2.1 Basic principles

Consolidated financial statements represent the financial statements of a group (i.e. the parent and its subsidiaries) in which the assets, liabilities, equity, income, expenses and cash flows of the parent and its subsidiaries are presented as those of a single economic entity. [IFRS 10 Appendix A]. This approach is referred to as ‘the entity concept’. As noted in Chapter 6 at 10, an investment entity generally measures its investments in subsidiaries at fair value through profit or loss in accordance with IFRS 9 – Financial Instruments – with limited exceptions. [IFRS 10.31‑33].

When preparing consolidated financial statements, an entity first combines the financial statements of the parent and its consolidated subsidiaries on a ‘line-by-line’ basis by adding together like items of assets, liabilities, equity, income, expenses and cash flows. IFRS 10 requires a parent to prepare consolidated financial statements using uniform accounting policies for like transactions and other events in similar circumstances (see 2.6 below). [IFRS 10.19, 21, B87]. Consolidation of an investee begins from the date the investor obtains control of the investee and ceases when the investor loses control of the investee. [IFRS 10.20, 21, B88].

In order to present financial information about the group as that of a single economic entity, the entity must: [IFRS 10.21, B86]

1. combine like items of assets, liabilities, equity, income, expenses and cash flows of the parent with those of its subsidiaries;
2. offset (eliminate) the carrying amount of the parent's investment in each subsidiary and the parent's portion of equity of each subsidiary (IFRS 3 – Business Combinations – explains how to account for any related goodwill, [IFRS 3.B63(a)], – see Chapter 9 at 13); and
3. eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full). Intragroup losses may indicate an impairment that requires recognition in the consolidated financial statements. IAS 12 – Income Taxes – applies to temporary differences that arise from the elimination of profits and losses resulting from intragroup transactions. See 2.4 below.

Income and expenses of a subsidiary are based on the amounts of the assets and liabilities recognised in the consolidated financial statements at the acquisition date. IFRS 10 gives the example of depreciation expense, which will be based on the fair values of the related depreciable assets recognised in the consolidated financial statements at the acquisition date, [IFRS 10.21, B88], but many items will have a fair value on acquisition that will affect subsequent recognition of income and expense.

Point (b) above refers to the elimination of the parent's investment and the parent's portion of equity. The equity in a subsidiary not attributable, directly or indirectly, to the parent, represents a non-controlling interest. [IFRS 10 Appendix A]. The profit or loss and each component of other comprehensive income of a subsidiary are attributed to the owners of the parent and to the non-controlling interests. [IFRS 10.24, B94]. Non-controlling interests in subsidiaries are presented within equity, separately from the equity of the owners of the parent. [IFRS 10.22]. Changes in a parent's ownership interest in a subsidiary that do not result in the parent losing control of the subsidiary are accounted for as equity transactions. [IFRS 10.23]. Accounting for non-controlling interests is discussed in more detail at 2.2 and 5 below.

2.2 Proportion consolidated

The basic procedures described above effectively mean that 100% of the assets, liabilities, income, expenses and cash flows of a subsidiary are consolidated with those of the parent, irrespective of the parent's ownership interest in the subsidiary. However, the profit or loss and each component of other comprehensive income of the subsidiary, and the equity of the subsidiary, are attributed to the parent and the non-controlling interest (if the subsidiary is not wholly owned).

As discussed in Chapter 6 at 4.3.4, when assessing control, an investor considers any potential voting rights that it holds as well as those held by others. Common examples of potential voting rights include options, forward contracts, and conversion features of a convertible instrument.

If there are potential voting rights, or other derivatives containing potential voting rights, the proportion of profit or loss, other comprehensive income and changes in equity allocated to the parent and non-controlling interests (see 5.6 below) in preparing consolidated financial statements is generally determined solely on the basis of existing ownership interests. It does not reflect the possible exercise or conversion of potential voting rights and other derivatives. [IFRS 10.21, 24, B89, B94].

Usually, there is no difference between the existing ownership interests and the present legal ownership interests in the underlying shares. However, allocating the proportions of profit or loss, other comprehensive income, and changes in equity based on present legal ownership interests is not always appropriate. For example, there may be situations where the terms and conditions of the potential voting rights mean that the existing ownership interest does not correspond to the legal ownership of the shares. IFRS 10 recognises that, in some circumstances, an entity has, in substance, an existing ownership interest as a result of a transaction that currently gives it access to the returns associated with an ownership interest. In such circumstances, the proportion allocated to the parent and non-controlling interests is determined by taking into account the eventual exercise of those potential voting rights and other derivatives that currently give the entity access to the returns. [IFRS 10.21, B90].

Where this is the case, such instruments are not within the scope of IFRS 9 (since IFRS 9 does not apply to subsidiaries that are consolidated). [IFRS 9.2.1(a)]. This scope exclusion prevents double counting of the changes in the fair value of such a derivative under IFRS 9, and of the effective interest created by the derivative in the underlying investment. In all other cases, instruments containing potential voting rights in a subsidiary are accounted for in accordance with IFRS 9. [IFRS 10.21, B91].

Example 7.1 below illustrates this principle.

Whether potential voting rights and other derivatives, in substance, already provide existing ownership interests in a subsidiary that currently give an entity access to the returns associated with that ownership interest will be a matter of judgement. Issues raised by put and call options over non-controlling interests, including whether or not such options give an entity present access to returns associated with an ownership interest (generally in connection with a business combination) are discussed further at 6 below. This chapter uses the term ‘present ownership interest’ to include existing legal ownership interests together with potential voting rights and other derivatives that, in substance, already provide existing ownership interests in a subsidiary.

The proportion allocated between the parent and a subsidiary might differ when a non-controlling interest holds cumulative preference shares (see 5.6 below).

2.3 Consolidating foreign operations

IFRS 10 does not specifically address how to consolidate subsidiaries that are foreign operations. As explained in IAS 21 – The Effects of Changes in Foreign Exchange Rates, an entity may present its financial statements in any currency (or currencies). If the presentation currency differs from the entity's functional currency, it needs to translate its results and financial position into the presentation currency. Therefore, when a group contains individual entities with different functional currencies, the results and financial position of each entity are translated into the presentation currency of the consolidated financial statements. [IAS 21.38]. The requirements of IAS 21 in respect of this translation process are explained in Chapter 15 at 6.

A reporting entity comprising a group with intermediate holding companies may adopt either the direct method or the step-by-step method of consolidation. IFRIC 16 – Hedges of a Net Investment in a Foreign Operation – refers to these methods as follows: [IFRIC 16.17]

• direct method – The financial statements of the foreign operation are translated directly into the functional currency of the ultimate parent.
• step-by-step method – The financial statements of the foreign operation are first translated into the functional currency of any intermediate parent(s) and then translated into the functional currency of the ultimate parent (or the presentation currency, if different).

An entity has an accounting policy choice of which method to use, which it must apply consistently for all net investments in foreign operations. [IFRIC 16.17]. It is asserted that both methods produce the same amounts in the presentation currency. [IAS 21.BC18]. We agree that both methods will result in the same amounts in the presentation currency for the statement of financial position. However, this does not necessarily hold true for income and expense items particularly if an indirectly held foreign operation is disposed of (as acknowledged in IFRIC 16, and discussed below). Differences will also arise between the two methods if an average rate is used, although these are likely to be insignificant. See Chapter 15 at 6.1.1, 6.1.5 and 6.6.3.

IFRIC 16 explains:

1. ‘The difference becomes apparent in the determination of the amount of the foreign currency translation reserve that is subsequently reclassified to profit or loss. An ultimate parent entity using the direct method of consolidation would reclassify the cumulative foreign currency translation reserve that arose between its functional currency and that of the foreign operation. An ultimate parent entity using the step-by-step method of consolidation might reclassify the cumulative foreign currency translation reserve reflected in the financial statements of the intermediate parent, i.e. the amount that arose between the functional currency of the foreign operation and that of the intermediate parent, translated into the functional currency of the ultimate parent.’ [IFRIC 16.BC36].

IFRIC 16 also provides guidance on what does and does not constitute a valid hedge of a net investment in a foreign operation, and on how an entity should determine the amounts to be reclassified from equity to profit or loss for both the hedging instrument and the hedged item, where the foreign operation is disposed of. It notes that in a disposal of a subsidiary by an intermediate parent, the use of the step-by-step method of consolidation may result in the reclassification to profit or loss of a different amount from that used to determine hedge effectiveness. An entity can eliminate this difference by determining the amount relating to that foreign operation that would have arisen if the entity had used the direct method of consolidation. However, IAS 21 does not require an entity to make this adjustment. Instead, it is an accounting policy choice that should be followed consistently for all net investments. [IFRIC 16.17].

IFRIC 16 is discussed in more detail in Chapter 15 at 6.1.5 and 6.6.3 and Chapter 53 at 5.3.

