IAS 28 INVESTMENTS IN ASSOCIATES AND IAS 28 (2011) INVESTMENTS IN ASSOCIATES AND JOINT VENTURES

1 INTRODUCTION

IAS 28 prescribes the accounting treatment of investments in associates. Associates are generally accounted for according to the equity method in the investor's consolidated financial statements.

In May 2011, the IASB amended IAS 28. The new version of the standard has to be applied in the financial statements as at Dec 31, 2013 (if the entity's reporting periods start on Jan 01 and end on Dec 31). Earlier application is permitted by the IASB (IAS 28.45). However, in the European Union, new IFRSs have to be endorsed by the European Union before they can be applied. There has been no endorsement with regard to the new version of IAS 28 as yet.

This chapter of the book is structured as follows:

• Section 2 discusses the rules applicable if the entity decides not to apply the new version of IAS 28 early.
• Section 3 discusses the main differences between the “old” and the “new” version of IAS 28.

2 FINANCIAL REPORTING WITHOUT EARLY APPLICATION OF THE AMENDMENTS TO IAS 28 ISSUED IN MAY 2011

2.1 The Term “Associate” and Scope of IAS 28

IAS 28 is applied in accounting for investments in associates (IAS 28.1). An associate is an entity (IAS 28.2).

• over which the investor has significant influence, and
• that is neither a subsidiary nor a joint venture.

Significant influence is the power to participate in the financial and operating policy decisions of the investee. However, if there is control or joint control, this rules out the existence of significant influence within the meaning of IAS 28 (IAS 28.2).

If an investor holds – directly or indirectly (e.g. through subsidiaries) – (IAS 28.6):

• 20% or more of the voting power of the investee, it is presumed that this results in significant influence over the investee unless it can be clearly demonstrated that this is not the case (refutable presumption of significant influence).
• Less than 20% of the voting power of the investee, it is presumed that this does not result in significant influence over the investee unless such influence can be clearly demonstrated (refutable presumption that there is no significant influence).

A substantial or majority ownership by another investor does not necessarily eliminate the possibility of the investor having significant influence (IAS 28.6). However, together with other facts this may indicate that there is no significant influence.

The presumptions above may be refuted by assessing qualitative criteria, which may involve discretion. Significant influence generally exists when one or more of the following criteria are met (IAS 28.7):

• Representation on the board of directors or equivalent governing body of the investee.
• Participation in policy-making processes, including participation in decisions about dividends of the investee.
• Material transactions between the investor and the investee.
• Interchange of managerial personnel between the investor and the investee.
• Provision of essential technical information.

Assessing whether there is significant influence is not only made on the basis of existing voting rights. Potential voting rights (e.g. share call options or convertible bonds that give the investor additional voting power when they are exercised or converted) also have to be taken into account if they are currently exercisable or convertible. Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until the occurrence of a future event or until a future date. All facts and circumstances that affect potential voting rights have to be examined except the intention of management and the financial ability to exercise or convert (IAS 28.8–28.9). The rules regarding potential voting rights in IAS 28.8–28.9 correspond with those for subsidiaries in IAS 27.14–27.15.1

IAS 28 does not apply to investments in associates held by venture capital organizations and mutual funds, unit trusts and similar entities (including investment-linked insurance funds) that are measured at fair value through profit or loss in accordance with IFRS 9 (IAS 28.1).

2.2 The Equity Method

2.2.1 Overview

In the investor's consolidated financial statements, investments in associates are usually accounted for using the equity method (IAS 28.13–28.14). According to this method, the shares are initially recognized at cost and adjusted thereafter for the post-acquisition change in the investor's share of net assets of the investee (IAS 28.2).

More precisely, the carrying amount of an investment in an associate is at first increased or decreased by the investor's share of the profit or loss of the investee after the acquisition date. This means that the investor's entry is “Dr Share of the profit or loss of associates Cr Investment” (if the associate has suffered a loss) or “Dr Investment Cr Share of the profit or loss of associates” (if the associate has generated a profit). Distributions received from an investee reduce the carrying amount of the investment, meaning that the entry in the investor's statement of financial position is “Dr Cash Cr Investment” (IAS 28.11). The carrying amount of the investment in the associate also changes, for example, if the associate issues shares against cash. In this case, the investor's entry is “Dr Investment Cr Cash”.

