International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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An investment entity may have an investment in another investment entity that is
formed in connection with the entity for legal, regulatory, tax or similar business
reasons. In this case, the investment entity investor need not have an exit strategy for
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that investment, provided that the investment entity investee has appropriate exit
strategies for its investments. [IFRS 10.B85H]. This is intended to prevent an entity that
conducts most of its investing activities through a subsidiary that is a holding company
from failing to qualify as an investment entity. [IFRS 10.BC248].
10.2.3
Earnings from investments
An investment entity must commit to its investors that its business purpose is to invest
funds solely for returns from capital appreciation, investment income or both.
An entity does not meet this condition when it, or another member of the group containing
the entity (i.e. the group that is controlled by the entity’s ultimate parent) obtains, or has
the objective of obtaining, other benefits from the entity’s investments that are not
available to other parties that are not related to the investee. ‘Other benefits’ means
benefits in addition to capital appreciation or investment return and such benefits include:
• the acquisition, use, exchange or exploitation of the processes, assets or
technology of an investee including the entity or another group member having
disproportionate, or exclusive, rights to acquire assets, technology, products or
services of any investee; for example by holding an option to purchase an asset
from an investee if the asset’s development is deemed successful;
• joint arrangements or other agreements between the entity or another group member
and an investee to develop, produce, market or provide products or services;
• financial guarantees or assets provided by an investee to serve as collateral for
borrowing arrangements of the entity or another group member (however, an
investment entity would still be able to use an investment in an investee as
collateral for any of its borrowings);
• an option held by a related party of the entity to purchase, from that entity or
another group member, an ownership interest in an investee of the entity; and
• except as described below, transactions between the entity or another group
member and an investee that:
• are on terms that are unavailable to entities that are not related parties of
either the entity, another group member or the investee;
• are not at fair value; or
• represent a substantial portion of the investee’s or the entity’s business
activity, including business activities of other group entities. [IFRS 10.B85I].
These requirements in respect of ‘other benefits’ are anti-avoidance provisions. As
explained in the Basis for Conclusions, the Board was concerned that an entity that
meets the definition of an investment entity could be inserted into a larger corporate
group in order to achieve a particular accounting outcome. This concern is illustrated
by an example of a parent entity using an ‘internal’ investment entity subsidiary to invest
in subsidiaries that may be making losses (e.g. research and development activities on
behalf of the overall group) and therefore record its investments at fair value, rather
than reflecting the underlying activities of the investee. Because of these concerns, the
Board has included the requirement that the investment entity, or other members of the
group containing the entity, should not obtain benefits from its investees that would be
unavailable to other parties that are not related to the investee. [IFRS 10.BC242].
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It is also clarified that an entity should demonstrate that fair value is the primary
measurement attribute used to evaluate the performance of its investments, both
internally and externally. [IFRS 10.BC252].
An entity is not disqualified from being classified as an investment entity because it
has investees in the same industry, market or geographical area that trade with each
other. This applies where the investment entity has a strategy to invest in more than
one investee in that industry, market or geographical area in order to benefit from
synergies that increase the capital appreciation and investment income from those
investees. [IFRS 10.B85J]. The Board decided that trading transactions or synergies that
arise between the investments of an investment entity should not be prohibited
because their existence does not necessarily mean that the investment entity is
receiving any returns beyond solely capital appreciation, investment return, or both.
[IFRS 10.BC243].
10.2.4
Fair value measurement
In order to qualify as an investment entity, a reporting entity must measure and evaluate
the performance of substantially all of its investments on a fair value basis. This is because
using fair value results in more relevant information than, for example, consolidation for
subsidiaries or the use of the equity method for interests in associates or joint ventures. In
order to demonstrate fair value measurement, an investment entity should:
(a) provide investors with fair value information and measure substantially all of its
investments at fair value in its financial statements whenever fair value is permitted
in accordance with IFRSs; and
(b) report fair value information to the entity’s key management personnel who use
fair value as the primary measurement attribute to evaluate the performance of
substantially all of its investments and to make investment decisions. [IFRS 10.B85K].