2.4 Intragroup eliminations

IFRS 10 requires intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group to be eliminated. Profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full as shown in Example 7.2 below. [IFRS 10.21, B86(c)].

Even though losses on intragroup transactions are eliminated in full, they may still indicate an impairment that requires recognition in the consolidated financial statements. [IFRS 10.21, B86(c)]. For example, if a parent sells a property to a subsidiary at fair value and this is lower than the carrying amount of the asset, the transfer may indicate that the property (or the cash-generating unit to which that property belongs) is impaired in the consolidated financial statements. This will not always be the case as the value-in-use of the asset (or cash-generating unit) may be sufficient to support the higher carrying value. Transfers between companies under common control involving non-monetary assets are discussed in Chapter 8 at 4.4.1; impairment is discussed in Chapter 20.

Intragroup transactions may give rise to a current and/or deferred tax expense or benefit in the consolidated financial statements. IAS 12 applies to temporary differences that arise from the elimination of profits and losses resulting from intragroup transactions. [IFRS 10.21, B86(c)]. These issues are discussed in Chapter 33 at 7.2.5 and 8.7. The application of IAS 12 to intragroup dividends and unpaid intragroup interest, royalties or management charges is discussed in Chapter 33 at 7.5.4, 7.5.5, 7.5.6 and 8.5.

Where an intragroup balance is denominated in a currency that differs to the functional currency of a transacting group entity, exchange differences will arise. See Chapter 15 at 6.3 for discussion of the accounting for exchange differences on intragroup balances in consolidated financial statements.

2.5 Non-coterminous accounting periods

The financial statements of the parent and its subsidiaries used in the preparation of the consolidated financial statements shall have the same reporting date. If the end of the reporting period of the parent is different from that of a subsidiary, the subsidiary must prepare, for consolidation purposes, additional financial information as of the same date as the financial statements of the parent, unless it is impracticable to do so. [IFRS 10.21, B92]. ‘Impracticable’ presumably means when the entity cannot apply the requirement after making every reasonable effort to do so. [IAS 1.7].

If it is impracticable for the subsidiary to prepare such additional financial information, then the parent consolidates the financial information of the subsidiary using the most recent financial statements of the subsidiary. These must be adjusted for the effects of significant transactions or events that occur between the date of those financial statements and the date of the consolidated financial statements. The difference between the date of the subsidiary's financial statements and that of the consolidated financial statements must not be more than three months. The length of the reporting periods and any difference between the dates of the financial statements must be the same from period to period. [IFRS 10.21, B93]. It is not necessary, as in some national GAAPs, for the subsidiary's reporting period to end before that of its parent.

This requirement seems to imply that, where a subsidiary that was previously consolidated using non-coterminous financial statements is now consolidated using coterminous financial statements (i.e. the subsidiary changed the end of its reporting period), comparative information should be restated so that financial information of the subsidiary is included in the consolidated financial statements for an equivalent period in each period presented. However, it may be that other approaches not involving restatement of comparatives would be acceptable, particularly where the comparative information had already reflected the effects of significant transactions or events during the period between the date of the subsidiary's financial statements and the date of the consolidated financial statements. Where comparatives are not restated, additional disclosures might be needed about the treatment adopted and the impact on the current period of including information for the subsidiary for a period different from that of the parent.

IAS 21 addresses what exchange rate should be used in translating the assets and liabilities of a foreign operation that is consolidated on the basis of financial statements made up to a different date to the reporting date used for the reporting entity's financial statements. This issue is discussed further in Chapter 15 at 6.4.

2.6 Consistent accounting policies

If a member of the group uses accounting policies other than those adopted in the consolidated financial statements for like transactions and events in similar circumstances, appropriate adjustments are made to that group member's financial statements in preparing the consolidated financial statements to ensure conformity with the group's accounting policies. [IFRS 10.21, B87].

IFRS 4 – Insurance Contracts – contains an exception to this general rule, as further discussed in Chapter 55 at 8.2.1.C. However, there is no such exception in IFRS 17 – Insurance Contracts.

3.1 Commencement and cessation of consolidation

A parent consolidates a subsidiary from the date on which the parent first obtains control, and ceases consolidating that subsidiary on the date on which the parent loses control. [IFRS 10.20, 21, B88]. IFRS 3 defines the acquisition date, which is the date on which the acquirer obtains control of the acquiree, [IFRS 3.8, Appendix A], (see Chapter 9 at 4.2).

The requirement to continue consolidating (albeit in a modified form) also applies to a subsidiary held for sale accounted for under IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations (see Chapter 4).

3.2 Accounting for a loss of control

IFRS 10 clarifies that an investor is required to reassess whether it controls an investee if the facts and circumstances indicate that there are changes to one or more of the three elements of control. [IFRS 10.8, B80]. The elements of control are: power over the investee; exposure, or rights, to variable returns from the investor's involvement with the investee; and the investor's ability to use its power over the investee to affect the amount of the investor's returns. [IFRS 10.7]. See Chapter 6 at 9 for further discussion, including examples of situation where a change in control may arise.

A parent may lose control of a subsidiary because of a transaction that changes its absolute or relative ownership level. For example, a parent may lose control of a subsidiary if:

• it sells some or all of the ownership interests;
• it contributes or distributes some or all of the ownership interests; or
• a subsidiary issues new ownership interests to third parties (therefore a dilution in the parent's interests occurs).

Alternatively, a parent may lose control without a change in absolute or relative ownership levels. For example, a parent may lose control on expiry of a contractual agreement that previously allowed the parent to control the subsidiary. [IFRS 10.BCZ180]. or on entry into a contractual arrangement which gives joint control with another party (or parties). A parent may also lose control if the subsidiary becomes subject to the control of a government, court, administrator, receiver, liquidator or regulator. This evaluation may require the exercise of judgement, based on the facts and circumstances, including the laws in the relevant jurisdiction (see Chapter 6 at 4.3.2 and 9.2).

If a parent loses control of a subsidiary, it is required to: [IFRS 10.25, 26, B98]

1. derecognise the assets (including any goodwill) and liabilities of the former subsidiary at their carrying amounts at the date when control is lost;
2. derecognise the carrying amount of any non-controlling interests in the former subsidiary at the date when control is lost. This includes any components of other comprehensive income attributable to them;
3. recognise the fair value of the consideration received, if any, from the transaction, event or circumstances that resulted in the loss of control;
4. recognise a distribution if the transaction, event or circumstances that resulted in the loss of control involves a distribution of shares of the subsidiary to owners in their capacity as owners (see 3.7 below);
5. recognise any investment retained in the former subsidiary at its fair value at the date when control is lost (see 3.3 below);
6. reclassify to profit or loss, or transfer directly to retained earnings if required by other IFRSs, the amounts recognised in other comprehensive income in relation to the subsidiary (see 3.5 below).

   If a parent loses control of a subsidiary, the parent accounts for all amounts previously recognised in other comprehensive income in relation to that subsidiary on the same basis as would be required if the parent had directly disposed of the related assets or liabilities. [IFRS 10.26, B99]. This is discussed at 3.5 below; and

7. recognise any resulting difference as a gain or loss in profit or loss attributable to the parent.

Any amounts owed to or by the former subsidiary (which cease to be eliminated on consolidation) should be accounted for in accordance with the relevant IFRSs. Such balances are often financial assets or financial liabilities, which are initially recognised at fair value in accordance with IFRS 9 at the date of loss of control. [IFRS 9.5.1.1, 5.1.1A, 5.1.2, 5.1.3]. See Chapter 49 at 3.

Sometimes, the parent may receive contingent consideration on the sale of a subsidiary. In most cases, the parent will have a contractual right to receive cash or another financial asset from the purchaser and, therefore, such balances are often financial assets within the scope of IFRS 9, and consequently initially measured at fair value. [IFRS 9.5.1.1].

IFRS 5's requirements apply to a non-current asset (or disposal group) that is classified as held for sale. See Chapter 4 at 2. The presentation requirements when the subsidiary of which the parent loses control meets the definition of a discontinued operation are discussed in Chapter 4 at 3. Chapter 20 at 8.5 addresses the allocation of goodwill when an operation is disposed of which forms part of a cash-generating unit to which goodwill has been allocated.

IFRS 10 refers only to loss of control of a subsidiary, without drawing a distinction between when the subsidiary is a business or not nor whether this happens as part of the ordinary activities of an entity or not. In June 2019, the Interpretations Committee discussed whether IFRS 10 or IFRS 15 – Revenue from Contracts with Customers – applies when an entity loses control of a single asset entity containing real estate as part of its ordinary activities.¹ This is discussed further at 3.2.1 below.