On the acquisition date it is necessary to determine the difference between the fair values of the investee's identifiable assets and liabilities and their carrying amounts in the investee's financial statements (fair value differences). A positive difference between the cost of the investment and the investor's share of the net fair value of the associate's identifiable assets and liabilities represents goodwill. In the investor's consolidated statement of financial position, such goodwill is not recognized as a separate asset. Instead, it is included in the carrying amount of the investment in the associate (IAS 28.23). This applies similarly regarding the investor's share of the fair value differences.

After the acquisition date, goodwill must not be amortized. Moreover, after the acquisition date, the investor's share of the change in the fair value differences (see above) of the associate has to be taken into account. For example, it might be the case that the fair value of a building of the associate exceeded the building's carrying amount on acquisition date. The resulting fair value difference has to be depreciated after the acquisition date. The investor's share of that depreciation affects the carrying amount of the investment in the associate as well as the investor's share of the profit or loss of the associate (IAS 28.23).

If the cost of the investment is below the investor's share of the net fair value of the associate's identifiable assets and liabilities, the difference (negative goodwill) is included as income when determining the investor's share of the associate's profit or loss in the period in which the investment is acquired (IAS 28.23b). As a result of the corresponding entry “Dr Investment Cr Share of the profit or loss of associates”, the carrying amount of the investment increases above cost.

The investor's share of the investee's other comprehensive income (e.g. arising from revaluations according to IAS 16) has to be taken into account when applying the equity method. This affects the investor's other comprehensive income (IAS 28.11). If an investor loses significant influence over an associate, the investor shall account for all amounts recognized in other comprehensive income related to that associate on the same basis as would be required if the associate had directly disposed of the related assets or liabilities. For example, if an associate has cumulative exchange differences relating to a foreign operation and the investor loses significant influence over the associate, the investor reclassifies the amounts previously recognized in other comprehensive income in relation to the foreign operation to profit or loss (IAS 28.19A).

The following applies when determining the share of the investor in the associate (expressed as a percentage) for the purpose of applying the equity method:

• The investor's share reflects present ownership interests, which means that it does not include potential voting rights. This differs from the assessment of whether there is significant influence (IAS 28.12).
• The group's share in an associate is the aggregate of the holdings in that associate by the parent and its subsidiaries. The holdings of the group's other associates or joint ventures are ignored for this purpose (IAS 28.21).

An important exception from applying the equity method to associates in the investor's consolidated financial statements are those investments that meet the definition of “held for sale” and are therefore accounted for in accordance with IFRS 5 (IAS 28.13–28.14). When the definition of “held for sale” is no longer met, the investment has to be accounted for according to the equity method as from the date of its classification as “held for sale.” This means that it is also necessary to adjust comparative information for prior periods (IAS 28.15).

2.2.2 Impairment Losses and Reversals of Impairment Losses

Investments in associates are tested for impairment as follows (IAS 28.31–28.33):

• The requirements of IAS 39 are applied when assessing whether the investment is impaired.
• If this is the case, the amount of the impairment loss is determined according to IAS 36 by comparing the investment's carrying amount with its recoverable amount. The recoverable amount of an investment is the higher of its value in use and its fair value less costs to sell.

Value in use is determined by estimating either of the following amounts (IAS 28.33):

• The investor's share of the present value of the estimated future cash flows expected to be generated by the associate.
• The present value of the estimated future cash flows expected to arise from dividends to be received from the associate and from its ultimate disposal. In our opinion it is necessary to assume that the entire profits are distributed even if this is not expected to take place in reality.

An impairment loss is not allocated to any asset that is included in the carrying amount of the investment in the associate. Therefore, the components goodwill and fair value adjustments that form part of the investment's carrying amount are not affected by the impairment loss. Instead, the impairment loss is treated as a separate component of the investment's carrying amount, which has a negative amount. Any reversal of the impairment loss is recognized according to IAS 36 to the extent that the recoverable amount of the investment subsequently increases (IAS 28.33).

