of assets or decreases of liabilities that result in an increase in equity, other than those
relating to contributions from equity participants. [IFRS 15 Appendix A]. Except in unusual
circumstances, the forgiveness of debt will be a contribution from owners and therefore
ought to be taken to equity.
It will usually be appropriate for a parent to add the payment to the investment in
the subsidiary as a capital contribution, subject always to impairment of the
investment but a parent may conclude that it is more appropriate to expense the
cost. If one subsidiary settles a liability of its fellow subsidiary, both of the entities
Separate and individual financial statements 583
may choose to recognise an equity element in the transaction, one subsidiary
recognises a capital contribution from the parent, while the other subsidiary
recognises a distribution to the parent.
4.4.5
Financial instruments within the scope of IFRS 9
IFRS 9 (except for certain trade receivables) requires the initial recognition of financial
assets and financial liabilities to be at fair value, [IFRS 9.5.1.1], so management has no policy
choice. Financial instruments arising from group transactions are initially recognised at
their fair value, with any difference between the fair value and the terms of the
agreement recognised as an equity transaction.
4.4.5.A
Interest-free or non-market interest rate loans
Parents might lend money to subsidiaries on an interest-free or low-interest basis and
vice versa. A feature of some intra-group payables is that they have no specified
repayment terms and are therefore repayable on demand. The fair value of a financial
liability with a demand feature is not less than the amount payable on demand,
discounted from the first date that the amount could be required to be paid. This means
that an intra-group loan payable on demand has a fair value that is the same as the cash
consideration given.
Loans are recognised at fair value on initial recognition based on the market rate
of interest for similar loans at the date of issue (see Chapter 45 at 3.3.1).
[IFRS 9.B5.1.1]. The party making the loan has a receivable recorded at fair value and
must on initial recognition account for the difference between the fair value and
the loan amount.
If the party making the non-market loan is a parent, it adds this to the carrying
value of its investment. The subsidiary will initially record a capital contribution
in equity. Subsequently, the parent will recognise interest income and the
subsidiary interest expense using the effective interest method so that the loan is
stated at the amount receivable/repayable at the redemption date. When the loan
is repaid, the overall effect in parent’s financial statements is of a capital
contribution made to the subsidiary as it has increased its investment and
recognised income to the same extent (assuming, of course, no impairment). By
contrast, the subsidiary has initially recognised a gain in equity that has been
reversed as interest has been charged.
If the subsidiary makes the non-market loan to its parent, the difference between the
loan amount and its fair value is treated as a distribution by the subsidiary to the parent,
while the parent reflects a gain. Again, interest is recognised so that the loan is stated at
the amount receivable and payable at the redemption date. This has the effect of
reversing the initial gain or loss taken to equity. Note that the effects in the parent’s
financial statements are not symmetrical to those when it makes a loan at below market
rates. The parent does not need to deduct the benefit it has received from the subsidiary
from the carrying value of its investment.
584 Chapter
8
The following example illustrates the accounting for a variety of intra-group loan
arrangements.
Example 8.9:
Interest-free and below market rate loans within groups
Entity S is a wholly owned subsidiary of Entity P. In each of the following scenarios one of the entities
provides an interest free or below market rate loan to the other entity.
1. P provides an interest free loan in the amount of $100,000 to S. The loan is repayable on demand.
On initial recognition the receivable is measured at its fair value, which in this case is equal to the cash
consideration given. The loan is classified as a current liability in the financial statements of the subsidiary.
The classification in the financial statements of the parent depends upon management intention. If the parent
had no intention of demanding repayment in the near term, the parent would classify the receivable as non-
current in accordance with paragraph 66 of IAS 1.
If S makes an interest-free loan to parent, the accounting is the mirror image of that for the parent.
2.
P provides an interest free loan in the amount of $100,000 to S. The loan is repayable when funds are available.
Generally, a loan that is repayable when funds are available will be classified as a liability. The classification
of such a loan as current or non-current and the measurement at origination date will depend on the
expectations of the parent and subsidiary of the availability of funds to repay the loan. If the loan is expected
to be repaid in three years, measurement of the loan would be the same as in scenario 3.
