Determining whether an ENTITY is an INVESTMENT ENTITY (exception to Consolidation)

On 31 October 2012, the IASB published Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27), providing an exception to the consolidation requirements in IFRS 10 for INVESTMENT ENTITIES.

The amendments define an investment entity and introduce an exception to consolidating particular subsidiaries for investment entities. These amendments require a parent that is an investment entity to measure those subsidiaries at FAIR VALUE through Profit or Loss in accordance with IFRS 9 Financial Instruments instead of consolidating those subsidiaries in its consolidated and separate financial statements. In addition, the amendments also introduce new disclosure requirements related to investment entities in IFRS 12 Disclosure of Interests in Other Entities and IAS 27 Separate Financial Statements.

Under IFRS 10 Consolidated Financial Statements, reporting entities were required to consolidate all investee that they control (i.e. all subsidiaries). Preparers and users of financial statements have suggested that consolidating the subsidiaries of investment entities does not result in useful information for investors. Rather, reporting all investments, including investments in subsidiaries, at fair value, provides the most useful and relevant information.

Para.27 of the amendments states that :

A parent shall determine whether it is an INVESTMENT ENTITY. An investment entity is an entity that :

1. obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services;
2. commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both; and
3. measures and evaluates the performance of substantially all of its investments on a fair value basis.

Para.28 further states that :

In assessing whether it meets the definition described in paragraph 27, an entity shall consider whether it has the following typical characteristics of an investment entity :

1. it has more than one investment
2. it has more than one investor
3. it has investors that are not related parties of the entity; and
4. it has ownership interests in the form of equity or similar interests

The absence of any of these typical characteristic does not necessarily disqualify an entity from being classified as an investment entity. An investment entity that does not have all of these typical characteristics provides additional disclosure required by paragraph 9A of IFRS 12 Disclosure of Interests in Other Entities.

In facts and circumstances indicate that there are changes to one or more of the three elements that make up the definition of an investment entity, as described in paragraph 27, or the typical characteristics of an investment entity, as described in paragraph 28, a parent shall reassess whether it is an investment entity.

A parent that either ceases to be an investment entity or become an investment entity shall account for the change in its status PROSPECTIVELY from the date at which the change in status occurred.

An Investment Entity shall not consolidate its subsidiaries. Instead, an investment entity shall measure an investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9 (HRD).

AMENDMENTS to IAS 27 Separate Financial Statements

Current IAS 27 Separate Financial Statements requires an entity to account for its investments in Subsidiaries, Joint Ventures and Associates either at COST or in accordance with IFRS 9 Financial Instruments in the entity’s SEPARATE Financial Statements.

Prior to the revision in 2003 of IAS 27 Consolidated and Separate Financial Statements and IAS 28 Investments in Associates, the Equity method was one of the options available to an entity to account for its investments in subsidiaries and associates in the entity’s separate financial statements. In 2003, the Equity method was removed from the options and the IASB decided to require the use of COST or IAS 39 Financial Instruments : Recognition and Measurement for all investments in subsidiaries, jointly controlled entities and associates included in the separate financial statements.

Further, in their responses to the IASB’s 2011 Agenda Consultation, some respondents said that:

1. the laws of some countries require listed companies to present separate financial statements prepared in accordance with local regulations;
2. those local regulations require the use of the equity method to account for investments in subsidiaries, joint ventures and associates; and
3. in most cases, the use of the equity method would be the only difference between the separate financial statements prepared in accordance with IFRSs and those prepared in accordance with local regulations.

Those respondents strongly supported the inclusion of the Equity method as one of the options for measuring investments in subsidiaries, joint ventures and associates in the separate financial statements of an entity.

In May 2012, the IASB decided to consider restoring the option to use the EQUITY method of accounting in separate financial statements.

Later, on 2 December 2013, the IASB published for public comment the Exposure Draft : Equity Method in Separate Financial Statements (Proposed amendments to IAS 27). The proposed amendments to IAS 27 would allow entities to use the Equity method to account for investments in subsidiaries, joint ventures and associates in their separate (parent only) financial statements.

Under the proposals, an entity would be permitted to account for its investments either :

1. at Cost; or
2. in accordance with IFRS 9; or
3. using the Equity method.

And, finally, on 12 August 2014, IASB published Equity Method in Separate Financial Statements (Amendments to IAS 27). The amendments to IAS 27 will allow entities to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate financial statements.

Subscribers to eIFRS can download the file from : eIFRS webpage

Cost of Investment – amendments to IFRS 1 and IAS 27

The amendments to IFRS 1. “First-time adoption of IFRS”, and IAS 27, “Consolidated and separate financial statements”, bring three major changes :

• The cost of a subsidiary, jointly controlled entity or associate in a parent’s separate financial statements, on transition to IFRS, is determined under IAS 27 or as a deemed cost. Deemed cost is either fair value or the carrying amount under the previous accounting practice.
• Dividends from a subsidiary, jointly controlled entity or associate are recognized as income. There is no longer a distinction between pre-acquisition and post-acquisition dividends.
• The cost of the investment of a new parent in a group (in a reorganization meeting certain criteria) is measured at the carrying amount of its share of equity as shown in the separate financial statements of the previous parent.

What was the reason for the amendment ?

The main reason for the amendment is to facilitate the transition to IFRS without significantly reducing the relevance of the financial statements. IAS 27 requires an entity to account for its investments at cost or in accordance with IAS 39 in its separate financial statements. For those accounted for at cost, a parent entity could previously recognize income from the investment only to the extent that distributions were received from post-acquisition earnings. Distributions in excess of post-acquisition earnings were recognized as a reduction to the cost of the investment.

Prior to the amendment, IFRS 1 required retrospective application of this method of calculating cost, which was often cumbersome to reconstruct for investments that had been held for several years. With the amendments, a first-time adopter can use a deemed cost, which may be the previous GAAP carrying amount.

If dividends are recognized as income and not as a reduction to the cost of the investment, is there risk of impairment ?

Yes, IAS 36 has been amended to identify circumstances when a dividend payment requires impairment testing. These circumstances include :

• Dividends exceeding the total comprehensive income (under IAS 1 – revised) of the subsidiary, jointly controlled entity or associate in the period the dividend is declared; or
• The carrying amount of the investment in the separate financial statements exceeding the carrying amount in the consolidated financial statements of the investee’s net assets, including goodwill.

How will the alleviate ‘dividend trap’ issues ?

Prior to the amendment, dividends from pre-acquisition earnings were recognized as a reduction of the cost of an investment. Because they were not recognized as profits by the parent, they were not available for further distribution. Under the new standard, dividends are credited to income and available for distribution, subject to there being no impairment and subject to local legal requirements.

Source : A Practical guide to new IFRSs for 2010 - PWC publication