The recoverable amount of an investment in an associate is determined for each associate, unless the associate does not generate cash inflows from continuing use that are largely independent of those from other assets of the entity (IAS 28.34).

2.2.3 Uniform Accounting Policies

When applying the equity method, the financial statements of the associate have to be adjusted to the accounting policies that are applied in the investor's consolidated financial statements (IAS 28.26–28.27).

When an associate has subsidiaries, joint ventures or associates, the profits or losses and net assets taken into account in applying the equity method are those recognized in the associate's financial statements (including the associate's share of the profits or losses and net assets of its joint ventures and associates), after any adjustments to uniform accounting policies (IAS 28.21).

2.2.4 Elimination of Intragroup Profits and Losses

Many of the procedures appropriate for the application of the equity method are similar to the consolidation procedures of IAS 27 for subsidiaries (IAS 28.20). An example is the elimination of intragroup profits or losses, required by IAS 27 (IAS 27.21).2 Profits and losses resulting from transactions between the investor (including its consolidated subsidiaries) and an associate are recognized by the investor only to the extent of unrelated investors' interests in the associate. For example, if the interest in an associate is 25%, this means that 25% of such profits and losses are eliminated while 75% of such profits or losses are presented in the investor's consolidated financial statements. Moreover, the following distinction is necessary (IAS 28.22):

• Upstream transactions (e.g. sales of assets from the associate to the investor): In such cases, the asset acquired is recognized in the investor's consolidated financial statements whereas the profit arising from the sale of the asset is included in the associate's financial statements. Therefore, the investor's elimination entry is “Dr Share of the profit or loss of associates Cr Asset acquired.” However, some authors believe that the entry “Dr Share of the profit or loss of associates Cr Investment” is acceptable, or even more appropriate.
• Downstream transactions (e.g. sales of assets from the investor to the associate): In such cases, the asset has already been derecognized in the investor's consolidated financial statements. Therefore, the investor's elimination entry is “Dr Profit (from the sale of the asset) Cr Investment.”

2.2.5 Continuing Losses

According to the equity method, losses of the associate reduce the carrying amount of the investment in the associate. Hence, in the case of continuing losses, the carrying amount of the investment would decrease to below zero after a certain period of time. However, according to IAS 28, the investor discontinues recognizing its share of further losses in such cases. This means that the carrying amount of the investment cannot become negative. If the associate subsequently reports profits, the investor resumes recognizing its share of those profits (by increasing the carrying amount of the investment) only after its share of the profits equals the share of losses that have not been recognized. There are some exceptions to these procedures (e.g. when the investor has incurred legal or constructive obligations or made payments on behalf of the associate) (IAS 28.29–28.30).

2.2.6 Balance Sheet Date of the Financial Statements of the Associate

When the associate's reporting period ends before the investor's balance sheet date, the difference between the balance sheet dates must not be more than three months. Otherwise, the associate has to prepare (for the use of the investor) financial statements as of the same date as the financial statements of the investor. In the case of differing balance sheet dates, adjustments have to be made for the effects of significant transactions or events that occur between these dates (IAS 28.24–28.25).

2.2.7 Application of the Concept of Materiality

In the case of associates, application of the concept of materiality (IAS 8.8) is often of particular importance. IFRSs, and consequently also the rules of IAS 28, relating to the equity method need not be applied when the effect of applying them is immaterial. Consequently, simplified procedures may be possible when applying the equity method in some cases.

2.3 Presentation

Investments accounted for using the equity method have to be presented as a separate line item in the statement of financial position (IAS 1.54e). The share of the profit or loss of these investments has to be presented as a separate line item in the statement of comprehensive income (IAS 1.82c). Also, the share of the other comprehensive income I and of the other comprehensive income II of investments accounted for using the equity method have to be presented as separate line items in the statement of comprehensive income. They must not be allocated to the other items of other comprehensive income (IAS 1.82A and 1.BC106c).