If S makes an interest-free loan to parent, the accounting is the mirror image of that for the parent.
3.
P provides an interest free loan in the amount of $100,000 to S. The loan is repayable in full after 3 years.
The fair value of the loan (based on current market rates of 10%) is $75,131.
At origination, the difference between the loan amount and its fair value (present value using current market
rates for similar instruments) is treated as an equity contribution to the subsidiary, which represents a further
investment by the parent in the subsidiary.
Journal entries at origination:
Parent
$
$
Dr
Loan receivable from subsidiary
75,131
Dr
Investment in subsidiary
24,869
Cr Cash
100,000
Subsidiary $
$
Dr Cash
100,000
Cr
Loan payable to parent
75,131
Cr
Equity – capital contribution
24,869
Journal entries during the periods to repayment:
Parent $
$
Dr
Loan receivable from subsidiary (Note 1)
7,513
Cr
Profit or loss – notional interest
7,513
Subsidiary $
$
Dr
Profit or loss – notional interest
7,513
Cr
Loan payable to parent
7,513
Note 1
Amounts represent year one assuming no payments before maturity. Year 2 and 3 amounts would be
$8,264 and $9,092 respectively i.e. accreted at 10%. At the end of year 3, the recorded balance of the loan
will be $100,000.
4. S provides a below market rate loan in the amount of $100,000 to P. The loan bears inte
rest at 4% and
is repayable in full after 3 years (i.e. $112,000 at the end of year 3). The fair value of the loan (based on
current market rates of 10%) is $84,147.
Separate and individual financial statements 585
At origination, the difference between the loan amount and its fair value is treated as a distribution from the
subsidiary to the parent.
Journal entries at origination:
Parent
$
$
Dr Cash
100,000
Cr
Loan payable to subsidiary
84,147
Cr
Profit or loss – distribution from subsidiary
15,853
Subsidiary
$
$
Dr
Loan receivable from parent
84,147
Dr
Retained earnings – distribution
15,853
Cr Cash
100,000
Journal entries during the periods to repayment:
Parent $
$
Dr
Profit or loss – notional interest
8,415
Cr
Loan payable to subsidiary
8,415
Subsidiary
$
$
Dr
Loan receivable from parent (Note 1)
8,415
Cr
Profit or loss – notional interest
8,415
Note 1
Amounts represent year one assuming no payments before maturity. Year 2 and 3 amounts would be $9,256
and $10,182, respectively i.e. accreted at 10% such that at the end of year 3 the recorded balance of the loan
will be $112,000 being the principal of the loan ($100,000) plus the interest payable in cash ($12,000).
4.4.5.B Financial
guarantee
contracts: parent guarantee issued on behalf of
subsidiary
Financial guarantees given by an entity that are within the scope of IFRS 9 must be
recognised initially at fair value. [IFRS 9.5.1.1]. If a parent or other group entity gives a
guarantee on behalf of an entity, this must be recognised in its separate or individual
financial statements. It is normally appropriate for a parent that gives a guarantee to
treat the debit that arises on recognising the guarantee at fair value as an additional
investment in its subsidiary. This is described in Chapter 41 at 3.4.
The situation is different for the subsidiary or fellow subsidiary that is the beneficiary
of the guarantee. There will be no separate recognition of the financial guarantee unless
it is provided to the lender separate and apart from the original borrowing, does not
form part of the overall terms of the loan and would not transfer with the loan if it were
assigned by the lender to a third party. This means that few guarantees will be reflected
separately in the financial statements of the entities that benefit from the guarantees.
Example 8.10: Financial guarantee contracts
A group consists of two entities, H plc (the parent) and S Ltd (H’s wholly owned subsidiary). Entity H has a
stronger credit rating than S Ltd. S Ltd is looking to borrow €100, repayable in five years. A bank has
indicated it will charge interest of 7.5% per annum. However, the bank has offered to lend to S Ltd at a rate
of 7.0% per annum if H plc provides a guarantee of S Ltd.’s debt to the bank and this is accepted by S Ltd.
