2.1.1.A Investments acquired for own shares or other equity instruments

In some jurisdictions, local law may permit investments acquired for an issue of shares to be recorded at a notional value (for example, the nominal value of the shares issued). In our view, this is not an appropriate measure of cost under IFRS.

A transaction in which an investment in a subsidiary, associate or joint venture is acquired in exchange for an issue of shares or other equity instruments is not specifically addressed under IFRS, since it falls outside the scope of both IFRS 9 and also IFRS 2 (see Chapter 34 at 2.2.3).

However, we believe that it would be appropriate, by analogy with IFRS on related areas (like IFRS 3), to account for such a transaction at the fair value of the consideration given (being fair value of equity instruments issued) or the assets received, if that is more reliably measured, together with directly attributable transaction costs.

2.1.1.B Investments acquired in common control transactions

When an investment in a subsidiary, associate or joint venture is acquired in a common control transaction, in our view, the cost should generally be measured at the fair value of the consideration given (be it cash, other assets or additional shares) plus, where applicable any costs directly attributable to the acquisition. However, when the purchase consideration does not correspond to the fair value of the investment acquired, in our view, the acquirer has an accounting policy choice to account for the investment at fair value of consideration given or may impute an equity contribution or dividend distribution and in effect account for the investment at its fair value.

Example 8.1 below illustrates the determination of the cost of an investment in a subsidiary in separate financial statements as described above.

In July and September 2011, the Interpretations Committee discussed group reorganisations in separate financial statements in response to a request asking for clarification on how entities that are established as new intermediate parents within a group determine the cost of their investments when they account for these investments at cost in accordance with paragraph 10(a) of IAS 27. In the agenda decision issued, the Interpretations Committee noted that the normal basis for determining the cost of an investment in a subsidiary under paragraph 10(a) of IAS 27 has to be applied to reorganisations that result in the new intermediate parent having more than one direct subsidiary.⁷ This differs from the wording in the original proposed wording for the tentative decision which referred to ‘the general principle of determining cost by the fair value of the consideration given’.⁸

Some have read this to mean that ‘the normal basis for determining the cost of investment’ in a common control transaction is not restricted to using the fair value of the consideration given, but that another basis for determining cost may be appropriate. One situation where we believe that it would be acceptable not to use the fair value of the consideration given is for a common control transaction where an investment in a subsidiary constituting a business is acquired in a share-for-share exchange. In that circumstance, we believe that it is also acceptable to measure the cost based on the carrying amount of the investment in the subsidiary in the transferor entity's separate financial statements immediately prior to the transaction, rather than at the fair value of the shares given as consideration.

Common control transactions are discussed further at 4 below. There are specific measurement requirements applicable to certain arrangements involving the formation of a new parent or intermediate parent, which are described at 2.1.1.E and 2.1.1.F below.

2.1.1.C Cost of investment in subsidiary, associate or joint venture acquired in stages

It may be that an investment in a subsidiary, associate or joint venture is acquired in stages so that, up to the date on which control, significant influence or joint control is first achieved, the initial investment was accounted for at fair value under IFRS 9. This raises the question of what the carrying amount should be in the separate financial statements when the cost method is applied.

The Interpretations Committee discussed this issue and concluded in January 2019 how an entity should apply the requirements of paragraph 10 of IAS 27 for the following fact pattern: the entity holds an initial investment in another entity (investee) that is an investment in an equity instrument as defined in paragraph 11 of IAS 32 – Financial Instruments: Presentation; the investee is not an associate, joint venture or subsidiary of the entity and, accordingly, the entity applies IFRS 9 in accounting for its initial investment (initial interest); subsequently the entity acquires an additional interest in the investee (additional interest), which results in the entity obtaining control of the investee, i.e. the investee becomes a subsidiary of the entity.

The Interpretations Committee observed that IAS 27 does not define ‘cost’, nor does it specify how an entity determines the cost of an investment acquired in stages and concluded that a reasonable reading of the requirements in IFRSs could result in the application of either one of the following two approaches:

• Approach 1 Fair value as deemed cost approach

  Under this approach the transaction is viewed as if the entity is exchanging its initial interest (plus consideration paid for the additional interest) for a controlling interest in the investee (exchange view). As a result the cost of investment will be determined as the fair value of the initial interest at the date of obtaining control of the subsidiary, plus any consideration paid for the additional interest.

• Approach 2 Accumulated cost approach

  Under this approach the transaction is viewed as if the entity is purchasing the additional interest while retaining the initial interest (non-exchange view). As a result, the cost of investment will be determined as the consideration paid for the initial interest (original consideration), plus any consideration paid for the additional interest.

Based on its analysis, the Committee concluded that a reasonable reading of the IFRS requirements could result in the application of either one of the two approaches.

In the exchange view the step acquisition transaction is considered a significant economic event – this is because an entity obtains control. The parallel can be drawn, for example, to a business combination achieved in stages [IFRS 3.BC384] or an entity that ceases to be an investment entity. [IFRS 10. BC271]. In these situations, the fair value of the existing investment is deemed to be the consideration paid at the date of the transaction or event.

On the other hand, the accumulated cost approach considers both, the initial acquisition of an interest that is neither an interest in a subsidiary, an associate or a joint venture and the acquisition of the controlling stake to be separate transactions.

The application of either one of the two approaches is an accounting policy choice and hence it should be applied consistently to all step acquisition transactions. The selected approach would also be disclosed in accordance with requirements of paragraphs 117‑124 of IAS 1 – Presentation of Financial Statements.

Although both approaches are acceptable, the Committee decided to report to the Board that, in their view, the fair value as deemed cost approach would provide more useful information to users of financial statements than the accumulated cost approach.⁹

The Committee also considered how an entity should account for any difference between the fair value of the initial interest at the date of obtaining control and its original consideration when applying the accumulated cost approach. The Committee concluded that the difference meets the definitions of income or expenses in the Conceptual Framework for Financial Reporting. Accordingly, the Committee concluded that, the entity recognises this difference in profit or loss, regardless of whether, before obtaining control, the investment had been measured at fair value through profit and loss or fair value through other comprehensive income, in accordance with paragraph 88 of IAS 1.

The two approaches are further explained in the following Example 8.2:

If changes to the carrying amount of the investment had resulted from an impairment charge, this charge may not necessarily be reversed. This is because the investment must still be considered for impairment in the separate financial statements of the investor.

Although the January 2019 agenda decision does not deal with IAS 28, we believe that it could also be applied by analogy to step acquisition transactions where an existing investment accounted for under IFRS 9 subsequently becomes an associate or a joint venture, to which the equity method is applied.

