IAS 28 isn't clear about the equity method accounting for a cross-holding situation where, for example, Parent owns 40% shares in Associate and Associate owns 20% shares in Parent. EY's International GAAP book in its IAS 28 chapter explains that in such a situation, Parent has to exclude, from its share of Associate's P&L, Associate's share of Parent's P&L (when Associate applies the equity method to the stock in Parent) or Associate's dividend income and revaluation gain/loss (when Associate accounts for the stock in Parent as FVTPL).
My question is how we can make consolidation entries in practice. My understanding is that, since EY I-GAAP explains the above treatment by analogy with IFRS 10, the consolidation entries I usually make to account for the stock in Parent owned by Subsidiary will apply accordingly. I usually make the following adjustments so that the resulting consolidated FS look as if Parent directly owned its own shares:
1. Reverse all the equity method or IFRS 9 entries on Subsidiary's FS and restate them as if Subsidiary had been applying the cost method to the stock in Parent
2. Eliminate Subsidiary's Investment in Parent against Parent's Equity (usually using a contra account called Treasury Stock at Cost)
3. Offset Subsidiary's Dividend Income and Parent's Dividend Declared
4. Deduct the number of shares owned by Subsidiary from the number of shares outstanding that is used for EPS calculation
5. When Subsidiary disposes of the stock in Parent, reverse the above 1 and 2 and recognize the cumulative adjustments of the above 1 directly as Equity (because the cumulative adjustments represents the difference between the cost and the value at disposal of the stock in Parent)
By analogy, the above 1, 3, 4, and 5 might also apply to the equity method as follows, though EY I-GAAP does not explicitly mention some of them:
1. Reverse all the equity method or IFRS 9 entries on Associate's FS and restate them as if Associate had been applying the cost method to the stock in Parent; then recognize Parent's Share of Associate's P&L
3. Offset Parent's Share of Associate's P&L (Associate's Dividend Income) and Parent's Dividend Declared
4. Deduct the share of the number of shares owned by Associate (i.e. 40% * 20% = 8%) from the number of shares outstanding that is used for EPS calculation
5. When Associate disposes of the stock in Parent, reverse the above 1 and recognize the share of cumulative adjustments directly as Equity
Is my understanding correct?
IAS 28 Reciprocal interests
Re: IAS 28 Reciprocal interests
So the parent is an associate of the associate due to significant influence? I don't have an answer but sounds like a nightmare on many fronts..
Re: IAS 28 Reciprocal interests
This may be one of the reasons that as I understand this kind of arrangement is prohibited in many jurisdictions, especially those based on UK Law.
Section 136 of UK Companies Act: Prohibition on subsidiary being a member of its holding company
For anyone interested there is a relevant (though not particularly helpful) Agenda Decision [isn't there always]: https://cdn.ifrs.org/-/media/feature/su ... aug-02.pdf
(Not Lawyer)
Section 136 of UK Companies Act: Prohibition on subsidiary being a member of its holding company
I am pretty sure this is the case for Australia and India(?).(1) Except as provided by this Chapter—
(a) a body corporate cannot be a member of a company that is its holding company, and
(b) any allotment or transfer of shares in a company to its subsidiary is void.
(2) The exceptions are provided for in—
section 138 (subsidiary acting as personal representative or trustee), and
section 141 (subsidiary acting as authorised dealer in securities).
For anyone interested there is a relevant (though not particularly helpful) Agenda Decision [isn't there always]: https://cdn.ifrs.org/-/media/feature/su ... aug-02.pdf
(Not Lawyer)
Re: IAS 28 Reciprocal interests
Not fully legal in my country either. I think Parent's voting right is cancelled when Associate gets more shares in Parent than a certain threshold. But, it often happens that Associate holds 0.1%, 1%, 5%, 10%, etc. shares in Parent and thus the accounting nightmare does happen too 
Re: IAS 28 Reciprocal interests
Btw, the EY book refers to the 2002 agenda decision and my question in other words is how we can implement it in practice 
Re: IAS 28 Reciprocal interests
I have seen an example as a result of share swap but as you say the associate has a small enough holding that it is just an investment, albeit an investment in its own largest member.
Re: IAS 28 Reciprocal interests
what a nightmare to deal with 
1. I would eliminate all impact in Associate's P/L relating to investment in parent (it will depend on whether it's IFRS 9 or equity method). So as you suggested I guess
2. Then recognise parent's share in net income / OCI of A. without "equity" gains/losses relating to investment in parent
3. I'm not sure whether any adjustment to parent's shares outstanding makes sense, associate is external to the group, so this is not similar to treasury shares IMO. You would overstate EPS this way, hm?
4. Dividends declared by the parent - hm, I would somehow reflect the fact that the share of A.'s net assets attributable to the parent increases because of reciprocal holdings. We won't do it through P/L, so maybe a dividend declared allocated to Associate is debited to the value of investment instead of decreasing parent's consolidated equity. Does that make sense to you?
