Adjustments as part of post-acquisition accounting

1. Assets of associate
2. An entity might impair the associate’s or the joint venture’s property, plant and equipment on acquisition, as part of the fair value exercise. Any subsequent impairment losses recognised by the associate or the joint venture would need to be reversed.
3. Pre-acquisition goodwill of associate
4. The investee’s assets used in calculating the goodwill arising on acquisition should not include any goodwill carried in the associate’s or joint venture’s balance sheet. Similarly, as part of the fair value exercise, an acquirer only recognises separately an intangible asset of the acquiree at the acquisition date if it meets the definition of an intangible asset.
5. The goodwill in the associate’s or joint venture’s books would not be an identifiable asset, and it would be ignored for the purpose of determining the goodwill arising on the acquisition of the associate or joint venture. Any goodwill impairment loss subsequently recognised by the associate or joint venture in its books would be added back when equity accounting the profits of the associate or joint venture, because the associate’s or joint venture’s goodwill is not an identifiable asset in the purchase price allocation. There would be an impairment trigger at the entity level, so the total carrying value of the associate would be tested for impairment.

Pre-acquisition goodwill impairment loss recognised by associate

If an entity has a 25% interest in an investee, and the investee’s profit for the period is C100 (after recognising a goodwill impairment loss of C20), the entity’s share of the investee’s profit for the period would be C30 (that is, 25% of C120). Any share of goodwill impairment loss recognised by an investee should be excluded from the entity’s share of the investee’s profit or loss for the period. The entity tests for impairment, under IAS 36, the entire carrying amount of its investment in the investee (including goodwill arising on the acquisition of the investee), by comparing the investment’s recoverable amount with its carrying amount whenever there is an indication that the investment might be impaired.

Treatment of post-acquisition goodwill arising from associate’s subsidiaries

An entity has a 25% interest in an associate that it acquired some years ago. At that time, the associate had a subsidiary (S1), and the associate’s consolidated financial statements contained goodwill. In the current financial year, the associate acquired another subsidiary (S2), and goodwill was generated on acquisition. The goodwill on acquisition of S1 in the associate’s books, when the entity acquires the associate, is not an identifiable asset, and it is subsumed into the investing entity’s goodwill arising on the acquisition of the associate. On the acquisition of S2, the goodwill arising in the associate’s books is not the entity’s goodwill, and it should be included in the share of net assets of the associate attributable to the entity. There is no separate disclosure of this goodwill, whether it arises on the acquisition of the associate itself or on subsequent acquisitions by the associate.

Determination of the group’s share or holding

The meaning of a group’s share or holding is not defined in the standard. Where the entity only has an interest in the equity share capital of the associate or the joint venture, the share to be equity accounted will normally be the number of shares held as a percentage of the total number of equity shares in issue. This amount will equate to the entity’s entitlement to dividends and other distributions. Complications arise where the investee has different classes of equity shares or where the entitlement to dividends, or capital on winding up, varies. The rights attaching to each class of share, as well as the substance of the respective right, need to be considered carefully to determine the appropriate percentage to be brought into the equity interest calculation.

In many situations, the share to be taken into account will be derived from the percentage holding in shares; in other situations, the economic interest might differ from the shareholding, but it will be the appropriate interest to take into account.

For example, the shareholdings in an associate might be 40:60, but the entities share profits in the ratio 30:70. In this case, it would be appropriate to equity account for the economic share rather than the equity participation.

Subsidiary has an investment in an associate

Entity A has an 80% interest in entity B. Entity B has a 40% investment in an associate. Entity A’s consolidated financial statements include 100% of the figures in entity B’s consolidated financial statements (that is, financial statements including the associate on an equity accounting basis). This means that, when calculating the appropriate share of the associate’s results to include in the consolidated profit and loss account for the group, it is the straight 40% investment that is brought into the group’s consolidated financial statements (and not 32% (80% × 40%)). This means that if, for example, the equity of the associate is C100 including a net profit for the period of C20, the investment in the associate is shown as C40 in the balance sheet, and the share of associate profit amounts to C8 (20 × 40%) and not C6.4 ((20 × 40%) × 80%). The difference of C1.6 is attributed to the non-controlling interests at the foot of the statement of comprehensive income, and C6.4 is attributed to the equity holders of the parent.

Indirect holding in an associate

Group A has two associates, entity B (22%) and entity C (25%). Entity B also has a 1% interest in entity C. In entity B’s books, the 1% interest in entity C is accounted for as an investment; and, in the consolidated financial statements, this investment is included as part of the net assets of entity B for the purposes of calculating the equity-accounted amount for entity B. The share of entity C that is taken into account in equity accounting for entity C is only the direct interest in entity C of 25%.

Determination of present ownership interest

An entity might, in substance, have a present ownership interest when, for example, it sells and simultaneously agrees to repurchase an ownership interest, but does not lose control of the ability to affect returns associated with that ownership interest. Where this is the case, the eventual exercise of the potential voting rights should be taken into account when determining the entity’s share to be equity accounted; this is because, in substance, the rights currently give access to affect the returns associated with an ownership interest and are considered a present ownership interest. An entity could simultaneously write put options to, and purchase call options from, an entity, with the options having substantially the same fixed strike prices and being exercisable at the same future date.

In this situation, it is virtually certain that one or other party will exercise the option, because it will be in the economic interests of one of them to do so. If the share price falls below the fixed strike price, the other party will exercise the put option and sell the shares (that is, the entity has retained access to the risks); or, if the share price increases above the fixed strike price, the entity will exercise the call option and buy the shares (that is, the entity has retained access to the benefits).

For a present ownership interest to exist, the potential voting rights must give access to the economic benefits associated with an ownership interest. It will be difficult to argue that potential voting rights give rise to a present ownership interest where the actual shareholder has the rights to dividends. It is wrong to equity account for profits that are more likely to be paid as dividend to the actual holder of the shares than to the entity holding the potential right. Although potential voting rights do not give a present ownership interest, the exercise price might be structured so as to give the holder of the potential voting right the effective interest in the dividends, and this would indicate that the holder of the potential voting right retains the economic benefits of the investment.