2.1.1.D Investment in a subsidiary accounted for at cost: Partial disposal

An entity that accounts for its investments in subsidiaries at cost in accordance with paragraph 10 of IAS 27 might dispose of parts of its investment in a subsidiary so that following the disposal the entity has neither control, joint control nor significant influence over the investee. This raises the question of how the carrying amount of the retained interests should be determined in the separate financial statements.

The Interpretations Committee, during its September 2018 and January 2019 meetings, discussed how an entity should account for a transaction whereby it disposes of part of its investment in a subsidiary that was previously accounted for at cost in accordance with paragraph 10 of IAS 27, so that following the disposal the entity has neither control, joint control nor significant influence over the investee.¹⁰

The Committee concluded that paragraph 9 of IAS 27 requires an entity to apply all applicable IFRSs in preparing its separate financial statements, except when accounting for investments in subsidiaries, associates and joint ventures to which paragraph 10 of IAS 27 applies. After the partial disposal transaction, the investee is not a subsidiary, associate or joint venture of the entity. Accordingly, the entity applies IFRS 9 for the first time in accounting for its retained interest in the investee. The Committee observed that the presentation election in paragraph 4.1.4 of IFRS 9 applies at initial recognition of an investment in an equity instrument which permits the holder of particular investments in equity instruments to present subsequent changes in fair value in other comprehensive income. Therefore, an investment in an equity instrument within the scope of IFRS 9 is eligible for the election if it is neither held for trading (as defined in Appendix A of IFRS 9) nor contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies.

Assuming the retained interest is not held for trading in the fact pattern discussed by the Committee:

1. the retained interest is eligible for the presentation election in paragraph 4.1.4 of IFRS 9, and
2. the entity would make this presentation election when it first applies IFRS 9 to the retained interest (i.e. at the date of losing control of the investee).¹¹

Any difference between the cost of the retained interest and its fair value on the date the entity loses control of the investee meets the definitions of income or expense in the Conceptual Framework for Financial Reporting. Accordingly, the Committee concluded that, applying paragraph 88 of IAS 1, the entity recognises this difference in profit or loss. This is the case regardless of whether the entity presents subsequent changes in fair value of the retained interest in profit or loss or other comprehensive income. The Committee also noted that its conclusion is consistent with the requirements in paragraph 22(b) of IAS 28 and paragraph 11B of IAS 27, which deal with similar and related issues.

2.1.1.E Formation of a new parent

IAS 27 explains how to calculate the cost of the investment when a parent reorganises the structure of its group by establishing a new entity as its parent and meets the following criteria:

1. the new parent obtains control of the original parent by issuing equity instruments in exchange for existing equity instruments of the original parent;
2. the assets and liabilities of the new group and the original group are the same immediately before and after the reorganisation; and
3. the owners of the original parent before the reorganisation have the same absolute and relative interests in the net assets of the original group and the new group immediately before and after the reorganisation.

The new parent measures cost at the carrying amount of its share of the equity items shown in the separate financial statements of the original parent at the date of the reorganisation (see 2.1.1.F below). [IAS 27.13].

This approach also applies if the entity that puts a new parent between it and the shareholders is not itself a parent, i.e. it has no subsidiaries. In such cases, references in the three conditions to ‘original parent’ and ‘original group’ are to the ‘original entity’. [IAS 27.14].

The type of reorganisation to which these requirements apply involves an existing entity and its shareholders agreeing to create a new parent between them without changing either the composition of the group or their own absolute and relative interests. This is not a general rule that applies to all common control transactions. Transfers of subsidiaries from the ownership of one entity to another within a group are not within the scope. The IASB has deliberately excluded extending the amendment to other types of reorganisations or to common control transactions more generally because of its plans to address this in its project on common control transactions. [IAS 27.BC27].

The IASB has identified business combinations under common control as a priority research project. In June 2014, the Board tentatively decided that the research project should consider business combinations under common control and group restructurings, and to give priority to considering transactions that involve third parties.¹² In October 2017, the Board tentatively decided to clarify that the scope of the business combinations under common control project includes transactions under common control in which a reporting entity obtains control of one or more businesses, regardless of whether IFRS 3 would identify the reporting entity as the acquirer if IFRS 3 were applied to the transaction.¹³ The scope will not specify to which financial statements of that reporting entity – consolidated, separate or individual – any accounting requirements developed in this project will apply. This is because the financial statements affected by any accounting requirements developed in the business combinations under common control project will depend on specifics of the transaction. This is also consistent with how the scope is set out in IFRS 3.¹⁴ The next step planned is the issuance of a Discussion Paper for public comment in the first half of 2020.¹⁵

In the meantime, entities will continue to account for such common control transactions in accordance with their accounting policies (see Chapter 10 at 3 and 4.4 below).

As well as the establishment of a new ultimate parent of a group, arrangements that could meet the criteria in paragraph 13 of IAS 27 mentioned above include the following:

1. Reorganisations in which the new parent does not acquire all classes of the equity instruments issued by the original parent.

   For example, the original parent may have preference shares that are classified as equity in addition to ordinary shares; the new parent does not have to acquire the preference shares in order for the transaction to be within scope. [IAS 27.BC24(a)].

2. A new parent obtains control of the original parent without acquiring all of the ordinary shares of the original parent. [IAS 27.BC24(a)]. The absolute and relative holdings must be the same immediately before and after the transaction. [IAS 27.13(c)].

   The requirements will apply, for example, if a controlling group of shareholders insert a new entity between themselves and the original parent that holds all of their original shares in the same ratio as before.

3. The establishment of an intermediate parent within a group. [IAS 27.BC24(b)].

   The principle is exactly the same as inserting a new parent company over the top of a group. ‘Original Parent’ will be an intermediate company within a group, owned by another group company. If the transaction is within scope, the intermediate parent will acquire Original Parent from its parent (the Owner) in a share for share swap. The group structure before and after the transaction can be summarised as follows:

If the composition of the underlying group changes, perhaps because the intermediate parent acquires only part of that group or because it acquires another subsidiary as part of the reorganisation, then the arrangement will not be within scope as the assets and liabilities of the group immediately after the reorganisation would not be ‘the same’ as those immediately before the reorganisation. [IAS 27.13(b)]. However, there might be arrangements where to establish an intermediate parent, shares have to be issued for an amount of cash, the value of which is typically driven by various legal concerns. Consequently, the assets and liabilities of the new group differ from the assets and liabilities of the original group (or subgroup) by the amount of cash received on the initial issue of shares by intermediate parent. In those cases, the issuance of shares of the intermediate parent in exchange for cash was merely done to allow the entity to be incorporated under the local jurisdiction. We believe that such arrangements are within the scope of the exemption, provided that the amount of cash is truly ‘de minimis’; that is, not sufficient to form a substantive part of the group reorganisation transaction such that the assets and liabilities of the group immediately before and after the reorganisation might still be considered ‘the same’.

