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
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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.
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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).
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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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