International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 157
venturers so that the overall financial position of the venturer does correspond to
the agreed relative shares in the venture. Our suggested treatment of such payments
in the context of a transaction within the scope of IAS 28 is illustrated in
Example 11.20 below. Although the example 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 11.20: Contribution of non-monetary assets to form a joint venture with
cash equalisation payment between venturers/investors
Suppose that the transaction in Example 11.19 was varied so that A is to have only a 36% interest in JV Co.
However, as shown by the introductory table in Example 11.19, A is contributing intangible assets worth
40% of the total fair value of JV Co. Accordingly, B makes good the shortfall by making a cash payment to
A equivalent to 4% of the fair value of JV Co, i.e. £10 million (4% of £250 million).
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This would require A to make the following accounting entries.
£m
£m
Investment in JV Co:
– Share of net identifiable assets of JV Co (1)
64.8
– Goodwill
(2)
10.8
Cash (equalisation payment from B)
10.0
Intangible assets contributed to JV Co (3)
60.0
Gain on disposal (4)
25.6
(1) 36% of fair value of separable net identifiable assets of new entity £79.2 million (36% of [£100 million +
£120 million] as in table in Example 11.19 above) less elimination of 36% of gain on disposal £14.4 million
(36% 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 in Example 11.19 above, contributed to JV Co) = £64.8 million.
This is equivalent to, and perhaps more easily calculated as, 36% of [book value of A’s intangible assets +
fair value of B’s separable net identifiable assets], i.e. 36% × [£60 million + £120 million] = £64.8 million.
Under the equity method, this £64.8 million together with the £10.8 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 in Example 11.19 above), less cash
equalisation payment received £10 million = £90 million less fair value of 36% share of separable net
identifiable assets of JV Co acquired £79.2 million (see (1) above) = £10.8 million.
This is equivalent to, and perhaps more easily calculated as, 36% of the fair value of B’s goodwill], i.e.
36% × £30 million = £10.8 million.
Under the equity method, as noted at (1) above, this £10.8 million together with the £64.8 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 £90 million (36% of £250 million) plus cash equalisation payment £10 million
= £100 million, less book value of intangible assets disposed of £60 million (as in table in Example 11.19 above)
= £40 million, less 36% of gain eliminated (£14.4 million) = £25.6 million. The £14.4 million eliminated
reduces A’s share of JV Co’s separable net identifiable assets by £14.4 million (see (1) above).
I
‘Artificial’ transactions
A concern with transactions such as this is that it is the relative, rather than the absolute,
value of the transaction that is of concern to the parties. In other words, in Example 11.19
above, it could be argued that the only clear inference that can be drawn is that A and
B have agreed that the ratio of the fair values of the assets/businesses they have each
contributed is 40:60, rather than that the business as a whole is worth £250 million.
Thus it might be open to A and B, without altering the substance of the transaction, to
assert that the value of the combined operations is £500 million (with a view to
enlarging their net assets) or £200 million (with a view to increasing future profitability).
Another way in which the valuation of the transaction might be distorted is through
disaggregation of the consideration. Suppose that the £60 million net assets contributed
by A in Example 11.19 above comprised:
£m
Cash 12
Intangible assets
48
60
Further suppose that, for tax reasons, the transaction was structured such that A was
issued with 4% of the shares of JV Co in exchange for the cash and 36% in exchange for
the intangible assets. This could lead to the suggestion that, as there can be no doubt as
Investments in associates and joint ventures 795
to the fair value of the cash, A’s entire investment must be worth £120 million (i.e.
£12 million × 40 / 4). Testing transactions for their commercial substance will require
entities to focus on the fair value of the transaction as a whole and not to follow the
strict legal form.
Of course, once cash equalisation payments are introduced, as in Example 11.20 above,
the transaction terms may provide evidence as to both the relative and absolute fair
values of the assets contributed by each party.
II
Accounting for the acquisition of a business on formation of a joint venture
IFRS 3 does not apply to business combinations that arise on the formation of a joint
venture. [IFRS 3.2(a)]. Therefore, it is not clear under IFRS how the acquisition by JV Co
of the former business of B in Example 11.20 above should be accounted for. Indeed, it
could also have been the case that A had also contributed a subsidiary, and JV Co would
have to account for the former businesses of both A and B. We consider that under the
GAAP hierarchy in IAS 8 the pooling of interests method is still available when
accounting for the businesses acquired on the formation of a joint venture and there
may be other approaches (including the acquisition method) that will be considered to
give a fair presentation in particular circumstances.
Where a new company is formed to create a joint venture and both venturers contribute a
business, we believe that it would also be acceptable under the GAAP hierarchy in
paragraph 11 of IAS 8 (see Chapter 3 at 4.3) to apply the acquisition method to both
businesses, as IFRS does not prevent entities from doing this and it provides useful
information to investors. However, in this case, the entity should ensure the disclosures
made are sufficient for users of the financial statements to fully understand the transaction.
If JV Co were to apply the acquisition method it could mean that the amounts taken up
in the financial statements of B may bear little relation to its share of the net assets of
the joint venture as reported in the underlying financial statements of the investee. This
would be the case if B accounted for the transaction by applying IAS 28 rather than
IFRS 10 (see 7.6.5.C below). For example, B’s share of any amortisation charge recorded
by JV Co must be based on the carrying amount of B’s share of JV Co’s intangible assets,
not as recorded in JV Co’s books (i.e. at fair val
ue) but as recorded in B’s books, which
will be based on book value for intangible assets contributed by B and at fair value for
intangible assets contributed by A. Accordingly it may be necessary for B to keep a
‘memorandum’ set of books for consolidation purposes reflecting its share of assets
originally its own at book value and those originally of A at fair value. The same would
apply to A if it had also contributed a subsidiary. In any event, in Example 11.20 above,
JV Co will have to account for the intangibles contributed by A at fair value as the
transaction represents a share-based payment transaction in terms of IFRS 2 – Share-
based Payment. Therefore, A will need to keep a ‘memorandum’ record relating to these
intangibles, so that it can make the necessary consolidation adjustments to reflect
amortisation charges based on its original book values.