The formation of a new parent was also considered by the Interpretation Committee in 2011. The Interpretations Committee noted ‘that the normal basis for determining the cost of an investment in a subsidiary under […] paragraph 10(a) of IAS 27 […] has to be applied to reorganisations that result in the new intermediate parent having more than one direct subsidiary. […] Paragraphs 13 and 14 of IAS 27 […] apply only when the assets and liabilities of the new group and the original group (or original entity) are the same before and after the reorganisation’. The Interpretations Committee observed that the reorganisations that result in the new intermediate parent having more than one direct subsidiary do not meet the conditions in IAS 27 and therefore the exemptions for group reorganisations in IAS 27 do not apply. They also cannot be applied by analogy because this guidance is an exception to the normal basis for determining the cost of investment in a subsidiary.¹⁶

For example, if in the group structure as presented above, the Intermediate Parent had been inserted between the Original Parent and its subsidiaries, paragraphs 13 and 14 of IAS 27 would not apply as there are several subsidiaries acquired by the Intermediate Parent. In this case, there has been no ‘parent’ that has been established by the Intermediate Parent as its new parent.

2.1.1.F Formation of a new parent: calculating the cost and measuring equity

IAS 27 states that the new parent measures cost at the carrying amount of its share of the ‘equity items’ shown in the separate financial statements of the original parent at the date of the reorganisation. [IAS 27.13]. It does not define ‘equity items’ but the term appears to mean the total equity in the original parent, i.e. its issued capital and reserves attributable to owners. This will be the equity as recorded in IFRS financial statements, so it will exclude shares that are classified as liabilities and include, for example, the equity component of a convertible loan instrument.

It is important to stress that the new parent does not record its investment at the consideration given (the shares that it has issued) or at the assets received (the fair value of the investments it has acquired or the book cost of those investments). Instead, it must look down, to the total of the equity in the original parent, which is the acquired entity. Even then, it does not record the investment at the amount of original parent's investments but at the amount of its equity; that is to say, its net assets.

The requirements do not apply to the measurement of any other assets or liabilities in the separate financial statements of either the original parent or the new parent, or in the consolidated financial statements. [IAS 27.BC25].

It is possible for the original parent to have negative equity because its liabilities exceed its assets. IAS 27 does not discuss this but we consider that in these circumstances the investment should be recorded at zero. There is no basis for recording an investment as if it were a liability.

The above applies only when the new parent issues equity instruments but it does not address the measurement of the equity of the new parent. IFRS has no general requirements for accounting for the issue of own equity instruments. Rather, consistent with the position taken by the Conceptual Framework that equity is a residual rather than an item ‘in its own right’, the amount of an equity instrument is normally measured by reference to the item (expense or asset) in consideration for which the equity is issued, as determined in accordance with IFRS applicable to that other item. The new parent will record the increase in equity at the carrying amount of the investments it has acquired (i.e. at cost), regardless of the amount and face value of the equity instruments issued.

The amount at which the new parent's issued share capital is recorded will depend on the relevant law in the jurisdiction applicable to the new parent. The shares may be recorded at fair value, which is the fair value of the investments acquired, or at an amount calculated on some other basis. Local law may allow a company to record its issued share capital at a nominal amount, e.g. the nominal (face) value of the shares. In some jurisdictions, intermediate holding companies that acquire an asset from a parent (the ‘transferor’) for shares at a premium are required by law to record the share capital issued (its nominal value and share premium) at the carrying value in the transferor's books of the asset transferred; if the nominal value exceeds this book amount, the shares are recorded at their total nominal value.

Once the share capital has been recorded, there will usually need to be an adjustment to equity so that in total the equity is equal to the carrying amount (i.e. cost) of the investments acquired. This adjustment may increase or decrease the acquirer's equity (comparing to share capital value) as it depends on the relative carrying amounts of the investment in the owner, original parent's equity and the number and value of the shares issued as consideration, as shown in the following example.

2.1.1.G Reverse acquisitions in the separate financial statements

For the purposes of consolidated financial statements IFRS 3 takes the view that the acquirer is usually the entity that issues its equity interests to acquire other entity, but recognises that in some business combinations, so-called ‘reverse acquisitions’, the issuing entity is the acquiree (see Chapter 9 at 14).

Under IFRS 3, a reverse acquisition occurs when the entity that issues securities (the legal acquirer) is identified as the acquiree for accounting purposes based on the guidance in the IFRS 3 (see Chapter 9 at 4.1). Perhaps more accurately, the legal acquiree must be identified as the acquirer for accounting purposes.

Existing IFRSs do not contain any guidance on accounting for reverse acquisitions in the separate financial statements. The application guidance in IFRS 3 only deals with the reverse acquisition accounting in the consolidated financial statements (see Chapter 9 at 14.3); no mention is made as to what should happen in the separate financial statements, if any, of the legal parent/accounting acquiree. However, the previous version of IFRS 3 indicated that reverse acquisition accounting applies only in the consolidated financial statements, and that in the legal parent's separate financial statements, the investment in the legal subsidiary is accounted for in accordance with the requirements in IAS 27. [IFRS 3 (2007).B8].

2.4.1.A The dividend exceeds the total comprehensive income

There are circumstances in which receipt of a dividend will trigger the first indicator, even if the dividend is payable entirely from the profit for the period.

First, the indicator states that the test is by reference to the income in the period in which the declaration is made. Dividends are usually declared after the end of the period to which they relate; an entity whose accounting period ends on 31 December 2020 will not normally declare a dividend in respect of its earnings in that period until its financial statements have been drawn up, i.e. some months into the next period ended 31 December 2021. We assume that it is expected that the impairment review itself will take place at the end of the period, in line with the general requirements of IAS 36 referred to above, in which case the dividends received in the period will be compared to the income of the subsidiary for that period. This means that there may be a mismatch in that, say, dividends declared on the basis of 2020 profits will be compared to total comprehensive income in 2021, but at least the indicator of impairment will be by reference to a completed period.

Second, the test is by reference to total comprehensive income, not profit or loss for the period. Total comprehensive income reflects the change in equity during a period resulting from transactions and other events, other than those changes resulting from transactions with owners in their capacity as owners. Total comprehensive income takes into account the components of ‘other comprehensive income’ that are not reflected in profit or loss that include:

1. changes in revaluation surpluses of property, plant and equipment or intangible assets (see Chapters 18 and 17, respectively);
2. remeasurements of defined benefit plans (see Chapter 35);
3. gains and losses arising from translating the financial statements of a foreign operation (see Chapter 15);
4. fair value changes from financial instruments measured at fair value through other comprehensive income (see Chapter 49); and
5. the effective portion of gains and losses on hedging instruments in a cash flow hedge (see Chapter 53). [IAS 1.7].

