International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards

by International GAAP 2019 (pdf)

  IAS 28 (see 2.3 below). Each ‘category’ of investment must be accounted for

  consistently. [IAS 27.10]. While ‘category’ is not defined, we take this to mean, for

  example, that it would be permissible for a parent that is not an investment entity to

  account for all subsidiaries at cost and all associates under IFRS 9.

  Where an investment in an associate or joint venture is accounted for in accordance

  with IFRS 9 in the consolidated financial statements, it must also be accounted for in

  the same way in the separate financial statements. [IAS 27.11]. The circumstances in which

  IFRS 9 is applied in consolidated financial statements are discussed in, respectively,

  Chapter 11 at 5 and Chapter 12 at 2.

  A parent that meets the definition of an investment entity is required to measure its

  investments in particular subsidiaries at fair value through profit or loss in accordance

  with IFRS 9 in its consolidated financial statements, [IFRS 10.31], and is required to

  account for them in the same way in the separate financial statements. [IAS 27.11A]. When

  an investment entity parent has shares in subsidiaries that only provide investment

  related services (and therefore are not subject to obligatory fair value measurement),

  that parent effectively has shares in two categories of subsidiaries. It therefore has still

  an accounting policy choice to account for those subsidiaries that only provide

  investment related services at cost, in accordance with IFRS 9, or using the equity

  method in its separate financial statements.

  When an entity becomes an investment entity the difference between the previous

  carrying value of the investment and its fair value at the date of change in status of the

  parent is recognised as a gain or loss in profit or loss. When a parent ceases to be an

  investment entity, it should follow paragraph 10 of IAS 27 and account for the

  investments in a subsidiary either at cost (the then fair value of the subsidiary at the date

  of the change in the status becomes the deemed cost), continue to account for the

  investment in accordance with IFRS 9, or apply the equity method. [IAS 27.11B].

  IAS 27 contains specific requirements related to the treatment of dividends from

  investments in subsidiaries, joint ventures or associates that are recognised in profit or

  loss unless the entity elects to use equity method, in which case the dividend is

  recognised as a reduction of the carrying amount of the investment. [IAS 27.12]. IAS 36 –

  Impairment of Assets – includes specific triggers for impairment reviews on receipt of

  dividends. These are discussed at 2.4.1 below.

  Separate and individual financial statements 543

  2.1 Cost

  method

  There is no general definition or description of ‘cost’ in IAS 27. How the term applies in

  practice is described in 2.1.1 below.

  IAS 27 addresses the cost of investment in a new holding company that becomes the

  parent of an existing parent in a one-for-one share exchange. This is discussed further

  in 2.1.1.D and 2.1.1.E below.

  IAS 27 also indicates that when an entity ceases to be an investment entity and its

  accounting policy is to account for investments in subsidiaries, associates or joint

  ventures at cost, the fair value as at the date of the change in status shall be used as the

  deemed cost. [IAS 27.11B].

  IFRS 1 – First-time Adoption of International Financial Reporting Standards – allows a

  ‘deemed cost’ transitional amendment for those applying IFRS for the first time in

  separate financial statements (see 2.1.2 below).

  2.1.1

  Cost of investment

  IAS 27 does not define what is meant by ‘cost’ except in the specific circumstances of

  certain types of group reorganisation, described below, and when an entity ceases to be

  an investment entity and accounts for investments in subsidiaries at cost as indicated

  above.

  As discussed further in Chapter 3 at 4.3, IAS 8 – Accounting Policies, Changes in

  Accounting Estimates and Errors – states that, in the absence of specific requirements

  in IFRS, management should first refer to the requirements and guidance in IFRS that

  deal with similar and related issues.

  The glossary to IFRS defines cost as ‘the amount of cash or cash equivalents paid or the

  fair value of the other consideration given to acquire an asset at the time of its

  acquisition or construction’.

  ‘Consideration given’ is likewise not defined, and therefore we believe that the key

  sources of guidance in IFRS are:

  • ‘consideration transferred’ in the context of a business combination, as referred to

  in paragraph 37 of IFRS 3 – Business Combinations; [IFRS 3.37] and

  • ‘cost’ as applied in relation to acquisitions of property, plant and equipment in

  accordance with IAS 16 – Property, Plant and Equipment, intangible assets in

  accordance with IAS 38 – Intangible Assets – and investment property in

  accordance with IAS 40 – Investment Property.

  Applying the requirements of IFRS 3, the ‘consideration transferred’ in a business

  combination comprises the sum of the acquisition date fair values of assets transferred

  by the acquirer, liabilities incurred by the acquirer to the former owners of the acquiree,

  and equity interests issued by the acquirer. This includes any liability (or asset) for

  contingent consideration, which is measured and recognised at fair value at the

  acquisition date. Subsequent changes in the measurement of the changes in the liability

  (or asset) are recognised in profit or loss (see Chapter 9 at 7.1).

