5.3.1 Investment entities exception

IFRS 10 requires entities that meet the definition of an investment entity to measure investments in subsidiaries at fair value through profit or loss in accordance with IFRS 9. The investment entities exception is discussed further in Chapter 6 at 10.

The application of the investment entity exception is not an accounting policy choice. If an entity meets the definition of an investment entity, it is required to measure its subsidiaries at fair value through profit or loss. To meet this definition, an investment entity must, among meeting other criteria, elect the exemption from applying the equity method in IAS 28 for its investments in associates and joint ventures. [IFRS 10.B85L(b)].

As discussed further at 7.8.1 below, if an entity that is not itself an investment entity has an interest in an associate or joint venture that is an investment entity, the investor may retain the fair value measurement applied by that investment entity associate or joint venture to the investment entity associate's or joint venture's interests in subsidiaries. [IAS 28.36A].

5.3.2 Application of IFRS 9 to exempt investments in associates or joint ventures

The reason that IAS 28 allows venture capital organisations, mutual funds, unit trusts and similar entities to measure investments in associates and joint ventures at fair value is because such entities often manage their investments based on fair values and so the application of IFRS 9 produces more relevant information. Furthermore, the financial statements would be less useful if changes in the level of ownership in an investment resulted in frequent changes in the method of accounting for the investment. Where investments are measured at fair value, the fair value is determined in accordance with IFRS 13 – Fair Value Measurement (see Chapter 14 at 5.1).

7.4.1 Initial carrying amount of an associate or joint venture following loss of control of an entity

Under IFRS 10, if a parent entity loses control of a subsidiary that constitutes a business in a transaction that is not a downstream transaction (see 7.6.5 below) and the retained interest is an investment in an associate or joint venture, then the entity must apply paragraph 25 of IFRS 10 The retained interest must be remeasured at its fair value, and this fair value becomes the cost on initial recognition of the investment in an associate or joint venture.

If the subsidiary does not constitute a business, it is not clear whether paragraph 25 of IFRS 10 applies to such a loss of control transaction. Therefore, we believe that an entity can develop an accounting policy to either apply paragraph 25 of IFRS 10 to the loss of control over only subsidiaries that constitute a business, or to the loss of control over all subsidiaries (i.e. those that constitute a business and those that do not).

Where an entity does not apply paragraph 25 of IFRS 10 to subsidiaries that do not constitute a business, it can apply the guidance in IAS 28 if the loss of control is through a downstream transaction, or it needs to develop an accounting policy in terms of IAS 8 – Accounting Policies, Changes in Accounting Estimates and Errors – on how to account for the retained interest for all other types of transactions.

Although it is clear that the initial carrying amount of the associate in the above example is the fair value of the retained interest, i.e. £800,000, does this mean that Entity A in applying the equity method under IAS 28 may need to remeasure the underlying assets and liabilities in Entity B at their fair values at the date Entity B becomes an associate i.e. effectively a new purchase price allocation is performed?

In our view, under paragraph 25 of IFRS 10, Entity A effectively accounts for the investment in Entity B as if it had acquired the retained investment at fair value as at the date control is lost and hence should be treated the same as the initial acquisition of an investment in an associate in terms of IAS 28 paragraph 32 (see 7.4 above). Therefore, the answer to the above question is ‘yes’. Accordingly, to apply the equity method from the date control is lost, Entity A must remeasure all the identifiable assets and liabilities underlying the investment at their fair values (or other measurement basis required by IFRS 3 at that date).

IAS 28 indicates that on initial recognition of an investment in an associate, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate, and that fair values are applied to measure all the identifiable assets and liabilities in calculating any goodwill or bargain purchase that exists. [IAS 28.26, 32].

Accordingly, in Example 11.5 above, based on the fair value of the identifiable assets and liabilities of Entity B of £1,600,000, Entity A's initial carrying amount of £800,000 will include goodwill of £160,000, being £800,000 – £640,000 (40% of £1,600,000). IFRS 13 provides detailed guidance about how fair value should be determined, which is discussed in Chapter 14.

The Post-Implementation Review (PIR) of IFRS 13 considered whether the unit of account for investments in subsidiaries, joint ventures and associates was the investment as a whole and not the individual financial instruments that constitute the investment. The PIR has been completed and at its March 2018 meeting, the IASB considered the findings of the PIR and concluded that IFRS 13 is working as intended. Hence no clarification in this regard was made. These issues are discussed further in Chapter 14 at 5.1.1.

7.4.2 Piecemeal acquisition of an associate or joint venture

7.5.1 Accounting for potential voting rights

In applying the equity method to a single investment of a specified number of ordinary shares of the investee, the proportionate share of the associate or joint venture to be accounted for will be based on the investor's ownership interest in the ordinary shares.

This will also generally be the case when potential voting rights or other derivatives containing potential voting rights exist in addition to the single investment in the ordinary shares, as IAS 28 states that an entity's interest in an associate or a joint venture is determined solely based on existing ownership interests and does not reflect the possible exercise or conversion of potential voting rights and other derivative instruments. [IAS 28.12].