This means that all losses on remeasurement that are allowed by IFRS to bypass profit or loss and be taken directly to other components of equity are taken into account in determining whether a dividend is an indicator of impairment. If a subsidiary, joint venture or associate pays a dividend from its profit for the year that exceeds its total comprehensive income because there have been actuarial losses on the pension scheme or a loss on remeasuring its hedging derivatives, then receipt of that dividend is an indicator of impairment to the parent.

The opposite must also be true – a dividend that exceeds profit for the period but does not exceed total comprehensive income (if, for example, the entity has a revaluation surplus on its property) is not an indicator of impairment. However, IAS 36 makes clear that its list of indicators is not exhaustive and if there are other indicators of impairment then the entity must carry out an impairment test in accordance with IAS 36. [IAS 36.13].

It must be stressed that this test is solely to see whether a dividend triggers an impairment review. It has no effect on the amount of dividend that the subsidiary, joint venture or associate may pay, which is governed by local law.

2.4.1.B The carrying amount exceeds the consolidated net assets

An indicator of impairment arises if, after paying the dividend, the carrying amount of the investment in the separate financial statements exceeds the carrying amount in the consolidated financial statements of the investee's net assets, including associated goodwill.

It will often be clear when dividends are paid out of profits for the period by subsidiaries, joint ventures or associates, whether the consolidated net assets of the investee in question have declined below the carrying amount of the investment. However, this might require the preparation of consolidated financial statements by an intermediate parent which is exempted from the preparation of consolidated financial statements.

Similar issues to those described above may arise, e.g. the subsidiary, joint venture or associate may have made losses or taken some sort of remeasurement to other comprehensive income in the period in which the dividend is paid. However, it is the net assets in the consolidated financial statements that are relevant, not those in the subsidiary's, joint venture's or associate's own financial statements, which may be different if the parent acquired the subsidiary.

Testing assets for impairment is described in Chapter 20. There are particular problems to consider in trying to assess the investments in subsidiaries, joint ventures and associates for impairment. These are discussed in Chapter 20 at 12.4.

2.4.1.C Returns of capital

Returns of share capital are not usually considered to be dividends and hence they are not directly addressed by IAS 27. They are an example of a ‘distribution’, the broader term applied when an entity gives away its assets to its members.

At first glance, a return of capital appears to be an obvious example of something that ought to reduce the carrying value of the investment in the parent. We do not think that is necessarily the case. Returns of capital cannot easily be distinguished from dividends. For example, depending on local law, entities may be able to:

• make repayments that directly reduce their share capital; or
• create reserves by transferring amounts from share capital into retained earnings and, at the same time or later, pay dividends from that reserve.

Returns of capital can be accounted for in the same way as dividends, i.e. by applying the impairment testing process described above. However, the effect on an entity that makes an investment (whether on initial acquisition of a subsidiary or on a subsequent injection of capital) and immediately receives it back (whether as a dividend or return of capital) generally will be that of a return of capital that reduces the carrying value of the parent's investment. In these circumstances there will be an impairment that is equal to the dividend that has been received (provided that the consideration paid as investment was at fair value). If there is a delay between the investment and the dividend or return of capital then the impairment (if any) will be a matter of judgement based on the criteria discussed above.

2.4.2.A Scope

IFRIC 17 applies to any distribution of a non-cash asset, including one that gives the shareholder a choice of receiving either non-cash assets or a cash alternative if it is within scope. [IFRIC 17.3].

The Interpretations Committee did not want the Interpretation to apply to exchange transactions with shareholders, which can include an element of distribution, e.g. a sale to one of the shareholders of an asset having a fair value that is higher than the sales price. [IFRIC 17.BC5]. Therefore, it applies only to non-reciprocal distributions in which all owners of the same class of equity instruments are treated equally. [IFRIC 17.4].

The Interpretation does not apply to distributions if the assets are ultimately controlled by the same party or parties before and after the distribution, whether in the separate, individual and consolidated financial statements of an entity that makes the distribution. [IFRIC 17.5]. This means that it will not apply to distributions made by subsidiaries but only to distributions made by parent entities or individual entities that are not themselves parents. In order to avoid ambiguity regarding ‘common control’ and to ensure that demergers achieved by way of distribution are dealt with, the Interpretation emphasises that ‘common control’ is used in the same sense as in IFRS 3. A distribution to a group of individual shareholders will only be out of scope if those shareholders have ultimate collective power over the entity making the distribution as a result of contractual arrangements. [IFRIC 17.6].

If the non-cash asset distributed is an interest in a subsidiary over which the entity retains control, this is accounted for by recognising a non-controlling interest in the subsidiary in equity in the consolidated financial statements of the entity, as required by IFRS 10 paragraph 23 (see Chapter 7 at 4). [IFRIC 17.7].

2.4.2.B Recognition, measurement and presentation

A dividend is not a liability until the entity is obliged to pay it to the shareholders. [IFRIC 17.10]. The obligation arises when payment is no longer at the discretion of the entity, which will depend on the requirements of local law. In some jurisdictions, the UK for example, shareholder approval is required before there is a liability to pay. In other jurisdictions, declaration by management or the board of directors may suffice.

The liability is measured at the fair value of the assets to be distributed. [IFRIC 17.11]. If an entity gives its owners a choice of receiving either a non-cash asset or a cash alternative, the entity estimates the dividend payable by considering both the fair value of each alternative and the associated probability of owners selecting each alternative. [IFRIC 17.12]. IFRIC 17 does not specify any method of assessing probability nor its effect on measurement.

IFRS 5's requirements apply also to a non-current asset (or disposal group) that is classified as held for distribution to owners acting in their capacity as owners (held for distribution to owners). [IFRS 5.5A, 12A, 15A]. This means that assets or asset groups within scope of IFRS 5 will be carried at the lower of carrying amount and fair value less costs to distribute. [IFRS 5.15A]. Assets not subject to the measurement provisions of IFRS 5 are measured in accordance with the relevant standard. In practice, most non-cash distributions of assets out of scope of the measurement provisions of IFRS 5 will be of assets held at fair value in accordance with the relevant standard, e.g. financial instruments and investment property carried at fair value. [IFRS 5.5]. Accordingly there should be little difference, if any, between their carrying value and the amount of the distribution.

The liability is adjusted as at the end of any reporting period at which it remains outstanding and at the date of settlement with any adjustment being taken to equity. [IFRIC 17.13]. When the liability is settled, the difference, if any, between its carrying amount and the carrying amount of the assets distributed is accounted for as a separate line item in profit or loss. [IFRIC 17.14‑15]. IFRIC 17 does not express any preference for particular line items or captions in the income statement.

It is rare for entities to distribute physical assets such as property, plant and equipment to shareholders, although these distributions are common within groups and hence out of scope of IFRIC 17. In practice, the Interpretation will have most effect on demergers by way of distribution, as illustrated in the following example.

