion is different on the date of initial application, IFRS 10 clarifies how the retrospective application should be applied. If IFRS 10 results in the consolidation of an entity not previously consolidated, the retrospective application differs depending on whether the investee is a business (as defined for business combination purposes, see Chapter 15) or not. If the investee is a business, the assets, liabilities and non-controlling interest of the previously unconsolidated entity are measured by application of the acquisition method of IFRS 3 from the date control of the investee is obtained in terms of IFRS 10. The investor only retrospectively adjusts the immediately preceding reporting period. When the date on which control was obtained was before the beginning of the immediately preceding reporting period, equity at the beginning of the immediately preceding reporting period should be adjusted with the difference between the amount of assets, liabilities and non-controlling interest recognised and the previous carrying amount of the investor's investment.
If, however, the investee is not a business, no goodwill is recognised for the transaction in terms of IFRS 3. The immediately preceding reporting period is also retrospectively adjusted. When the date on which control was obtained was before the beginning of the previous reporting period, equity at the beginning of that period is adjusted with the difference between the amount of assets (excluding goodwill), liabilities and non-controlling interest recognised and the previous carrying amount of the investor's investment.
If it is impracticable to measure the investee's assets, liabilities and non-controlling interest, different guidance is also provided for businesses and non-businesses. In the case of a business, IFRS 3 is applied from the deemed acquisition date. The deemed acquisition date is the beginning of the earliest period the application of IFRS 3 is practicable, which could be the current period. The same principles apply for non-businesses, except that goodwill is not calculated. If the current period is the earliest period that the application of IFRS 3 is practicable, the adjustment to equity is only made at the beginning of the current period.
Application of IFRS 3 to account for the acquisition of control as described above depends on when control was obtained. If the acquisition date precedes the effective date of IFRS 3 (2008 version), the entity has the choice to apply either IFRS 3 (2004 version) or IFRS 3 (2008 version) to account for the business combination. If the acquisition date is after the effective date of IFRS 3 (2008), then that is the standard that must be applied. Refer to Chapter 15.
If IFRS 10 results in the non-consolidation of an entity that was previously consolidated, the investment in the investee is measured at the amount it should have been measured as if IFRS 10 was applicable at the date of acquisition of the investment or when control was previously lost. The results of the previous reporting period are adjusted retrospectively. If the date the investment was acquired or control was lost is before the beginning of the previous reporting period, equity is adjusted at the beginning of the previous reporting period as the difference between the previous carrying amount of the assets, liabilities and non-controlling interest and the recognised amount of the investment. The impracticability guidance discussed above is also applicable in this instance.
When the accounting of a joint venture is changed from proportionate consolidation to the equity method, the investment is recognised from the beginning of the previous reporting period. On that date the investment is measured at the aggregate of the asset and liabilities (including goodwill) recognised in terms of the proportionate consolidation method. This becomes the deemed cost on initial recognition. The deemed cost should, however, be assessed for impairment, and any impairment loss adjusts the opening retained earnings at that date. If the aggregate of the assets and liabilities recognised in terms of proportionate consolidation results in a negative net asset, a corresponding liability shall only be recognised if the entity has a legal or constructed liability for such an amount. If not, retained earnings is adjusted and the non-recognition of the liability and the entity's share in the cumulative unrecognised losses of the joint venture must be disclosed. The entity also discloses the breakdown of the assets and liabilities aggregated into the one-line investment.
When a joint operation is changed from the equity method to accounting for assets and liabilities, the entity derecognises the investment at the beginning of the previous reporting period and any other items that form part of its net investment in the joint operation. The entity's share of the assets and liabilities (including goodwill included in the equity investment) of the joint operation is recognised in accordance with the contractual arrangement and based on the information used for application of the equity method. Any difference between the assets and liabilities recognised and the net investment derecognised is first offset against goodwill, if it represents a credit balance. Any balance remaining or debit balance is recognised in retained earnings. A reconciliation should be provided between the investment derecognised and the assets and liabilities recognised, identifying the amount recognised in retained earnings.
An entity that previously accounted for its interest in a joint operation at cost in its separate financial statements is required to derecognise the investment and recognise its share of the assets and liabilities of the joint operation. Similarly, a reconciliation should be provided between the amounts by identifying the amount recognised in retained earnings.