Where a parent loses control over a subsidiary because it has sold or contributed its interest in a subsidiary to an associate or joint venture (accounted for using the equity method), there is a conflict between the requirements of IFRS 10 and those of IAS 28 – Investments in Associates and Joint Ventures. This is because IAS 28 restricts any gain arising on the sale of an asset to an associate or joint venture (or on the contribution of a non-monetary asset in exchange for an equity interest in an associate or a joint venture) to that attributable to the unrelated investors’ interests in the associate or joint venture, whereas IFRS 10 does not. In order to resolve the conflict, in September 2014, the IASB had issued Sale or Contribution of Assets between an Investor and its Associate or Joint Venture (Amendments to IFRS 10 and IAS 28) – but subsequently deferred the effective date of application of the amendments. This issue is discussed further at 3.3.2 and 7.1 below.

The following parts of this section address further issues relating to accounting for the loss of control of a subsidiary including: where an interest is retained in the former subsidiary (see 3.3 below), loss of control in multiple arrangements (see 3.4 below), the treatment of other comprehensive income on loss of control (see 3.5 below), deemed disposals (see 3.6 below), and demergers and distributions (see 3.7 below).

3.3 Accounting for a loss of control where an interest is retained in the former subsidiary

According to IFRS 10, when a parent loses control of a subsidiary, it must recognise any investment retained in the former subsidiary at its fair value at the date when control is lost. Any gain or loss on the transaction will be recorded in profit or loss. The fair value of any investment that it retains at the date control is lost, including any amounts owed by or to the former subsidiary, will be accounted for, as applicable, as:

• the fair value on initial recognition of a financial asset (see Chapter 49 at 3); or
• the cost on initial recognition of an investment in an associate or joint venture (see Chapter 11 at 7.4.1).

The IASB's view is that the loss of control of a subsidiary is a significant economic event that marks the end of the previous parent-subsidiary relationship and the start of a new investor-investee relationship, which is recognised and measured initially at the date when control is lost. IFRS 10 is based on the premise that an investor-investee relationship differs significantly from a parent-subsidiary relationship. Therefore, the IASB decided that ‘any investment the parent has in the former subsidiary after control is lost should be measured at fair value at the date that control is lost and that any resulting gain or loss should be recognised in profit or loss.’ [IFRS 10.BCZ182].

The following discussion addresses the accounting for the loss of control in certain situations – where the interest retained in the former subsidiary is a financial asset (see 3.3.1 below); where the interest retained in the former subsidiary is an associate or joint venture that is accounted for using the equity method (see 3.3.2 below); and where the interest retained in the former subsidiary is a joint operation (see 3.3.3 below).

3.4 Loss of control in multiple arrangements

If a parent loses control of a subsidiary in two or more arrangements or transactions, sometimes they should be accounted for as a single transaction. [IFRS 10.26, B97]. IFRS 10 only allows a parent to recognise a gain or loss on disposal of a subsidiary when the parent loses control over it. This requirement could present opportunities to structure the disposal in a series of disposals, thereby potentially reducing the loss recognised. Example 7.7 below illustrates the issue in IFRS 10 as follows. [IFRS 10.BCZ185].

However, even if an entity wanted to conceal losses on a disposal of a subsidiary, the opportunities are limited given the requirements of IAS 36 – Impairment of Assets – and IFRS 5, which usually require recognition of an impairment loss even before the completion of any sale, [IFRS 10.BCZ186], (although they do not require reclassification of losses recognised in other comprehensive income).

In determining whether to account for the arrangements as a single transaction, a parent considers all the terms and conditions of the arrangements and their economic effects. One or more of the following circumstances indicate that it is appropriate for a parent to account for multiple arrangements as a single transaction: [IFRS 10.26, B97]

• they are entered into at the same time or in contemplation of each other;
• they form a single transaction designed to achieve an overall commercial effect;
• the occurrence of one arrangement is dependent on the occurrence of at least one other arrangement; or
• one arrangement considered on its own is not economically justified, but it is economically justified when considered together with other arrangements. An example is a disposal of shares priced below market that is compensated by a subsequent disposal priced above market.

These indicators clarify that arrangements that are part of a package are accounted for as a single transaction. However, there is a risk that by casting too wide a net, an entity might end up accounting for a transaction that is truly separate as part of transaction in which the loss of control occurred.

IFRS 10 is silent on how an entity accounts for multiple arrangements that are part of a single transaction. Depending on the facts and circumstances, the parent accounts for these transactions in one of the following ways:

• Advance payment – If the parent does not lose control over the subsidiary and access to the benefits associated with ownership until later steps in the transaction, then it accounts for the first step of the transaction as an advance receipt of consideration and continues to consolidate the subsidiary until the later date. In many cases, the assets and liabilities of the consolidated subsidiary would be a disposal group held for sale under IFRS 5 (see Chapter 4 at 2.1.3.A).
• Immediate disposal – If the parent loses control and access to benefits associated on the first step of the transaction, then it ceases to consolidate the former subsidiary immediately, recognises a gain or loss on disposal, and accounts for the consideration due in the second step as deferred consideration receivable.

Example 7.8 below illustrates a fact pattern where the entity would need to evaluate how to account for transactions that are linked.

3.5 Other comprehensive income

If a parent loses control of a subsidiary, all amounts previously recognised in other comprehensive income are accounted for on the same basis as would be required if the parent had directly disposed of the related assets or liabilities. If a gain or loss previously recognised in other comprehensive income would be reclassified to profit or loss on the disposal of the related assets or liabilities, the parent reclassifies the gain or loss from equity to profit or loss (as a reclassification adjustment) when it loses control of the subsidiary. Therefore:

1. if a revaluation surplus previously recognised in other comprehensive income would be transferred directly to retained earnings on the disposal of the asset, the parent transfers the revaluation surplus directly to retained earnings when it loses control of the subsidiary; [IFRS 10.26, B99]
2. remeasurement gains or losses on a defined benefit plan recognised in other comprehensive income would not be reclassified to profit or loss when the parent loses control of the subsidiary, but may be transferred within equity, [IAS 19.122], and
3. on disposal of a subsidiary that includes a foreign operation, the cumulative amount of the exchange differences relating to that foreign operation (that is recognised in other comprehensive income and accumulated in the separate component of equity) is reclassified from equity to profit or loss, except for the amounts that have been attributed to the non-controlling interests. Those amounts are derecognised, and not reclassified to profit or loss. [IAS 21.48‑48B]. This would appear to mean that it is only the parent's share of the cumulative exchange differences that is reclassified; those attributable to the non-controlling interests are not reclassified as they have already been included within the carrying amount of the non-controlling interest that is derecognised as part of calculating the gain or loss attributable to the parent.

There are two different interpretations of how to treat other comprehensive income accumulated in equity that would be reclassified to profit or loss on the disposal of the related assets or liabilities, both of which are acceptable. Approach (1) below is more consistent with the treatment of exchange differences relating to foreign operations, as described at (c) above.

1. Reclassification of other comprehensive income related to parent interest only – IFRS 10 requires derecognition of the non-controlling interests (including any components of other comprehensive income attributable to them) at the date when control is lost, which implies derecognition of the non-controlling interests without any need for reclassification. [IFRS 10.26, B98(a)]. In addition, IFRS 10 requires recognition of a gain or loss in profit or loss to be attributable to the parent, [IFRS 10.26, B98(d)], which again implies that there should be no reclassification of other comprehensive income in respect of the non-controlling interests.
2. Reclassification of other comprehensive income related to parent and the non-controlling interest – IFRS 10 specifically requires that ‘if a gain or loss previously recognised in other comprehensive income would be reclassified to profit or loss on the disposal of the related assets or liabilities, the parent shall reclassify the gain or loss from equity to profit or loss (as a reclassification adjustment) when it loses control of the subsidiary.’ [IFRS 10.26, B99]. That would clearly require reclassification of the entire balance of other comprehensive income accumulated within equity. However, where this is done, the portion of the reclassification adjustment attributable to the non-controlling interest should be included as part of the profit or loss attributable to the non-controlling interests, not as part of the profit or loss attributable to the parent.

Example 7.9 below illustrates the application of the above requirements.

3.6 Deemed disposal

A subsidiary may cease to be a subsidiary, or a group may reduce its interest in a subsidiary, other than by actual disposal. This is commonly referred to as a ‘deemed disposal’. Deemed disposals may arise for many reasons, including:

• a group does not take up its full allocation in a rights issue by a subsidiary in the group;
• a subsidiary declares scrip dividends that are not taken up by its parent, so that the parent's proportional interest is diminished;
• another party exercises its options or warrants issued by a subsidiary;
• a subsidiary issues shares to third parties; or
• a contractual agreement by which a group obtained control over a subsidiary is terminated or changed.

A deemed disposal that results in the loss of control of a subsidiary is accounted for as a regular disposal. This accounting is illustrated in Example 7.10 below.

As indicated at 3.3.2.F above, the IASB has discussed issues relating to the unit of account for investments in subsidiaries, joint ventures and associates, and their fair value measurement under IFRS 13.

