value of the equity instruments issued.
The amount at which the new parent’s issued share capital is recorded will depend on
the relevant law in the jurisdiction applicable to the new parent. The shares may be
recorded at fair value, which is the fair value of the investments acquired, or at an
amount calculated on some other basis. Local law may allow a company to record its
issued share capital at a nominal amount, e.g. the nominal (face) value of the shares. In
some jurisdictions, intermediate holding companies that acquire an asset from a parent
(the ‘transferor’) for shares at a premium are required by law to record the share capital
issued (its nominal value and share premium) at the carrying value in the transferor’s
books of the asset transferred; if the nominal value exceeds this book amount, the shares
are recorded at their total nominal value.
Once the share capital has been recorded, there will usually need to be an adjustment
to equity so that in total the equity is equal to the carrying amount (i.e. cost) of the
investments acquired. This adjustment may increase or decrease the acquirer’s equity
(comparing to share capital value) as it depends on the relative carrying amounts of the
investment in the owner, original parent’s equity and the number and value of the shares
issued as consideration, as shown in the following example.
Example 8.4:
Formation of new parent, statutory share capital and
adjustments to equity
Intermediate Parent A acquires the investments in Original Parent from Parent; the structure after the
arrangement is as illustrated above in 2.1.1.D. Parent carries its investment in Original Parent at £200 but it
has a fair value of £750. Original Parent’s equity in its separate financial statements is £650. Intermediate
Parent A issues shares with a nominal value of £100 to Parent.
In accordance with IAS 27 paragraph 13, Intermediate Company records its investment in Original Parent at
£650. Depending on local law, it might record its share capital (including share premium where appropriate) at:
(i) £750, being the fair value of the consideration received for the shares. It records a negative adjustment
of £100 elsewhere in equity; or
(ii) £100, being the nominal value of the shares issued. It records a credit adjustment of £550 elsewhere in
equity; or
(iii) £200, being the carrying value of the investment in Parent. It records a credit adjustment of £450
elsewhere in equity.
Separate and individual financial statements 553
2.1.2
Deemed cost on transition to IFRS
IFRS 1 allows a first-time adopter an exemption with regard to its investments in
subsidiaries, joint ventures and associates in its separate financial statements. [IFRS 1.D15].
If it elects to apply the cost method, it can either measure the investment in its separate
opening IFRS statement of financial position at cost determined in accordance with
IAS 27 or at deemed cost. Deemed cost is either:
(i) fair value (determined in accordance with IFRS 13 – Fair Value Measurement) at
the entity’s date of transition to IFRSs in its separate financial statements; or
(ii) previous GAAP carrying amount as at the entity’s date of transition to IFRSs in its
separate financial statements.
As with the other asset measurement exemptions, the first-time adopter may choose
either (i) or (ii) above to measure each individual investment in subsidiaries, joint
ventures or associates that it elects to measure using a deemed cost. [IFRS 1.D15].
2.2
IFRS 9 method
Under IFRS 9, the equity investments in subsidiaries, joint ventures or associates would
likely be classified as financial assets measured at fair value through profit or loss or, as
financial assets measured at fair value through other comprehensive income (OCI), if an
entity elects at initial recognition to present subsequent changes in their fair value in OCI.
In the former case, changes in the fair value of the investments will be recognised in profit
or loss. In the latter case, gains or losses from changes in the fair value will be recognised
in OCI and will never be reclassified to profit or loss. The classification requirements of
IFRS 9 are discussed in Chapter 44, and the measurement principles of IFRS 9 on initial
and subsequent measurement are discussed in detail in Chapters 45 and 46.
One issue that has been discussed by the IASB that is relevant in determining the fair
value of investments in subsidiaries, joint ventures and associates is the unit of account
for such investments.
In September 2014, the IASB issued an Exposure Draft (ED) Measuring Quoted
Investments in Subsidiaries, Joint Ventures and Associates at Fair Value (proposed
amendments to IFRS 10, IFRS 12, IAS 27, IAS 28 and IAS 36). The ED proposed to clarify
that the unit of account for investments in subsidiaries, joint ventures and associates be
the investment as a whole and not the individual financial instruments that constitute the
investment. However, in January 2016, the IASB decided not to consider this topic further
until the Post-implementation Review (PIR) of IFRS 13 has been done.15 The Board plans
to publish a Project Summary and Feedback Statement in the fourth quarter of 2018,
summarising the project’s findings and planned follow-up activities.16
2.3 Equity
method
IAS 27 allows entities to use the equity method as described in IAS 28 to account for
investments in subsidiaries, joint ventures and associates in their separate financial
statements.17 Where the equity method is used, dividends from those investments are
recognised as a reduction from the carrying value of the investment.18 The application of
the equity method under IAS 28 is discussed in Chapter 11 at 7. Some jurisdictions require
the use of the equity method to account for investments in subsidiaries, associates and
554 Chapter
8
joint ventures in the separate financial statements. In many cases this was the only GAAP
difference to IFRS and hence the IASB provided the option to use the equity method.
