Increase in stake of associate

Example 1 – Entity’s stake in associate is increased Entity B has an associate, entity A, that has 100 shares on issue at C1 per share, of which entity B owns 20. The carrying value of the investment in entity B’s balance sheet is C20. No goodwill was recognised, because the first tranche was acquired at the date when entity A was incorporated. The following year, entity A increases its share capital by C16 (16 × C1), which is contributed by entity B. The fair value of entity’s A net assets was C74 before the share issue, and it increased to C90 after the share capital contribution. Entity B’s holding is now increased to 31% (36/116 shares). Entity B has acquired an additional 11% of its interest in entity A (that is, its interest has increased from 20% to 31%).

As mentioned, there is no step-up of investment to fair value for the previously owned 20%. As such, the first tranche of 20% will be maintained at the carrying value of C20. Goodwill is determined on the second tranche as follows: C Cost of the second tranche acquired (11%) 16 – Share acquired in the fair value of the existing net identifiable assets (31% − 20%) × C74 8 – Share acquired in the cash received by entity A following the increase in share capital (31% × C16) 5 Total share acquired in the net identifiable assets of entity A 13 Goodwill 3 In entity B’s consolidated financial statements, equity interest (that is, entity B’s shareholding in entity A) increased to 31%, and the carrying amount of the investment in entity A amounts to C36 (C20 + C16), with goodwill of C3.

Example 2 – Increase of shareholding through share buy-back by associate Associate A has issued 100 shares, of which entity X owns 20 (20%). The fair value of associate A is C600, while the fair value of its net assets is C300. Associate A is carried in the books of entity X at C60 (equal to its share of net assets, because no goodwill was recognised on the first tranche). Associate A buys back 20 shares from other shareholders for C120. As a result, entity X’s ownership increases to 25% (20/80 shares), but entity A’s net assets decrease to C180 (C300 − C120). It can be argued that the entity’s deemed cost to acquire the additional 5% is represented by the entity’s share of the cash amount that the associate pays in order to buy back the shares (20% of C120 = C24).

Deemed cost reduces the carrying amount of the ‘old’ investment and is, at the same time, treated as the cost of the new investment: Carrying amount of the old investment after the transaction: C60 − C24 = C36 (can be reconciled to the entity’s share in net assets: 20% × C180 = C36) Notional purchase price allocation for the new investment: C Deemed cost 24 Share of net assets (5% × 180) 9 Notional goodwill 15 As a result of the above accounting, the investment in entity A will be carried at C60 (C60 − C24 used for buy back + C24 deemed cost), consisting of: C Share of net assets 45 Notional goodwill 15 60 The same economic impact and accounting result would be achieved if, instead of buying back the shares, associate A had paid a dividend of C1.2 per share to all of its shareholders (in total C120, including C24 to entity X) and entity X had used the dividend received to buy 5% additional shares from other shareholders. Under both scenarios, the end result is the same: Net assets of the associate have decreased from C300 to C180 (and fair value from C600 to C480). Entity X’s share has increased from 20% to 25%. Net cash flow for entity X was zero. Dr Cash C24 Cr Associate C24 to account for the dividends received Dr Associate C24 (consisting of share of net assets 5% × C180 = C9 and notional goodwill C15) Cr Cash C24 to account for the additional share purchase.

As a result, the investment in entity A is carried at C60 (C60 – C24 received as dividends + C24 paid for new shares), consisting of: C Share of net assets 45 Notional goodwill 15 60 In summary, since the associate has not participated in the transaction in any way, there is no effect on the investment in the associate. The associate’s carrying amount in entity A’s books will not change as a result of the dividend, but the components of the carrying amount will change.