It is questionable whether impairment losses and reversals of impairment losses relating to investments in associates have to be included in the line item “share of the profit or loss of investments accounted for using the equity method” or not. In our opinion both approaches are acceptable.

2.4 Separate Financial Statements of the Investor

In separate financial statements it is not possible to account for investments in associates using the equity method. Instead, investments in associates are accounted for either (IAS 28.35 and IAS 27.38):

If investments in associates are accounted for in accordance with IFRS 9 in the consolidated financial statements they have to be accounted for in the same way in the investor's separate financial statements (IAS 27.40).

2.5 Preparation of the Consolidated Financial Statements

The starting point for the application of the equity method is the aggregated financial statements of the investor and its subsidiaries. The aggregated financial statements result from adding together like items of assets, liabilities, equity, income, and expenses included in the statements of financial position II and in the statements of comprehensive income II of the investor and its subsidiaries.4 In the aggregated statement of financial position, the investment is included on the basis of its carrying amount determined according to the rules described in Section 2.4. Thus, at each balance sheet date of the investor's consolidated financial statements, that carrying amount has to be adjusted to the carrying amount determined according to the equity method. Thereby, amounts having affected profit or loss of previous periods are recognized directly in retained earnings, in the current period.5

2.6 Examples with Solutions6

Example 1

Indirect voting power

Parent P and its subsidiary S hold shares of entity A:

Required

(a) Determine whether it can be refutably presumed that A is an associate in P's consolidated financial statements.

(b) If this is the case, assume that A is an associate and determine the interest in A (expressed as a percentage) that is used when applying the equity method.

Hints for solution

In particular Sections 2.1 and 2.2.1.

Solution

(a) When determining whether there is significant influence over A, the shares held by S also have to be taken into account in full. Together P and S hold 20% of the voting power of A. This means that it is refutably presumed that there is significant influence over A and that A is therefore an associate (IAS 28.6).

(b) The equity method is applied on the basis of 20%, which means that 20% of the associate's profit or loss is recognized in P's consolidated financial statements. For example, 20% of a loss of A would have to be recognized as a reduction of the carrying amount of the investment in A (IAS 28.21). Part of the associate's profit or loss is attributed to the non-controlling interest in S.

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Example 2

Application of the equity method – introductory example

On Jan 01, 01, entity E gains significant influence over entity A by acquiring 25% of the shares of A for CU 100. Thus, A becomes an associate of E. The carrying amount of A's equity as at Jan 01, 01, is CU 280. On Jan 01, 01, fair value of A's buildings exceeds their carrying amount in A's separate financial statements by CU 40. On that date, the remaining useful life of these buildings is 10 years. On Dec 31, 03, A pays a dividend of CU 20 to its owners. E's share of this dividend is CU 5 (= CU 20 · 25%).

A generates the following amounts of profit or loss:

Year	A's profit or loss for the year
01	–40
02	−72
03	–76

E accounts for its investment in A at cost in its separate financial statements (IAS 28.35 and IAS 27.38).

Posting status (in E's separate financial statements):

Required

Prepare any necessary entries in E's consolidated financial statements for the years 01–03 and determine the amount of goodwill that is part of the carrying amount of E's investment in A. The reporting periods of both E and A end on Dec 31.

Hints for solution

In particular Sections 2.2.1 and 2.5.

Solution

Goodwill, which is part of the carrying amount of the investment in A, is the excess of the cost of the investment over the investor's share of the net fair value of the associate's identifiable assets and liabilities (IAS 28.23a):

	100%	25%
Carrying amount of A's equity	280	70
Fair value adjustment (buildings)	40	10
Fair value of A's equity	320	80
Cost		100
Goodwill		20

Jan 01, 01

In E's consolidated financial statements the shares are initially measured at their cost of CU 100 (IAS 28.11). This is the same accounting treatment as in E's separate financial statements. Hence, no further entry is necessary on Jan 01, 01.

Dec 31, 01

In E's separate financial statements as at Dec 31, 01, no entry is necessary with regard to the investment, which is accounted for at cost. This means that the investment's carrying amount remains CU 100.

