control of a joint venture controls its holding in the shares of the associate or joint
venture, it does not control the assets and liabilities of that associate or joint venture.
Therefore, the investor does not account for the assets and the liabilities of the associate
or joint venture, but only accounts for its investment in the associate or joint venture as
a whole.
Although the equity method, in accordance with IAS 28, generally adopts consolidation
principles, it also has features of a valuation methodology as discussed below.
IAS 28 notes that many procedures appropriate for the application of the equity
method, and described in more detail in 7.3 to 7.12 below, are similar to the
consolidation procedures described in IFRS 10 (see Chapter 7). Furthermore, IAS 28
explains that the concepts underlying the procedures used in accounting for the
acquisition of a subsidiary are also adopted in accounting for the acquisition of an
investment in an associate or a joint venture. [IAS 28.26]. However, it is unclear
precisely what these concepts are, as no further explanation is given. The position
Investments in associates and joint ventures 765
has been confused even further because in the context of an amendment to IAS 39
– Financial Instruments: Recognition and Measurement [now IFRS 9] regarding the
application of the exemption in paragraph 2(g) [now paragraph 2(f)], it is stated that
‘The Board noted that paragraph 20 of IAS 28 [now paragraph 26 of IAS 28] explains
only the methodology used to account for investments in associates. This should not
be taken to imply that the principles for business combinations and consolidations
can be applied by analogy to accounting for investments in associates and joint
ventures.’ [IFRS 9.BCZ2.42].
The similarities between equity accounting and consolidation include:
• appropriate adjustments to the entity’s share of the associate’s or joint venture’s
profits or losses after acquisition are made in order to account, for example, for
depreciation of the depreciable assets based on their fair values at the
acquisition date;
• recognising goodwill relating to an associate or a joint venture in the carrying
amount of the investment;
• non-amortisation of the goodwill;
• any excess of the investor’s share of the net fair value of the associate’s identifiable
assets and liabilities over the cost of the investment is included as income in the
determination of the entity’s share of the associate or joint venture’s profit or loss
in the period in which the investment is acquired;
• the elimination of unrealised profits on ‘upstream’ and ‘downstream’ transactions
(see 7.6.1 below); and
• application of uniform accounting policies for like transactions when possible
and evidenced.
However, there are also a number of differences between equity accounting and
consolidation, including:
• the investor ceases to recognise its share of losses of an associate or joint venture
once the investment has been reduced to zero;
• the treatment of loans and borrowings (including preference shares classified as
debt by the investee) between the reporting entity and its associates or joint
ventures (see 7.6.3 below);
• the investor cannot capitalise its own borrowing costs in respect of an associate’s
or joint venture’s assets under construction (an equity accounted investment is not
a qualifying asset under IAS 23 – Borrowing Costs – regardless of the associate’s
or joint venture’s activities or assets); and
• the investor considers whether there is any additional impairment loss with respect
to its net investment.
As there is no clear principle underlying the application of the equity method different
views on how to account for certain transactions for which the standard has no clear
guidance might be taken, depending on which principle (i.e. consolidation or valuation
of an investment) is deemed to take precedence. We address these issues in the
following sections.
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7.3
Date of commencement of equity accounting
An investor will begin equity accounting for an associate or a joint venture from the date
on which it has obtained significant influence over the associate or joint control over
the joint venture (and is not otherwise exempt from equity accounting for it). On
acquisition of the investment, any difference between the cost of the investment and
the entity’s share of the net fair value of the investee’s identifiable assets and liabilities
is accounted for as follows:
• Goodwill relating to an associate or a joint venture is included in the carrying
amount of the investment. Amortisation of that goodwill is not permitted.
• Any excess of the entity’s share of the net fair value of the investee’s identifiable
assets and liabilities over the cost of the investment is included as income in the
determination of the entity’s share of the associate or joint venture’s profit or loss
in the period in which the investment is acquired.