The entity must disclose, if applicable:

1. the carrying amount of the dividend payable at the beginning and end of the period: and
2. the increase or decrease in the carrying amount recognised in the period as a result of a change in the fair value of the assets to be distributed. [IFRIC 17.16].

If an entity declares a dividend that will take the form of a non-cash asset after the end of a reporting period but before the financial statements are authorised the following disclosure should be made:

1. the nature of the asset to be distributed;
2. the carrying amount of the asset to be distributed as of the end of the reporting period; and
3. the estimated fair value of the asset to be distributed as of the end of the reporting period, if it is different from its carrying amount, and the information about the method used to determine that fair value required by IFRS 13 – paragraphs 93(b), (d), (g) and (i) and 99 (see Chapter 14 at 20.3). [IFRIC 17.17].

4.4.1.A Sale of PP&E from the parent to the subsidiary for an amount of cash not representative of the fair value of the asset.

The parent and subsidiary are both parties to the transaction and both must recognise it. As the asset is recognised by the acquiring entity at cost, and not necessarily at fair value, a choice exists as to how the cost is determined. Does the consideration comprise two elements, cash and equity, or cash alone?

In some jurisdictions, some entities are legally required to conduct such transactions at fair value.

However, what if the asset is sold for more than fair value? What are the implications if, in the above example, the PP&E sold for 80 has a carrying value of 80 but its fair value is 75? There are a number of explanations that may affect the way in which the transaction is accounted for:

• The excess reflects additional services or goods included in the transaction, e.g. future maintenance that will be accounted for separately.
• The excess reflects the fact that the asset's value in use (‘VIU’) is at least 80. There are instances when PP&E is carried at an amount in excess of fair value because its VIU, or the VIU of the cash-generating unit of which it is a part, is unaffected by falls in fair value. Plant and machinery often has a low resale value; vehicles lose much of their fair value soon after purchase; and falls in property values may not affect the VIU of the head office of a profitable entity (see Chapter 20). In such cases there is no reason why the subsidiary cannot record the asset it has acquired for the cash it has paid, which means that it effectively inherits the transferor's carrying value. An impairment test potentially would not reveal any requirement to write down the asset, assuming of course that other factors do not reduce the asset's VIU (e.g. the fact that the asset will after the sale be part of a different cash generating unit).
• The excess over fair value is a distribution by the subsidiary to the parent that will be accounted for in equity. This treatment is a legal requirement in some jurisdictions, which means that the overpayment must meet the legal requirements for dividends, principally that there be sufficient distributable profits to meet the cost.
• The asset is impaired before transfer, i.e. both its fair value and VIU are lower than its carrying amount, in which case it must be written down by the transferor before the exchange takes place. If it is still sold for more than its fair value, the excess will be accounted for as a distribution received (by the parent) and a distribution made by the subsidiary (as above).

4.4.1.B The parent exchanges PP&E for a non-monetary asset of the subsidiary.

The parent and subsidiary are both parties to the transaction and both must recognise it. The exchange of an asset for another non-monetary asset is accounted for by recognising the received asset at fair value, unless the transaction lacks commercial substance (as defined by IAS 16) or the fair value of neither of the exchanged assets can be measured reliably. [IAS 16.24]. The requirements of IAS 16 are explained in Chapter 18 at 4.4; the treatment required by IAS 38 and IAS 40 is the same.

The mere fact that an exchange transaction takes place between entities under common control does not of itself indicate that the transaction lacks commercial substance. However, in an exchange transaction between unrelated parties the fair value of the assets is usually the same but this does not necessarily hold true of transactions between entities under common control.

If the fair value of both assets can be measured reliably there may be a difference between the two. IAS 16 suggests that, if an entity is able to determine reliably the fair value of either the asset received or the asset given up, then the fair value of the asset given up is used to measure the cost of the asset received. [IAS 16.26]. However, IAS 16 actually requires an entity to base its accounting for the exchange on the asset whose fair value is most clearly evident. [IAS 16.26]. If fair values are different it is possible that the group entities have entered into a non-reciprocal transaction. This means that the entity has the policy choice described at 4.3 above, which in this case means that there are three alternative treatments; it can recognise the transaction as follows:

• Method (a) – an exchange of assets at fair value of the asset received with an equity transaction. Any difference between the fair value of the asset received and the fair value of the asset given up is an equity transaction, while the difference between the carrying value of the asset given up and its fair value is recognised in profit or loss;
• Method (b) – an exchange of assets at fair value of the asset received without recognising an equity element. The asset received is recognised at its fair value with any resulting difference to the carrying value of the asset given up is recognised in profit or loss; or
• Method (c) – apply a ‘cost’ method based on IAS 16 (the fair value of the asset given up is used to measure the cost of the asset received) under which each entity records the asset at the fair value of the asset it has given up. This could result in one of the parties recording the asset it had received at an amount in excess of its fair value, in which case it may be an indicator for impairment of the asset. It would be consistent with the principles outlined at 4.3 above to treat the write down as an equity transaction, i.e. an addition to the carrying value of the subsidiary by the parent and a distribution by the subsidiary.

If the fair value of only one of the exchanged assets can be measured reliably, IAS 16 allows both parties to recognise the asset they have received at the fair value of the asset that can be measured reliably. [IAS 16.26]. Underlying this requirement is a presumption that the fair value of both assets is the same, but one cannot assume this about common control transactions.

If the fair value of neither of the exchanged assets can be measured reliably, or the transaction does not have commercial substance, both the parent and subsidiary recognise the received asset at the carrying amount of the asset they have given up.

4.4.1.C Acquisition and sale of assets for shares

These transactions include the transfer of inventory, property plant and equipment, intangible assets, investment property and investments in subsidiaries, associates and joint ventures by one entity in return for shares of the other entity. These transactions are usually between a parent and subsidiary where the subsidiary is the transferee that issues shares to the parent in exchange for the assets received.

1. Accounting treatment by the subsidiary

Transactions that include the transfer of inventory, property plant and equipment, intangible assets, and investment property are within the scope of IFRS 2, as goods have been received in exchange for shares. The assets are recognised at fair value, unless the fair value cannot be estimated reliably, and an increase in equity of the same amount is recognised. If the fair value of the assets cannot be estimated reliably, the fair value of the shares is used instead. [IFRS 2.10].

Transactions in which an investment in a subsidiary, associate or joint venture is acquired in exchange for shares is not specifically addressed under IFRS, since it falls outside the scope of both IFRS 9 and IFRS 2. However, we believe that it would be appropriate, by analogy with IFRS on related areas (like IFRS 3), to account for such a transaction at the fair value of the consideration given (being fair value of equity instruments issued) or the assets received, if that is more easily measured, together with directly attributable transaction costs. As discussed at 2.1.1.B above, when the purchase consideration does not correspond to the fair value of the investment acquired, in our view, the acquirer has an accounting policy choice to account for the investment at fair value of the consideration given or may impute an equity contribution or dividend distribution and in effect account for the investment at its fair value. Alternatively, if the investment in a subsidiary constitutes a business and is acquired in a share-for-share exchange, it is also acceptable to measure the cost based on the original carrying amount of the investment in the subsidiary in the transferor entity's separate financial statements, rather than at the fair value of the shares given as consideration.