However, as an exception to this, IAS 28 recognises that in some circumstances, an entity has, in substance, an existing ownership interest because of a transaction that currently gives it access to the returns associated with an ownership interest. In such circumstances, the proportion allocated to the entity is determined by considering the eventual exercise of those potential voting rights and other derivative instruments that currently give the entity access to the returns. [IAS 28.13]. The standard does not provide any example of such circumstances, but an example might be a presently exercisable option over shares in the investee at a fixed price combined with the right to veto any distribution by the investee before the option is exercised or combined with features that adjust the exercise price with respect to dividends paid.

IFRS 9 does not apply to interests in associates and joint ventures that are accounted for using the equity method. When instruments containing potential voting rights in substance currently give access to the returns associated with an ownership interest in an associate or a joint venture, the instruments are not subject to IFRS 9. In all other cases, instruments containing potential voting rights in an associate or a joint venture are accounted for in accordance with IFRS 9. [IAS 28.14]. Once the potential voting rights are exercised and the share in the investee increases, the fair value of such instruments at the exercise date is part of the cost to be recognised in accounting for the step increase (see 7.4.2 above).

7.5.2 Cumulative preference shares held by parties other than the investor

If an associate or joint venture has outstanding cumulative preference shares that are held by parties other than the investor and that are classified as equity, the investor computes its share of profits or losses after adjusting for the dividends on such shares, whether or not the dividends have been declared. [IAS 28.37].

Although Example 11.9 below illustrates cumulative preference shares issued by an associate, the accounting would be the same if the shares were issued by a joint venture.

7.5.3 Several classes of equity

When an associate or joint venture has a complicated equity structure with several classes of equity shares that have varying entitlements to net profits, equity or liquidation preferences, the investor needs to assess carefully the rights attaching to each class of equity share in determining the appropriate percentage of ownership interest.

7.5.4 Where the reporting entity is a group

A group's share in an associate or joint venture is the aggregate of the holdings in that associate or joint venture by the parent and its subsidiaries. The holdings of the group's other associates or joint ventures are ignored for this purpose. [IAS 8.27]. Example 11.10 below illustrates the group's share in an associate where investments are also held by other entities in the group.

7.5.5 Where the investee is a group: non-controlling interests in an associate or joint venture's consolidated financial statements

When an associate or joint venture itself has subsidiaries, the profits or losses, other comprehensive income and net assets considered in applying the equity method are those recognised in the associate or joint venture's consolidated financial statements, but after any adjustments necessary to give effect to uniform accounting policies (see 7.8 below). [IAS 28.27].

It may be that the associate or joint venture does not own all the shares in some of its subsidiaries, in which case its consolidated financial statements will include non-controlling interests. Under IFRS 10, any non-controlling interests are presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. Profit or loss and each component of other comprehensive income are attributed to the owners of the parent and to the non-controlling interests. [IFRS 10.22, B94]. The profit or loss and other comprehensive income reported in the associate or joint venture's consolidated financial statements will include 100% of the amounts relating to the subsidiaries, but the overall profit or loss and total comprehensive income will be split between the amounts attributable to the owners of the parent (i.e. the associate or joint venture) and those attributable to the non-controlling interests. The net assets in the consolidated statement of financial position will also include 100% of the amounts relating to the subsidiaries, with any non-controlling interests in the net assets presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent.

IAS 28 does not explicitly say whether the investor should base the accounting for its share of the associate or joint venture's profits, other comprehensive income and net assets under the equity method on the amounts before or after any non-controlling interests in the associate or joint venture's consolidated accounts. However, as the investor's interest in the associate or joint venture is as an owner of the parent, the share is based on the profit or loss, comprehensive income and equity (net assets) that are reported as being attributable to the owners of the parent in the associate or joint venture's consolidated financial statements, i.e. after any amounts attributable to the non-controlling interests. This is consistent with the implementation guidance to IAS 1, where it is indicated that the amounts disclosed for ‘share of profits of associates’ and ‘share of other comprehensive income of associates’ represent the amounts ‘attributable to owners of the associates, i.e. it is after tax and non-controlling interests in the associates’.¹⁰

7.6.1 Elimination of ‘upstream’ and ‘downstream’ transactions

IAS 28 requires gains and losses resulting from what it refers to as ‘upstream’ and ‘downstream’ transactions between an entity (including its consolidated subsidiaries) and its associate or joint venture to be recognised in the entity's financial statements only to the extent of unrelated investors’ interests in the associate or joint venture. ‘Upstream’ transactions are, for example, sales of assets from an associate or a joint venture to the investor. ‘Downstream’ transactions are, for example, sales or contributions of assets from the investor to its associate or its joint venture. The investor's share in the associate's or joint venture's gains or losses resulting from these transactions is eliminated. [IAS 28.28].

IAS 28 is not entirely clear as to how this very generally expressed requirement translates into accounting entries, but we suggest that an appropriate approach might be to proceed as follows:

• in the income statement, the adjustment should be taken against either the investor's profit or the share of the associate's or joint venture's profit, according to whether the investor or the associate or joint venture recorded the profit on the transaction, respectively; and
• in the statement of financial position, the adjustment should be made against the asset which was the subject of the transaction if it is held by the investor or against the carrying amount for the associate or joint venture if the asset is held by the associate or joint venture.

This is consistent with the approach required by IAS 28 in dealing with the elimination of unrealised gains and losses arising on contributions of non-monetary assets to an associate or joint venture in exchange for an equity interest in the associate or joint venture (see 7.6.5 below).