By contrast, in E's consolidated financial statements the equity method has to be applied. Consequently, the carrying amount of the investment is adjusted for E's share of A's profit and for E's share of the depreciation of the fair value adjustment in respect of the buildings:

Dec 31, 02

In 02, the carrying amount of the investment changes as follows in E's consolidated financial statements according to the equity method:

	100%	25%
Carrying amount of the investment as at Jan 01, 02		109
Loss for 02	−72	−18
Depreciation of the fair value adjustment	−4	−1
Change in the carrying amount in 02		–19
Carrying amount of the investment as at Dec 31, 02		–90

The starting point for the entries necessary when applying the equity method is E's aggregated financial statements for the current reporting period in which the carrying amount of the investment in A is included on the basis of its cost of CU 100. Thus, the carrying amount of the investment of CU 100 has to be reduced to CU 90. E's share of A's loss and of the depreciation of the fair value adjustment relating to the buildings result in a loss of CU –19, which has to be recognized by E in 02 according to the equity method. The amount of CU +9 recognized in profit or loss in 01 is recognized in retained earnings in 02.7

Dec 31, 03

In 03, the carrying amount of the investment changes as follows in E's consolidated financial statements according to the equity method:

	100%	25%
Carrying amount of the investment as at Jan 01, 03		90
Profit for 03	–76	19
Distribution	−20	−5
Depreciation of the fair value adjustment	−4	−1
Change in the carrying amount in 03		13
Carrying amount of the investment as at Dec 31, 03		103

The starting point for the entries necessary when applying the equity method is E's aggregated financial statements for the current reporting period in which the carrying amount of the investment in A is included on the basis of its cost of CU 100. Thus, the carrying amount of the investment of CU 100 has to be increased to CU 103. The dividend income that is included in E's aggregated statement of comprehensive income has to be eliminated because, according to the equity method, dividends reduce the carrying amount of the investment. E's share of A's profit and of the depreciation of the fair value adjustment result in income of CU +18, which has to be recognized by E in 03 according to the equity method. The amount of CU –19 recognized in profit or loss in 02 as well as the amount of CU +9 recognized in retained earnings in 02 are recognized in retained earnings in 03 (CU –19 + CU 9 = CU –10).8

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Example 3

Impairment loss and reversal of the impairment loss

The situation is the same as in Example 2. However, it is assumed that A's profit or loss in each of the years 01–03 is zero and that there is no dividend. Recoverable amount of the investment in A is CU 75 on Dec 31, 01, CU 74 on Dec 31, 02, and CU 105 on Dec 31, 03. Assume that no impairment loss for the investment in A is recognized in E's separate financial statements.

Required

Prepare any necessary entries in E's consolidated financial statements for the years 01–03. The reporting periods of both E and A end on Dec 31.

E does not include impairment losses relating to associates in the line item “share of the profit or loss of investments accounted for using the equity method” in its statement of comprehensive income.

Hints for solution

In particular Sections 2.2.1, 2.2.2, and 2.5.

Solution

Year 01

In E's consolidated financial statements the shares are initially measured at their cost of CU 100 (IAS 28.11). This is the same accounting treatment as in E's separate financial statements. Hence, no further entry is necessary on Jan 01, 01.

In E's separate financial statements as at Dec 31, 01 no entry is made with regard to the investment which is accounted for at cost. This means that the investment's carrying amount remains CU 100.

By contrast, in E's consolidated financial statements the equity method has to be applied, which is illustrated below.

On Jan 01, 01, the carrying amount of the investment consists of the following components (see Example 2):

Goodwill	20
Fair value adjustment (buildings)	10
Remaining part of the investment	70
Carrying amount of the investment as at Jan 01, 01	100

In 01, the carrying amount of the investment changes as follows:

Carrying amount as at Jan 01, 01	100
Depreciation of the fair value adjustment	−1
Carrying amount as at Dec 31, 01 (before testing for impairment)	99
Recoverable amount	75
Impairment loss	−24