Entity increases stake in associate but does not gain control

A group made an investment of 20% in an associate in 20X1. The investment cost C12 million and the book value (also fair value) of the associate’s net assets at that date was C50 million. In 20X3, it makes a further investment of 20% in the company, to bring its total investment to 40%. The fair value of the consideration given for the additional 20% is C16 million. The net assets of the associate stand in its books at C68 million on the date of the increase in stake. The fair value exercise shows that the company’s net assets are worth C75 million. The goodwill arising on acquisition and the balance sheet treatment in the group would be as follows:

C’m Original investment 12 Share of the fair value of net assets (20% × C50m) (10) Goodwill arising on first tranche 2 Second investment 16 Share of the fair value of net assets (20% × C75m) (15) Goodwill arising on second tranche 1 Total goodwill 3

The goodwill figure that emerges is instinctively correct, because it reflects the fact that a premium of C1 million (that is, C16m − (C75m × 20%)) arises on the acquisition of the additional 20%. The amount included in the consolidated balance sheet comprises cost of C28 million (of which C3 million is goodwill) and the equity-accounted profits, after acquisition of the first tranche, of C3.6 million ((C68m − C50m) × 20%).

Associates involved in common control transactions

At the beginning of 2013, IFRIC discussed a received request to provide clarification of the accounting for an acquisition of an interest in an associate or a joint venture from an entity under common control. The IFRIC considered whether it is appropriate to apply the scope exemption for business combinations under common control by analogy with the acquisition of an interest in an associate or a joint venture under common control. The IFRIC concluded that this issue would be better considered within the context of broader projects for business combinations under common control and the equity method of accounting. Based on current literature, the common control exemption in IFRS 3 applies only to business combinations (that is, acquisition of a subsidiary by a parent); there is no such explicit exemption in IAS 28. IAS 28.26 however states that the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture.

In our view, the exemption in IFRS 3 should not be applied by analogy however given the lack of specific guidance in the area there is diversity in practice Careful analysis of the facts and circumstances and consideration of the requirements of IAS 1 for transactions with owners in their capacity as owners is required whenever the acquisition of an interest in an associate or a joint venture under common control occurs.

Example 1 – Associate is transferred round a group Entity C, which also has some subsidiaries (these are not shown on the above diagram), prepares financial statements under IFRS. It exchanges its interests in associate D in return for a participating interest in entity B. The transaction has taken place under the control of entity A. Can entity C treat it in the same way as if it was a common control business combination?

Carrying value in entity C’s consolidated financial statements Fair value of 100% of business C C Entity D 350 2,500 Entity B (before transfer) 650 The fair value of entity B’s net assets before the transaction is C500. Entity C cannot use the common control exemption. This exemption applies only to business combinations (that is, acquisition of a subsidiary by a parent); there is no such exemption in IAS 28. Entity C should treat the transfer of associate D as a disposal, because entity D is no longer its associate. A disposal will give rise to a gain or loss in entity C’s consolidated financial statements. IAS 28 requires that, when an investor ceases to have significant influence over an associate but retains an interest in that investment, that retained interest should be remeasured to fair value, thus giving rise to a remeasurement gain or loss. This, in turn, will affect the amount of carrying value of entity C’s investment in associate B. Calculation of gain on disposal: C Consideration received (fair value of share of entity B acquired) 130 Amount disposed of – 10% of previous interest in entity D: C350 (35) Remeasuring retained interest to fair value (18% × C2,500 – 90% × C350) 135 230 Carrying value of associate investment in entity B group in entity C’s consolidated financial statements: C Fair value of 20% of entity B: C650 (includes C30 of notional goodwill) 130 Fair value of 18% of entity D: C2,500 450 580

Example 2 – Associate involved in a common control transaction Before: After: Entity A holds a 30% interest in associate C. Entity C is a 70% subsidiary of entity B and is consolidated along with entity D, which is a wholly owned subsidiary of entity B. Entity B decides to sell its 100% stake in entity D to entity C for C100 in a common control transaction for group B. The net asset value of entity D is C60. Entity C has chosen to apply predecessor accounting to the transaction in its consolidated financial statements under IFRS. The application of predecessor accounting would result in a C40 debit to equity in entity C’s consolidated financial statements: C Purchase consideration 100 Predecessor value of entity D 60 Debit to equity 40 In entity C’s separate financial statements, it would record its investment in entity D at the purchase consideration of C100.