Appropriate adjustments to the entity’s share of the associate’s or joint venture’s profit
or loss after acquisition are made in order to account, for example, for depreciation of
the depreciable assets based on their fair values at the acquisition date. Similarly,
appropriate adjustments to the entity’s share of the associate’s or joint venture’s profit
or loss after acquisition are made for impairment losses such as for goodwill or property,
plant and equipment. [IAS 28.32].
In most situations, this is when the investor acquires the investment in the associate
or joint venture. Determining whether an entity has significant influence is discussed
at 4 above.
7.4
Initial carrying amount of an associate or joint venture
Under the equity method, an investment is initially recognised at cost. [IAS 28.3].
However, ‘cost’ for this purpose is not defined.
In July 2009, the Interpretations Committee discussed the lack of definition and issued
an agenda decision, clarifying that the cost of an investment in an associate at initial
recognition comprises its purchase price and any directly attributable expenditures
necessary to obtain it.6 Therefore, any acquisition-related costs are not expensed (as is
the case in a business combination under IFRS 3) but are included as part of the cost of
the associate.
The glossary to IFRS defines cost as being 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; [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 inve
stment property in accordance
with IAS 40 – Investment Property.
Investments in associates and joint ventures 767
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).
Consequently, in our view, the same treatment may be applied to contingent
consideration arrangements in relation to the purchase of an associate or a joint venture,
i.e. the initial carrying amount of an associate or joint venture includes the fair value of
any contingent consideration arrangement. In this case, subsequent changes in the
contingent consideration would be accounted for under IFRS 9.
The considerations regarding applying the cost requirements of other standards have
previously been discussed by the Interpretations Committee, and the discussions are
summarised in Chapter 8 at 2.1.1.
The Interpretations Committee agenda decision did not provide any specific guidance
in relation to a piecemeal acquisition of an associate or a joint venture. This is discussed
further at 7.4.2 below.
7.4.1
Initial carrying amount of an associate or joint venture following loss
of control of an entity
Under IFRS 10, if a parent entity loses control of a subsidiary that constitutes a
business in a transaction that is not a downstream transaction (see 7.6.5 below) and
the retained interest is an investment in an associate or joint venture, then the entity
must apply IFRS 10.25. The retained interest must be remeasured at its fair value,
and this fair value becomes the cost on initial recognition of the investment in an
associate or joint venture.
If the subsidiary does not constitute a business, it is not clear whether IFRS 10.25 applies
to such a loss of control transaction. Therefore, we believe that an entity can develop
an accounting policy to either apply IFRS 10.25 to the loss of control over only
subsidiaries that constitute a business, or to the loss of control over all subsidiaries (i.e.
those that constitute a business and those that do not).
Where an entity does not apply IFRS 10.25 to subsidiaries that do not constitute a
business, it can apply the guidance in IAS 28 if the loss of control is through a
downstream transaction, or it needs to develop an accounting policy in terms of IAS 8
– Accounting Policies, Changes in Accounting Estimates and Errors – on how to
account for the retained interest for all other types of transactions.
Example 11.5: Accounting for retained interest in an associate or joint venture
following loss of control of a subsidiary that is a business due to
sale of shares to third party
Entity A owns 100% of the shares of Entity B. Entity B meets the definition of a business. The interest was
originally purchased for £500,000 and £40,000 of directly attributable costs relating to the acquisition were
incurred. Upon its reporting date, Entity A sells 60% of the shares to Entity C for £1,300,000. As a result of
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the sale, Entity C obtains control over Entity B, but by retaining a 40% interest, Entity A determines that it
has significant influence over Entity B.
At the date of disposal, the carrying amount of the net identifiable assets of Entity B in Entity A’s consolidated
financial statements is £1,200,000 and there is also goodwill of £200,000 relating to the acquisition of
Entity B. The fair value of the identifiable assets and liabilities of Entity B is £1,600,000. The fair value of
Entity A’s retained interest of 40% of the shares of Entity B is £800,000, which includes goodwill.
Upon Entity A’s sale of 60% of the shares of Entity B, it deconsolidates Entity B and accounts for its
investment in Entity B as an associate using the equity method of accounting.