It is important to note that the impairment loss must not be allocated to any asset that is included in the carrying amount of the investment in the associate. Consequently, goodwill and the fair value adjustment are not changed by the impairment. Instead, the impairment loss is a separate component of the investment's carrying amount, which has a negative amount (IAS 28.33). Hence, the investment consists of the following components as at Dec 31, 01:

Goodwill	20
Fair value adjustment (buildings)	9
Impairment	−24
Remaining part of the investment	70
Carrying amount of the investment as at Dec 31, 01	75

E does not include impairment losses relating to associates in the line item “share of the profit or loss of investments accounted for using the equity method” in its statement of comprehensive income. Consequently, the following entry is made:

Year 02

In 02, only the fair value adjustment relating to the buildings is depreciated, which has the following effect on the carrying amount of the investment and its components:

In 03, the fair value adjustment relating to the buildings is depreciated, which reduces the carrying amount of the investment to CU 73:

Reversing the impairment loss of CU 24 recognized in 01 would increase the carrying amount of the investment from CU 73 to CU 97. Since the recoverable amount is CU 105 on Dec 31, 03, the reversal of the impairment loss is recognized in full:

Accordingly, the investment consists of the following components, on Dec 31, 03:

Goodwill	20
Fair value adjustment (buildings)	7
Remaining part of the investment	70
Carrying amount of the investment as at Dec 31, 03	97

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Example 4

Negative goodwill

On Dec 31, 01, entity E gains significant influence over entity A, by acquiring 25% of the shares of A for CU 8. This means that A becomes an associate of E. Fair value of A's equity as at Dec 31, 01, is CU 40. E accounts for the investment in A at cost in its separate financial statements (IAS 28.35 and IAS 27.38).

Posting status (in E's separate financial statements):

Required

Assess whether negative goodwill arises in E's consolidated financial statements in connection with the acquisition of A. If this is the case, prepare the appropriate entry. The reporting periods of both E and A end on Dec 31, 01.

Hints for solution

In particular Section 2.2.1.

Solution

Since the cost of the investment of CU 8 is below E's share of the fair value of A's equity of CU 10 (= CU 40 · 25%), negative goodwill of CU 2 arises, which has to be recognized as income (IAS 28.23b). In E's separate financial statements the carrying amount of the investment is CU 8. Consequently, the carrying amount of the investment has to be increased by CU 2 (i.e. from CU 8 to CU 10) in E's consolidated financial statements.

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Example 5

Continuing losses

On Jan 01, 01, entity E makes a contribution in cash of CU 10 during the incorporation of entity A, for which E receives 25% of the shares of A. After that, A is an associate of E.

A generates the following amounts of profit or loss:

Year	A's profit or loss for the year
01	−24
02	−28
03	+20

E accounts for its investment in A at cost, in its separate financial statements (IAS 28.35 and IAS 27.38).

Posting status (in E's separate financial statements):

Required

Prepare any necessary entries in E's consolidated financial statements for the years 01–03. The reporting periods of both E and A end on Dec 31. Presume that E has neither incurred legal or constructive obligations nor made payments on behalf of the associate (IAS 28.30).

Hints for solution

In particular Section 2.2.5.

Solution

In E's consolidated financial statements the shares are initially recognized at their cost of CU 10 (IAS 28.11). This is the same accounting treatment as in E's separate financial statements. Hence, no further entry is necessary on Jan 01, 01.

On Dec 31, 01, E recognizes its share of A's loss of CU 6 (= CU 24 · 25%):

E's share of A's loss for 02 of CU 7 (= CU 28 · 25%) is only recognized to the extent of CU 4 because the carrying amount of the investment would otherwise become negative (IAS 28.29–28.30).

In 03, E resumes recognizing its share of A's profits of CU 5 (= CU 20 · 25%) only after its share of the profits equals the share of losses that have not been recognized in 02. The latter amount is CU 3. Therefore, E only recognizes income in the amount of CU 2 (IAS 28.30).