Examples 11.11 and 11.12 below illustrate our suggested approach to this requirement of IAS 28. Both examples deal with the reporting entity H and its 40% associate A. The journal entries are based on the premise that H's financial statements are initially prepared as a simple aggregation of H and the relevant share of its associates. It is further assumed that prior period equity-accounting journal entries are not carried forward to the next reporting period. The entries below would then be applied to the numbers at that stage of the process. Although these examples illustrate transactions between the reporting entity and an associate, the accounting would be the same if the transactions occurred between the reporting entity and a joint venture.

It may be that a transaction between an investor and its associate or joint venture indicates a reduction in the net realisable value or an impairment loss of the asset that is the subject of the transaction. IAS 28 requires that when downstream transactions provide evidence of a reduction in the net realisable value of the assets to be sold or contributed, or of an impairment loss of those assets, those losses shall be recognised in full by the investor. When upstream transactions provide evidence of a reduction in the net realisable value of the assets to be purchased or of an impairment loss of those assets, the investor shall recognise its share in those losses. [IAS 28.29].

The effect of these requirements is illustrated in Examples 11.13 and 11.14 below. Although these examples illustrate transactions between the reporting entity and a joint venture, the accounting would be the same if the transactions occurred between the reporting entity and an associate.

7.6.2 Reciprocal interests

Reciprocal interests (or ‘cross-holdings’) arise when an associate itself holds an investment in the reporting entity. It is unlikely that a joint venture would hold an investment in the reporting entity but, if it did, the discussion below would apply equally to such a situation.

7.6.3 Loans and borrowings between the reporting entity and its associates or joint ventures

The requirement in IAS 28 paragraph 28 to eliminate partially unrealised profits or losses on transactions with associates or joint ventures is expressed in terms of transactions involving the transfer of assets. The requirement for partial elimination of profits could be read to not apply to items such as interest paid on loans and borrowings between the reporting entity and its associates or joint ventures, since such loans and borrowings do not involve the transfer of assets giving rise to gains or losses. Moreover, they are not normally regarded as part of the investor's share of the net assets of the associate or joint venture, but as separate transactions, except in the case of loss-making associates or joint ventures, where interests in long-term loans and borrowings may be required to be accounted for as if they were part of the reporting entity's equity investment in determining the carrying value of the associate or joint venture against which losses may be offset (see 7.9 below). If this reading of IAS 28 is followed, loans and borrowings between the reporting entity and its associates or joint ventures would not be eliminated in the reporting entity's consolidated accounts because the respective assets and liabilities of associates and joint ventures are not recognised by the group.

However, if the associate or joint venture has capitalised the borrowing costs then the investor would need to eliminate a relevant share of its interest income and realise it as the associate depreciates the qualifying asset. The same principle applies to eliminate a share of the capitalised management or advisory fees charged to an associate or joint venture.

7.6.4 Statement of cash flows

In the statement of cash flows (whether in the consolidated or separate financial statements) no adjustment is made in respect of the cash flows relating to transactions with associates or joint ventures. This contrasts with the requirement, in any consolidated statement of cash flows, to eliminate the cash flows between members of the group in the same way that intragroup transactions are eliminated in the profit and loss account and statement of financial position.

7.6.5 Contributions of non-monetary assets to an associate or a joint venture

It is fairly common for an entity to create or change its interest in an associate or a joint venture by contributing some of the entity's existing non-monetary assets to that associate or joint venture. This raises several issues as to how such transactions should be accounted for, in particular whether they should be accounted for at book value or fair value.

IAS 28 requires the contribution of a non-monetary asset to an associate or a joint venture in exchange for an equity interest in the associate or joint venture to be accounted for in accordance with paragraph 28, except when the contribution lacks commercial substance, as described in IAS 16 (see 7.6.5.A below and Chapter 18 at 4.4). [IAS 28.30]. Paragraph 28 requires gains and losses resulting from transactions between an entity and its associate or joint venture to be recognised only to the extent of unrelated interests in the associate or joint venture. The investor's share in the associate's or joint venture's gains or losses resulting from those transactions is eliminated (see 7.6.1 above for a discussion of the requirements relating to such transactions). However, there is a conflict between the requirements of IAS 28 and the requirements in IFRS 10 relating to accounting for the loss of control of a subsidiary, when a subsidiary is contributed by the investor to an associate or joint venture, and control over the subsidiary is consequently lost. This is discussed below at 7.6.5.C below.

If a contribution lacks commercial substance, the gain or loss is regarded as unrealised and is not recognised unless paragraph 31 also applies. Such unrealised gains and losses are to be eliminated against the investment accounted for using the equity method and are not to be presented as deferred gains or losses in the entity's consolidated statement of financial position or in the entity's statement of financial position in which investments are accounted for using the equity method. [IAS 28.30]. Where ‘unrealised’ losses are eliminated in this way, the effect will be to apply what is sometimes referred to as ‘asset swap’ accounting. In other words, the carrying value of the investment in the associate or joint venture will be the same as the carrying value of the non-monetary assets transferred in exchange for it, subject of course to any necessary provision for impairment uncovered by the transaction.