2. Accounting treatment by the parent

The parent has disposed of an asset in exchange for an increased investment in a subsidiary. Based on what has been said at 2.1.1 above, the cost of investment should be recorded at the fair value of the consideration given i.e. the fair value of the asset sold. Such a transaction has also the nature of an exchange of assets and by analogy to paragraph 24 of IAS 16, the investment should be measured at fair value unless the exchange transaction lacks commercial substance or the fair value of neither the investment received nor the asset given up is reliably measurable. If the investment cannot be measured at fair value, it is measured at the carrying value of the asset given up. [IAS 16.24].

The asset's fair value may be lower than its carrying value but it is not impaired unless its VIU is insufficient to support that carrying value (see 4.4.1.A above). If there is no impairment, the parent is not prevented from treating the carrying value of the asset as an addition to the investment in the subsidiary solely because the fair value is lower. If the asset is impaired then this should be recognised before reclassification, unless the reorganisation affects, and increases, the VIU.

If the fair value is higher than the carrying value and the investment is accounted for at fair value as discussed above, the transferring entity recognises a gain. In certain circumstances it might not be appropriate to account for the transaction at fair value due to lack of commercial substance. For example, exchanging the asset for an investment in the shares of a subsidiary that holds nothing but the asset given as consideration may not give rise to a gain on transfer.

4.4.1.D Contribution and distribution of assets

These transactions include transfers of inventory, property plant and equipment, intangible assets, investment property and investments in subsidiaries, associates and joint ventures from one entity to another for no consideration. These arrangements are not contractual but are equity transactions: either specie capital contributions (an asset is gifted by a parent to a subsidiary) or non-cash distributions (an asset is given by a subsidiary to its parent). IFRIC 17 explicitly excludes intra-group non-cash distributions from its scope (see 2.4.2 above). [IFRIC 17.5].

The relevant standards (IAS 2, IAS 16, IAS 38 and IAS 40) refer to assets being recognised at cost. Similarly, investments in subsidiaries, associates and joint ventures may be recognised at cost under IAS 27 as discussed at 2.1 above. Following the principles described at 4.3 above, the entity receiving the asset has a choice: recognise it at zero or at fair value. It is in practice more common for an entity that has received an asset in what is purely an equity transaction to recognise it at fair value.

The entity that gives away the asset must reflect the transaction. A parent that makes a specie capital contribution to its subsidiary will recognise an increased investment in that subsidiary (in principle at fair value, recognising a gain or loss based on the difference from the carrying amount of the asset) provided the increase does not result in the impairment of the investment, or an expense (based on the carrying amount of the asset given away). A subsidiary that makes a distribution in specie to its parent might account for the transaction by derecognising the distributed asset at its carrying value against retained earnings. However, the subsidiary could also account for the distribution at fair value, if the fair value could be established reliably. This would potentially result in recognising a gain in profit or loss for the difference between the fair value of the asset and its carrying value. There would also be a charge to equity for the distribution, recognised and measured at the fair value of the asset. This is consistent with IFRIC 17, although the distribution is not in scope.

4.4.1.E Transfers between subsidiaries

As noted at 4.2 above, similar principles apply when the arrangement is between two subsidiaries rather than a subsidiary and parent. To illustrate this, assume that the transaction in Example 8.8 above takes place between two subsidiaries rather than parent and subsidiary.

In some circumstances the transfer of an asset from one subsidiary to another may affect the value of the transferor's assets to such an extent as to be an indicator of impairment in respect of the parent's investment in its shares. This can happen if the parent acquired the subsidiary for an amount that includes goodwill and the assets generating part or all of that goodwill have been transferred to another subsidiary. As a result, the carrying value of the shares in the parent may exceed the fair value or VIU of the remaining assets. This is discussed further in Chapter 20 at 12.3.

4.4.2.A Has a business been acquired?

IFRS 3 defines a business as ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs or other economic benefits directly to investors or other owners, members or participants’. [IFRS 3 Appendix A]. See Chapter 9 at 3.2 for descriptions of the features of a business.

4.4.2.B If a business has been acquired, how should it be accounted for?

As described in Chapter 10 at 3, we believe that until such time as the IASB finalises its conclusions under its project on common control transactions entities should apply either:

1. the pooling of interest method; or
2. the acquisition method (as in IFRS 3).

In our view, where the acquisition method of accounting is selected, the transaction must have substance from the perspective of the reporting entity. This is because the method results in a reassessment of the value of the net assets of one or more of the entities involved and/or the recognition of goodwill. Chapter 10 discusses the factors that will give substance to a transaction and although this is written primarily in the context of the acquisition of an entity by another entity, it applies equally to the acquisition of a business by an entity or a legal merger of two subsidiaries.

4.4.2.C Purchase and sale of a business for equity or cash not representative of the fair value of the business

The principles are no different to those described at 4.4.1.A above. The entity may:

• recognise the transaction at fair value, regardless of the values in any agreement, with any difference between that amount and fair value recognised as an equity transaction; or
• recognise the transaction at the consideration agreed between the parties, being the amount of cash paid or fair value of shares issued.

From the perspective of the acquirer of the business, the above choice matters only when the acquisition method is applied in accounting for the business acquired. Depending on which approach is applied, goodwill on the acquisition may be different (or there can even be a gain on bargain purchase recognised). This is discussed further in Chapter 10 at 3.2. When the pooling of interest method is applied, the difference between the consideration paid and carrying value of net assets received is always recognised in equity no matter whether the consideration agreed between the parties represents the fair value of the business. If no consideration is payable for the transfer of the business, this could affect the assessment as to whether the transaction has substance to enable the acquisition method to be applied.

From the perspective of the seller of the business, the choice will impact any gain or loss recognised on the disposal. Recognising the transaction on the basis of the consideration agreed will result in a gain or loss based on the difference between the consideration received and the carrying value of the business disposed. Recognising the transaction at fair value including an equity element imputed will result in the gain or loss being the difference between the fair value of the business and its carrying value. If no consideration is received for the transfer of the business, the transaction may be considered to be more in the nature of a distribution in specie, the accounting for which is discussed at 4.4.1.D above.

4.4.2.D If the net assets are not a business, how should the transactions be accounted for?