Alternatively, if JV Co were to apply the pooling of interest method, A would need to keep
a ‘memorandum’ set of books for consolidation purposes because its share of assets that
were originally those of B should be carried at fair value rather than carry-over cost.
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7.6.5.C
Conflict between IAS 28 and IFRS 10
In Example 11.19 above, we considered 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. 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. Under IAS 28, the contributing investor is required 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 party to the associate or joint venture. This leads
to an adjustment of the carrying amount of the assets of the associate or joint venture.
However, under IFRS 10, where an entity loses control of an entity, but retains an
interest that is to be accounted for as an associate or joint venture, the retained interest
must be remeasured at its fair value and is included in calculating the gain or loss on
disposal of the subsidiary. This fair value becomes the cost on initial recognition of the
associate or joint venture. [IFRS 10.25]. Consequently, under IFRS 10, the gain is not
restricted to the extent that the gain is attributable to the other party to the associate or
joint venture, and there is no adjustment to reduce the fair values of the net identifiable
assets contributed to the associate or joint venture.
In September 2014, the IASB issued Sale or Contribution of Assets between an Investor
and its Associate or Joint Venture (amendments to IFRS 10 and IAS 28) to address the
conflict between IFRS 10 and IAS 28.17 The amendments require that:
• the partial gain or loss recognition for transactions between an investor and its
associate or joint venture only applies to the gain or loss resulting from the sale or
contribution of assets that do not constitute a business as defined in IFRS 3; and
• the gain or loss resulting from the sale or contribution of assets that constitute a
business as defined in IFRS 3, between an investor and its associate or joint venture
be recognised in full.
In December 2015, the IASB deferred the effective date of these amendments
indefinitely due to feedback that the recognition of a partial gain or loss when a
transaction involves assets that do not constitute a business, even if these assets are
housed in a subsidiary, is inconsistent with the initial measurement requirements of
IAS 28.32(b) (see 7.4 above). This issue will be reconsidered as part of the equity method
research project (see 11 below). However, entities may apply the amendments before
the effective date.
We believe that until the amendments become mandatorily effective, and where the
non-monetary asset contributed is an interest in a subsidiary that constitutes a business,
entities have an accounting policy choice as to whether to apply IFRS 10 or IAS 28,
although the requirements of IFRS 10 deal with the specific issue of loss of control,
whereas the requirements of IAS 28 are more generic. Once selected, the entity must
apply the selected policy consistently. Nevertheless, where the requirements of IFRS 10
are followed for transactions involving a contribution of an interest in a subsidiary that
constitute a business, IAS 28 would generally apply to other forms of non-monetary
assets contributed, such as items of property, plant and equipment or intangible assets
and an interest in a subsidiary that does not constitute a business. However, if an entity
elects to apply IFRS 10.25 to the loss of control over all investments in subsidiaries
Investments in associates and joint ventures 797
(i.e. those that constitute a business and those that do not) (see 7.4.1 above), it will apply
IFRS 10.25 to the contribution of a subsidiary that does not constitute a business.
In Example 11.21 below, we illustrate how party B, which has contributed a subsidiary
that constitute a business in return for its interest in the joint venture in the transaction
set out in Example 11.19 above, would account for the transaction by applying the
requirements of IFRS 10, i.e. party B has elected to apply IFRS 10 to the loss of control
transaction even though it is a downstream transaction. Although the example is based
on a transaction resulting in the formation of a joint venture, the accounting treatment
by party B would be the same if it had obtained an interest in an associate.
Example 11.21: Contribution of subsidiary to form a joint venture – applying IFRS 10
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 parties agree that the total 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 that is a business, 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 implicit 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
The application of IFRS 10 to the transaction would result i
n B reflecting the following accounting entry.
£m £m
Investment in JV Co:
– Share of net identifiable assets of JV Co (1)
132
– Goodwill
(2)
18
Separable net identifiable assets and goodwill contributed to JV
100
Co (3)
Gain on disposal (4)
50
(1) 60% of fair value of separable net identifiable assets of new entity £132 million (60% of [£100 million
+ £120 million] as in table above). There is no elimination of 60% of the gain on disposal.
Under the equity method, this £132 million together with the £18 million of goodwill (see (2) below)
would be included as the equity accounted amount of JV Co.
(2) Fair value of consideration given of £60 million (being 40% of £150 million as in table above) plus fair
value of retained interest of £90 million (being 60% of £150 million) less fair value of 60% share of
separable net identifiable assets of JV Co acquired £132 million (see (1) above).
Under the equity method, as noted at (1) above, this £18 million together with the £132 million relating
to the separable net identifiable assets would be included as the equity accounted amount of JV Co.
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(3) Previous carrying amount of net identifiable assets contributed by B as in table above, now deconsolidated.
In reality there would be a number of entries to deconsolidate these on a line-by-line basis.
(4) Fair value of consideration received of £60 million (being 60% of £100 million as in table above) plus
fair value of retained interest of £90 million (being 60% of £150 million) less book value of assets
disposed of £100 million (see (3) above) = £50 million.
7.7
Non-coterminous accounting periods
In applying the equity method, the investor should use the most recent financial
statements of the associate or joint venture. Where the reporting dates of the investor
and the associate or joint venture are different, IAS 28 requires the associate or joint