No charge was made by H plc to S Ltd in respect of the guarantee. The fair value of the guarantee is calculated
at €2, which is the difference between the present value of the contractual payments discounted at 7.0% and
7.5%. If the bank were to assign the loan to S Ltd to a third party, the assignee would become party to both
the contractual terms of the borrowing with S Ltd as well as the guarantee from H plc.
586 Chapter
8
H plc will record the guarantee at its fair value of €2.
S Ltd will record its loan at fair value including the value of the guarantee provided by the parent. It will
simply record the liability at €100 but will not recognise separately the guarantee provided by the parent.
If the guarantee was separate, S Ltd would record the liability at its fair value without the guarantee of €98
with the difference of €2 recorded as a capital contribution.
4.5 Disclosures
Where there have been significant transactions between entities under common control
that are not on arm’s length terms, it will be necessary for the entity to disclose its
accounting policy for recognising and measuring such transactions.
IAS 24 applies whether or not a price has been charged so gifts of assets or services and
asset swaps are within scope. Details and terms of the transactions must be disclosed
(see Chapter 35 at 2.5).
References
1
IFRIC Update, March 2015, p.11.
9 Staff Paper, IFRS Interpretations Committee
2
IFRIC Update, March 2015, p.11.
Meeting, September 2018, Agenda reference 6B,
3
IFRIC Update, March 2006, p.7.
IAS
27 Separate Financial Statements –
4 Agenda paper for the meeting of the Accounting
Investment in a subsidiary accounted for at cost:
Regulatory Committee on 2nd February 2007
Step acquisition.
(document ARC/08/2007), Subject: Relationship
10 IASB Update, June 2014, p.9.
between the IAS Regulation and the 4th and 7th
11 IASB Update, October 2017, p.4.
Company Law Directives – Can a company 12 Slide deck, ASAF Meeting, December 2017,
preparing both individual and consolidated
Agenda ref 8A, Business Combinations under
accounts in accordance with adopted IFRS issue
Common Control, Scope of the project, p.21.
the individual accounts before the consolidated
13 IASB Work plan as at 22 July 2018.
accounts?, European Commission: Internal 14 IFRIC Update, September 2011, p.3.
Market and Services DG: Free movement of
15 IASB Update, January 2016, p.4.
capital, company law and corporate governance:
16 IASB Work plan as at 22 July 2018.
Accounting/PB D(2006), 15
January 2007, 17 Equity Method in Separate Financial Statements
para. 3.1.
(Amendments to IAS 27), para. 4.
5
IFRIC Update, March 2016, p.5.
18 Equity Method in Separate Financial Statements
6
IFRIC Update, July 2009, p.3.
(Amendments to IAS 27), para. 12.
7
IFRIC Update, September 2011, p.3.
19 Equity Method in Separate Financial Statements
8 Staff Paper, IFRS Interpretations Committee
(Amendments to IAS 27), para. BC10G.
Meeting, July 2011, Agenda reference 7, IAS 27
Consolidated and Separate Financial Statements
– Group reorganisations in separate financial
statements, Appendix A.
587
Chapter 9
Business combinations
1 INTRODUCTION ............................................................................................ 593
1.1
IFRS 3 (as revised in 2008) and subsequent amendments .......................... 594
1.1.1
Post-implementation review .......
....................................................... 595
1.1.2 Proposed
amendments to IFRS 3 ..................................................... 596
2 SCOPE OF IFRS 3 ......................................................................................... 597
2.1
Mutual entities ....................................................................................................... 597
2.2
Arrangements out of scope of IFRS 3 ............................................................... 597
2.2.1
Formation of a joint arrangement ..................................................... 597
2.2.2
Acquisition of an asset or a group of assets that does not
constitute a business ........................................................................... 598
2.2.3
Business combinations under common control ............................ 600
3 IDENTIFYING A BUSINESS COMBINATION .................................................. 600
3.1
Identifying a business combination .................................................................. 600
3.2
Definition of a business ...................................................................................... 600
3.2.1
Inputs, processes and outputs ............................................................ 601
3.2.2
‘Capable of’ from the viewpoint of a market participant ............. 601
3.2.3 Identifying
business combinations ................................................... 602
3.2.4
Development stage entities ............................................................... 604
3.2.5
Presence of goodwill ........................................................................... 605
3.2.6
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 116