Even though one entity acquires the net assets of another, this is not necessarily a business combination. IFRS 3 rules out of scope acquisitions of assets or net assets that are not businesses, noting that:

1. ‘This IFRS does not apply to […] the acquisition of an asset or a group of assets that does not constitute a business. In such cases the acquirer shall identify and recognise the individual identifiable assets acquired (including those assets that meet the definition of, and recognition criteria for, intangible assets in IAS 38 – Intangible Assets) and liabilities assumed. The cost of the group shall be allocated to the individual identifiable assets and liabilities on the basis of their relative fair values at the date of purchase. Such a transaction or event does not give rise to goodwill.’ [IFRS 3.2(b)].

If the acquisition is not a business combination, it will be an acquisition of assets for cash or shares or for no consideration (see 4.4.1.A, 4.4.1.C and 4.4.1.D above).

4.4.3.A Distributions of businesses without consideration – subsidiary transferring business to the parent.

From one perspective the transfer is a distribution and the model on which to base the accounting is that of receiving a dividend. Another view is that the parent has exchanged the investment in shares for the underlying assets and this is essentially a change in perspective from an equity interest to a direct investment in the net assets and results. Neither analogy is perfect, although both have their supporters.

In all circumstances, the following two major features will impact the accounting of the transfer by the parent:

• whether the subsidiary transfers the entirety of its business or only part of it; and
• whether the transfer is accounted for at fair value or at ‘book value’.

Book value in turn may depend on whether the subsidiary has been acquired by the parent, in which case the relevant book values would be those reflected in the consolidated financial statements of the parent, rather than those in the subsidiary's financial statements.

The two perspectives (dividend approach and exchange of investment for assets) translate into two approaches to accounting by the parent:

1. Parent effectively has received a distribution that it accounts for in its income statement at the fair value of the business received. It reflects the assets acquired and liabilities assumed at their fair value, including goodwill, which will be measured as at the date of the transfer. The existing investment is written off to the income statement:
   • this treatment can be applied in all circumstances;
   • this is the only appropriate method when the parent carries its investment in shares at fair value applying IFRS 9;
   • when the subsidiary transfers one of its businesses but continues to exist, the investment is not immediately written off to the income statement, but is subject to impairment testing.
2. Parent has exchanged its investment or part of its investment for the underlying assets and liabilities of the subsidiary and accounts for them at book values. The values that are reported in the consolidated financial statements become the cost of these assets for the parent.
   • This method is not appropriate if the investment in the parent is carried at fair value, in which case method (i) must be applied.
   • When the subsidiary transfers one of its businesses but continues to exist, the investment is not immediately written off to the income statement, but is subject to impairment testing.

   The two linked questions when using this approach are how to categorise the difference between the carrying value of the investment and the assets transferred and whether or not to reflect goodwill or an ‘excess’ (negative goodwill) in the parent's financial statements. This will depend primarily on whether the subsidiary had been acquired by the parent (the only circumstances in which this approach allows goodwill in the parent's financial statements after the transfer) and how any remaining ‘catch up’ adjustment is classified.

These alternative treatments are summarised in the following table:

Notes

(1) If the parent established the subsidiary itself and its investment reflects only share capital it has injected an excess of the carrying value over the net assets received will not be recognised as goodwill. This generally arises because of losses incurred by the transferred subsidiary.

If the subsidiary's net assets exceed the carrying value of the investment then this will be due to profits or other comprehensive income retained in equity.

(2) The catch-up adjustment is not an equity transaction so all of it can be recognised in income. However, to the extent that it has arisen from a transaction that had occurred directly in equity, such as a revaluation, an entity can make a policy choice to recognise this element in equity. In this case the remaining amount is recognised in income. The entity can also take a view that as although the transfer of business is a current period transaction, the differences relate to prior period and hence should be recognised in equity.

(3) Because this was originally an acquisition, the values in the consolidated financial statements (and not the subsidiary's underlying records) become ‘cost’ for the parent. The assets and liabilities will reflect fair value adjustments made at the time of the business combination. Goodwill or negative goodwill will be the amount as at the date of the original acquisition.

If the business of the acquired subsidiary is transferred to the parent company as a distribution shortly after acquisition of that subsidiary, the accounting shall follow IAS 27 in relation to the dividend payment by the subsidiary. It might be accounted for effectively as a return of capital. The parent eliminates its investment in the subsidiary or part of its investment (based on the relative fair value of the business transferred compared to the value of the subsidiary), recognising instead the assets and liabilities of the business acquired at their fair value including the goodwill that has arisen on the business combination. The effect is to reflect the substance of the arrangement which is that the parent acquired a business. Comparative data is not restated in this case.

4.4.3.B Legal merger of parent and subsidiary

A legal merger can occur for numerous reasons, including facilitating a listing or structuring to transfer the borrowings obtained to acquire an entity to be repaid by the entity itself or to achieve tax benefits. Legal mergers always affect the individual or separate financial statements of the entities involved. As legal mergers are not specifically discussed in IFRS, different views and approaches are encountered in practice.

In many jurisdictions it is possible to effect a ‘legal merger’ of a parent and its subsidiary whereby the two separate entities become a single entity without any issue of shares or other consideration. This is usually the case when there is a legal merger of a parent with its 100% owned subsidiary. Depending on the jurisdiction, different scenarios might take place.

It is not uncommon for a new entity to be formed as a vehicle used in the acquisition of an entity from a third party in a separate transaction. Subsequently both entities legally merge. Judgement is required to make an assessment as to whether a legal merger occurs ‘close to’ the date of acquisition, including considering the substance of the transaction and the reasons for structuring. If this is the case i.e. a new entity is formed concurrently with (or near the date of) the acquisition of a subsidiary, and there is a legal merger of the new entity and the subsidiary, these transactions are viewed as a single transaction in which a subsidiary is acquired and is discussed in Chapter 9.

Even though the substance of the legal merger may be the same, whether the survivor is the parent or subsidiary affects the accounting.

a) The parent is the surviving entity

The parent's consolidated financial statements

The legal merger of the parent and its subsidiary does not affect the consolidated financial statements of the group. Only when non-controlling interests (NCI) are acquired in conjunction with the legal merger transaction, is the transaction with the NCI holders accounted for as a separate equity transaction (i.e. transactions with owners in their capacity as owners). [IFRS 10.23].

Even if there is no consolidated group after the legal merger, in our view, according to IFRS 10 consolidated financial statements are still required (including comparative financial statements) in the reporting period in which the legal merger occurs. Individual financial statements are the continuation of the consolidated group – in subsequent reporting periods, the amounts are carried forward from the consolidated financial statements (and shown as the comparative financial statements).

In the reporting period in which the legal merger occurs the parent is also permitted, but not required, to present separate financial statements under IFRS.

