not involve the transfer of assets giving rise to gains or losses. Moreover, they are not
normally regarded as part of the investor’s share of the net assets of the associate or
joint venture, but as separate transactions, except in the case of loss-making associates
or joint ventures, where interests in long-term loans and borrowings may be required
to be accounted for as if they were part of the reporting entity’s equity investment in
determining the carrying value of the associate or joint venture against which losses may
be offset (see 7.9 below). If this reading of IAS 28 is followed, loans and borrowings
between the reporting entity and its associates or joint ventures would not be eliminated
in the reporting entity’s consolidated accounts because the respective assets and
liabilities of associates and joint ventures are not recognised by the group.
However, if the associate or joint venture has capitalised the borrowing costs then the
investor would need to eliminate a relevant share of its interest income and realise it as the
associate depreciates the qualifying asset. The same principle applies to eliminate a share
of the capitalised management or advisory fees charged to an associate or joint venture.
7.6.4
Statement of cash flows
In the statement of cash flows (whether in the consolidated or separate financial
statements) no adjustment is made in respect of the cash flows relating to transactions
with associates or joint ventures. This contrasts with the requirement, in any
consolidated statement of cash flows, to eliminate the cash flows between members of
the group in the same way that intragroup transactions are eliminated in the profit and
loss account and statement of financial position.
7.6.5
Contributions of non-monetary assets to an associate or a joint
venture
It is fairly common for an entity to create or change its interest in an associate or a joint
venture by contributing some of the entity’s existing non-monetary assets to that
associate or joint venture. This raises a number of issues as to how such transactions
should be accounted for, in particular whether they should be accounted for at book
value or fair value.
IAS 28 requires the contribution of a non-monetary asset to an associate or a joint
venture in exchange for an equity interest in the associate or joint venture to be
accounted for in accordance with paragraph 28, except when the contribution lacks
commercial substance, as described in IAS 16 (see 7.6.5.A below and Chapter 18 at 4.4).
[IAS 28.30]. Paragraph 28 requires gains and losses resulting from transactions between an
entity and its associate or joint venture to be recognised only to the extent of unrelated
interests in the associate or joint venture. The investor’s share in the associate’s or joint
venture’s gains or losses resulting from those transactions is eliminated (see 7.6.1 above
for a discussion of the requirements relating to such transactions). However, there is a
conflict between the requirements of IAS 28 and the requirements in IFRS 10 relating
to accounting for the loss of control of a subsidiary, when a subsidiary is contributed by
the investor to an associate or joint venture, and control over the subsidiary is
consequently lost. This is discussed below at 7.6.5.C below.
790 Chapter
11
If such a contribution lacks commercial substance, the gain or loss is regarded as
unrealised and is not recognised unless paragraph 31 also applies. Such unrealised gains
and losses are to be eliminated against the investment accounted for using the equity
method and are not to be presented as deferred gains or losses in the entity’s
consolidated statement of financial position or in the entity’s statement of financial
position in which investments are accounted for using the equity method. [IAS 28.30].
Where ‘unrealised’ losses are eliminated in this way, the effect will be to apply what is
sometimes referred to as ‘asset swap’ accounting. In other words, the carrying value of
the investment in the associate or joint venture will be the same as the carrying value of
the non-monetary assets transferred in exchange for it, subject of course to any
necessary provision for impairment uncovered by the transaction.
If, in addition to receiving an equity interest in an associate or a joint venture, an entity
receives monetary or non-monetary assets, the entity recognises in full in profit or loss
the portion of the gain or loss on the non-monetary contribution relating to the
monetary or non-monetary assets received. [IAS 28.31].