3.7 Demergers and distributions of non-cash assets to owners

Groups may dispose of subsidiaries by way of a demerger. This situation typically involves the transfer of the subsidiaries to be disposed of, either:

• directly to shareholders, by way of a dividend in kind; or
• to a newly formed entity in exchange for the issue of shares by that entity to the shareholders of the disposing entity.

IFRS 10 requires recognition of a distribution of shares of the subsidiary to owners in their capacity as owners, but does not describe how to account for such transactions. [IFRS 10.26, B98(b)]. Instead, IFRIC 17 – Distributions of Non-cash Assets to Owners –addresses distributions of subsidiary shares to shareholders. The application of IFRIC 17 in the context of demergers is discussed below. The application of IFRIC 17 to assets in general is discussed in Chapter 8 at 2.4.2.

4.1 Reattribution of other comprehensive income

If there has been a partial disposal of a subsidiary without a loss of control and the disposal includes a foreign operation, the proportionate share of the cumulative amount of exchange differences recognised in other comprehensive income is reattributed to the non-controlling interests in that foreign operation (see Chapter 15 at 6.6.2). [IAS 21.48C]. If the entity subsequently disposes of the remainder of its interest in the subsidiary, the exchange differences reattributed to the non-controlling interests are derecognised (i.e. along with the rest of the non-controlling interest balance) but are not separately reclassified to profit or loss (see Chapter 15 at 6.6.1). [IAS 21.48B]. In other words, on loss of control, only the exchange differences attributable to the controlling interest immediately before loss of control are reclassified to profit or loss. The accounting is illustrated in Example 7.13 below.

Although not explicitly addressed in IFRS 10 or IAS 21, the IASB has clarified that IFRS requires the reattribution of other amounts recognised in other comprehensive income. The May 2009 IASB Update noted that in the Board's view ‘there is no need to clarify the following points, because the relevant requirements are clear: …

• When a change in ownership in a subsidiary occurs but does not result in the loss of control, the parent must reattribute other comprehensive income between the owners of the parent and the non-controlling interest.’²¹

Example 7.11 below illustrates accounting for reattribution of other comprehensive income.

The IASB's views also clarify that the reattribution approach is required on an increase in ownership interest without gaining control. Again, neither IFRS 10 nor IAS 21 addresses this explicitly. Example 7.12 below illustrates the reattribution approach upon an increase in ownership interest.

Example 7.13 below illustrates the reclassification of reattributed exchange differences upon subsequent loss of control. This shows that the reattribution of the exchange differences arising on the change in the parent's ownership of the subsidiary (as illustrated in Examples 7.11 and 7.12 above) affects the gain recognised on loss of control of the subsidiary.

4.2 Goodwill attributable to non-controlling interests

It is not clear under IFRS 10 what happens to the non-controlling interests’ share of goodwill, when accounting for transactions with non-controlling interests.

However, we believe that the parent should reallocate a proportion of the goodwill between the controlling and non-controlling interests when their relative ownership interests change. Otherwise, the loss recognised upon loss of control (see 3.2 above) or goodwill impairment would not reflect the ownership interest applicable to that non-controlling interest. Chapter 20 at 9 discusses how an entity tests goodwill for impairment, where there is a non-controlling interest. The issues arising include:

• calculation of the ‘gross up’ of the carrying amount of goodwill (for the purposes of the impairment test) because the non-controlling interest is measured at its proportionate share of net identifiable assets and hence its share of goodwill is not recognised;
• the allocation of impairment losses between the parent and the non-controlling interest; and
• reallocation of goodwill between the non-controlling interest and controlling interest after a change in a parent's ownership interest in a subsidiary that does not result in loss of control.

Under IFRS 3, the proportion of goodwill that is attributable to the non-controlling interest is not necessarily equal to the ownership percentage. The most common situation where this occurs is when the parent recognised the non-controlling interest at its proportionate share of the acquiree's identifiable net assets and therefore does not recognise any goodwill for the non-controlling interest (see Chapter 9 at 5.1 and 8.2). This situation might also occur because goodwill has been recognised for both the parent and the non-controlling interest but the parent's goodwill reflects a control premium that was paid upon acquisition (see Chapter 9 at 8.1).

Example 7.14 below illustrates one approach to reallocating goodwill where there is a change in ownership of the subsidiary with no loss of control (for a situation where the non-controlling interest is recognised initially at its fair value).

In Example 7.14 above, the non-controlling interest was recognised and measured at its fair value at the acquisition date. If the non-controlling interest had been measured based on its proportionate share of net assets, the proportionate allocation approach described in the example would have resulted in the same accounting for the transaction where the parent's ownership interest had decreased. However, where the parent increased its ownership interest, as the carrying amount of the non-controlling interest did not include any amount for goodwill, the adjustment to the non-controlling interest would only have been €100 million resulting in a debit to the parent's equity of €15 million.

The proportionate allocation approach described in Example 7.14 above is just one method that may result in relevant and reliable information. However, other approaches may also be appropriate depending on the circumstances. We consider that an entity is not precluded from attributing goodwill on a basis other than ownership percentages if to do so is reasonable, e.g. because the non-controlling interest is measured on a proportionate share (rather than fair value) and because of the existence of a control premium. In such circumstances, an allocation approach which takes into account the acquirer's control premium will result in a goodwill balance that most closely resembles the balance that would have been recorded had the non-controlling interest been recorded at fair value. An entity may also be able to allocate impairment losses on a basis that recognises the disproportionate sharing of the controlling and the non-controlling interest in the goodwill book value. This is discussed further in Chapter 20 at 9.

4.3 Non-cash acquisition of non-controlling interests

One issue considered by the Interpretations Committee is the accounting for the purchase of a non-controlling interest by the controlling shareholder when the consideration includes non-cash items, such as an item of property, plant and equipment. More specifically, the submitter asked the Interpretations Committee to clarify whether the difference between the fair value of the consideration given and the carrying amount of such consideration should be recognised in equity or in profit or loss. The submitter asserted that, according to the requirements of the then IAS 27 – Consolidated and Separate Financial Statements (now reflected in IFRS 10), the difference described should be recognised in equity, whereas applying IFRIC 17 by analogy, the difference should be recognised in profit or loss (see 3.7 above).

The Interpretations Committee noted that the requirements of the then IAS 27 (now reflected in IFRS 10), deal solely with the difference between the carrying amount of the non-controlling interest and the fair value of the consideration given; this difference is required to be recognised in equity. These requirements do not deal with the difference between the fair value of the consideration given and the carrying amount of such consideration. [IFRS 10.24, B96]. The difference between the fair value of the assets transferred and their carrying amount arises from the derecognition of those assets. IFRSs generally require an entity to recognise, in profit or loss, any gain or loss arising from the derecognition of an asset.²²

4.4 Transaction costs

Although IFRS 10 is clear that changes in a parent's ownership interest in a subsidiary that do not result in the parent losing control of the subsidiary are equity transactions (i.e. transactions with owners in their capacity as owners), [IFRS 10.23], it does not specifically address how to account for related transaction costs. Only incremental costs directly attributable to the equity transaction that otherwise would have been avoided qualify as transaction costs. [IAS 32.37].

In our view, any directly attributable incremental transaction costs incurred to acquire an outstanding non-controlling interest in a subsidiary, or to sell a non-controlling interest in a subsidiary without loss of control, are deducted from equity. This is regardless of whether the consideration is in cash or shares. This is consistent with both guidance elsewhere in IFRS regarding the treatment of such costs, [IAS 32.35, 37, IAS 1.109], and the view expressed by the Interpretations Committee.²³ Although where shares are given as consideration there is no change in total consolidated equity, there are in fact two transactions – an issue of new equity and a repurchase of existing equity. The entity accounts for the transaction costs on the two elements in the same manner as if they had occurred separately. The tax effects of transaction costs of equity instruments are discussed in Chapter 33 at 10.3.5.

IFRS does not specify where to allocate the costs in equity – in particular, whether to the parent (who incurred the costs) or to the non-controlling interest (whose equity was issued/repurchased). Therefore, the parent may choose where to allocate the costs within equity, based on the facts and circumstances surrounding the change in ownership, and any legal requirements of the jurisdiction.

Regardless of the account in equity to which the charge is allocated, the amount is not reclassified to profit or loss in future periods. Consequently, if the costs are allocated to the non-controlling interest, this amount must be separately tracked. If a subsidiary is later sold in a separate transaction (i.e. loss of control), the transaction costs previously recognised directly in equity to acquire or sell the non-controlling interest are not reclassified from equity to profit and loss, because they do not represent components of other comprehensive income.