If, in addition to receiving an equity interest in an associate or a joint venture, an entity receives monetary or non-monetary assets, the entity recognises in full in profit or loss the portion of the gain or loss on the non-monetary contribution relating to the monetary or non-monetary assets received. [IAS 28.31].

In January 2018, the Interpretations Committee was asked how an entity should account for a transaction in which it contributes property, plant and equipment to a newly formed associate in exchange for shares in the associate. In the fact pattern described in the request, the entity and the fellow investors in the associate are entities under common control. The investors each contribute items of PPE to the new entity in exchange for shares in that entity. The Interpretations Committee firstly observed that unless a standard specifically excludes common control transactions from its scope, an entity applies the applicable requirements in the standard to common control transactions. In terms of paragraph 28 of IAS 28, the entity should recognise gains and losses resulting from the downstream transactions only to the extent of unrelated investors’ interests in the associate. The word ‘unrelated’ does not mean the opposite of ‘related’ as it is used in the definition of a related party in IAS 24 – Related Party Disclosures. Finally, the Interpretations Committee observed that if there is initially any indication that the fair value of the property, plant and equipment contributed might differ from the fair value of the acquired equity interest, the entity first assesses the reasons for this difference and reviews the procedures and assumptions it has used to determine fair value. The entity should recognise a gain or loss on contributing the property, plant and equipment and a carrying amount for the investment in the associate that reflects the determination of those amounts based on the fair value of the assets contributed, unless the transaction provides objective evidence that the entity's interest in the associate might be impaired. If this is the case, the entity also considers the impairment requirements in IAS 36 – Impairment of Assets. If, having reviewed the procedures and assumptions used to determine fair value, the fair value of the property, plant and equipment is more than the fair value of the acquired interest in the associate, this would provide objective evidence that the entity's interest in the associate might be impaired. The Interpretations Committee concluded that the principles and requirements in IFRS standards provide an adequate basis for an entity to account for the contribution non-monetary assets to an associate in the fact pattern described in the request and did not add any items to its agenda.¹⁵

7.8.1 Exemption for associates or joint ventures that are investment entities

If an entity that is not itself an investment entity has an interest in an associate or joint venture that is an investment entity, the entity may, when applying the equity method, elect to retain the fair value measurement applied by that investment entity associate or joint venture to the investment entity associate's or joint venture's interests in subsidiaries. This election is made separately for each investment entity associate or joint venture, at the later of the date on which:

1. the investment entity associate or joint venture is initially recognised;
2. the associate or joint venture becomes an investment entity; and
3. the investment entity associate or joint venture first becomes a parent. [IAS 28.36A].

7.8.2 Temporary exemption from IFRS 9 applied by an insurer

For an insurer that meets specified criteria, IFRS 4 – Insurance Contracts – provides a temporary exemption that permits, but does not require, the insurer to apply IAS 39 rather than IFRS 9 until IFRS 17 becomes effective. An entity is permitted, but not required, to retain the relevant accounting policies applied by the associate or joint venture as follows:

1. the entity applies IFRS 9 but the associate or joint venture applies the temporary exemption from IFRS 9; or
2. the entity applies the temporary exemption from IFRS 9 but the associate or joint venture applies IFRS 9. [IFRS 4.20O].

When an entity uses the equity method to account for its investment in an associate or joint venture:

1. if IFRS 9 was previously applied in the financial statements used to apply the equity method to that associate or joint venture (after reflecting any adjustments made by the entity), then IFRS 9 shall continue to be applied; or
2. if the temporary exemption from IFRS 9 was previously applied in the financial statements used to apply the equity method to that associate or joint venture (after reflecting any adjustments made by the entity), then IFRS 9 may be subsequently applied. [IFRS 4.20P].

An entity may apply the above exemptions separately for each associate or joint venture. [IFRS 4.20Q].

7.11.1 Dividends or other forms of distributions

Although paragraph 10 of IAS 28 does not explicitly refer to dividends or other forms of distribution that are reflected in the associate's statement of changes in equity, it does state that distributions received from an investee reduce the carrying amount of the investment. Generally, the distributions received will be the equivalent of the investor's share of the distributions made to the owners of the associate reflected in the associate's statement of changes in equity. Thus, they are effectively eliminated as part of applying the equity method.

However, this may not always be the case. For example, when an associate declares scrip dividends which are not taken up by the investor, the investor's proportionate interest in the associate is reduced. In this situation, the investor should account for this as a deemed disposal (see 7.12.5 below).

7.11.2 Issues of equity instruments

Where an associate or joint venture has issued equity instruments, the effect on its net assets will be reflected in the associate's or joint venture's statement of changes in equity. Where the investor has participated in the issue of these equity instruments, it will account for its cost of doing so by increasing its carrying amount of the associate or joint venture. If, as a consequence of the investor's participation in such a transaction, the investee has become an associate or joint venture of the investor, or the investor has increased its percentage ownership interest in an existing associate or joint venture (but without obtaining control), the investor should account for this as an acquisition of an associate or joint venture or a piecemeal acquisition of an associate or joint venture (see 7.4.2 above). Thus, the amounts reflected in the associate's or joint venture's statement of changes in equity are effectively eliminated as part of applying the equity method.