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Example 6A

Other comprehensive income arising from equity instruments held by the associate – early application of IFRS 9 (as issued in Oct 2010)9

The situation is the same as in Example 5. However, A's profit or loss for 01 is zero. Moreover, on Jan 01, 01, A acquires shares of entity X for CU 8, which are measured by A at fair value through other comprehensive income (IFRS 9.5.7.1b and 9.5.7.5). On Dec 31, 01, fair value of these shares is CU 12. On Aug 03, 02, A sells the shares for CU 12. With respect to equity instruments measured at fair value through other comprehensive income, no transfers of the fair value reserve to retained earnings are made (IFRS 9.B5.7.1).

Required

Prepare any necessary entries in E's consolidated financial statements from Jan 01, 01 until Aug 03, 02. The reporting periods of both E and A end on Dec 31.

Hints for solution

In particular Section 2.2.1.

Solution

In E's consolidated financial statements, the shares are initially recognized at their cost of CU 10 (IAS 28.11). This is the same accounting treatment as in E's separate financial statements. Hence, no further entry is necessary on Jan 01, 01.

On Dec 31, 01, A makes the following entry in its financial statements relating to the shares: “Dr Shares Cr Other comprehensive income I (fair value reserve) CU 4.” Accordingly, E recognizes its share of the associate's other comprehensive income I (OCI I) of CU 1 (= CU 4 · 25%) in a separate item of OCI in its consolidated financial statements (IAS 1.82A and 1.BC106c):

On Aug 03, 02, A derecognizes the shares (“Dr Cash Cr Shares”). No further entry is made by A. According to the equity method, E does not make any entry in this regard.

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Example 6B

Other comprehensive income arising from equity instruments held by the associate – application of the “old” version of IAS 3910

The situation is the same as in Example 5. However, A's profit or loss for 01 is zero. Moreover, on Jan 01, 01, A acquires shares of entity X for CU 8, which are classified as “available for sale” (IAS 39.9) by A. On Dec 31, 01, fair value of these shares is CU 12. On Aug 03, 02 A sells the shares for CU 12.

Required

Prepare any necessary entries in E's consolidated financial statements from Jan 01, 01 until Aug 03, 02. The reporting periods of both E and A end on Dec 31.

Hints for solution

In particular Section 2.2.1.

Solution

In E's consolidated financial statements, the shares are initially recognized at their cost of CU 10 (IAS 28.11). This is the same accounting treatment as in E's separate financial statements. Hence, no further entry is necessary on Jan 01, 01.

On Dec 31, 01, A makes the following entry in its financial statements relating to the shares classified as “available for sale” (IAS 39.55b): “Dr Shares Cr Other comprehensive income II (fair value reserve) CU 4.” Accordingly, E recognizes its share of the associate's other comprehensive income II (OCI II) of CU 1 (= CU 4 · 25%) in a separate item of OCI in its consolidated financial statements (IAS 1.82A and 1.BC106c):

On Aug 03, 02, A derecognizes the shares and consequently also the fair value reserve in its financial statements (IAS 39.55b): “Dr OCI II (fair value reserve) Cr Profit or loss CU 4.” E makes a corresponding entry in its consolidated financial statements:

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Example 7

Elimination of intragroup profits and losses

Entity E holds 25% of the shares of its associate A.

Version (a)

In 01, A purchases merchandise for CU 16, which it sells (and delivers) to E for CU 20, i.e. A's profit margin is CU 4 (ignoring other costs). In 02, E sells (and delivers) that merchandise to its customers.

Version (b)

In 01, E purchases merchandise for CU 16, which it sells (and delivers) to A for CU 20, i.e. E's profit margin is CU 4 (ignoring other costs). In 02, A sells (and delivers) that merchandise to its customers.

Required

Prepare any necessary entries in E's consolidated financial statements for the years 01 and 02. The reporting periods of both E and A end on Dec 31.

Hints for solution

In particular Sections 2.2.4 and 2.5.