  The Interpretations Committee and IASB have discussed the topic Variable payments

  for the separate acquisition of PPE and intangible assets for a number of years,

  544 Chapter

  8

  attempting to clarify how the initial recognition of the variable payments, such as

  contingent consideration, and subsequent changes in the value of those payments

  should be recognised. The scope of the past deliberations did not specifically include

  the cost of an investment in a subsidiary, associate or joint venture. However, as they

  consider general principles about the recognition of variable payments we believe they

  can also be considered relevant in determining the cost of such investments.

  There was diversity of views about whether the liability for contingent

  consideration relating to separate acquisition of property, plant and equipment and

  intangible assets falls within the scope of IAS 37 – Provisions, Contingent Liabilities

  and Contingent Assets – or within the scope of IAS 39 – Financial Instruments:

  Recognition and Measurement (this is still relevant after IFRS 9 adoption as well).

  This affects the initial recognition and also subsequent accounting for changes in the

  value of the contingent consideration. The Interpretations Committee discussed the

  issue during 2011 and 2012 and put further discussions on hold until the IASB had

  completed the discussions concerning the treatment of variable payments in the

  leases project. When the Interpretations Committee recommenced its discussions

  in 2015 they were unable to reach a consensus on (i) whether a purchaser recognises

  a liability at the date of purchasing an asset for variable payments tha
t depend on

  future activity or instead recognises a liability only when the related activity occurs

  and (ii) how the purchaser measures the liability. They noted that there are questions

  about the accounting for variable payments subsequent to the purchase of the asset.

  Eventually, in March 2016 the Interpretations Committee decided that the issue is

  too broad for it to address and concluded that the IASB should address accounting

  for variable payments more comprehensively.5

  Until the IASB issues further guidance, differing views remain about the circumstances

  in which, and to what extent, variable payments such as contingent consideration

  should be recognised when initially recognising the underlying asset. There are also

  differing views about the extent to which subsequent changes should be recognised

  through profit or loss or capitalised as part of the cost of the asset.

  The topic is discussed in relation to intangible assets, property, plant and equipment

  and investment property in Chapter 17 at 4.5, Chapter 18 at 4.1.9 and Chapter 19

  at 4.10 respectively.

  Where entities have made an accounting policy choice regarding recognition of

  contingent consideration and accounting for the subsequent changes in separate

  financial statements, the policy should be disclosed and consistently applied.

  Another question relates to the treatment of any transaction costs as, under IFRS 3,

  these costs are recognised as expenses, whereas in accordance with IAS 32 – Financial

  Instruments: Presentation – and IFRS 9, they are treated as reduction of the proceeds

  of the debt or equity securities issued. Accordingly, the applicable treatment will have

  an impact on the related goodwill in the consolidated financial statements.

  At its meeting in July 2009, the Interpretations Committee, in discussing the

  determination of the initial carrying amount of an equity method investment, noted that

  IFRSs consistently require assets not measured at fair value through profit or loss to be

  measured on initial recognition at cost. Generally stated, cost includes the purchase

  Separate and individual financial statements 545

  price and other costs directly attributable to the acquisition or issuance of the asset such

  as professional fees for legal services, transfer taxes and other transaction costs.6

  Given that IAS 27 does not separately define ‘cost’, we believe it is appropriate to apply this

  general meaning of ‘cost’ in determining the cost of investments in subsidiaries, associates

  or joint ventures in separate financial statements. Therefore, in our opinion, the cost of

  investment in a subsidiary in the separate financial statements includes any transaction

  costs incurred even if such costs are expensed in the consolidated financial statements.

  2.1.1.A

  Investments acquired for own shares or other equity instruments

  In some jurisdictions, local law may permit investments acquired for an issue of shares

  to be recorded at a notional value (for example, the nominal value of the shares issued).

  In our view, this is not an appropriate measure of cost under IFRS.

  A transaction in which an investment in a subsidiary, associate or joint venture is

  acquired in exchange for an issue of shares or other equity instruments is not specifically

  addressed under IFRS, since it falls outside the scope of both IFRS 9 and also IFRS 2 –

  Share-based Payment (see Chapter 30 at 2.2.3).

  However, we believe that it would be appropriate, by analogy with IFRS on related

  areas (like IFRS 3), to account for such a transaction at the fair value of the consideration

  given (being fair value of equity instruments issued) or the assets received, if that is more

  reliably measured, together with directly attributable transaction costs.