If, on the other hand, the investor has not participated in the issue of equity instruments reflected in the associate's or joint venture's statement of changes in equity, e.g. shares have been issued to third parties or the investor has not taken up its full allocation of a rights issue by the associate or joint venture, the investor's proportionate interest in the associate or joint venture is diminished. In such situations, it should account for the transaction as a deemed disposal (see 7.12.5 below).

7.11.3 Equity-settled share-based payment transactions

Another item that may feature in an associate's or joint venture's statement of changes in equity is the credit entry relating to any equity-settled share-based payment transactions of the associate or joint venture; the debit entry of such transactions is recognised by the associate or joint venture as an expense within its profit or loss.

How should such a transaction be reflected by the investor in equity accounting for the associate or joint venture, particularly the impact of the credit to equity recognised by the associate or joint venture?

As the share-based payment expense is included within the profit or loss of the associate or joint venture, this will be reflected in the share of the associate's or joint venture's profit or loss recognised in the investor's profit or loss. [IAS 28.10]. As far as the credit to equity that is included in the associate's or joint venture's statement of changes in equity is concerned, there are two possible approaches:

1. ignore the credit entry; or
2. reflect the investor's share of the credit entry as a ‘share of other changes in equity of associates or joint ventures’ in the investor's statement of changes in equity.

We believe that approach (a) should be followed, rather than approach (b). The description of the equity method in IAS 28 states that ‘the carrying amount [of the investment in an associate or a joint venture] is increased or decreased to recognise the investor's share of the profit or loss of the investee after the date of acquisition. … Adjustments to the carrying amount may also be necessary for changes in the investor's proportionate interest in the investee arising from changes in the investee's other comprehensive income.’ [IAS 28.10].

As far as the credit to shareholders’ equity recognised by the associate or joint venture is concerned, this is not part of comprehensive income and given that paragraph 10 of IAS 28 implies that the investor only recognises its share of the elements of profit or loss and of other comprehensive income, the investor should not recognise any portion of the credit to shareholders’ equity recognised by the associate or joint venture. If and when the options are exercised, the investor will account for its reduction in its proportionate interest as a deemed disposal (see 7.12.5 below).

This approach results in the carrying amount of the equity investment no longer corresponding to the proportionate share of the net assets of the investee (as reported by the investee). However, this is consistent with the requirement in IAS 28 for dealing with undeclared dividends on cumulative preference shares held by parties other than the investor (see 7.5.2 above). [IAS 28.37]. In that situation, the undeclared dividends have not yet been recognised by the investee at all, but the investor still reduces its share of the profit or loss (and therefore its share of net assets). The impact of applying this approach is illustrated in Example 11.23 below. Although the example is based on an equity-settled share-based payment transaction of an associate, the accounting treatment would be the same if it been a transaction undertaken by a joint venture.

As indicated in Example 11.23 above, when the options are exercised, the investor will account for the reduction in its proportionate interest in the associate or joint venture as a deemed disposal (see 7.12.5 below). On the other hand, if the options had lapsed unexercised, having already vested, the associate or joint venture would make no further accounting entries to reverse the expense already recognised, but may make a transfer between different components of equity (see Chapter 34 at 6.1.3). In that situation, as the investor's share of the net assets of the associate or joint venture is now increased as a result (effectively, the impact of the original expense on the share of net assets is reversed), we believe the investor can account for the increase as a debit to the investment in associate and the credit as either a gain in profit or loss or as a credit within equity. Once selected, the investor must apply the selected policy consistently.

7.11.4 Effects of changes in parent/non-controlling interests in subsidiaries

It may be that the associate or joint venture does not own all the shares in some of its subsidiaries, in which case its consolidated financial statements will include non-controlling interests. Under IFRS 10, any non-controlling interests are presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent. Profit or loss and each component of other comprehensive income are attributed to the owners of the parent and to the non-controlling interests. [IFRS 10.22, B94]. The profit or loss and other comprehensive income reported in the associate's or joint venture's consolidated financial statements will include 100% of the amounts relating to the subsidiaries, but the overall profit or loss and total comprehensive income will be split between the amounts attributable to the owners of the parent (i.e. the associate or joint venture) and those attributable to the non-controlling interests. The net assets in the consolidated statement of financial position will also include 100% of the amounts relating to the subsidiaries, with any non-controlling interests in the net assets presented in the consolidated statement of financial position within equity, separately from the equity of the owners of the parent.

The issue of whether the investor's share of the associate's or joint venture's profits, other comprehensive income and net assets under the equity method should be based on the amounts before or after any non-controlling interests in the associate's or joint venture's consolidated accounts is discussed at 7.5.5 above. As the investor's interest in the associate or joint venture is as an owner of the parent, it is appropriate that the share is based on the profit or loss, comprehensive income and equity (net assets) that are reported as being attributable to the owners of the parent in the associate's or joint venture's consolidated financial statements, i.e. after any amounts attributable to the non-controlling interests.

Under IFRS 10, changes in a parent's ownership interest in a subsidiary that do not result in a loss of control are accounted for as equity transactions. [IFRS 10.23]. In such circumstances the carrying amounts of the controlling and non-controlling interests are adjusted to reflect the changes in their relative interests in the subsidiary. Any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognised directly in equity and attributed to the owners of the parent. [IFRS 10.B96].

How should such an amount attributed to the owners of the parent that is recognised in the associate's or joint venture's statement of changes in equity be reflected by the investor in equity accounting for the associate or joint venture?

