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

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  other comprehensive income. [IFRS 3.42].

  Although 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], no further

  explanation is given. This raises the issue as to what impact the concepts inherent within

  IFRS 3 should have on the accounting for associates and joint ventures.

  As discussed at 7.4 above, the Interpretations Committee previously clarified that

  the initial cost of an equity accounted investment comprises the purchase price and

  directly attributable expenditures necessary to obtain it. Although the implications

  for the piecemeal acquisition of an associate are not explicitly addressed, it

  appeared that, as the Interpretations Committee considered that the initial

  recognition of the associate is to be based on its cost, the accounting should reflect

  a cost-based approach.

  However, in July 2010, the Interpretations Committee received a request to

  address the accounting for an investment in an associate when the investment was

  purchased in stages and classified as available-for-sale (AFS) in terms of IAS 39

  770 Chapter

  11

  until it became an associate.8 Interestingly, despite the earlier decision in 2009,

  the Staff Paper produced for the meeting recommended that ‘the fair value of an

  investment classified as AFS prior to the investor obtaining significant influence

  over that investment should be the deemed cost of that pre-existing interest at the

  date the investor obtains significant influence over the associate. The accumulated

  changes in fair value accounted for in OCI should be reclassified to profit or loss

  at that date.’ The Staff Paper further recommended that such a clarification of

  IAS 28 be included within the Annual Improvements project.9 Thus, the Staff was

  recommending that an IFRS 3 approach should be applied, rather than a cost-

  based approach.

  Although the Staff made such recommendations, it is not entirely clear what the

  Interpretations Committee made of them as the IFRIC Update following the meeting

  merely states that the Interpretations Committee discussed what amount the investment

  in an associate should be initially measured at, and the accounting for any accumulated

  changes in fair value relating to the investment recognised in other comprehensive

  income (OCI), at the date significant influence is obtained and the investment is no

  longer categorised as AFS. However, due to the acknowledged diversity in practice in

  accounting for associates purchased in stages, the Interpretations Committee

  recommended that the issue be referred to the IASB for consideration.10 To date this

  has not yet been considered by the IASB.

  In the light of these statements by the Interpretations Committee, we believe that an

  entity should account for the step acquisition of an associate or a joint venture by

  applying that either:

  (a) a cost-based approach; or

  (b) a fair value (IFRS 3) approach.

  Once selected, the investor must apply the selected policy consistently.

  I

  Applying a cost-based approach

  Where a cost-based approach is applied to accounting for a step acquisition of an

  associate or a joint venture, this involves the determination of:

  (a) the cost of the investment;

  (b) whether or not any catch-up adjustment is required when first applying equity

  accounting (i.e. an adjustment for the share of investee’s profits and other equity

  movements as if the previously held interest was equity accounted; and

  (c) the goodwill implicit in the investment (or gain on bargain purchase).

  Not all of these aspects of the accounting for a piecemeal acquisition of an associate or

  a joint venture were addressed by the Interpretations Committee agenda decision

  in 2009. Accordingly, in our view, the combination of answers to these questions results

  in four approaches that may be applied to account for a step acquisition of an associate

  or a joint venture where a cost-based approach is adopted. Once selected, the investor

  must apply the selected policy consistently.

  Investments in associates and joint ventures 771

  In all approaches, cost is the sum of the consideration given for each tranche together

  with any directly attributable costs. However, as a result of the answers to (b) and (c)

  above, the four approaches are as follows:

  Catch-up equity accounting

  Determination of goodwill/gain on

  adjustment for previously held interest

  bargain purchase

  Approach 1

  None

  Difference between sum of the cost of each tranche and

  share of fair value of net identifiable assets at date

  investment becomes an associate or joint venture

  Approach 2

  None

  Difference between the cost of each tranche and the share of

  fair value of net identifiable assets acquired in each tranche

  Approach 3

  For profits (less dividends), and changes

  Difference between the cost of each tranche and the share of

  in other comprehensive income (OCI)

  fair value of net identifiable assets acquired in each tranche

  Approach 4

  For profits (less dividends), changes

  Difference between the cost of each tranche and the share of

  in OCI and changes in fair value of

  fair value of net identifiable assets acquired in each tranche

  net assets

  The reasons for using the above cost-based approaches are discussed further below and

  are illustrated in Example 11.6. Although the example illustrates the step-acquisition of

  an associate, the accounting would be the same if the transaction had resulted in the

  step-acquisition of a joint venture.