4.5 Contingent consideration on purchase of a non-controlling interest

IFRS 10 does not provide guidance on accounting for remeasurement of contingent consideration relating to the purchase of a non-controlling interest. The question arises as to whether the remeasurement should be accounted for in profit or loss, or in equity (on the grounds that it is related to the purchase of the non-controlling interest – see 4 above). This discussion assumes that the purchase of the non-controlling interest is separate from the business combination. It is not uncommon for a written put and/or a purchased call option over a non-controlling interest to be put in place at the time of a business combination. The accounting for such transactions (including forward contracts to sell non-controlling interests) is discussed in 6 below.

IFRS 3 addresses the accounting for remeasurement of contingent consideration recognised by the acquirer in a business combination. Contingent consideration is initially recognised at its fair value. Contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity. Contingent consideration not classified as equity that is within the scope of IFRS 9 is measured at fair value at each reporting date and changes in its fair value are recognised in profit or loss in accordance with IFRS 9. Contingent consideration not within the scope of IFRS 9 is also recognised in profit or loss. [IFRS 3.39, 40, 58, IFRS 9.4.2.1(e)]. See Chapter 9 at 7.1.

The purchase of a non-controlling interest is not a business combination and, consequently, IFRS 3 requirements do not apply. In practice, most contingent consideration meets the definition of a financial liability and would fall within the scope of IFRS 9.

In our view, a distinction should be drawn between the initial recognition of the contingent consideration classified as a financial liability, which is a transaction with the non-controlling interest, and its subsequent measurement. On initial recognition, contingent consideration is recognised at its fair value, the non-controlling interest purchased is derecognised (and any balancing adjustment is reflected in parent equity). Subsequent movements in contingent consideration classified as a financial liability are recognised in accordance with IFRS 9 (in profit or loss, as explained below) rather than regarded as relating to a transaction with the non-controlling interest (and recognised in equity). If the contingent consideration is classified as an equity instrument, it will not be remeasured.

Depending on the terms and conditions, the contingent consideration may be classified as a financial liability at amortised cost, or at fair value through profit or loss. [IFRS 9.4.2.1‑4.2.2]. In both cases, subsequent remeasurements for any changes in estimated contractual cash flows or fair value, or on final settlement of the financial liability are recognised in profit or loss (except for any fair value movements attributable to own credit risk required to be recognised in other comprehensive income, where the financial liability is designated at fair value through profit or loss). See Chapter 48 at 3, 4 and 7, and Chapter 50 at 2.2, 2.4 and 3.

5.1 The definition of non-controlling interests

IFRS 10 defines a non-controlling interest as ‘equity in a subsidiary not attributable, directly or indirectly, to a parent.’ [IFRS 10 Appendix A]. The principle underlying accounting for non-controlling interests is that all residual economic interest holders of any part of the consolidated entity have an equity interest in that consolidated entity.

Consequently, non-controlling interests relate to consolidated subsidiaries, and not to those investments in subsidiaries accounted at fair value through profit or loss in accordance with IFRS 9 by an investment entity (see Chapter 6 at 10.3). [IFRS 10.31‑33]. This principle applies regardless of the decision-making ability of that interest holder and where in the group that interest is held. Therefore, any equity instruments issued by a subsidiary that are not owned by the parent (apart from those that are required to be classified by IAS 32 – Financial Instruments: Presentation – as financial liabilities in the consolidated financial statements, as discussed at 5.5 below) are non-controlling interests, including:

• ordinary shares;
• convertible debt and other compound financial instruments;
• preference shares that are classified as equity (including both those with, and without, an entitlement to a pro rata share of net assets on liquidation);
• warrants;
• options over own shares; and
• options under share-based payment transactions.

Options and warrants are non-controlling interests, regardless of whether they are vested and regardless of the exercise price (e.g. whether they are ‘in-the-money’).

IAS 32 defines an equity instrument as ‘any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities’. [IAS 32.11]. This is consistent with the definition of ‘equity’ in the IASB's Conceptual Framework for Financial Reporting published in 2018. [CF 4.63‑4.64]. Hence, the reference to ‘equity’ in the definition of a non-controlling interest refers to those ‘equity instruments’ of a subsidiary that are not attributable, directly or indirectly, by its parent. This also means that financial instruments that are not classified within equity in accordance with IAS 32 (e.g. total return swaps) are not included within the definition of a non-controlling interest.

If a parent has an indirect ownership interest in the subsidiary, this is taken into account in computing the non-controlling interest. For example, if a parent has a 60% direct interest in Subsidiary A (which in turn owns 80% of Subsidiary B), there will be a 52% (i.e. 100% – (60% × 80%)) non-controlling interest in Subsidiary B's equity. Where Subsidiary A acquired Subsidiary B in a business combination, there will also be a 40% non-controlling interest in the goodwill arising in the consolidated financial statements. This situation is illustrated in Example 7.17 at 5.2.1 below (note though that in the specific example the non-controlling interest in the goodwill arising on acquisition of the Target is not simply 40% of the goodwill amount, as the Target has also issued warrants).

5.2 Initial measurement of non-controlling interests

5.3 Measurement of non-controlling interests where an associate holds an interest in a subsidiary

Neither IFRS 10 nor IAS 28 explains how to account for non-controlling interests when the group owns an associate which has a holding in a subsidiary. A non-controlling interest is defined as ‘the equity in a subsidiary not attributable, directly or indirectly to a parent’. [IFRS 10 Appendix A]. It is unclear whether this should be computed based on the ownership interests held by the group (i.e. by the parent and any consolidated subsidiary), or whether it should also take into account the indirect ownership of the subsidiary held by the associate.

The reciprocal interests can also give rise to a measure of double-counting of profits and net assets between the investor and its associate.

We believe that there are two possible approaches to determine the amount of non-controlling interests in the subsidiary:

1. the non-controlling interests are determined after considering the associate's ownership of the subsidiary (‘look through approach’); or
2. the non-controlling interests are determined based on the holdings of the group in the subsidiary (‘black box approach’).

An entity should apply the chosen approach consistently.

In applying the ‘look through approach’, the parent must not recognise the share of the subsidiary's results recognised by the associate applying the equity method, in order to avoid double-counting. The ‘black box approach’ will often lead to reporting higher consolidated net assets and results than when using the ‘look through approach’ as this adjustment is not made, although the amounts attributed to owners of the parent should be the same under both approaches. The two approaches are illustrated in Example 7.18 below.

5.4 Presentation of non-controlling interests

IFRS 10 requires non-controlling interests to be presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. [IFRS 10.22]. Profit or loss and each component of other comprehensive income are attributed to the owners of the parent and to the non-controlling interests. Attribution of total comprehensive income to the non-controlling interests continues even if it results in a deficit balance. [IFRS 10.24, B94]. Deficit balances are considered further at 5.6.1 below.

The presentation of non-controlling interests in the primary financial statements is addressed in Chapter 3 at 3.1.5 (statement of financial position), [IAS 1.54], 3.2.2 (statement of profit or loss), [IAS 1.81B], 3.2.4 (statement of comprehensive income), [IAS 1.81B], and 3.3 (statement of changes in equity). [IAS 1.106].

5.5 Non-controlling interests classified as financial liabilities

In spite of the general requirement in IFRS 10 to treat non-controlling interests as equity, a non-controlling interest is classified by IAS 32 as a financial liability and payments to the non-controlling interest as interest expense if the group as a whole has an obligation to deliver cash or another financial asset in respect of the instrument, or to settle it in a manner that results in its classification as a financial liability. [IAS 32.AG29]. See Chapter 47 at 4.8.1.

One particular issue considered by the Interpretations Committee is the classification, in the consolidated financial statements of a group, of puttable instruments that are issued by a subsidiary but that are not held, directly or indirectly, by the parent. The question asked was whether these instruments, which are classified as equity instruments in the financial statements of the subsidiary in accordance with IAS 32, [IAS 32.16A, 16B], should be classified as equity or liability in the parent's consolidated financial statements.

The Interpretations Committee noted that paragraphs 16A-16D of IAS 32 state that puttable instruments and instruments that impose on the entity an obligation to deliver to another party a pro rata share of the net assets of the entity only on liquidation meet the definition of a financial liability. These instruments are classified as equity in the financial statements of the subsidiary as an exception to the definition of a financial liability if all relevant requirements are met. [IAS 32.16A, 16B, 16C, 16D]. This exception applies only to the financial statements of the subsidiary and does not extend to the parent's consolidated financial statements. [IAS 32.AG29A]. Consequently, these financial instruments should be classified as financial liabilities in the parent's consolidated financial statements.²⁴

In our view, where a non-controlling interest is classified as equity in consolidated financial statements, it is subject to all the requirements of IAS 32 relating to own equity. For example, put or call options over non-controlling interests accounted for as equity should be accounted for in consolidated financial statements as contracts over own equity instruments under IAS 32 (see Chapter 47 at 11).

In some cases, the effect of options over what are in law non-controlling interests may be such that no non-controlling interests are recognised in the financial statements, particularly when such options are issued as part of a business combination (see 6 below).