In order to meet the requirements in (a) above, an investment entity would:
• elect to account for any investment property using the fair value model in IAS 40
– Investment Property;
• elect the exemption from applying the equity method in IAS 28 for its investments
in associates and joint ventures; and
• measure its financial assets at fair value using the requirements in IFRS 9. [IFRS 10.B85L].
As described in the Basis for Conclusions, investments measured at fair value in the
statement of financial position with fair value changes recognised in other
comprehensive income rather than through profit or loss still satisfy the fair value
measurement condition of the definition of an investment entity. [IFRS 10.BC251].
However, an investment entity should not account for more than an insignificant
amount of financial assets at amortised cost under IFRS 9, nor fail to elect the fair value
measurement options in IAS 28 or IAS 40. [IFRS 10.BC250].
Fair value measurement applies only to an investment entity’s investments. There is no
requirement to measure non-investment assets such as property, plant and equipment
or liabilities such as financial liabilities at fair value. [IFRS 10.B85M].
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10.2.5
Holding more than one investment
An investment entity would typically hold several investments to diversify its risk and
maximise its returns. These may be held directly or indirectly, for example by holding a single
investment in another investment entity that itself
holds several investments. [IFRS 10.B85O].
However, holding a single investment does not necessarily prevent an entity from
meeting the definition of an investment entity. Examples where an investment entity
may hold only a single investment are when the entity:
• is in its start-up period and has not yet identified suitable investments and,
therefore, has not yet executed its investment plan to acquire several investments;
• has not yet made other investments to replace those it has disposed of;
• is established to pool investors’ funds to invest in a single investment when that
investment is unobtainable by individual investors (e.g. when the required
minimum investment is too high for an individual investor); or
• is in the process of liquidation. [IFRS 10.B85P].
As holding only one investment is not a typical characteristic of an investment entity,
this would require disclosure as a significant judgement (see 10.1 above).
10.2.6
Having more than one investor
An investment entity would typically have several investors who pool their funds to gain
access to investment management services and investment opportunities they might not
have had access to individually. In the Board’s opinion, having more than one investor makes
it less likely that the entity, or other members of the group containing the entity, would obtain
benefits other than capital appreciation or investment income (see 10.2.3 above).
[IFRS 10.B85Q].
Although the Board considers that an investment entity would typically have more than
one investor, there is no conceptual reason why an investment fund with a single
investor should be disqualified from being an investment entity. Therefore, the
presence of more than one investor is a typical characteristic of an investment entity
rather than as part of the definition of an investment entity. [IFRS 10.BC260].
An investment entity may be formed by, or for, a single investor that represents or
supports the interests of a wider group of investors such as a pension fund, a government
investment fund or a family trust. [IFRS 10.B85R].
The Board acknowledges that there may be times when the entity temporarily has a
single investor. For example, an investment entity may have a single investor when it:
• is within its initial offering period and the entity is actively identifying suitable investors;
• has not yet identified suitable investors to replace ownership interests that have
been redeemed; or
• is in the process of liquidation. [IFRS 10.B85S].
These examples are not stated to be exhaustive and there could be other reasons why
an investment entity might have only one investor. Having only one investor is not a
typical characteristic of an investment entity. The fact that an entity is considered to be
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an investment entity despite having only one investor is a significant judgement
requiring disclosure (see 10.1 above).
10.2.7 Unrelated
investors
An investment entity would typically have several investors that are not related parties
of the entity or other members of the group containing the entity. The existence of
unrelated investors makes it less likely that the entity, or other members of the group
containing the entity, would obtain benefits other than capital appreciation or
investment income (see 10.2.3 above). [IFRS 10.B85T].
As the definition of a related party includes an entity which has significant influence
over a reporting entity, when read literally this means that, typically, an entity that is
significantly influenced by one or more parties by, for example, having investors with a
greater than twenty percent ownership interest (see Chapter 11 at 4), cannot be an
investment entity.