In our view, the investor may account for its share of the change of interest in the net assets/equity of the associate or joint venture because of the associate's or joint venture's equity transaction by applying either of the approaches set out below:

1. reflect it as part of the share of other changes in equity of associates or joint ventures’ in the investor's statement of changes in equity; or
2. reflect it as a gain or loss within the share of associate's or joint venture's profit or loss included in the investor's profit or loss.

Once selected, the investor must apply the selected policy consistently.

Approach (a) reflects the view that although paragraph 10 of IAS 28 only refers to the investor accounting for its share of the investee's profit or loss and other items of comprehensive income, this approach is consistent with the equity method as described in paragraph 10 of IAS 28 since it:

1. reflects the post-acquisition change in the net assets of the investee; [IAS 28.3] and
2. faithfully reflects the investor's share of the associate's transaction as presented in the associate's consolidated financial statements. [IAS 28.27].

Since, the transaction does not change the investor's ownership interest in the associate it is not a deemed disposal (see 7.12.5 below) and, therefore, there is no question of a gain or loss on disposal arising. Approach (b) reflects the view that:

1. the investor should reflect the post-acquisition change in the net assets of the investee; [IAS 28.3]
2. from the investor's perspective the transaction is not ‘a transaction with owners in their capacity as owners’ – the investor does not equity account for the NCI (see 7.5.5 above). So, whilst the investee must reflect the transaction as an equity transaction, from the investor's point of view the increase in the investment is a ‘gain’. This is consistent with the treatment of unrealised profits between a reporting entity and an associate (see 7.6.1 above). The NCI's ownership is treated as an ‘external’ ownership interest to the investor's group. Therefore, consistent with this approach, any transaction which is, from the investor's perspective a transaction with an ‘external’ ownership interest can give rise to a gain or loss;
3. the increase in the investee's equity is also not an item of other comprehensive income as referred to in paragraph 10 of IAS 28;
4. any increase in the amount of an asset should go to profit or loss if not otherwise stated in IFRS. Paragraph 88 of IAS 1 states that an ‘entity shall recognise all items of income and expense in a period in profit or loss unless an IFRS requires or permits otherwise.’

We believe it is appropriate for the investor to recognise the change in net assets/equity relating to the transaction with NCI as this approach does not ignore the principle in paragraph 3 of IAS 28 of recognising post–acquisition changes in the investee's net assets.

These approaches are illustrated in Example 11.24 below. Although the example is based on a transaction by an associate, the accounting would be the same if it had been undertaken by a joint venture.

7.12.1 Investment in associate or joint venture becoming a subsidiary

If because of an increased investment in an associate or joint venture an investor obtains control over the investee, or there is a change in circumstances such that the investor obtains control over the investee, the investment becomes a subsidiary. The entity discontinues the use of the equity method and accounts for its investment in accordance with IFRS 3 and IFRS 10. [IAS 28.22]. In this situation, IFRS 3 requires revaluation of the previously held interest in the equity accounted investment at its acquisition-date fair value, with recognition of any gain or loss in profit or loss. [IFRS 3.41‑42]. The accounting for an increase in an associate or joint venture that becomes a subsidiary is discussed further in Chapter 9 at 9.

In addition, the entity accounts for all amounts previously recognised in other comprehensive income in relation to that investment on the same basis as would have been required if the investee had directly disposed of the related assets or liabilities. [IAS 28.22].

Therefore, if a gain or loss previously recognised in other comprehensive income by the investee would be reclassified to profit or loss on the disposal of the related assets or liabilities, the entity reclassifies the gain or loss from equity to profit or loss (as a reclassification adjustment) when the equity method is discontinued. For example, if an associate or a joint venture has cumulative exchange differences relating to a foreign operation and the entity discontinues the use of the equity method, the entity shall reclassify to profit or loss the gain or loss that had previously been recognised in other comprehensive income in relation to the foreign operation. [IAS 28.23].

7.12.2 Retained investment in the former associate or joint venture is a financial asset

If an investor disposes of a portion of its investment, such that it no longer has significant influence or joint control over the investee, it will discontinue the use of the equity method. If the retained interest is a financial asset, the entity measures the retained interest at fair value. The fair value of the retained interest is to be regarded as its fair value on initial recognition as a financial asset in accordance with IFRS 9.

In such situations, the entity recognises in profit or loss any difference between:

1. the fair value of any retained interest and any proceeds from disposing of a part interest in the associate or joint venture; and
2. the carrying amount of the investment at the date the equity method was discontinued.

Furthermore, the entity accounts for all amounts previously recognised in other comprehensive income in relation to that investment on the same basis as would have been required if the investee had directly disposed of the related assets or liabilities. [IAS 28.22].

Therefore, if a gain or loss previously recognised in other comprehensive income by the investee would be reclassified to profit or loss on the disposal of the related assets or liabilities, the entity reclassifies the gain or loss from equity to profit or loss (as a reclassification adjustment) when the equity method is discontinued. For example, if an associate or a joint venture has cumulative exchange differences relating to a foreign operation and the entity discontinues the use of the equity method, the entity reclassifies to profit or loss the gain or loss that had previously been recognised in other comprehensive income in relation to the foreign operation. [IAS 28.23].