  2.1.1.B Investments

  acquired

  in common control transactions

  When an investment in a subsidiary, associate or joint venture is acquired in a common

  control transaction, in our view, the cost should generally be measured at the fair value

  of the consideration given (be it cash, other assets or additional shares) plus, where

  applicable any costs directly attributable to the acquisition. However, when the

  purchase consideration does not correspond to the fair value of the investment

  acquired, in our view, the acquirer has an accounting policy choice to account for the

  investment at fair value of consideration given or may impute an equity contribution or

  dividend distribution and in effect account for the investment at its fair value.

  Example 8.1 below illustrates the determination of the cost of an investment in a

  subsidiary in separate financial statements as described above.

  Example 8.1:

  Cost of a subsidiary in separate financial statements when the

  pooling of interest method is applied in consolidated financial

  statements

  Parent has a 100% direct interest in Sub 1 and Sub 2. As part of a group reorganisation, the parent transfers

  its direct interest in Sub 2 to Sub 1 in exchange for consideration of:

  Scenario 1 – €200 (equal to the fair value of Sub 2);

  Scenario 2 – €150.

  The carrying amount of the investment in Sub 2 in the separate financial statements of Parent is €50. The

  carrying amount of Sub 2’s net assets in the separate financial statements of Sub 2 is €110.

  Sub 1 accounts for the acquisition of Sub 2 using the pooling of interest method in its consolidated

  financial statements.

  546 Chapter

  8

  In Scenario 1, the cost of an investment in a subsidiary that is acquired as part of a group reorganisation is

  the fair value of the consideration given (be it cash, other assets or additional shares), plus, where applicable,

  any costs directly attributable to the acquisition. Therefore, the cost to Sub 1 is €200. The cost is not the

  carrying amount of the investment in Sub 2 in the separate financial statements of Parent (i.e. €50), nor the

  carrying amount of Sub 2’s net assets in the separate financial statements of Sub 2 (i.e. €110).

  In Scenario 2, the conclusion in Scenario 1 applies even if the fair value of the consideration given is more

  or less than the fair value of the acquiree. Therefore, the cost of investment is €150. However, the acquirer

  may choose to recognise an equity element (equity contribution or dividend distribution). In this case, the

  cost of investment is €200 with €50 recognised as an equity contribution.

  In July and September 2011, the Interpretations Committee discussed group

  reorganisations in separate financial statements in response to a request asking for

  clarification on how entities that are established as new intermediate parents within a

  group determine the cost of their investments when they account for these investments

  at cost in accordance with paragraph 10(a) of IAS 27. In the agenda decision issued, the

  Interpretations Committee noted that the normal basis for determining the cost of an

  investment in a subsidiary under paragraph 10(a) of IAS 27 has to be applied to

  reorganisations that result in the new intermediate parent having more than one direct

  subsidiary.7 This differs from the wording in the original proposed wording for the

  tentative decision which referred to ‘the general principle of determining cost by the

  fair value of t
he consideration given’.8

  Some have read this to mean that ‘the normal basis for determining the cost of

  investment’ in a common control transaction is not restricted to using the fair value of

  the consideration given, but that another basis for determining cost may be appropriate.

  One situation where we believe that it would be acceptable not to use the fair value of

  the consideration given is for a common control transaction where an investment in a

  subsidiary constituting a business is acquired in a share-for-share exchange. In that

  circumstance, we believe that it is also acceptable to measure the cost based on the

  carrying amount of the investment in the subsidiary in the transferor entity’s separate

  financial statements immediately prior to the transaction, rather than at the fair value of

  the shares given as consideration.

  Common control transactions are discussed further at 4 below. There are specific

  measurement requirements applicable to certain arrangements involving the formation

  of a new parent or intermediate parent, which are described at 2.1.1.D and 2.1.1.E below.

  2.1.1.C Cost

  of

  investment

  in subsidiary, associate or joint venture acquired in

  stages

  It may be that an investment in a subsidiary, associate or joint venture was acquired in

  stages so that, up to the date on which control, significant influence or joint control was

  first achieved, the initial investment was accounted for at fair value under IFRS 9. This

  raises the question of what the carrying amount should be in the separate financial

  statements when the cost method is applied.

  Separate and individual financial statements 547

  In our view, in the case of an acquisition in stages, there is only one acceptable method

  of accounting for the investment in the separate financial statements. The cost of the

  investment is the sum of the consideration given for each tranche.

  The Interpretations Committee discussion in 2009 referred to above at 2.1.1 indicates that

  cost of investment reflects the consideration given (purchase price) rather than the fair

  value of any interest held that is ‘given up’. In IFRS 3, any investment held prior to a

  second acquisition that gives control is considered to be ‘given up’ in exchange for a