In the Basis for Conclusions to IAS 27, the IASB indicates that in general, the application
of the equity method to investments in subsidiaries, joint ventures and associates in the
separate financial statements of an entity is expected to result in the same net assets and
profit or loss attributable to the owners as in the entity’s consolidated financial statements.
However, there may be situations where this might not be the case, including:19
• Impairment testing requirements in IAS 28.
For an investment in a subsidiary accounted for in separate financial statements using
the equity method, goodwill that forms part of the carrying amount of the investment
in the subsidiary is not tested for impairment separately. Instead, the entire carrying
amount of the investment in the subsidiary is tested for impairment in accordance
with IAS 36 as a single asset. However, in the consolidated financial statements of
the entity, because goodwill is recognised separately, it is tested for impairment by
applying the requirements in IAS 36 for testing goodwill for impairment.
• Subsidiary that has a net liability position.
&nbs
p; IAS 28 requires an investor to discontinue recognising its share of further losses when
its cumulative share of losses of the investee equals or exceeds its interest in the
investee, unless the investor has incurred legal or constructive obligations or made
payments on behalf of the investee, in which case a liability is recognised, whereas
there is no such requirement in relation to the consolidated financial statements.
• Capitalisation of borrowing costs incurred by a parent in relation to the assets
of a subsidiary.
IAS 23 – Borrowing Costs – notes that, in some circumstances, it may be
appropriate to include all borrowings of the parent and its subsidiaries when
computing a weighted average of the borrowing costs. When a parent borrows
funds and its subsidiary uses them for the purpose of obtaining a qualifying asset,
in the consolidated financial statements of the parent the borrowing costs incurred
by the parent are considered to be directly attributable to the acquisition of the
subsidiary’s qualifying asset. However, this would not be appropriate in the
separate financial statements of the parent where the parent’s investment in the
subsidiary is a financial asset which is not a qualifying asset.
In these situations, there will not be alignment of the net assets and profit or loss of an
investment in a subsidiary between the consolidated and separate financial statements.
2.3.1
First-time adoption of IFRS
IFRS 1 allows a first-time adopter that accounts for an investment in a subsidiary, joint
venture or associate using the equity method in the separate financial statements to apply the
exemption for past business combinations to the acquisition of the investment. [IFRS 1.D15A].
The exemption for past business combinations is discussed in Chapter 5 at 5.2. The first-time
adopter can also apply certain exemptions to the assets and liabilities of subsidiaries,
associates and joint ventures when it becomes a first-time adopter for the separate financial
statements later than its parent or subsidiary. [IFRS 1.D15A]. These exemptions are discussed in
Chapter 5 at 5.9.
Separate and individual financial statements 555
2.4
Dividends and other distributions
IAS 27 contains a general principle for dividends received from subsidiaries, joint
ventures or associates. This is supplemented by specific indicators of impairment in
IAS 36 that apply when a parent entity receives the dividend. The general principle and
the specific impairment indicators are discussed in 2.4.1 below.
IFRIC 17 – Distributions of Non-cash Assets to Owners – considers in particular the
treatment by the entity making the distribution. Details about the requirements of that
Interpretation are discussed in 2.4.2 below.
2.4.1
Dividends from subsidiaries, joint ventures or associates
IAS 27 states that an entity recognises dividends from subsidiaries, joint ventures or
associates in its separate financial statements when its right to receive the dividend is
established. The dividend is recognised in profit or loss unless the entity elects to use
the equity method, in which case the dividend is recognised as a reduction from the
carrying amount of the investment. [IAS 27.12].
Dividends are recognised only when they are declared (i.e. the dividends are
appropriately authorised and no longer at the discretion of the entity). IFRIC 17
expands on this point: the relevant authority may be the shareholders, if the
jurisdiction requires such approval, or management or the board of directors, if the
jurisdiction does not require further approval. [IFRIC 17.10]. If the declaration is made
after the reporting period but before the financial statements are authorised for
issue, the dividends are not recognised as a liability at the end of the reporting period
because no obligation exists at that time. Such dividends are disclosed in the notes
in accordance with IAS 1 – Presentation of Financial Statements. [IAS 10.13]. A parent
cannot record income or a reduction of the equity accounted investment and
recognise an asset until the dividend is a liability of its subsidiary, joint venture or
associate, the paying company.