Separate financial statements

In the parent's separate financial statements two approaches are available, if the investment in the subsidiary was previously measured at cost. An entity chooses its policy and applies it consistently. Under both approaches, any amounts that were previously recognised in the parent's separate financial statements continue to be recognised at the same amount, except for the investment in the subsidiary that is merged into the parent.

We believe that approach (i) below, a distribution at fair value, is the preferable approach, but approach (ii) below, liquidation from the consolidated financial statements, is also acceptable.

1. The legal merger is in substance the distribution of the business from subsidiary to the parent.

   The investment in the subsidiary is first re-measured to fair value as at the date of the legal merger, with any resulting gain recognised in profit or loss. The investment in the subsidiary is then de-recognised. The acquired assets (including investments in subsidiaries, associates, or joint ventures held by the merged subsidiary) and assumed liabilities are recognised at fair value. Any difference gives rise to goodwill or income (bargain purchase, which is recognised in profit or loss).

2. The legal merger is in substance the redemption of shares in the subsidiary, in exchange for the underlying assets of the subsidiary.

   Giving up the shares for the underlying assets is essentially a change in perspective of the parent of its investment, from a ‘direct equity interest’ to ‘the reported results and net assets.’ Hence, the values recognised in the consolidated financial statements become the cost of these assets for the parent. The acquired assets (including investments in subsidiaries, associates, or joint ventures held by the merged subsidiary) and assumed liabilities are recognised at the carrying amounts in the consolidated financial statements as of the date of the legal merger. This includes any associated goodwill, intangible assets, or other adjustments arising from measurement at fair value upon acquisition that were recognised when the subsidiary was originally acquired, less the subsequent related amortisation, depreciation, impairment losses, as applicable.

   The difference between:

   1. the amounts assigned to the assets and liabilities in the parent's separate financial statements after the legal merger; and
   2. the carrying amount of the investment in the merged subsidiary before the legal merger;

   is recognised in one of the following (accounting policy choice):

   • profit or loss;
   • directly in equity; or
   • allocated to the appropriate component in the separate financial statements in the current period (e.g. current period profit or loss, current period other comprehensive income, or directly to equity) of the parent based on the component in which they were recognised in the financial statements of the merged subsidiary.

If the investment in the subsidiary was measured at fair value in the separate financial statements of the parent then only method (i) is applicable, because there is a direct swap of the investment with the underlying business. The parent would already have reflected the results of transactions that the subsidiary entered into since making its investment. Because the underlying investment in the subsidiary is de-recognised, this also triggers the reclassification of any amounts previously recognised in other comprehensive income and accumulated within a separate component of equity to be recognised in profit or loss.

In the separate financial statements, regardless of which approaches or varieties of approaches are used, comparative information should not be restated to include the merged subsidiary. The financial position and results of operations of the merged subsidiary are reflected in the separate financial statements only from the date on which the merger occurred.

b) The subsidiary is the surviving entity

Some argue that the legal form of a merger is more important in the context of the individual financial statements or separate financial statements of the subsidiary as these have a different purpose, being the financial statements of a legal entity. Others contend that as the legal mergers are not regulated in IFRS the accounting policy selected should reflect the economic substance of transactions, and not merely the legal form. This results in two possible approaches. We believe that approach (i) below, the economic approach, is the preferable approach and generally provides the most faithful representation of the transaction. However, approach (ii) below, the legal approach, may be appropriate when facts and circumstances indicate that the needs of the users of the general-purpose financial statements after the legal merger are best served by using the financial statements of the surviving subsidiary as the predecessor financial statements. This need must outweigh the needs of users who previously relied upon the general-purpose financial statements of the parent (as such information might no longer be available e.g. where following the merger there is no group). Consideration is given as to whether either set of users can otherwise obtain the information needed using special-purpose financial statements.

1. The economic approach

   The legal merger between the parent and subsidiary is considered to have no substance. The amounts recognised after the legal merger are the amounts that were previously in the consolidated financial statements, including goodwill and intangible assets recognised upon acquisition of that subsidiary. The consolidated financial statements after the legal merger also reflect any amounts in the consolidated financial statements (pre-merger) related to subsidiaries, associates, and joint ventures held by the surviving subsidiary. If the surviving subsidiary prepares separate financial statements after the legal merger, the subsidiary recognises the amounts that were previously recognised in the consolidated financial statements of the parent, as a contribution from the parent in equity.

2. The legal approach

   The financial statements after the legal merger reflect the legal form of the transaction from the perspective of the subsidiary. There are two methods (as described below) with respect to recognising the identifiable assets acquired of the parent or liabilities assumed from the parent; regardless of which is used, amounts recognised previously in the consolidated financial statements with respect to the parent's acquisition of the surviving subsidiary (e.g. goodwill, intangible assets, fair value purchase price adjustments) are not recognised by the subsidiary. The surviving subsidiary does not recognise any change in the basis of subsidiaries, associates and joint ventures that it held before the legal merger.

   Fair value method

   If a merged parent meets a definition of business, the transaction is accounted for as an acquisition, with the consideration being a ‘contribution’ from the parent recognised in equity at fair value. Principles in IFRS 3 apply then by analogy.

   The subsidiary recognises:

   1. the identifiable assets acquired and liabilities assumed from the parent at fair value;
   2. the fair value of the parent as a business as a contribution to equity; and
   3. the difference between (1) and (2) as goodwill or gain on a bargain purchase.

   If the merged parent does not meet the definition of a business, the identifiable assets acquired or liabilities assumed are recognised on a relative fair value basis.

   Book value method

   Under this method the subsidiary accounts for the transaction as a contribution from the parent at book values. The subsidiary recognises the identifiable assets acquired or liabilities assumed from the parent at the historical carrying amount and the difference in equity. The historical carrying amounts might be the carrying amounts previously recognised in the parent's separate financial statements, the amounts in the ultimate parent's consolidated financial statements, or in a sub-level consolidation (prior to the merger).

Whatever variation of the legal approach is applied, the subsidiary may not recognise amounts that were previously recognised in the consolidated financial statements that related to the operations of the subsidiary, because there is no basis in IFRS for the subsidiary to recognise fair value adjustments to its internally generated assets or goodwill that were recognised by its parent when it was first acquired. Therefore, the carrying amount of the assets (including investments in subsidiaries, associates, and joint ventures) and liabilities held by subsidiary are the same both before and after a legal merger (there is no revaluation to fair value). There is also no push-down accounting of any goodwill or fair value adjustments recognised in the consolidated financial statements related to the assets and liabilities of the subsidiary that were recognised when the parent acquired the subsidiary.

In the separate financial statements, regardless of which approaches or varieties of approaches are used, comparative information should not be restated to include the merged parent. The financial position and results of operations of the merged parent are reflected in the separate financial statements only from the date on which the merger occurred.

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 49 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.

The following example illustrates the accounting for a variety of intra-group loan arrangements.

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 49 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.