When the retained interest after the partial disposal of an interest in a joint venture or a partial disposal of an interest in an associate that includes a foreign operation is a financial asset that includes a foreign operation, IAS 21 – The Effects of Changes in Foreign Exchange Rates – requires it to be accounted for as a disposal. [IAS 21.48A]. As such, it should be noted that the reclassification adjustment from equity to profit or loss is for the full amount that is in other comprehensive income and not just a proportionate amount based upon the interest disposed of. The Basis for Conclusions to IAS 21 explains that the loss of significant influence or joint control is a significant economic event that warrants accounting for the transaction as a disposal under IAS 21, [IAS 21.BC33‑34], and hence the transfer of the full exchange difference rather than just the proportionate share that would be required if this was accounted for as a partial disposal under IAS 21.

The accounting described above applies not only when an investor disposes of an interest in an associate or joint venture, but also where it ceases to have significant influence due to a change in circumstances. For example, when an associate issues shares to third parties, changes to the board of directors may result in the investor no longer having significant influence over the associate. Therefore, the investor will discontinue the use of the equity method.

7.12.3 Investment in associate becomes a joint venture (or vice versa)

If an investment in an associate becomes an investment in a joint venture or an investment in a joint venture becomes an investment in an associate, the entity does not discontinue the use of the equity method. In such circumstances, the entity continues to apply the equity method and does not remeasure the retained interest. [IAS 28.24].

When the change in status of the investment results from the acquisition of an additional interest in the investee, the increase in the investment is accounted for as discussed at 7.4.2.C above. When the change in status results from the disposal of an interest in the investee, this is accounted for as explained at 7.12.4 below.

As discussed at 6 and at 7.12 above, if a portion of an interest in an associate or joint venture fulfils the criteria for classification as held for sale, it is only that portion that is accounted for under IFRS 5. An entity maintains the use of the equity method for the retained interest until the portion classified as held for sale is finally sold.

7.12.4 Partial disposals of interests in associate or joint venture where the equity method continues to be applied

IAS 28 does not explicitly state that an entity should recognise a gain or loss when it disposes of a part of its interest in an associate or a joint venture, but the entity continues to apply the equity method. However, as explained below, it is evident that a gain or loss should be recognised on the partial disposal.

The standard requires that when an entity's ownership interest in an associate or a joint venture is reduced, but the entity continues to apply the equity method, the entity reclassifies to profit or loss the proportion of the gain or loss that had previously been recognised in other comprehensive income relating to that reduction in ownership interest if that gain or loss would be required to be reclassified to profit or loss on the disposal of the related assets or liabilities. [IAS 28.25].

In addition, IAS 21 requires for such partial disposals that the investor should ‘reclassify to profit or loss only the proportionate share of the cumulative amount of the exchange differences recognised in other comprehensive income’. [IAS 21.48C].

That means that the investor recognises in profit or loss a proportion of:

• foreign exchange differences recognised in other comprehensive income under IAS 21;
• accumulated hedging gains and losses recognised in other comprehensive income under IFRS 9 (see Chapter 53) (or IAS 39); and
• any other amounts previously recognised in other comprehensive income that would have been recognised in profit or loss if the associate had directly disposed of the assets to which they relate,

in each case proportionate to the interest disposed of.

IAS 21 requires that the proportion of the foreign exchange differences are reclassified ‘when the gain or loss on disposal is recognised’. [IAS 21.48]. In addition, the Interpretations Committee in the context of deemed disposals (see 7.12.5 below), noted that reclassification of amounts to profit or loss from other comprehensive income is generally required as part of determining the gain or loss on a disposal.

Although IFRS 10 requires that partial disposals of subsidiaries, where control is retained, are accounted for as equity transactions (see Chapter 7 at 3.3) and no profit or loss is recognised, we do not believe that this has an impact on the accounting for a partial disposal of an associate or a joint venture (which continues to be accounted for under the equity method). Under equity accounting an investor only accounts for its own interest. Given that the other investors’ ownership in the associate is not reflected in the accounts of an investor there is no basis for concluding that partial disposals can be treated as equity transactions.

7.12.5 Deemed disposals

An investor's interest in an associate or a joint venture may be reduced other than by an actual disposal. Such a reduction in interest, which is commonly referred to as a deemed disposal, gives rise to a ‘dilution’ gain or loss. Deemed disposals may arise for a number of reasons, including:

• the investor does not take up its full allocation in a rights issue by the associate or joint venture;
• the associate or joint venture declares scrip dividends which are not taken up by the investor so that its proportional interest is diminished;
• another party exercises its options or warrants issued by the associate or joint venture; or
• the associate or joint venture issues shares to third parties.

In some situations, the circumstances giving rise to the dilution in the investor's interest may be such that the investor no longer has significant influence over the investee. In that case, the investor will account for the transaction as a disposal, with a retained interest in a financial asset measured at fair value. This is described at 7.12.2 above. However, in other situations, the deemed disposal will only give rise to a partial disposal, such that the investor will continue to equity account for the investee.

As discussed in more detail at 7.12.4 above, although IAS 28 does not explicitly state that an entity should recognise a gain or loss on partial disposal of its interest in an associate or a joint venture when the entity continues to apply the equity method, it is evident that a gain or loss should be recognised on partial disposals.