Solution (a)

Year 01

The sale of the merchandise to E represents an upstream transaction. A has generated an intragroup profit of CU 4 (= CU 20 – CU 16) by selling the merchandise to E. The intragroup profit has to be eliminated to the extent of E's interest in A, i.e. to the extent of 25% (CU 4 · 25% = CU 1). The elimination is effected by reducing the carrying amount of the merchandise (or alternatively, the carrying amount of the investment in A) by CU 1:

Year 02

At first the profit or loss recognized in 01 has to be recognized in retained earnings. Since E already sold the merchandise the profit of CU 1 has to be recognized:

Solution (b)

Year 01

The sale of the merchandise to A represents a downstream transaction. In E's consolidated financial statements, revenue and cost of sales are only included to the extent of 75%. This means that 25% of E's revenue (CU 5) and 25% of E's cost of sales (CU 4) are eliminated. The difference of CU 1 reduces the carrying amount of E's investment in A because the merchandise sold has already been derecognized in E's consolidated financial statements:

Year 02

The entry presented above resulted in a total reduction of profit or loss of CU 1. This amount has to be recognized in retained earnings, in 02. Since A already sold the merchandise, the revenue and cost of sales eliminated in 01 have to be recognized.

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3 THE AMENDMENTS TO IAS 28 ISSUED IN MAY 2011

The most important changes from the previous version of IAS 28 are as follows (IAS 28.BC56):

• The accounting for joint ventures has been incorporated into IAS 28. IFRS 11 is applied in order to determine the type of joint arrangement in which the investor is involved. Once it has determined that it has an interest in a joint venture, the investor recognizes an investment and accounts for it using the equity method according to IAS 28 (unless the investor is exempted from applying the equity method) (IAS 28.IN6). However, it is important to note that the “old” requirements for jointly controlled entities specified in IAS 31 also referred to IAS 28 with regard to the rules for applying the equity method (if the entity elected to measure jointly controlled entities according to the equity method and not using proportionate consolidation) (IAS 31.40). Hence, this change (excluding the new rules of IFRS 11,11 which among others prohibit proportionate consolidation) will not affect the accounting treatment of interests in joint ventures, in most cases.
• The scope exceptions for venture capital organizations and mutual funds, unit trusts and similar entities, including investment-linked insurance funds12 have been eliminated and characterized as measurement exemptions from the requirement to measure investments in joint ventures and associates according to the equity method.
• The new version of IAS 28 also requires a portion of an investment in a joint venture or an associate to be classified as “held for sale” if the disposal of that portion would fulfill the criteria to be so classified according to IFRS 5. Any retained portion in the investment not classified as “held for sale” has to be accounted for according to the equity method until disposal of the portion classified as “held for sale” takes place (even if the disposal will have the effect that neither significant influence nor joint control will exist in the future). After the disposal has effectively taken place, the entity has to assess whether (IAS 28.20 and 28.15):
  • the retained interest is still an interest in an associate or joint venture that has to be accounted for according to the equity method, or
  • the retained interest neither represents a joint venture nor an associate, which means that it has to be accounted for according to IFRS 9.
• The consensus of SIC 13 has been incorporated into IAS 28.
• The disclosure requirements have been placed in IFRS 12.

1 See the chapter on IAS 27/IFRS 10, Section 2.1.

2 See the chapter on IAS 27/IFRS 10, Section 2.3.4.

3 If IFRS 9 was not applied early, the investments would normally be measured at fair value. However, the equity instruments would be measured at cost if fair value could not be determined reliably (IAS 39.AG80–39.AG81).

4 See the chapter on IAS 27/IFRS 10, Section 2.3.1.

5 In this respect we also refer to the considerations in the chapter on IFRS 3, Section 9, regarding the repetition of consolidation entries of prior periods.

6 Deferred tax is ignored in these examples. Moreover, it is presumed that there are no differences between the associate's separate financial statements and its statement of financial position II and statement of comprehensive income II.

7 See Section 2.5.

8 See Section 2.5.

9 See the chapter on IFRS 9/IAS 39, Section 2.3.7 with regard to equity instruments designated as “at fair value through other comprehensive income.”

10 The “old” version of IAS 39 refers to the version of IAS 39 before IFRS 9 and its consequential amendments. See the chapter on IFRS 9/IAS 39, Section 3.2 with regard to equity instruments classified as “available for sale.”

11 See the chapter on IAS 31/IFRS 11, Section 3.

12 See Section 2.1.