1. I would eliminate all impact in Associate's P/L relating to investment in parent (it will depend on whether it's IFRS 9 or equity method). So as you suggested I guess
2. Then recognise parent's share in net income / OCI of A. without "equity" gains/losses relating to investment in parent
3. I'm not sure whether any adjustment to parent's shares outstanding makes sense, associate is external to the group, so this is not similar to treasury shares IMO. You would overstate EPS this way, hm?
4. Dividends declared by the parent - hm, I would somehow reflect the fact that the share of A.'s net assets attributable to the parent increases because of reciprocal holdings. We won't do it through P/L, so maybe a dividend declared allocated to Associate is debited to the value of investment instead of decreasing parent's consolidated equity. Does that make sense to you?
Re: IAS 28 Reciprocal interests
Thank you, Marek.
As for Dividend Declared, it seems I was not clear enough about the reversing entries in the point 1, but I think we are on the same page. By the cost method I meant to state the investment in Parent at cost and recognize dividends as income unlike the equity method. So, Associate's Dividend Income is first recognized as part of Parent's share of Associate's P&L and increases Parent's carrying amount of Investment in Associate. Parent then has to eliminate the share of Associate's Dividend Income and I think Parent's Dividend Declared is the only possible account that can be offset against. Does it make sense?
"Recognize Parent's share of Associate's P&L/OCI excluding capital gains/losses relating to Associate's investment in Parent" is a to-the-point expression. That's exactly the objective of the point 1. Also, it makes the point 5 clearer because the unrecognized capital gains/losses are the very thing that should subsequently be recognized in Equity when Associate disposes of the stock in Parent.
As for EPS, the EY book recommends to adjust outstanding shares in the case where Associate applies the equity method, saying that the adjusted EPS equals to the hypothetical dividend per share when P and A distribute all the profit including the share of P&L of each other. Actually, assuming P and A distribute all the profit -> P and A distribute all the dividend -> P and A distribute all the dividend -> (repeat infinitely), we do arrive at the same DPS as the adjusted EPS, though I'm not fully making sense of the mathematical reasons. The same logic holds in IFRS 9 cases and IMO the nature of the stock in Parent from Parent's point of view won't change depending on Associate's significant influence. So, I think the outstanding shares should be adjusted in IFRS 9 too. But the EY book isn't clear in IFRS 9 cases so perhaps there is a room for accounting policy choice.
As for Dividend Declared, it seems I was not clear enough about the reversing entries in the point 1, but I think we are on the same page. By the cost method I meant to state the investment in Parent at cost and recognize dividends as income unlike the equity method. So, Associate's Dividend Income is first recognized as part of Parent's share of Associate's P&L and increases Parent's carrying amount of Investment in Associate. Parent then has to eliminate the share of Associate's Dividend Income and I think Parent's Dividend Declared is the only possible account that can be offset against. Does it make sense?
"Recognize Parent's share of Associate's P&L/OCI excluding capital gains/losses relating to Associate's investment in Parent" is a to-the-point expression. That's exactly the objective of the point 1. Also, it makes the point 5 clearer because the unrecognized capital gains/losses are the very thing that should subsequently be recognized in Equity when Associate disposes of the stock in Parent.
As for EPS, the EY book recommends to adjust outstanding shares in the case where Associate applies the equity method, saying that the adjusted EPS equals to the hypothetical dividend per share when P and A distribute all the profit including the share of P&L of each other. Actually, assuming P and A distribute all the profit -> P and A distribute all the dividend -> P and A distribute all the dividend -> (repeat infinitely), we do arrive at the same DPS as the adjusted EPS, though I'm not fully making sense of the mathematical reasons. The same logic holds in IFRS 9 cases and IMO the nature of the stock in Parent from Parent's point of view won't change depending on Associate's significant influence. So, I think the outstanding shares should be adjusted in IFRS 9 too. But the EY book isn't clear in IFRS 9 cases so perhaps there is a room for accounting policy choice.
Re: IAS 28 Reciprocal interests
as for dividends declared by the parent, I'm not sure I understand what you mean... it's not easy to use simple debit/credit notation when illustrating consolidation, but maybe you're up for the challenge? 
re. EPS and shares - OK makes sense
re. EPS and shares - OK makes sense
Re: IAS 28 Reciprocal interests
Yeah, I'm almost done with this. The only thing I missed in the previous post might be the tax effect that should be reversed together with Associate's IFRS 9 entries. Thank you
Re: IAS 28 Reciprocal interests
Canada
Company is a hold Co which holds listed stocks either directly or via closed end funds that it controls
In 2010 and prior, GAAP required ALL reciprocal shares be eliminated. EPS are not useful. Net asset value/share is as the Co trades at a very material discount to its nav
On conversion to IFRS in 2011, the Co ceased to disclose its recip shares but included them as part of shares o/s and marked those Co's shares it held at FMV. Given the discount they trade at relative to nav, the effect was to reduce IFRS nav compared to previous GAAP nav. Since then, the reciprocal shares have gone undisclosed and its largest shareholders were unaware of them and the implications they had on "true" nav and float
However, one of the publicly traded closed end funds the Co controls owns the Co's shares both directly as well as indirectly (the closed end fund owns a private co which only holds some of the Co's shares). The direct shares are eliminated as reciprocal shares ONLY for eps calculations for the Co. They are not eliminated for nav calculations, nor are any of the indirect shares eliminated for either eps or nav.
