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ANALYSIS: Investment in subsidiaries, joint ventures and associates

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Entities have been given the option to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate financial statements. By Mareli Dippenaar CA(SA) and Danielle van Wyk CA(SA)

The International Accounting Standards Board (IASB) published amendments to the International Accounting Standard (IAS) 27, Separate Financial Statements (IAS 27), in August 2014. The amendments give entities the option to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate financial statements. This option, as an amendment to IAS 27, is additional to the current two options available which allow entities to account for their investments in subsidiaries, joint ventures and associates either at cost or in accordance with International Financial Reporting Standard (IFRS) 9, Financial Instruments (IFRS 9), in their separate financial statements. IFRS 9 is effective for annual periods beginning on or after 1 January 2018, although entities can early adopt IFRS 9. In the meantime, IAS 39, Financial Instruments: Recognition and Measurement (IAS 39), remains effective.

However, prior to the revision of IAS 27 and IAS 28, Investments in Associates and Joint Ventures (IAS 28), in 2003, the equity method was available as one of the options to account for investments in subsidiaries or associates in an investor’s separate financial statements. No particular treatment was prescribed for joint ventures in a venturer’s separate financial statements before 2003.

It was suggested by respondents to the IASB’s 2011, Agenda Consultation, to restore the option of the equity method, the reason being that the only difference between separate financial statements prepared in accordance with IFRS and those prepared in accordance with local regulations in some countries is the use of the equity method, which is often required by those local regulations. The amendments will therefore assist some jurisdictions to move to IFRS for separate financial statements, which will reduce compliance costs without reducing the information available to investors.

IAS 27, paragraph 6 has been amended to clarify that ‘separate financial statements’ also includes those financial statements presented in addition to the financial statements of an investor that does not have investments in subsidiaries but that has investments in associates or joint ventures that are accounted for using the equity method, as required by IAS 28 (that is, ‘consolidated’ statements). The reason for this amendment was to avoid possible confusion about the applicability of the disclosure requirements of IFRS 12, Disclosure of Interests in Other Entities (IFRS 12), which does not apply to an entity’s separate financial statements, except if an entity has interests in unconsolidated structured entities and prepares separate financial statements as its only financial statements (IFRS 12, paragraph 6(b)).

The equity method is described in IAS 28 as ‘a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income’ (IAS 28, paragraph 3).

The basic differences of the various options available to investors in accordance with IAS 27 (as amended) to account for their investments in subsidiaries, associates or joint ventures in their separate financial statements are set out in the table below.

In assessing which option to elect, entities might consider the advantages and disadvantages of each option. Accounting for its investments in subsidiaries, joint ventures or associates at cost might be seen as the easiest option compared to the application of the equity method, which provides more informative reporting of the investor’s net assets and profit or loss. Where local regulations require the use of the equity method, it is likely that entities will also choose the equity method in their IFRS financial statements, because of the cost-effectiveness thereof. Entities that do not have investments in subsidiaries, but that have investments in associates or joint ventures that are required by IAS 28 to be accounted for using the equity method (that is, in their ‘consolidated’ statements) are less likely to choose the equity method in their separate financial statements and the IASB expects that such entities are likely to choose the cost or IFRS 9 option. Selecting the equity method for investments in subsidiaries, joint ventures and associates is generally expected to result in the same net assets and profit or loss attributable to the owners as in the entity’s consolidated financial statements, except in the following circumstances, which should not be regarded as an exhaustive list:

  • Where goodwill is recognised in the consolidated financial statements in respect of investments in subsidiaries and impairment tests were performed
  • Where subsidiaries have net liability positions, or
  • Where the parent has capitalised borrowing costs incurred in relation to the assets of a subsidiary

It is important to remember that once an option has been chosen by an entity, it needs to apply the same accounting for each category of investments (IAS 27, paragraph 10). The amendments are effective for annual periods beginning on or after 1 January 2016 and should be applied retrospectively as a change in accounting policy in accordance with IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors. Earlier application is permitted.

OPTIONS AVAILABLE TO INVESTORS

[Click here to view Table]

NOTES

  • Investments accounted for at cost or using the equity method that are classified as held for sale or for distribution (or included in a disposal group that is classified as held for sale or for distribution) should be accounted for in accordance with IFRS 5, Non-current Assets Held for Sale and Discontinued Operations. The measurement of investments accounted for in accordance with IFRS 9 or IAS 39 is not changed in such circumstances.
  • Venture capital organisations, mutual funds, unit trusts and similar entities that hold investments in associates or joint ventures may elect to measure those investments at fair value through profit or loss (in accordance with IFRS 9/IAS 39) in both their ‘consolidated’ and separate financial statements. Investment entities (defined in IFRS 10, Consolidated Financial Statements) are required to measure some of their investments in subsidiaries at fair value through profit or loss (in accordance with IFRS 9 / IAS 39). The specific requirements for changes in status of investors (becoming or ceasing to be investment entities) are excluded from the scope of this article.
  • A change in status in this context refers, for example, to circumstances where an investment changes from an investment in associate or joint venture to an investment in a subsidiary (or any combination of changes) where the entity applies different methods of accounting for its different categories of investments (for example subsidiaries at cost, associates at fair value, and joint ventures using the equity method).

Authors: Mareli Dippenaar CA(SA) and Danielle van Wyk CA(SA) are both accounting lecturers in the School of Accountancy at the University of Stellenbosch