Presentation of long-term loans to associates

Entity A owns 25% of entity B’s equity share capital. Entity A has significant influence over entity B and, therefore, entity B is an associate of entity A. Entity A also owns 75% of entity B’s 7% cumulative preference share capital (that is, 1.5 million preference shares with a nominal value of C1 each). The interest in the preference share capital is considered to be part of the entity’s net investment in the associate. For simplicity, it is assumed (for the purpose of this example) that no goodwill arose on the acquisition of the associate and that fair value equalled book value. Entity B’s balance sheet is as follows:

C’m

Fixed assets                                                                                                                      7.0

Inventories                                                                                                                        1.5

Trade receivables                                                                                                            1.0

Cash                                                                                                                                   0.5

Trade payables                                                                                                                 (3.0)

Preference shares (treated as debt)                                                                               (2.0)

Net assets                                                                                                                          5.0

The amount that entity A equity accounts for is 25% of C5 million (that is, C1.25 million). This amount is shown in the entity’s consolidated (or economic interest) financial statements as ‘investments accounted for using the equity method’. The preference share capital’s cost of C1.5 million (75% of C2 million) represents its fair value on initial recognition. The preference share capital is initially recognised as a financial asset at fair value in accordance with IFRS 9 (IAS 39), and it is subsequently measured in accordance with that standard. This amount is shown in the entity’s consolidated (or economic interest) financial statements as a financial asset. Practice varies for the balance sheet presentation. IAS 1 requires investments accounted for using the equity method to be shown as a line item on the balance sheet. The equity investment in an associate and any other long term-interests can be shown under separate line items in line with their different measurement bases (for instance, ‘investments accounted for under the equity method’ and within ‘financial assets’). Under this approach, the equity-accounted amount of C1.25 million would be shown separately from the interest in the preference shares. Alternatively, on the basis that, under paragraph 38 of IAS 28, the interest in an associate is it carrying amount determined using the equity method, together with any long-term interests that, in substance, form part of the entity’s net investment in the associate, these could be shown as a single line item in the balance sheet (for instance, ‘investment in associates’), with sufficient disclosure in the notes of the component parts of the investment.

Measurement of long-term interests that, in substance, form part of the net investment

In October 2017, the IASB issued amendments to IAS 28. The amendments clarify that IFRS 9 applies to long-term interests in associates or joint ventures. Long-term interests are interests that, in substance, form part of the net investment but are not accounted for using equity accounting. The Board clarified in IAS 28 that: the IFRS 9 requirements are applied to long-term interests before applying the loss allocation and impairment requirements of IAS 28; and the entity should not take account of any adjustments to the carrying amount of long-term interests that result from the application of IAS 28, when applying the IFRS 9 requirements. The illustrative example of the IAS 28 Amendment portrays a comprehensive scenario illustrating how an entity (investor) accounts for various long-term interests that, in substance, form part of the entity’s net investment in an associate (long-term interests) applying IFRS 9 in accounting for its long-term interests and IAS 28 to its net investment in the associate, which includes those long-term interests. These amendments are effective from 1 January 2019, with earlier application permitted. Retrospective application would be required in accordance with IAS 8. Transition requirements for entities that apply the amendments after they first apply IFRS 9 would be similar to those in IFRS 9 regarding classification and measurement.

Question 1: An investor has a 20%-owned associate, accounted for using the equity method. The investor has issued a loan of C100 to this associate and has recognised an ECL impairment loss of C10 (that is, the net book value of the loan in the investor’s books is C90). How should the investor account for this impairment loss in its financial statements?

Answer 1:

The investor should apply the IFRS 9 impairment considerations on the loan. No (elimination) adjustment should be applied to the impairment loss.

Question 2: An investor holds 20% of the class A ordinary shares in the issuer entity (equity investment) and 20% of the preference shares paying a 10% coupon (an obligation). The preference shares have the same voting rights as ordinary shares but have a fixed return. From the perspective of the issuer, under IAS 32, the preference shares would be debt instruments. How should the investor account for the investment in the ordinary and preference shares in its consolidated financial statements?

Answer 2: The investment in the ordinary shares is accounted for under IAS 28. The investment in the preference shares is accounted for under IFRS 9, and is subject to IFRS 9’s ECL model, but forms part of the investor’s net investment in the issuer that is tested for impairment under IAS 28.

Question 3: An investor holds 20% of the class A ordinary shares in the issuer entity which provide voting rights and access to profits. The terms of the class A ordinary shares require the issuer to distribute all its available profits to class A shareholders. The investor, as holder of 20% of the shares, is entitled to 20% of the profits. From the perspective of the issuer, under IAS 32, the class A shares would be debt instruments due to the contractual obligation to pay dividends. How should the investor account for the investment in the class A ordinary shares in its consolidated financial statements?

Answer 3: The investment in class A ordinary shares is accounted for using the equity method as prescribed by IAS 28 because the shares contain voting rights and give access to the returns associated with an ownership interest.

Common presentation issues in the statement of comprehensive income or income statement

Reference to standard: IAS 1 para 82

1. Can the entity’s share of the associate’s or the joint venture’s results be included before or adjacent to operating profit? Yes. This might apply where the associate or the joint venture is an integral vehicle through which the group conducts its operations and its strategy. Using this presentation, the associate’s results are still shown post-tax.
2. How should impairment charges relating to the investment in the associate or joint venture be disclosed? The presentation of impairment charges should follow the presentation of the entity’s share of the associate’s or the joint venture’s results. The impairment charge should be presented as a separate line item adjacent to the share of the associate’s or the joint venture’s results, and not included as part of the share of the associate’s or the joint venture’s results.
3. How should gains and losses on disposals of associates and joint ventures be presented? Presentation is dependent of the facts and circumstances. These will normally be presented as part of the entity’s operating activities. In certain circumstances, it might be appropriate to recognise gains and losses from disposals of associates and joint ventures outside the entity’s operating profit, if it is clear that the disposal is a one-off transaction (that is, it is not expected that the entity will have similar transactions in the future and there is no history of having similar transactions in the past). The entity’s consolidated or economic interest financial statements should also include sufficient disclosures to aid the users of the financial statements.
4. Should the associate’s or joint venture’s discontinued operations be included within the IFRS 5 discontinued operations line? No, there is no requirement to ‘strip out’ the entity’s share of its associate’s or its joint venture’s discontinued operations and include it within the IFRS 5 discontinued operations line.

Common presentation issues in the balance sheet

Reference to standard: IFRS 12 para 21

1. Can the investment in the associate or joint venture be revalued? It is not permitted, once the balance sheet interest has been ascertained using the equity method of accounting, to then revalue the investment in the associate or the joint venture to its market value, even where the entity is listed. However, the fair value of investments in associates and joint ventures for which there are quoted market prices is required to be disclosed.
2. Should other interests, such as loans to associates and joint ventures, be included within this line item?