Once dividends are taken to income the investor must determine whether or not the
investment has been impaired as a result. IAS 36 requires the entity to assess at each
reporting date whether there are any ‘indications of impairment’. Only if indications of
impairment are present will the impairment test itself have to be carried out. [IAS 36.8-9].
The list of indicators in IAS 36 includes the receipt of a dividend from a subsidiary, joint
venture or associate where there is evidence that:
(i) the dividend exceeds the total comprehensive income of the subsidiary, joint
venture or associate in the period the dividend is declared; or
(ii) the carrying amount of the investment in the separate financial statements exceeds
the carrying amounts in the consolidated financial statements of the investee’s net
assets, including associated goodwill. [IAS 36.12(h)].
2.4.1.A
The dividend exceeds the total comprehensive income
There are circumstances in which receipt of a dividend will trigger the first indicator,
even if the dividend is payable entirely from the profit for the period.
First, the indicator states that the test is by reference to the income in the period in which
the declaration is made. Dividends are usually declared after the end of the period to which
556 Chapter
8
they relate; an entity whose accounting period ends on 31 December 2019 will not normally
declare a dividend in respect of its earnings in that period until its financial statements have
been drawn up, i.e. some months into the next period ended 31 December 2020. We
assume that it is expected that the impairment review itself will take place at the end of the
period, in line with the general requirements of IAS 36 referred to above, in which case the
dividends received in the period will be compared to the income of the subsidiary for that
period. This means that there may be a mismatch in that, say, dividends declared on the
basis of 2019 profits will be compared to total comprehensive income in 2020, but at least
the indicator of impairment will be by reference to a completed period.
Second, the test is by reference to total comprehensive income, not profit or loss for
the period. Total comprehensive income reflects the change in equity during a period
resulting from transactions and other events, other than those changes resulting from
transactions with owners in their capacity as owners. Total comprehensive income
takes into account the components of ‘other comprehensive income’ that are not
reflected in profit or loss that include:
(a) changes in revaluation surpluses of property, plant and equipment or intangible
assets (see Chapters 17 and 18);
(b) remeasurements of defined benefit plans (see Chapter 31);
(c) gains and losses arising from translating the financial statements of a foreign
operation (see Chapter 15);
(d) fair value changes from financial instruments measured at fair value through other
comprehensive income (see Chapter 44); and
> (e) the effective portion of gains and losses on hedging instruments in a cash flow
hedge (see Chapters 49). [IAS 1.7].
This means that all losses on remeasurement that are allowed by IFRS to bypass profit or loss
and be taken directly to other components of equity are taken into account in determining
whether a dividend is an indicator of impairment. If a subsidiary, joint venture or associate
pays a dividend from its profit for the year that exceeds its total comprehensive income
because there have been actuarial losses on the pension scheme or a loss on remeasuring its
hedging derivatives, then receipt of that dividend is an indicator of impairment to the parent.
The opposite must also be true – a dividend that exceeds profit for the period but does
not exceed total comprehensive income (if, for example, the entity has a revaluation
surplus on its property) is not an indicator of impairment. However, IAS 36 makes clear
that its list of indicators is not exhaustive and if there are other indicators of impairment
then the entity must carry out an impairment test in accordance with IAS 36. [IAS 36.13].
It must be stressed that this test is solely to see whether a dividend triggers an
impairment review. It has no effect on the amount of dividend that the subsidiary, joint
venture or associate may pay, which is governed by local law.
2.4.1.B
The carrying amount exceeds the consolidated net assets
An indicator of impairment arises if, after paying the dividend, the carrying amount of the
investment in the separate financial statements exceeds the carrying amount in the
consolidated financial statements of the investee’s net assets, including associated goodwill.
Separate and individual financial statements 557
It will often be clear when dividends are paid out of profits for the period by subsidiaries,
joint ventures or associates, whether the consolidated net assets of the investee in
question have declined below the carrying amount of the investment. However this
might require the preparation of consolidated financial statements by an intermediate
parent which is exempted from the preparation of consolidated financial statements.
Similar issues to those described above may arise, e.g. the subsidiary, joint venture or
associate may have made losses or taken some sort of remeasurement to other
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 110