However, an entity may still qualify as an investment entity even though its investors are
related to the entity. To support this, an example is illustrated in which an investment
entity sets up a separate ‘parallel’ fund for a group of its employees (such as key
management personnel) or other related party investors, which mirrors the investment of
the entity’s main investment fund. It is stated that this ‘parallel’ fund may qualify as an
investment entity even though all of its investors are related parties. [IFRS 10.B85U]. In this
example, the key determinant in concluding that the parallel fund is an investment entity
is that it is being managed for capital appreciation or investment income.
Although IFRS 10 provides only one example of a fund which qualifies as an investment
entity with investors that are related parties, it is explained in the Basis for Conclusions
that respondents to the Investment Entities ED provided ‘examples of entities with
related investors that they believed should qualify as investment entities’. [IFRS 10.BC261].
10.2.8 Ownership
interests
An investment entity is typically, but is not required to be, a separate legal entity.
Ownership interests in an investment entity will usually be in the form of equity or
similar interests (e.g. partnership interests), to which proportionate shares of the net
assets of the investment entity are attributed. However, having different classes of
investors, some of which have rights only to a specific investment or groups of
investments or which have different proportionate shares of the net assets, does not
preclude an entity from being an investment entity. [IFRS 10.B85V].
It is rationalised in the Basis of Conclusions that holding a proportionate share of the net
assets of an investment entity explains in part why fair value is more relevant to investors
of an investment entity because the value of each ownership interest is linked directly to
the fair value of the entity’s investments. [IFRS 10.BC263]. However, whether there is this form
of ownership interest in an entity should not be a deciding factor and would
inappropriately exclude certain structures from investment entity status. One example
illustrated by the Basis for Conclusions is entities that do not have units of ownership
interest in the form of equity or similar interests is a pension fund or sovereign wealth fund
with a single direct investor which may have beneficiaries that are entitled to the net assets
of the investment fund, but do not have ownership units. Another example is funds with
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different share classes or funds in which investors have discretion to invest in individual
assets. [IFRS 10.BC264, BC266]. In both of these examples, the investors are entitled to a
proportionate share of at least part of the assets of the fund although not the entire fund.
An entity that has significant ownership interests in the form of debt that does not meet
the definition of equity may still qualify as an investment entity, provided that the debt
holders are exposed to variable returns from changes in the fair value of the entity’s net
assets. [IFRS 10.B85W].
10.2.9
Investment entity illustrative examples
The following examples illustrate the application of the investment entity criteria and
are based on illustrative examples contained in IFRS 10.
Example 6.43: A limited partnership that is an investment ent
ity
An entity, Limited Partnership (LP) is formed in 2017 with a 10-year life. The offering memorandum states that
LP’s purpose is to invest in entities with rapid growth potential, with the objective of realising capital
appreciation over their life. Entity GP (the general partner of LP) provides 1% of the capital to LP and has
responsibility for identifying suitable investments for the partnership. Approximately 75 limited partners, who
are unrelated to Entity GP, provide 99% of the capital to the partnership. LP begins its investment activities
in 2017 but no investments are identified until 2018 when LP acquires a controlling interest in ABC Corp.
The group structure at 31.12.2018 is illustrated as follows:
Entity GP
75 unrelated Limited Partners
1%
99%
LP
ABC Corp
In 2019, LP acquires equity interests in five additional operating companies. Other than acquiring those equity
interests, LP conducts no other activities. LP measures and evaluates its investments on a fair value basis and
this information is provided to Entity GP and the external investors.
LP plans to dispose of its interests in each of its investees during the 10 year stated life of the partnership.
Such disposals include the outright sale for cash, the distribution of marketable equity securities to investors
following the successful public offering of the investees’ securities and the disposal of investments to the
public or other unrelated entities.
In this example, LP meets the definition of an investment entity from formation in 2017 to 31 December 2019 because:
• LP has obtained funds from limited partners and is providing them with investment management services;
• LP’s only activity is acquiring equity interests in operating companies with the purpose of realising
capital appreciation over the life of the investments. LP has identified and documented exit strategies
for its investments, all of which are equity investments; and
• LP measures and evaluates its investments on a fair value basis and reports this financial information to
its investors.
In addition, LP displays the following typical characteristics of an investment entity:
• LP is funded by many investors;
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