5.6 Subsequent measurement of non-controlling interests

A proportion of profit or loss, other comprehensive income and changes in equity is only attributed to those instruments included within non-controlling interests if they give rise to an existing ownership interest. Non-controlling interests, that are potential voting rights and other derivatives that require exercise or conversion (such as options, warrants, or share-based payment transactions), generally do not receive an allocation of profit or loss, other comprehensive income and changes in equity. [IFRS 10.21, 24, B89, B94]. However, as discussed at 2.2 above, allocating the proportions of profit or loss, other comprehensive income and changes in equity based on present legal ownership interests is not always appropriate. An entity also considers the eventual exercise of potential rights and other derivatives if, in substance, they provide an existing ownership interest that currently gives it access to the returns associated with that ownership interest. In that case, the proportion allocated to the parent and non-controlling interests takes into account the eventual exercise of those potential voting rights and other derivatives. [IFRS 10.21, B90]. As noted at 2.2 above, this chapter uses the term ‘present ownership interest’ to include existing legal ownership interests, together with potential voting rights and other derivatives that, in substance, already provide existing ownership interests in a subsidiary.

Where a gain or loss is recognised by a non-wholly-owned subsidiary in an upstream transaction with its parent, the gain or loss is eliminated on consolidation. Therefore, the profit or loss allocated to the non-controlling interest excludes the non-controlling interest's share of that eliminated gain or loss (see 2.4 above).

Where a subsidiary has granted options over its own shares under an equity-settled share-based payment transaction, the share-based payment expense recognised in profit or loss will be attributable to the parent and any other non-controlling interest that has a present ownership in the subsidiary. None of the expense is attributed to the non-controlling interest represented by the options under the share-based payment transaction. The corresponding entry taken to equity by the subsidiary in respect of the options under the share-based payment transaction will be recognised as non-controlling interest in the consolidated financial statements.

If a subsidiary has outstanding cumulative preference shares classified as equity that are held by non-controlling interests, the parent is required to compute its share of profits or losses after adjusting for the dividends on these shares, whether or not dividends have been declared. [IFRS 10.24, B95]. This effectively means that the non-controlling interests represented by the cumulative preference shares are being allocated a portion of the profit or loss equivalent to the dividends.

In addition, where an entity has a complicated equity structure with several classes of equity shares that have varying entitlements to net profits, equity or liquidation preferences, the parent needs to assess carefully the rights attaching to each class of equity share in determining the appropriate percentage of ownership interest.

When the proportion of equity held by the non-controlling interests changes, e.g. because a potential voting right is exercised, the carrying amount originally recognised in non-controlling interests is adjusted to reflect the change in the relative interests in the subsidiary. [IFRS 10.24, B96]. In our view, this requirement in IFRS 10 also means that if potential voting rights lapse unexercised, the amount originally recognised in non-controlling interests is reversed, so that the carrying amounts of the controlling and non-controlling interests reflect the relative interests in the subsidiary. Otherwise, amounts previously recognised related to lapsed potential voting rights would remain recognised as part of the non-controlling interests until the next remeasurement of non-controlling interests occurs, which may be an unrelated transaction, or which may never occur.

6.1 Call options only

Call options are considered when determining whether the entity has obtained control, as discussed at Chapter 6 at 4.3.4. Where it is determined that an entity has control over another entity, the proportions of profit or loss, other comprehensive income and changes in equity allocated to the parent and non-controlling interests are based on present ownership interests, and generally do not reflect the possible exercise or conversion of potential voting rights under call options. [IFRS 10.21, 24, B89, B94]. The eventual exercise of potential voting rights under the call option are reflected in the proportion of profit or loss, other comprehensive income and changes in equity only if in substance the entity already has access to the returns associated with that ownership interest. [IFRS 10.21, 24, B90, B94]. This assessment depends on the terms of the call option, and judgement is required.

6.2 Put options only

Under current IFRS, it is not clear how to account for put options that are granted to holders of non-controlling interests (‘NCI puts’) at the date of acquiring control of a subsidiary (or, indeed, after gaining control). There is a lack of explicit guidance in IFRS and potential contradictions between the requirements of IFRS 10 and IAS 32.

This issue has been the subject of much debate over the years. Although it is clear that, under current IFRS, the NCI put itself gives rise to a liability representing the exercise price (see 6.2.1 below for a discussion of the measurement of this liability), there are a number of decisions that must be made in order to account for the arrangements, including:

• whether or not the terms of the NCI put mean that it gives the parent a present ownership interest in the underlying securities (see 6.2.2 below); and
• where the parent does not have a present ownership interest, whether or not a non-controlling interest continues to be recognised, i.e. should the parent recognise both the non-controlling interest and the financial liability for the NCI put.

In the latter case, there are a number of additional decisions that must be made, in particular the basis on which the non-controlling interest is recognised.

Although the Interpretations Committee unequivocally confirmed as early as 2006 that an NCI put with an exercise price to be settled in cash is itself a financial liability,²⁵ the nature of the financial liability remains controversial and has been discussed by the Interpretations Committee and the IASB on a number of occasions. In June 2014, the IASB decided that this issue will be considered as part of the broader project looking at the distinction between liabilities and equity – the Financial Instruments with Characteristics of Equity (‘FICE’) project.²⁶ In June 2018, the IASB issued Discussion Paper – Financial instruments with Characteristics of Equity and intends to decide the direction of the project in Q4 2019.²⁷ The FICE project is discussed further at 7.3 below.

The previous deliberations have been in the context of an NCI put that is required to be settled for cash. The Interpretations Committee has also considered a request in 2016 regarding how an entity accounts for an NCI put in its consolidated financial statements where the NCI put has a strike price that will be settled by delivery of a variable number of the parent's own equity instruments. Specifically, the Interpretations Committee was asked to consider whether, in its consolidated financial statements, the parent recognises:

1. a financial liability representing the present value of the option's strike price – in other words, a gross liability; or
2. a derivative financial liability presented on a net basis measured at fair value.

The Interpretations Committee was also asked whether the parent applies the same accounting in its consolidated financial statements for NCI puts for which the parent has the choice to settle the exercise price either in cash or by way of delivery of a variable number of its own equity instruments to the same value.

However, on the basis of its previous discussions and the IASB's FICE project, the Interpretations Committee decided in November 2016 not to add this issue to its agenda.²⁸

Given that the Interpretations Committee did not conclude on this matter, in our view, both approaches are acceptable.

Like the previous deliberations of the Interpretations Committee and the IASB, the discussion that follows relates to NCI puts that are required to be settled in cash.

6.2.1 The financial liability for the NCI put

As indicated at 5.1 above, IFRS 10 regards the non-controlling interest as ‘equity’ in the consolidated financial statements. Under current IFRS, any contractual obligation to purchase non-controlling interests – such as a put option granted to non-controlling interests – gives rise to a financial liability measured at the present value of the redemption amount (for example, for the present value of the forward repurchase price, option exercise price or other redemption amount). Subsequently, the financial liability is measured in accordance with IFRS 9 (see Chapter 47 at 5.3 and 11.3.2). [IAS 32.23, AG27(b)].

IAS 32 offers no guidance as to how the financial liability should be measured if the number of shares to be purchased and/or the date of purchase are not known. In our view, it would be consistent with the requirement of IFRS 13 that liabilities with a demand feature such as a demand bank deposit should be measured at not less than the amount payable on demand, [IFRS 13.47], to adopt a ‘worst case’ approach (see Chapter 47 at 5.3 and Chapter 14 at 11.5). In other words, it should be assumed that the purchase will take place on the earliest possible date for the maximum number of shares.

The accounting for the remaining aspects of the put option is discussed below; this depends in part upon an assessment of the terms of the transaction and, in some areas, involves a choice of accounting policy which, once selected, must be applied consistently.

Figure 7.2 below summarises the analysis that we believe should be performed, the questions to be addressed and the approaches that apply.

The diagram above (and 6.2.3.A to 6.2.3.D below) indicate that, under approaches 1, 2 and 4, changes in the IFRS 9 financial liability subsequent to initial recognition are recognised in profit or loss. This would be the case regardless of whether the financial liability is subsequently remeasured at amortised cost or at fair value through profit or loss under IFRS 9. However, if the financial liability is designated at fair value under IFRS 9, the fair value changes attributable to changes in credit risk are normally recognised in other comprehensive income (see Chapter 50 at 2.4).

6.2.4 Assessing whether multiple transactions should be accounted for as a single arrangement

As discussed at 3.4 above, IFRS 10 provides guidance on when to account for two or more arrangements as a single transaction when a parent loses control of a subsidiary. However, neither IFRS 10 nor IFRS 3 specifically addresses the accounting for a sequence of transactions that begins with an acquirer gaining control over another entity, followed by acquiring additional ownership interests shortly thereafter.