In January 2018, the Interpretations Committee was asked how an entity should
account for a transaction in which it contributes property, plant and equipment to a
newly formed associate in exchange for shares in the associate. In the fact pattern
described in the request, the entity and the fellow investors in the associate are
entities under common control. The investors each contribute items of PPE to the
new entity in exchange for shares in that entity. The Interpretations Committee
firstly observed that unless a standard specifically excludes common control
transactions from its scope, an entity applies the applicable requirements in the
standard to common control transactions. In terms of paragraph 28 of IAS 28, the
entity should recognise gains and losses resulting from the downstream transactions
only to the extent of unrelated investors’ interests in the associate. The word
‘unrelated’ does not mean the opposite of ‘related’ as it is used in the definition of a
related party in IAS 24 – Related Party Disclosures. Finally, the Interpretations
Committee observed that if there is initially any indication that the fair value of the
property, plant and equipment contributed might differ from the fair value of the
acquired equity interest, the entity first assesses the reasons for this difference and
reviews the procedures and assumptions it has used to determine fair value. The
entity should recognise a gain or loss on contributing the property, plant and
equipment and a carrying amount for the investment in the associate that reflects
the determination of those amounts based on the fair value of the assets contributed,
unless the transaction provides objective evidence that the entity’s interest in the
associate might be impaired. If this is the case, the entity also considers the
impairment requirements in IAS 36 – Impairment of Assets. If, having reviewed the
procedures and assumptions used to determine fair value, the fair value of the
property, plant and equipment is more than the fair value of the acquired interest in
the associate, this would provide objective evidence that the entity’s interest in the
associate might be impaired. The Interpretations Committee concluded that the
principles and requirements in IFRS standards provide an adequate basis for an
entity to account for the contribution non-monetary assets to an associate in the
fact pattern described in the request and did not add any items to its agenda.16
Investments in associates and joint ventures 791
7.6.5.A ‘Commercial
substance’
As noted above, IAS 28 requires that a transaction should not b
e treated as realised
when it lacks commercial substance as described in IAS 16. That standard states that an
exchange of assets has ‘commercial substance’ if:
(a) the configuration (risk, timing and amount) of the cash flows of the asset received
differs from the configuration of the cash flows of the asset transferred; or
(b) the entity-specific value of the portion of the entity’s operations affected by the
transaction changes as a result of the exchange; and
(c) the difference in (a) or (b) above is significant relative to the fair value of the assets
exchanged. [IAS 16.25].
IAS 16’s ‘commercial substance’ test is designed to enable an entity to measure, with
reasonable objectivity, whether the asset that it has acquired in a non-monetary
exchange is different to the asset it has given up.
The first stage is to determine the cash flows both of the asset given up and of the asset
acquired (the latter being the interest in the associate or joint venture). This
determination may be sufficient by itself to satisfy (a) above, as it may be obvious that
there are significant differences in the configuration of the cash flows. The type of
income may have changed. For example, if the entity contributed a non-monetary asset
such as a property or intangible asset to the associate or joint venture, the reporting
entity may now be receiving a rental or royalty stream from the associate or joint
venture, whereas previously the asset contributed to the cash flows of the cash-
generating unit of which it was a part.
However, determining the cash flows may not result in a clear-cut conclusion, in which
case the entity-specific value will have to be calculated. This is not the same as a value in
use calculation under IAS 36, in that the entity is allowed to use a discount rate based on
its own assessment of the risks specific to the operations, not those that reflect current
market assessments, [IAS 16.BC22], and post-tax cash flows. [IAS 16.25]. The transaction will
have commercial substance if these entity-specific values are not only different to one
another but also significant compared to the fair values of the assets exchanged.
The calculation may not be highly sensitive to the discount rate as the same rate is used
to calculate the entity-specific value of both the asset surrendered and the entity’s
interest in the associate or joint venture. However, if the entity considers that a high
discount rate is appropriate, this will have an impact on whether or not the difference
is significant relative to the fair value of the assets exchanged. It is also necessary to
consider the significance of:
(a) the requirement above that the entity should recognise in its income statement the
portion of any gain or loss arising on the transfer attributable to the other investors;
(b) the general requirements of IAS 28 in respect of transactions between investors
and their associates or joint ventures; and
(c) the general requirement of IFRS 3 to recognise assets acquired in a business
combination at fair value (see Chapter 9 at 5).
792 Chapter
11
As a result, we consider that it is likely that transactions entered into with genuine
commercial purposes in mind are likely to pass the ‘commercial substance’ tests
outlined above.
7.6.5.B
Contributions of non-monetary assets – practical application
IAS 28 does not give an example of the accounting treatment that it envisages when a gain
is treated as ‘realised’. We believe that the intended approach is that set out in Example 11.19
below. In essence, this approach reflects the fact that the reporting entity has:
(a) acquired an interest in an associate or joint venture and the entity’s share of the
fair value of the net identifiable assets that must be accounted for at fair value
(see 7.4 above); but
(b) is required by IAS 28 to restrict any gain arising as a result of the exchange relating
to its own assets to the extent that the gain is attributable to the other investor in
the associate or joint venture. This leads to an adjustment of the carrying amount
of the assets of the associate or joint venture.