In the absence of further guidance, we believe that gains or losses on deemed disposals should be recognised in profit or loss, and this will include amounts reclassified from other comprehensive income.

However, what is not clear is whether any of the notional goodwill component of the carrying amount of the associate or joint venture should be considered in the calculation of the gain or loss on the deemed disposal. We believe that it is appropriate to consider the entire carrying amount of the associate or joint venture, i.e. including the notional goodwill, as shown in Example 11.25 below. Although the example is based on a deemed disposal of an associate, the accounting would be the same if it had been a deemed disposal of a joint venture.

IAS 28 defines the equity method as ‘a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post acquisition change in the investor's share of the investee's net assets. …’ [IAS 28.3]. A literal reading of this definition suggests that in calculating the loss on dilution, the investor should only take account of the change in its share of the associate's or joint venture's net assets but not account for a change in the notional goodwill component.

However, paragraph 42 of IAS 28 specifically states that goodwill included in the carrying amount of an investment in an associate or a joint venture is not separately recognised. Hence, we believe that it should not be excluded from the cost of a deemed disposal either.

Although the IASB did not explicitly consider accounting for deemed disposals of associates or joint ventures, paragraph 26 of IAS 28 refers to the concepts underlying the procedures used in accounting for the acquisition of a subsidiary in accounting for acquisitions of an investment in an associate or joint venture. Therefore, it is appropriate to account for deemed disposals of associates or joint ventures in the same way as deemed disposals of subsidiaries.

10.1.1 Statement of financial position

Unless an investment, or a portion of an investment, in an associate or a joint venture is classified as held for sale in accordance with IFRS 5 (see 6 above), the investment, or any retained interest in the investment not classified as held for sale, is classified as a non-current asset. [IAS 28.15]. The aggregate of investments in associates and joint ventures accounted for using the equity method are presented as a discrete line item in the statement of financial position. [IAS 1.54(e)].

IAS 28 does not explicitly define what is meant by ‘investment … in an associate or a joint venture’. However, paragraph 38 states that ‘the interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture determined under the equity method together with any long-term interests that, in substance, form part of the investor's net investment in the associate or joint venture. … Such items may include preference shares and long-term receivables or loans but do not include trade receivables, trade payables or any long-term receivables for which adequate collateral exists, such as secured loans.’ [IAS 28.38]. Some have interpreted this as a requirement to present the investment in ordinary shares and other long-term interests in associates within the same line item.

Yet, when associates are profitable, long-term interests such as loans are normally accounted for under IFRS 9 rather than under the equity method. Therefore, it is generally considered acceptable to present the investment in ordinary shares in associates and joint ventures and other long-term interests in associates and joint ventures in separate line items.

Goodwill relating to an associate or joint venture is included in the carrying amount of the investment, [IAS 28.32], as is illustrated in Extract 11.2 below.

10.1.2 Profit or loss

In the statement of comprehensive income or separate income statement, the aggregate of the investor's share of the profit or loss of associates and joint ventures accounted for using the equity method must be shown. [IAS 1.82(c)]. ‘Profit or loss’ in this context is interpreted in the implementation guidance to IAS 1 as meaning the ‘profit attributable to owners’ of the associates and joint ventures, i.e. it is after tax and non-controlling interests in the associates or joint ventures.¹⁸ There is no requirement as to where in the statement of comprehensive income or separate income statement the investor's share of the profit or loss of associates and joint ventures accounted for using the equity method should be shown, and different approaches are therefore seen in practice. As discussed in Chapter 3 at 3.2.2.A, some entities present operating income on the face of the income statement. In this case, equity accounted investments may form part of operating activities with their results included in that measure and with non-operating investments excluded from it. Another acceptable alternative may be to exclude the results of all associates and joint ventures from operating profit.

Nokia for example includes its share of the (post-tax) results of associates after operating profit, but before pre-tax profit:

In contrast, Nestlé includes its share of the post-tax results of associates below tax expense:

10.1.3 Other items of comprehensive income

The investor's share of items recognised in other comprehensive income by the associate or joint venture is recognised in the investor's other comprehensive income. [IAS 28.10].

In December 2014, the IASB issued Disclosure Initiative (amendments to IAS 1). Paragraph 82A of IAS 1 was amended to clarify that entities must present the share of other comprehensive income of associates and joint ventures accounted for using the equity method, separated into the share of items that, in accordance with other IFRSs:

• will not be subsequently reclassified to profit or loss; and
• will be reclassified subsequently to profit or loss when specific conditions are met. [IAS 1.82A].

The amendment applied to annual periods beginning on or after 1 January 2016.

‘Other comprehensive income’ in this context is interpreted in the implementation guidance to IAS 1 as meaning the ‘other comprehensive income attributable to owners’ of the associates and joint ventures, i.e. it is after tax and non-controlling interests in the associates or joint ventures.¹⁹

10.1.4 Statement of cash flows

IAS 7 – Statement of Cash Flows – notes that for an equity accounted investment, reporting in the cash flow statement is limited to cash flows between the investor and the investee, such as dividends received. The question arises as to whether dividends received should be recognised as operating or investing cash flows. As discussed in Chapter 40 at 4.4.1, IAS 7 is not prescriptive; however, entities should select an accounting policy and apply it consistently.