This frequently happens where public offers are made to a group of shareholders and there is a regulatory requirement for an acquirer to make an offer to the non-controlling shareholders of the acquiree.

The Interpretations Committee considered this issue and tentatively agreed that the initial acquisition of the controlling stake and the subsequent mandatory tender offer should be treated as a single transaction. However, there was no consensus among the Interpretations Committee members on whether a liability should be recognised for the mandatory tender offer at the date that the acquirer obtains control of the acquiree. A small majority expressed the view that a liability should be recognised in a manner that is consistent with IAS 32. Other Interpretations Committee members expressed the view that a mandatory tender offer to purchase non-controlling interests is not within the scope of IAS 32 or IAS 37 – Provisions, Contingent Liabilities and Contingent Assets – and that a liability should therefore not be recognised.²⁹ The issue was escalated to the IASB³⁰ which subsequently decided that the project on put options written on non-controlling interests should be incorporated into the broader project looking at the distinction between liabilities and equity – the Financial Instruments with Characteristics of Equity (‘FICE’) project (see 7.3 and 7.4 below).³¹

In our view, a simple distinction between a statutory obligation and a contractual obligation is not always clear. Statutory requirements (such as a mandatory tender offer or a statutory process that has the same effect) may have the effect of modifying the contractual terms of the equity instruments, thereby giving rise to a contractual obligation to purchase the equity instruments. The rules and regulations regarding tender offers differ by jurisdiction and careful analysis of the facts and circumstances is needed. In any event, even if it is established there is no contractual obligation, the effects of a mandatory tender offer are economically similar to a contractual NCI put and, in the absence of specific IFRS accounting guidance, it may be appropriate to account in the same way. We believe that this is an area where the IASB should provide further clarification.

Meanwhile, in the absence of any explicit guidance in IFRS for such transactions, we believe that entities generally have an accounting policy choice to:

1. account for the transaction as a single linked transaction in which control is gained (a single business combination); or
2. account for the transaction as a discrete transaction (a business combination, followed by an acquisition of non-controlling interests).

However, policy (a) can only be applied where the acquisition of non-controlling interest is assessed as linked to the same transaction as that by which control is gained (as explained in 6.2.4.A below). Entities would need to apply the policy consistently (for example, if policy (a) is applied, it should be applied for all transactions where the criteria for linked transactions are met). Entities applying policy (a) should refer to 6.2.4.B for accounting for linked transactions.

Where an entity adopts policy (b) to account for the transaction as a discrete transaction, a further determination needs to be made as to whether (and at what point), based on the facts and circumstances, the mandatory tender offer gives rise to a contractual obligation. The accounting is as follows:

• Where a mandatory tender offer is considered to give rise to a contractual obligation to purchase the equity shares (or the transaction is accounted by analogy in the same way as a contractual put), an obligation for the NCI put is recognised in accordance with the guidance on Approaches 1 to 4 described in 6.2 above (and consistent with the guidance in 6.4 below). While the exact point at which a contractual obligation arises in the mandatory tender process will depend on the specific facts and circumstances in the relevant jurisdiction, we would generally expect that an irrevocable and enforceable offer made by the acquirer to purchase the non-controlling interests will constitute a contractual obligation.
• If no contractual obligation arises in advance of the purchase (and the transaction is not accounted by analogy in the same way as a contractual put), the purchase of the non-controlling interest is accounted for as a separate equity transaction when it occurs (see 4 above). An obligation is recognised for the statutory obligation for the mandatory tender offer, if onerous, in accordance with IAS 37.

This is summarised in the following decision tree at Figure 7.3 below.

This shows a simplified decision chart for accounting for a mandatory tender offer following the acquisition of a controlling stake in an investee. It is important that this is read in conjunction with the text in 6.2.4 above as well as the sections cross referenced from the boxes in the chart.

6.2.4.A Identifying a linked transaction

The acquisition of the non-controlling interest is a linked transaction when it arises from the same transaction as that by which control was gained. This will generally be the case where it arises as part of the same offer, including where legal or regulatory requirements lead to the offer being extended through the creation of a shareholder put, or acquirer compulsory acquisition rights.

In many cases, it will be clear where there is a single offer. Where it is not clear, the existence of all of the following factors indicate a linked transaction:

• the option over the remaining interest and subsequent acquisition is not negotiated separately by the non-controlling shareholders;
• the offer period is short; and
• the price per share offered for subsequent increases is fixed and consistent with the price paid for the controlling interest.

These factors are generally all present in the case of public offers to the entire group of shareholders. They may not all be present for private offers where, for example, some of the options may be for extended terms.

If a put option is granted over the non-controlling interest and the terms of the put option are such that the present ownership interest attached to the underlying shares is gained at the same time as gaining control, this will satisfy the second criterion above. Whilst the put may nominally extend over a long period, the effect is that ownership has already passed to the acquirer. See 6.2.2 above for the factors to be considered in assessing whether or not the acquirer gains present ownership interest over the underlying shares. Where the other criteria above are also met, this is a linked transaction.

6.2.4.B Accounting for the linked transaction (where a policy to account as a single business combination is followed)

A linked transaction is accounted for as if all ownership interests were acquired at the acquisition date as part of the transaction to gain control.

The consideration transferred is the sum of the amount paid for the controlling and non-controlling interest (that is acquired as part of the linked transaction) and the percentage acquired is the sum of the respective shareholdings. If, at the date of gaining control the non-controlling interest has not actually been acquired, a financial liability is recognised at the present value of the amount payable upon exercise of the option to acquire the non-controlling interest.

If at the date the non-controlling interest is actually acquired, the percentage acquired differs to that originally accounted for as being acquired, the purchase accounting is adjusted to reflect the actual percentage acquired. A ‘true up’ exercise is performed to adjust the total consideration paid and therefore the amount of goodwill recognised. It is not accounted for as a partial disposal of non-controlling interest (changes in ownership interest without loss of control are addressed at 4 above). The non-controlling interest is measured as of the date of acquisition, not as of the date that the offer expires.

When the transaction is linked because the arrangement provides a present ownership interest in the non-controlling interest, the entity will not recognise the non-controlling interest. Accounting for the transaction is as described in Approach 1 at 6.2.3.A above.

Example 7.19 below illustrates the accounting for a linked transaction.

6.3 Combination of call and put options

In some business combinations, there might be a combination of call and put options, the terms of which may be equivalent or may be different.

The appropriate accounting for such options is determined based on the discussions in 6.1 and 6.2 above. However, where there is a call and put option with equivalent terms, particularly at a fixed price, the combination of the options is more likely to mean that they give the acquirer a present ownership interest. Where the exercise price is at fair value (or an amount that approximates fair value), however, the returns of ownership arising from fair value movements will accrete to the non-controlling interest and consequently, this situation is unlikely to give the acquirer a present ownership interest.

In cases where the combination of call and put options gives the acquirer a present ownership interest, where the options are over all of the shares not held by the parent, the acquirer has effectively acquired a 100% interest in the subsidiary at the date of the business combination. The entity may be in a similar position as if it had acquired a 100% interest in the subsidiary with either deferred consideration (where the exercise price is fixed) or contingent consideration (where the settlement amount is not fixed, but is dependent upon a future event). See Chapter 9 at 7.

As noted at 6 above, similar considerations also apply where the acquirer entered into a forward purchase contract for the shares held by the other shareholders.

6.4 Call and put options entered into in relation to existing non-controlling interests

The discussion in 6.1 and 6.2 above focused on call and put options entered into at the same time as control is gained of the subsidiary. However, an entity may enter into the options with non-controlling shareholders after gaining control. The appropriate accounting policy will still be based on the discussions in 6.1 and 6.2 above.

Where the entity already has a controlling interest and as a result of the options now has a present ownership interest in the remaining shares concerned, or concludes that IAS 32 takes precedence, the non-controlling interest is no longer recognised within equity. The transaction is accounted for as an acquisition of the non-controlling interest, i.e. it is accounted for as an equity transaction (see 4 above), because such acquisitions are not business combinations under IFRS 3.

6.5 Put and call options in separate financial statements

Purchased call options (and written put options) over shares in an acquired subsidiary are derivatives in the separate financial statements. Note that this treatment differs from that in the consolidated financial statements which is addressed generally at 6 above.

A purchased call option over shares in an acquired subsidiary is initially recognised as a financial asset at its fair value, with any subsequent changes in the fair value of the option recognised in profit or loss. Similarly, a written put option over shares in an acquired subsidiary is initially recognised as a financial liability at its fair value, with any subsequent changes in the fair value of the option recognised in profit or loss.

The initial credit entry for the call option (and the initial debit entry for the put option) will depend on the transactions giving rise to the options. For example, the entity may have paid (or received) consideration for the call (or put option) in a separate transaction or as part of a larger transaction.

