International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
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specifically asked whether:
• the gain from the transaction should be eliminated only to the extent that it does
not exceed the carrying amount of the entity’s interest in the joint venture; or
• the remaining gain in excess of the carrying amount of the entity’s interest in the joint
venture should also be eliminated and if so, what it should be eliminated against.
The Interpretations Committee determined that the entity should eliminate the gain
from a ‘downstream’ transaction to the extent of the related investor’s interest in the
joint venture, even if the gain to be eliminated exceeds the carrying amount of the
entity’s interest in the joint venture, as required by paragraph 28 of IAS 28. Any
eliminated gain that is in excess of the carrying amount of the entity’s interest in the
joint venture should be recognised as deferred income.12 In July 2013, the IASB
tentatively agreed with the views of the Interpretations Committee and directed the
staff to draft amendments to IAS 28.13 However, in June 2015, the IASB tentatively
decided to defer further work on this topic to the equity accounting research project.
This is discussed further at 11 below.
Considering the missing guidance in IAS 28 we believe that, until the IASB issues an
amendment to IAS 28, the investor can either recognise the excess as ‘deferred
income’ or restrict the elimination to the amount required to reduce the investment
to zero. The treatment chosen is based on the investor’s accounting policy choice
for dealing with other situations where IAS 28 is unclear, reflecting whether the
investor considers the equity method of accounting to be primarily a method of
consolidation or a method of valuing an investment. The investor should apply a
consistent accounting policy to such situations.
Example 11.15: Elimination of downstream unrealised profits in excess of the
investment
An investor has a 40% investment in an associate, which it carries in its statement of financial position at
€800,000. The investor sells a property to the associate in exchange for cash, which results in a profit of
€3 million. After the sale, 40% of that profit (i.e. €1.2 million) is unrealised from the investor’s perspective.
The two approaches for determining to what extent a profit in excess of the carrying value of the investment
should be eliminated are as follows:
Method of consolidation approach – excess of the unrealised profit over the carrying value of the investment
recognised as ‘deferred income’
This approach gives precedence to the requirements in paragraph 26 of IAS 28, which is also consistent with
the general requirement to apply IFRS 10 consolidation elimination principles. [IAS 28.26]. Although
paragraph 38 of IAS 28 requires an investor to discontinue application of the equity method when an
investor’s share of losses equals or exceeds its interest in the associate (see 7.9 below), [IAS 28.38], the
elimination does not represent a real ‘loss’ to the investor but is simply the non-recognition of a gain as a
result of normal consolidation principles. Therefore, paragraph 38 of IAS 28 is subordinate to the requirement
to eliminate unrealised profits.
Investments in associates and joint ventures 785
Accordingly, the investor eliminates the investor’s total share of the unrealised profit against the carrying
amount of the investment in the associate until reaching zero, recognising the excess as a ‘deferred income’
or similar balance, as follows:
€
€
Profit on sale of property
1,200,000
Investment in associate
800,000
‘Deferred income’
400,000
This leaves a net profit of €1.8 million recognised in the consolidated financial statements. The investor
recognises deferred income as the asset or the investment in the associate is realised (e.g. upon disposal of
the investor’s investment in the associate, or upon the disposal or depreciation of the asset by the associate.
Method of valuing investment approach – restricts the elimination to the amount required to reduce the
investment to zero
This approach views the requirements of paragraph 38 of IAS 28 as taking precedence over the requirements
of paragraph 28 of IAS 28 to eliminate unrealised profits from a transaction between the investor and the
associate. The elimination of the full amount of the share of unrealised profit effectively results in the
recognition of a ‘loss’ to the investor. Furthermore, by deferring the ‘loss’, the investor is effectively
recognising a negative investment balance, which is not permitted or required under IAS 28 when the investor
does not have any further legal or constructive obligations in relation to the asset or the associate.
Accordingly, if the investor does not have any further legal or constructive obligations in relation to the asset
or the associate, no liability exists and no further profit is deferred. The investor eliminates the unrealised
profit to the extent that it reduces the carrying value of the investment to zero, as follows:
€
€
Profit on sale of property
800,000
Investment in associate
800,000
This leaves a net profit of €2.2 million recognised in the consolidated financial statements. The investor does
not recognise further profits in the associate until they exceed the unrecognised unrealised profits of €400,000.
7.6.1.B
Transactions between associates and/or joint ventures
When transactions take place between associates and/or joint ventures, which are
accounted for under the equity method, we believe the investor should apply the
requirements of IAS 28 and IFRS 10 by analogy and eliminate its share of any unrealised
profits or losses. [IAS 28.26, 29, IFRS 10.B86].