  Example 11.6: Accounting for existing financial instruments on the

  step-acquisition of an associate (cost-based approach)

  An investor acquired a 10% interest in an investee for $100. Three years later the investor acquired a further

  15% interest in the investee for $225. The investor now holds a 25% interest and is able to exercise significant

  influence. For the purposes of the example, directly attributable costs have been ignored. Also, any deferred

  tax implications have been ignored.

  The investor had been accounting for its initial 10% interest at fair value in accordance with IFRS 9. The

  financial information relating to the investee can be summarised as follows:

  Year of initial

  Year of step-

  acquisition

  acquisition

  100%

  10%

  100% 15%

  $

  $

  $

  $

  Purchase consideration

  100

  225

  Change in fair value

  50

  Fair value of shares in year of initial acquisition

  150

  Book value of net identifiable assets of investee

  600

  900

  Fair value of net identifiable assets of investee *)

  800

  80

  1,200

  180

  Profit since acquisition in year of step acquisition


  500

  50

  Dividends declared between initial and step-

  –200

  –20

  acquisition

  Increase in fair value of net identifiable assets of

  400

  40

  investee

  Cost plus post-acquisition changes in net identifiable

  130

  assets

  Other changes in fair value of the investee

  10

  *) The fair value uplift from $600 to $800 relates entirely to non-depreciable assets.

  772 Chapter

  11

  The accounting for this step-acquisition under each approach is as follows (all amounts in $):

  Catch-up

  equity

  Initial equity

  Goodwill in initial

  accounting adjustment

  accounted amount

  amount of associate

  Approach 1

  0

  325

  Cost less share of fair value of

  net identifiable assets at time

  investment becomes an

  associate

  325 – (25% × 1200) = 25

  Approach 2

  0

  325

  Cost less share of fair value of

  net identifiable assets at each

  tranche

  100 – (10% × 800) = 20 +

  225 – (15% × 1200) = 45

  Total = 65

  Approach 3

  10% of profits (less dividends)

  325 + 30 = 355

  Cost less share of fair value of

  10% × (500 – 200) = 30

  net identifiable assets at each

  tranche

  100 – (10% × 800) = 20 +

  225 – (15% × 1200) = 45

  Total = 65

  Approach 4

  10% of profits (less dividends)

  325 + 70 = 395

  Cost less share of fair value of

  and changes in fair value of

  net identifiable assets at each

  assets

  tranche

  10% × (500 – 200 + 400) = 70

  100 – (10% × 800) = 20 +

  225 – (15% × 1200) = 45

  Total = 65

  Cost of investment

  In all four approaches, the cost of the investment is the sum of the consideration given for the two tranches

  ($325), being the original purchase price of $100 for the existing 10% interest plus the $225 paid for the

  additional 15% interest.

  Therefore, in both the separate and consolidated financial statements, the following occurs:

  (a) If the investor measured the original investment at fair value through profit or loss, the changes in fair

  value previously recognised through profit or loss (excluding dividend income) are reversed through

  retained earnings to bring the asset back to its original cost.

  (b) If the investor measured the original investment at fair value through other comprehensive income

  (OCI), the changes in fair value previously recognised are reversed through equity reserves to bring the

  asset back to its original cost.

  The investor continues to recognise dividend income in the statement of comprehensive income (in profit or

  loss) up to the date the entity becomes an associate, irrespective of whether the investor measures the

  investment at fair value through profit or loss or at fair value through other comprehensive income.

  In all four approaches, the difference between the fair value of the original 10% of $150 and the cost of the

  first tranche of $100 is adjusted against retained earnings within equity or against other equity reserves. The

  change in the fair value of $50 will be reflected in other comprehensive income in the statement of

  comprehensive income if the investor measured the original investment at fair value through other

  comprehensive income (OCI).

  Catch-up adjustment

  Approaches 1 and 2 do not recognise a ‘catch-up’ equity accounting adjustment relating to the first tranche

  of the investment held by the investor.