In Example 11.19 below, we consider the accounting by party A to the transaction where
the non-monetary assets it has contributed are intangible assets. On the other hand,
party B has contributed an interest in a subsidiary. In some transactions, particularly the
formation of joint ventures, both parties may contribute interests in subsidiaries. The
requirements in IFRS 10 relating to the accounting for loss of control of a subsidiary are
inconsistent with the accounting required by IAS 28, as discussed at 7.6.5.C below.
Although Example 11.19 below is based on a transaction resulting in the formation of a
joint venture, the accounting treatment by party A would be the same if it had obtained
an interest in an associate.
Example 11.19: Contribution of non-monetary assets to form a joint venture
A and B are two major pharmaceutical companies, which agree to form a joint venture (JV Co). A will own
40% of the joint venture, and B 60%. The total fair value of the new business of JV Co is £250 million.
A’s contribution to the venture is a number of intangible assets, in respect of which A’s consolidated statement
of financial position reflects a carrying amount of £60 million. The fair value of the intangible assets
contributed by A is considered to be £100 million, i.e. equivalent to 40% of the total fair value of JV Co of
£250 million.
B contributes a subsidiary, in respect of which B’s consolidated statement of financial position reflects
separable net identifiable assets of £85 million and goodwill of £15 million. The fair value of the separable
net identifiable assets is considered to be £120 million. The fair value of the business contributed is
£150 million (60% of total fair value of JV Co of £250 million).
The book and fair values of the assets/businesses contributed by A and B can therefore be summarised as
follows:
A
B
(in £m)
Book value
Fair value
Book value
Fair value
Intangible assets
60
100
Separable net identifiable
85
120
assets
Goodwill
15
30
Total 60
100
100
150
How should A apply IAS 28 in accounting for the set-up of the joint venture?
Investments in associates and joint ventures 793
The requirements of IAS 28 paragraph 23 require that A should recognise the identifiable assets at fair value
upon the acquisition of its 40% interest in the new venture. However, as noted above, any gain or loss
recognised by A must reflect only the extent to which it has disposed of the assets to the other partners in the
venture (i.e. in this case, 60% – the extent to which A’s intangible assets are effectively transferred to B
through B’s 60% interest in the new venture).
This gives rise to the following accounting entry.
£m £m
Investment in JV Co
– Share of net identifiable assets of JV Co (1)
> 72
– Goodwill
(2)
12
Intangible assets contributed to JV Co (3)
60
Gain on disposal (4)
24
(1) 40% of fair value of separable net identifiable assets (including A’s intangible assets) of new entity
£88 million (40% of [£100 million + £120 million] as in table above) less elimination of 40% of gain on
disposal £16 million (40% of £40 million, being the difference between the book value [£60 million]
and fair value [£100 million] of A’s intangible assets, as in table above, contributed to JV Co) =
£72 million.
This is equivalent to, and perhaps more easily calculated as, 40% of [book value of A’s intangible assets
+ fair value of B’s separable net identifiable assets], i.e. 40% × [£60 million + £120 million] =
£72 million.
Under the equity method, this £72 million together with the £12 million of goodwill (see (2) below)
would be included as the equity accounted amount of JV Co.
(2) Fair value of consideration given £100 million (as in table above) less fair value of 40% share of
separable net identifiable assets of JV Co acquired £88 million (see (1) above) = £12 million.
This is equivalent to, and perhaps more easily calculated as, 40% of the fair value of B’s goodwill, i.e.
40% × £30 million = £12 million.
Under the equity method, as noted at (1) above, this £12 million together with the £72 million relating
to the separable net identifiable assets would be included as the equity accounted amount of JV Co.
(3) Previous carrying amount of intangible assets contributed by A, now deconsolidated.
(4) Fair value of business acquired £100 million (40% of £250 million) less book value of intangible assets
disposed of £60 million (as in table above) = £40 million, less 40% of gain eliminated (£16 million) =
£24 million. The £16 million eliminated reduces A’s share of JV Co’s separable net identifiable assets
by £16 million (see (1) above).
It is common when joint ventures are set up in this way for the fair value of the
assets contributed not to be exactly in proportion to the fair values of the venturers’
agreed relative shares. Cash ‘equalisation’ payments are then made between the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 156