From entity A’s perspective, the common control exemption does not apply, because it applies only to business combinations, and there has been no business combination from entity A’s perspective. From entity A’s perspective, entity C has recognised a debit in equity of C40 as a result of a transaction under common control. IAS 28 is silent on transactions in an associate’s equity that do not affect the associate’s profit or loss or other comprehensive income, so entity A needs to develop an accounting policy that best reflects the substance of this transaction.

Use of provisional figures on acquisition of an associate

IAS 28 does not specifically address what to do if only provisional figures are available on the acquisition of an associate or a joint venture. Under IFRS 3, where a subsidiary is acquired, a one-year period is allowed for the fair values used in the acquisition accounting to be finalised, and provisional figures can be used at a reporting period end. Where an entity acquires an associate or a joint venture, it might be necessary to use provisional figures if there are valid reasons why the information used to complete the accounting for the acquisition is not final at the balance sheet date.

Implications of limited access to associate’s financial information

1. Implications of limited access to financial information

The primary difference between an associate interest and an interest in a subsidiary is the level of the entity’s influence. An entity controls its subsidiaries and, therefore, has access to the information necessary for carrying out certain procedures at acquisition and on consolidation, but it exercises only significant influence over its associates and joint control over its joint ventures. This might mean that access to information to ascertain fair values on acquiring an associate or a joint venture interest, or that is necessary to make the required adjustments, is limited. The standard does not give any guidance on the extent of these procedures. Although estimates could be used, such a limitation in itself might call into question the entity’s relationship with its associate. Where the information available is extremely limited, the entity will need to reassess whether or not it actually has significant influence over the associate.

2. Implications of regulations regarding dissemination of information of associate

The standard makes no reference to regulations on the dissemination of information that could possibly restrict the extent to which the financial statements of an entity might contain information about its associates, unless such information is available to other interested parties at the same time. This is of particular importance where the associate is itself listed. An entity should, therefore, consider how to satisfy any regulations that apply concerning the publication of price sensitive information about its associates.

Accounting for other changes in net assets of the associate or joint venture

IAS 28 is silent on how to treat changes in the equity of an associate or a joint venture, other than those that are recorded in other comprehensive income. Such changes include, for example, gains and losses arising on an associate’s transactions with non-controlling interest shareholders of its subsidiaries (recorded directly in equity in the associate’s books) and movements in the share-based payment reserves of the associate or the joint venture. In these cases, the effects of the transactions are recorded in equity of the associate, but outside profit or loss and other comprehensive income. In the absence of any specific guidance in terms of the presentation of such transactions by the entity, the reporting entity needs to develop and apply consistently an accounting policy that best reflects the substance of these transactions.

Accounting in the consolidated financial statements of the parent

A group has an investment in an associate, and this investment is held by more than one of its subsidiaries. One subsidiary, which is an investment linked insurance fund (or mutual fund, unit trust or venture capital organisation), accounts for the investment in its associate, on initial recognition in its separate financial statements, at fair value through profit or loss in accordance with IFRS 9 (IAS 39). Another subsidiary accounts for its investment in the same associate in accordance with IAS 28, and thus uses the equity accounting method.

Can both measurement bases be used in the consolidated financial statements of their parent?

Different measurement bases can be applied to portions of an investment in an associate, where part of the investment is designated, on initial recognition, at fair value through profit or loss in accordance with the venture capital scope exemption. The group is required to determine if it has significant influence over that investment and, if it does, the group measures the portion of the investment in the associate to which the venture capital scope exemption is applied at fair value through profit or loss, and the remaining investment in the associate is accounted for using the equity method of accounting. [IAS 28 para 19].