Entity A’s initial carrying amount of the associate must be based on the fair value of the retained interest, i.e.
£800,000. It is not based on 40% of the original cost of £540,000 (purchase price plus directly attributable
costs) as might be suggested by the Interpretations Committee statement discussed at 7.4 above, nor is it
based on 40% of the carrying amount of the net identifiable assets plus goodwill, totalling £1,400,000.
Although it is clear that the initial carrying amount of the associate in the above example
is the fair value of the retained interest, i.e. £800,000, does this mean that Entity A in
applying the equity method under IAS 28 may need to remeasure the underlying assets
and liabilities in Entity B at their fair values at the date Entity B becomes an associate
i.e. effectively a new purchase price allocation is performed?
In our view, under paragraph 25 of IFRS 10, Entity A effectively accounts for the
investment in Entity B as if it had acquired the retained investment at fair value as at the
date control is lost and hence should be treated the same as the initial acquisition of an
investment in an associate in terms of IAS 28 paragraph 32 (see 7.4 above). Therefore,
the answer to the above question is ‘yes’. Accordingly, in order to apply the equity
method from the date control is lost, Entity A must remeasure all of the identifiable
assets and liabilities underlying the investment at their fair values (or other measurement
basis required by IFRS 3 at that date).
IAS 28 indicates that on initial recognition of an investment in an associate, the concepts
underlying the procedures used in accounting for the acquisition of a subsidiary are also
adopted in accounting for the acquisition of an investment in an associate, and that fair
values are applied to measure all of the identifiable assets and liabilities in calculating
any goodwill or bargain purchase that exists. [IAS 28.26, 32].
Accordingly, in Example 11.5 above, based on the fair value of the identifiable assets and
liabilities of Entity B of £1,600,000, Entity A’s initial carrying amount of £800,000 will
include goodwill of £160,000, being £800,000 – £640,000 (40% of £1,600,000).
IFRS 13 provides detailed guidance about how fair value should be determined, which
is discussed in Chapter 14.
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. In January 2016, the IASB decided not to consider this topic
further until the Post-implementation Review (PIR) of IFRS 13 is complete. The PIR has
been completed. At its March 2018 meeting, the IASB considered the findings of the PIR
and concluded that IFRS 13 is working as intended. However, the IASB decided that
it
would consider the PIR’s findings on the usefulness of disclosures in its work on Better
Investments in associates and joint ventures 769
Communication in Financial Reporting, continue liaison with the valuation profession,
monitor new developments in practice and promote knowledge development and
sharing. The IASB also decided that it would conduct no other follow up activities, for
example further work in the area of prioritising the unit of account or Level 1 inputs
(because the costs of such work would exceed its benefits). A Project Summary and
Feedback Statement is expected to be published in the fourth quarter of 2018.7 These
issues are discussed further in Chapter 14 at 5.1.1.
7.4.2
Piecemeal acquisition of an associate or joint venture
7.4.2.A
Financial instrument becoming an associate or joint venture
An entity may gain significant influence or joint control over an existing investment
upon acquisition of a further interest or due to a change in circumstances. IAS 28 is
unclear on how an investor should account for an existing investment, accounted for
under IFRS 9 that subsequently becomes an associate or a joint venture, to be accounted
for under the equity method. In our view there are various approaches available. These
are discussed in more detail below.
IFRS 3 is clear that in a business combination where control over an acquiree is
achieved in stages, the previously held (existing) investment in that acquiree is
required to be revalued to fair value through profit or loss. [IFRS 3.42]. If this
previously held investment was held at fair value through profit and loss, this would
have happened automatically. If the investment was classified as at fair value
through other comprehensive income, any previous fair value remeasurement
would be within other comprehensive income and on the date of the business
combination, any such amount would not be reclassified to profit or loss as per the
requirements of IFRS 9 (see Chapter 46 at 2.5), although the cumulative gain or loss
can be reclassified within equity based on the entity’s accounting policy applied to
the treatment of cumulative gains or losses within equity upon the derecognition of
investments in equity instruments designated to be measured at fair value through
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 151
