Determination of cost of an investment in an associate and treatment of contingent consideration

IAS 28 contains no specific guidance on how to account for contingent consideration. Like acquisition costs, the treatment of contingent consideration is not dealt with specifically in IAS 28. At the date of acquisition, an estimate of the contingent consideration is usually included as part of the cost of the acquisition. There are different treatments for subsequent changes in the contingent consideration. The following two methods are considered as acceptable for the accounting of subsequent changes in contingent consideration: Cost-based approach. Any revisions to the contingent consideration estimates, after the date of acquisition, are accounted for as changes in estimates in accordance with IAS 8, to be accounted for on a prospective basis. The change in the liability, as a result of the revised cash flows, would be adjusted to the cost of the asset and, in accordance with paragraph 37 of IAS 8, recognised as part of the associate’s carrying amount rather than in profit or loss.

By analogy with IFRS 3. The guidance for contingent consideration under IFRS 3 is based on the fair value approach. Under this approach, all contingent consideration is classified and measured at fair value at the acquisition date. By analogy with paragraph 58 of IFRS 3, the contingent consideration is classified either as a liability or as equity. Contingent consideration that is classified as an equity instrument is not remeasured. Contingent consideration that is classified as an asset or liability is accounted for under IFRS 9 (IAS 39). Any change in the contingent consideration is then accounted for in profit and loss in accordance with IFRS 9 (IAS 39).

Classification as held for sale

An entity shall apply IFRS 5 to an investment, or a portion of an investment, in an associate or a joint venture that meets the criteria to be classified as held for sale. Any retained portion of an investment in an associate or a joint venture that has not been classified as held for sale shall be accounted for using the equity method until disposal of the portion that is classified as held for sale takes place. After the disposal takes place, an entity shall account for any retained interest in the associate or joint venture in accordance with IFRS 9 unless the retained interest continues to be an associate or a joint venture, in which case the entity uses the equity method.

When an investment, or a portion of an investment, in an associate or a joint venture previously classified as held for sale no longer meets the criteria to be so classified, it shall be accounted for using the equity method retrospectively as from the date of its classification as held for sale. Financial statements for the periods since classification as held for sale shall be amended accordingly.

Accounting for monetary and nonmonetary assets exchanged on formation of an associate or joint venture or subsequently

Any monetary or non-monetary assets exchanged during the formation of the associate or the joint venture, or subsequently, should be considered when determining the consideration received by the entity. An entity might receive cash (either directly from the other investors in the associate or joint venture, or from the joint venture itself) as well as shares for the asset or business transferred to the associate or joint venture. Where cash is received from the other investors (and not the associate or joint venture itself), the earnings process is complete in relation to the cash element of the consideration. For example, an entity transfers an asset with a fair value of C1,000 and a carrying amount of C900 to an associate or a joint venture in which it has a 40% interest. The entity receives, in exchange, both cash consideration of C250 from the other investors and shares in the associate or joint venture with a fair value of C750. The gain would be treated as realised for the portion of the consideration received in cash from the other investors.

The gain on the portion of the consideration received in shares is only realised to the extent of the other party’s share in the associate or joint venture. The realised gain in this example is therefore C70 ((C100 × 25%) + (C100 × 75% × 60%)). The unrealised portion of the gain only becomes fully realised once the asset is sold by the associate or joint venture (for example, to a third party). Another example is where a parent has a property that it contributes to a 55/45 joint venture for an issue of shares. The carrying value of the property is C1,000 and its fair value is C1,200. It would recognise a gain in the consolidated profit or loss of C90 (C200 × 45%), because the unrelated entity’s interest is 45%.

Methods by which an associate can arise from the disposal of a subsidiary

There are various methods by which a subsidiary investment can be changed to an associate investment. Some examples are set out below:

1. An entity sells a share of a subsidiary company, which has reduced the entity’s shareholding to below 50% of the entity’s voting rights, although the entity has retained significant influence and, accordingly, it is now an associate.
2. A subsidiary issues shares to a third party such that the entity’s shareholding reduces below 50% of the entity’s voting rights, although significant influence is retained.
3. The entity ceases to have the power to govern at, for example, the 40% level, but continues to have significant influence.

Determining cost of an associate acquired in stages

There are two approaches that could be adopted where an entity increases its stake in another entity and an existing investment becomes an associate for the first time. Those two methods are: ‘Cost of each purchase’ method. The cost of an associate acquired in stages is measured as the sum of the consideration paid for each purchase plus a share of the investee’s profits and other equity movements (for example, revaluation). Any acquisition-related costs are treated as part of the investment in the associate. ‘Fair value as deemed cost’ method (by analogy with IFRS 3). The cost of an associate acquired in stages is measured as the sum of the fair value of the interest previously held plus the fair value of any additional consideration transferred as of the date when the investment became an associate. Because this method is based on analogy with IFRS 3, any acquisition-related costs are expensed in the periods in which they are incurred. This is different from acquisition-related costs on initial recognition, those costs form part of the carrying amount of an associate. This view is based on the July 2009 IFRIC rejection. The accounting method chosen by the entity should be applied consistently for all such transactions whereby an entity increases its investment from a trade investment to an associate undertaking.