  Investments in associates and joint ventures 773

  On the other hand, Approaches 3 and 4 do recognise a ‘catch-up’ equity accounting adjustment relating to

  the first tranche of the investment held by the investor. This adjustment is recognised against the appropriate

  balance within equity – that is, retained earnings, or other equity reserve. To the extent that they are

  recognised, these will be reflected in other comprehensive income in the statement of comprehensive income.

  Goodwill

  Approach 1 determines goodwill in a single calculation based on amounts at the date the investment becomes

  an associate.

  On the other hand, Approaches 2, 3 and 4 determine goodwill based on separate calculations at the date of

  acquisition of each tranche.

  The rationale for each of the four approaches is as follows:

  Approach 1

  Paragraph 32 of IAS 28 states that ‘An investment is accounted for using the equity method from the date on

  which it becomes an associate or a joint venture.’

  Recognising any catch-up adjustments may be interpreted as a form of equity accounting for a period prior

  to gaining significant influence, which contradicts this principle of IAS 28.

  IAS 28 refers to the fact that an investor applies equity accounting to the investment once it is an associate.

  Therefore, cumulative adjustments for periods prior to this event are not recognised.

  Paragraph 32 of IAS 28 (see 7.4 above) also goes on to state that ‘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:

  (a) Goodwill relating to an associate or joint venture is included in the carrying amount of the investment.

  Amortisation of that goodwill is not permitted.

  (b) 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.’

  However, paragraph 32 of IAS 28 does not specify at which dates the fair values of the net identifiable assets

  are to be determined. It may be interpreted to mean only at the date that the investment becomes an associate

  or a joint venture. This is also consistent with the approach in IFRS 3 whereby the underlying fair values of

  net identifiable assets are only determined at one time rather than determining them several times for

  individual transactions leading to the change in the economic event.

  This approach avoids some of the practical difficulties encountered when applying the other approaches.

  However, the drawback of this approach is that goodwill may absorb the effects of other events, because a

  portion of the cost is determined at a different date to the fair value of the assets.

  Approach 2

  No catch-up adjustment is recognised, similar to the reasons noted in Approach 1. However, paragraph 32 of

  IAS 28 is interpreted to mean that the fair values of the associate’s or joint venture’s net identifiable assets

  are determined at a date that corresponds to the date at which consideration was given. Therefore, the fair

  values are determined for each tranche. This may require the fair values to be determined for previous periods

  when no such exercise was performed at the date of the origin
al purchase.

  The drawback of this approach is that the measurement of the assets and liabilities is based on fair values at

  different dates.

  Approach 3

  A catch-up adjustment is recognised to reflect the application of the equity method as described in

  paragraph 10 of IAS 28 with respect to the first tranche. However, the application of that paragraph

  restricts the adjustment only to the share of profits and other comprehensive income relating to the first

  tranche. That is, there is no catch-up adjustment made for changes in the fair value of the net identifiable

  assets not recognised by the investee (except for any adjustments necessary to give effect to uniform

  accounting policies).

  774 Chapter

  11

  Similar to Approach 2, paragraph 32 of IAS 28 is interpreted to mean that the fair values of the

  associate’s or joint venture’s net identifiable assets are determined at a date that corresponds to the date

  at which consideration was given. Therefore, the fair values are determined for each tranche. This may

  require the fair values to be determined for previous periods when no such exercise was performed at

  the date of the original purchase.

  The drawbacks of this approach are the same as Approach 2.

  Approach 4

  This approach is based on the underlying philosophy of equity accounting, which is to reflect the investor’s

  share of the underlying net identifiable assets plus goodwill inherent in the purchase price. Therefore, where

  the investment was acquired in tranches, a catch-up adjustment is necessary in order to apply equity

  accounting from the date the investment becomes an associate or a joint venture as required by paragraph 32

  of IAS 28. The catch-up adjustment reflects not only the post-acquisition share of profits and other

  comprehensive income relating to the first tranche, but also the share of the unrecognised fair value

  adjustments based on the fair values at the date of becoming an associate or a joint venture.

  Similar to Approach 2, paragraph 32 of IAS 28 is interpreted to mean that the fair values of the

 

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