Where a purchased call option (or written put) option lapses, the financial asset (or financial liability) is derecognised, with a debit (or credit) to profit or loss. Where a purchased call option (or written put option) is exercised, the financial asset (or financial liability) is derecognised with an adjustment to the cost of investment of purchasing the shares subject to the option.

The fair value of the purchased call option (or written put option) may not be significant if it is exercisable at the fair value (or at an amount that approximates fair value) of the underlying shares at the date of exercise. Where there is both a purchased call and a written put option, particularly where the options have the same fixed redemption price, it is likely that the fair values of the purchased call option and written put option will differ.

7.1 Sale or contribution of assets between an investor and its associate or joint venture (amendments to IFRS 10 and IAS 28)

One issue that the IASB has been trying to resolve was a conflict between the IFRS 10 requirements relating to loss of control over a subsidiary and those of IAS 28 for transactions where a parent sells or contributes an interest in a subsidiary to an associate or a joint venture. In order to resolve the conflict, in September 2014, the IASB had issued Sale or Contribution of Assets between an Investor and its Associate or Joint Venture (Amendments to IFRS 10 and IAS 28).

These amendments, where applied, would require the gain or loss resulting from the loss of control of a subsidiary that does not contain a business (as defined in IFRS 3) – as a result of a sale or contribution of a subsidiary to an existing associate or a joint venture (that is accounted for using the equity method) – to be recognised only to the extent of the unrelated investors’ interests in the associate or joint venture. The same requirement applies to the remeasurement gain or loss relating to the former subsidiary if, following the transaction, a parent retains an investment in a former subsidiary and the former subsidiary is now an associate or a joint venture that is accounted for using the equity method.³³ However, a full gain or loss would be recognised on the loss of control of a subsidiary that constitutes a business, including cases in which the investor retains joint control of, or significant influence over, the investee.

In the Basis of Conclusions, the IASB clarifies that the amendments do not apply where a transaction with a third party leads to a loss of control (even if the retained interest in the former subsidiary becomes an associate or joint venture that is accounted for using the equity method), nor where the investor elects to measure its investments in associates or joint ventures at fair value in accordance with IFRS 9. [IFRS 10.BC 190I].

These amendments were to be applied prospectively to transactions occurring in annual periods beginning on or after 1 January 2016, with earlier application permitted.³⁴ However, in December 2015, the IASB issued a further amendment – Effective Date of Amendments to IFRS 10 and IAS 28. This amendment defers the effective date of the September 2014 amendments until the IASB has finalised any revisions that result from the IASB's research project on the equity method (although the IASB now plans no further work on this project until the Post-implementation Reviews of IFRS 10, IFRS 11 and IFRS 12 are undertaken).³⁵ At the time of writing, work on the Post-implementation Reviews of IFRS 10, IFRS 11 and IFRS 12 was expected to start in Q2 2019 (and the pipeline research project on the equity method is expected to start in the second half of 2019).³⁶

Nevertheless, the IASB has continued to allow early application of the September 2014 amendments, which must be disclosed, as it did not wish to prohibit the application of better financial reporting. [IFRS 10.C1C, BC190L-190O, IAS 28.45C, BC37J].³⁷

The amendments are discussed at 3.3.2 and 3.3.2.B above.

7.2 Sale or contribution of assets to a joint operation (where the entity has joint control or is a party to the joint operation)

In July 2016, the Interpretations Committee discussed whether an entity should remeasure its retained interest in the assets and liabilities of a joint operation when the entity loses control of a business, or an asset or group of assets that is not a business. In the transaction discussed, the entity either retains joint control of a joint operation or is a party to a joint operation (with rights to assets and obligations for liabilities) after the transaction.

Because of the similarity between the transaction being discussed by the Interpretations Committee and a sale or contribution of assets to an associate or joint venture (see 7.1 above), the Interpretations Committee decided not to add the issue to its agenda, but instead to recommend that the IASB consider the issue at the same time that it further considers the accounting for the sale or contribution of assets to an associate or a joint venture. The Interpretations Committee observed that the Post-implementation Reviews of IFRS 10 and IFRS 11 would provide the IASB with an opportunity to consider loss of control transactions and a sale or contribution of assets to an associate or joint venture.³⁸ At the time of writing, work on the Post-implementation Reviews of IFRS 10 and IFRS 11 were expected to start in Q2 2019.³⁹

The decision of the Interpretations Committee, and the accounting for such transactions are discussed further at 3.3.3 above.

7.3 Accounting for put options written on non-controlling interests – Financial Instruments with Characteristics of Equity (‘FICE’) project

The Interpretations Committee and the IASB have been debating the accounting for put options written on non-controlling interests (‘NCI puts’) over a number of years. Many of these issues have now been considered by the FICE project.

In June 2018, the IASB issued Discussion Paper – Financial instruments with Characteristics of Equity.⁴⁰ The Discussion Paper proposes an approach that articulates the principles for classification of financial instruments as either financial liabilities or equity (from the perspective of the issuer), without significantly altering most existing classification outcomes of IAS 32 (although there would be some changes). There are separate classification principles for derivative financial instruments (because of particular challenges arising from classification of derivatives on own equity).

The IASB's preferred approach would also require consistent accounting for redemption obligation arrangements, including NCI puts and compound instruments. The requirement to identify a gross liability component would also apply to redemption obligation arrangements that require a transfer of a variable number of own shares, if the amount of the contractual obligation to transfer own shares is independent of the entity's available economic resources.

Applying the IASB's preferred approach (should the proposals ultimately lead to amendments to IFRSs) to the accounting for an NCI put in the consolidated financial statements would thus require:

• recognition of a liability component at the redemption amount (which will be subsequently measured in accordance with IFRS 9);
• derecognition of the non-controlling interest – the ordinary shares of the subsidiary that represent the non-controlling interest – on which put options are written, at the fair value of the ordinary shares of the subsidiary at the date the put options are issued; and
• recognition of an equity component for the (implicit) written call option on the subsidiary's shares. If the NCI put is a fair value put, the equity component would be nil.

Under the IASB's preferred approach, gains or losses, including those arising from subsequent measurement of the liability component, would be recognised as income and expense, while changes in the equity components would be recognised in the statement of changes in equity. If the NCI put is exercised and settled by delivering cash at the end of the option exercise period, the financial liability would be derecognised and the carrying amount of the equity component would be reclassified within equity. If the NCI put expires unexercised, the financial liability and the carrying amount of the equity component would be derecognised, and the non-controlling interest in the shares of the subsidiary would be recognised.⁴¹

In March 2019 and June 2019, the IASB discussed emerging themes from the feedback to the Discussion Paper through comment letters and outreach activities but no decisions were made. A decision on the project direction is expected to be made in Q4 2019.⁴² See Chapter 47 at 12 for further discussion of the FICE project, including the Discussion Paper.

7.4 Mandatory purchase of non-controlling interests

As discussed more fully at 6.2.4 above, neither IFRS 10 nor IFRS 3 specifically addresses the accounting for a sequence of transactions that begins with an acquirer gaining control over another entity, followed by it acquiring additional ownership interests shortly thereafter. This frequently happens where public offers are made to a group of shareholders and there is a regulatory requirement for an acquirer to make an offer to the non-controlling shareholders of the acquiree. This issue had been considered by the Interpretations Committee and was escalated to the IASB. In February 2017, the IASB tentatively decided as part of its FICE project (see 7.3 above) to consider whether it should take any action to address the accounting for mandatory tender offers, including potential disclosure requirements.⁴³

As noted at 7.3 above, in June 2018, the IASB issued Discussion Paper – Financial instruments with Characteristics of Equity. The Discussion Paper takes the view that classification based on an assessment of contractual terms consistent with IFRS 9 would result in, for example, the obligations that arise in mandatory tender offers, which have similar consequences to those that arise from written put options, not being considered for the purpose of classification because they are beyond the scope of IAS 32. Other IFRSs might have specific guidance for issues that arise when an entity accounts for rights and obligations arising from law (such as IAS 37). However, the IASB did not design other IFRSs to address the classification of liabilities and equity.

Alternatively, if the treatment of rights and obligations that arise from law were considered as equivalents of contractual terms under IAS 32 then mandatory tender offers might be accounted for consistently with written put options. However, the Discussion Paper considered that such a fundamental change to the scope of IAS 32 and IFRS 9 to include rights and obligations that arise from law could have consequences beyond the distinction between liabilities and equity.

In the IASB's preliminary view, an entity would apply the IASB's preferred approach to the contractual terms of a financial instrument consistently with IAS 32 and IFRS 9. The IASB will consider whether it should take any action to address the accounting for mandatory tender offers, including potential disclosure requirements, following its analysis of responses to this Discussion Paper.⁴⁴ As noted at 7.3 above, a decision on the project direction is expected to be made in Q4 2019.⁴⁵