Example 11.16: Elimination of profits and losses resulting from transactions
between associates and/or joint ventures
Entity H has a 25% interest in associate A and a 30% interest in joint venture B.
During the reporting period, associate A sold inventory costing £1.0 million to joint venture B for
£1.2 million. All of inventory remains on B’s statement of financial position at the end of the reporting period.
Entity H eliminates £15,000 (i.e. 30% × 25% × £200,000) as its share of the profits that is unrealised.
Although paragraph 29 of IAS 28 only refers to upstream and downstream transactions between an investor
and its associate or its joint venture, we consider this to be an illustration of the typical transactions to be
eliminated as a result of the requirements of paragraph 26 of IAS 28 that ‘Many of the procedures that are
appropriate for the application of the equity method are similar to the consolidation procedures described in
IFRS 10’, and are not the only situations to be eliminated by this principle. Therefore, applying the same
principles in paragraph 29 of IAS 28 and paragraph B86 of IFRS 10, the unrealised profit in the investor’s
financial statements arising from any transaction between the associates (and/or joint ventures) is eliminated
to the extent of the related investor’s interests in the associates (and/or joint ventures) as appropriate.
786 Chapter
11
In practice, however, it may be difficult to d
etermine whether such transactions have
taken place.
7.6.2 Reciprocal
interests
Reciprocal interests (or ‘cross-holdings’) arise when an associate itself holds an
investment in the reporting entity. It is unlikely that a joint venture would hold an
investment in the reporting entity but, in the event that it did, the discussion below
would apply equally to such a situation.
7.6.2.A
Reciprocal interests in reporting entity accounted for under the equity
method by the associate
Where the associate’s investment in the reporting entity is such that the associate in
turn has significant influence over the reporting entity and accounts for that
investment under the equity method, a literal interpretation of paragraph 27 of
IAS 28 is that an investor records its share of an associate’s profits and net assets,
including the associate’s equity accounted profits and net assets of its investment in
the investor. The reciprocal interests can therefore give rise to a measure of double
counting of profits and net assets between the investor and its associate.
Paragraph 26 of IAS 28 states that many of the procedures appropriate for the
application of the equity method are similar to the consolidation procedures
described in IFRS 10. Therefore, the requirement in paragraph B86 of IFRS 10 to
eliminate intragroup balances, transactions, income and expenses should be applied
by analogy. [IAS 28.26, IFRS 10.B86].
Neither IFRS 10 nor IAS 28 explains how an entity should go about eliminating the
double counting that arises from reciprocal holdings. We believe that a direct holding
only (or net approach) is applicable, whereby the profit of the investor is calculated by
adding its direct investment in the associate to its trading profits, as shown in
Example 11.17.
Example 11.17: Elimination of equity-accounted reciprocal interests14
Entity A has a 40% equity interest in entity B and conversely, entity B has a 30% interest in entity A. How
should entity A and entity B account for their reciprocal investment?
The structure of the reciprocal holdings is shown in the diagram below:
‘Outside’
shareholders
Entity A
70%
30% interest
40% interest
‘Outside’
Entity B
shareholders
60%
Investments in associates and joint ventures 787
Entity A
Share in equity of B
40%
Shares in A held by ‘outside’ shareholders
70%
Trading profit of A (before share in profit of B)
€60,000
Net assets of A (before share in net assets of B)
€600,000
Number of shares in issue
100,000
Entity B
Share in equity of A
30%
Shares in B held by ‘outside’ shareholders
60%
Trading profit of B (before share in profit of A)
€110,000
Net assets of B (before share in net assets of A)
€1,100,000
Number of shares in issue
40,000
Income
The profit for the period is calculated by adding the direct interest in the associate’s profit:
Profit entity A = €60,000 + 40% × trading profit entity B = €60,000 + 40% × €110,000 = €104,000
Profit entity B = €110,000 + 30% × trading profit entity A = €110,000 + 30% × €60,000 = €128,000
Statement of financial position
A similar approach can be applied to calculate the net assets of A and B:
Net assets of A including share in B without eliminations = €600,000 + 40% × €1,100,000 = €1,040,000
Net assets of B including share in A without eliminations = €1,100,000 + 30% × €600,000 = €1,280,000
Earnings per share
The profits related to the reciprocal interests have been ignored. Therefore, in calculating the earnings per
share it is necessary to adjust the number of shares to eliminate the reciprocal holdings: For entity A it can be
argued that it indirectly owns 40% of B’s 30% interest, i.e. entity A indirectly owns 12% (= 40% × 30%) of
its own shares. Those shares should therefore be treated as being equivalent to ‘treasury shares’ and be ignored
for the purposes of the EPS calculation.