At the date of initial application of the amendments to IFRS 10, IFRS 12 and IAS 27, an entity must assess whether it is an investment entity on the basis of the facts and circumstances that exist at that date. If, at the date of initial application, an entity concludes that it is an investment entity, it will retrospectively measure its investment in each subsidiary at fair value through profit or loss as if the investment entity principles had always been effective.
The disclosure requirements of IFRS 12 are not required to be applied for any period presented before the immediately preceding reporting period. Comparative disclosures of unconsolidated structured entities are also not required for the immediately preceding period in the period of initial application.
Although the IFRS 10 consolidation project was a joint project with the FASB, the FASB has not issued the related proposed changes. Changes introduced by IFRS 10, IFRS 11 and IFRS 12 are not incorporated into US GAAP. The basic consolidation and equity accounting principles, however, remain the same.
US GAAP requires preparation of consolidated financial statements, with certain industry-specific exceptions. US GAAP also contains certain quantitative thresholds regarding investment at risk for stakeholders that impact requirements to consolidate entities. Certain leases with a company whose primary purpose is to lease property back to a company under certain circumstances must be consolidated. US GAAP permits different reporting dates for the parent and subsidiary up to three months, but only if the use of the same reporting date is impracticable. The effects of significant events between the dates must be disclosed. US GAAP does not require uniform accounting policies within the group.
Under US GAAP, consolidation of entities is based on a controlling financial interest model, which includes a variable interest entity (VIE) model and, if the VIE model is not applicable, a voting interest model. Under the VIE model, a reporting entity has a controlling financial interest in a VIE if it is has the power to direct the activities of the VIE that most significantly impact the VIE's economic performance and the obligation to absorb losses or the rights to receive benefits from the VIE. According to the voting interest model, a controlling financial interest generally exists if a reporting entity has continuing power to govern the financial and operating policies of an entity. In assessing control, substantive kick-out rights are sometimes viewed differently under US GAAP. Under US GAAP the concept of “de facto control” does not exist.
Under US GAAP, like IFRS, control of a VIE is evaluated on a continuous basis; however, under US GAAP, control of a non-VIE is reassessed only when there is a change in the voting interest of the investee.
In a business combination, US GAAP requires non-controlling interest (NCI) to be recorded at fair market value, whereas under IFRS there is an option to record NCI at its proportionate interest in the net assets or at fair market value.
In the case of the loss of control, under US GAAP, all amounts recognised in accumulated OCI are reclassified.
Push down accounting is required in certain circumstances for public companies and optional for private companies under US GAAP. Push down accounting is not allowable under IFRS.
For equity-method investments under US GAAP, potential voting rights are not considered when determining significant influence. Entities have the option to account for equity-method investees at fair value. If fair value is not elected, and significant influence exists, the equity method of accounting is required. Uniform accounting policies between investor and investee are not required.
Under US GAAP, the carrying amount of an equity-method investee is written down only if the impairment can be deemed as “other than temporary.” US GAAP provides specific guidelines on changes in the status of an equity-method investee.
Under US GAAP, there is no definition of a “joint arrangement” and of a “joint operation.” Unlike IFRS the definition of a “joint venture” refers to a jointly controlled activity. Joint ventures defined as in accordance to IFRS are generally accounted under US GAAP using the equity method of accounting, unless the fair value option is elected. Proportionate consolidation is permitted in limited circumstances to account for interests in unincorporated entities where it is an established practice in a particular industry.
Under US GAAP, unlike IFRS, which only permits fair value accounting of an investment company investee if the parent is itself an investment company, investments in investment entities are always accounted for at fair value if the investee meets the characteristics of an investment company. These characteristics are very similar to IFRS. This is because the FASB and IASB undertook a joint project in 2011 to more closely align the accounting for investment entities.
Under US GAAP, unlike IFRS, there is no topic that deals with the disclosure about an entity's interests in other entities like IFRS 12 does. The disclosure requirements related to the composition of the group and the interests of non-controlling interests in the group's activities and cash flows are not as extensive as under IFRS.
US GAAP does not require disclosure about an entity's interest in joint arrangements. On the other hand, disclosures are required about an entity's involvement with both consolidated and unconsolidated VIE and disclosures required by investment companies in respect of investee are more extensive than under IFRS.