Number of A shares after elimination of ‘treasury shares’ = 100,000 × (100% – 12%) = 88,000 shares
While entity B indirectly owns 30% of A’s 40% interest, i.e. entity B indirectly owns 12% (= 30% × 40%) of
its own shares.
Number of B shares after elimination of ‘treasury shares’ = 40,000 × (100% – 12%) = 35,200 shares
The earnings per share for the shareholders of A and B should be calculated as follows:
Earnings per share A = €104,000 ÷ 88,000 = €1.18
Earnings per share B = €128,000 ÷ 35,200 = €3.64
The earnings per share is equivalent to the hypothetical dividend per share in the case of full distribution of
all profits.
Conclusion
This method takes up the investor’s share of the associate’s profits excluding the equity income arising on
the reciprocal shareholdings and only eliminates the effects of an entity’s indirect investment in its own
shares. The financial statements therefore reflect both the interests of the ‘outside’ shareholders and the
interests that B shareholders have in A. It is worthwhile noting that the combined underlying trading profit of
A and B is only €170,000 (i.e. €60,000 + €110,000), whereas their combined reported profit is €232,000 (i.e.
€104,000 + €128,000). Similarly, the combined underlying net assets of A and B are only €1,700,000,
whereas the combined reported net assets are €2,320,000.
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The elimination of reciprocal interests was discussed by the Interpretations
Committee in August 2002. The Interpretations Committee agreed not to require
publication of an Interpretation on this issue, but did state that ‘like the
consolidation procedures applied when a subsidiary is consolidated, the equity
method requires reciprocal interests to be eliminated.’15
7.6.2.B
Reciprocal interests in reporting entity not accounted for under the
equity method by the associate
In some situations the associate’s investment in the reporting entity is such that the
associate does not have significant influence over the reporting entity and accounts for
that investment under IFRS 9, either as at fair value through other comprehensive
income or at fair value through profit or loss. Although the associate is not applying the
equity method, the reciprocal interest can still give rise to a measure of double counting
of profits and net assets between the investor and its associate when the investor
accounts for its share of the profits and net assets of the associate. Again, paragraph 26
of IAS 28 states that many of the procedures appropriate for the application of the
equity method are similar to the consolidation procedures described in IFRS 10.
Therefore, the requirement in paragraph B86 of IFRS 10 to eliminate intragroup
balances, transactions, income and expenses should be applied by analogy. Accordingly,
in our view, the investor eliminates income fr
om the associate’s investment in the
investor, in the investor’s equity accounting. This elimination includes dividends and
changes in fair value recognised either in profit or loss or other comprehensive income.
Example 11.18: Elimination of reciprocal interests not accounted for under the
equity method
Investor A has a 20% interest in an Associate B. Associate B has a 10% interest in A, which does not give
rise to significant influence.
Scenario 1
Associate B recognises a profit of $1,300 for the year, which includes a dividend of $100 received from
Investor A and a gain of $200 from measuring its investment in Investor A at fair value through profit or loss.
In this scenario, Investor A’s equity method share of Associate B’s profit and loss is $200, being 20% of
Associate B’s profit of $1,000 after excluding income (dividend of $100 plus fair value gain of $200) on its
investment in Investor A.
Scenario 2
Associate B recognises a profit of $1,100 for the year, which includes a dividend of $100 received from
Investor A, and recognises $200 in other comprehensive income from measuring its investment in Investor A
as a financial asset at fair value through other comprehensive income.
In this scenario, Investor A’s equity method share of Associate B’s profit and loss is $200, being 20% of
Associate B’s profit of $1,000 after excluding income (dividend of $100) on its investment in Investor A.
Investor A’s share of Associate B’s other comprehensive income also excludes the gain of $200 recognised
in other comprehensive income arising from its investment in Investor A.
7.6.3
Loans and borrowings between the reporting entity and its associates
or joint ventures
The requirement in IAS 28 to eliminate partially unrealised profits or losses on
transactions with associates or joint ventures is expressed in terms of transactions
involving the transfer of assets. The requirement for partial elimination of profits could
Investments in associates and joint ventures 789
be read to not apply to items such as interest paid on loans and borrowings between the
reporting entity and its associates or joint ventures, since such loans and borrowings do