The substantial majority of the reciprocal shares are not eliminated as are likely held by private co's wholly owned by the Co set up to hold the Co's shares.
As the Co's shares trade at a material discount to their IFRS nav, the GAAP nav (should recips be eliminated) is much higher. The decision by the Co to use an interpretation to avoid disclosure and elimination of recips and thus report a much lower nav is part of a strategy employed to buy out minority over at discounts to nav. Last year there was near complete capitulation of Institutional investors as the Company was able to buy back almost 8% of shares o/s at a shocking 60% discount to nav (which needless to say was massively accretive for those left standing!).
Can anyone comment on how they managed to avoid elimination of reciprocals upon conversion to IFRS
Company is a hold Co which holds listed stocks either directly or via closed end funds that it controls
In 2010 and prior, GAAP required ALL reciprocal shares be eliminated. EPS are not useful. Net asset value/share is as the Co trades at a very material discount to its nav
On conversion to IFRS in 2011, the Co ceased to disclose its recip shares but included them as part of shares o/s and marked those Co's shares it held at FMV. Given the discount they trade at relative to nav, the effect was to reduce IFRS nav compared to previous GAAP nav. Since then, the reciprocal shares have gone undisclosed and its largest shareholders were unaware of them and the implications they had on "true" nav and float
However, one of the publicly traded closed end funds the Co controls owns the Co's shares both directly as well as indirectly (the closed end fund owns a private co which only holds some of the Co's shares). The direct shares are eliminated as reciprocal shares ONLY for eps calculations for the Co. They are not eliminated for nav calculations, nor are any of the indirect shares eliminated for either eps or nav.
The substantial majority of the reciprocal shares are not eliminated as are likely held by private co's wholly owned by the Co set up to hold the Co's shares.
As the Co's shares trade at a material discount to their IFRS nav, the GAAP nav (should recips be eliminated) is much higher. The decision by the Co to use an interpretation to avoid disclosure and elimination of recips and thus report a much lower nav is part of a strategy employed to buy out minority over at discounts to nav. Last year there was near complete capitulation of Institutional investors as the Company was able to buy back almost 8% of shares o/s at a shocking 60% discount to nav (which needless to say was massively accretive for those left standing!).
Can anyone comment on how they managed to avoid elimination of reciprocals upon conversion to IFRS
Re: IAS 28 Reciprocal interests
Even under IFRS, reciprocal interests must be eliminated if a consolidated subsidiary owns the shares in its parent. Is the closed-end fund really consolidated by the holding company? Isn't it excluded from the consolidation using the investment entity exemption of IFRS10?
Re: IAS 28 Reciprocal interests
Sorry wasn't clear. The closed end fund is not consolidated as parent owns 25%. The direct holdings of the parent by the closed end fund are eliminated as reciprocals for EPS purposes only. The closed end fund also wholly owns a private co that exclusively holds parent shares. These are not eliminated.
However, the closed end fund represents only small fraction of overall reciprocals. There is a much larger amount held in other wholly owned private co's directly by the parent.
Ultimately, it seems that IFRS allows the Company to avoid disclosure and elimination of reciprocals simply by hiding them in an extra layer of private co wholly owned by parent (or the closed end fund). Canadian GAAP saw through that charade and demanded elimination. IFRS was a major step backwards and/or the Company is using a very generous interpretation to hide reciprocals and understate NAV.
However, the closed end fund represents only small fraction of overall reciprocals. There is a much larger amount held in other wholly owned private co's directly by the parent.
Ultimately, it seems that IFRS allows the Company to avoid disclosure and elimination of reciprocals simply by hiding them in an extra layer of private co wholly owned by parent (or the closed end fund). Canadian GAAP saw through that charade and demanded elimination. IFRS was a major step backwards and/or the Company is using a very generous interpretation to hide reciprocals and understate NAV.
Re: IAS 28 Reciprocal interests
Are there two private companies, one wholly owned by the fund and the other wholly owned by the parent? It's strange that the shares held by the latter aren't stated as deduction of equity. As for the former, I think the shares held by associates need to be disclosed in accordance with IAS 1.79. It is controversial whether to eliminate the shares held by associates because IFRS generally treats associates as an external entity, but still IFRS is conceptually designed to allow users of financial statements to assess the impact of the reciprocal holdings.
Re: IAS 28 Reciprocal interests
its hard to say for certain but the closed end fund holds shares (unsure if wholly owned or not) in the private which exclusively holds parent shares. the closed end fund also directly holds parent shares, hence my reference to them as either direct or indirect. as the closed end fund is also publicly traded, the direct holdings are eliminated for eps purposes at the parent but the indirect are not. neither are eliminated for nav/share calculations. all told, the closed end funds holdings represent less than 20% of the total amount of recpirocals at conversion to IFRS and all evidence suggests the tally has grown (through buybacks over the years)
the larger balance is outside the closed end fund but inside the parent, in other privates but as there is no disclosure, its hard to say if just one or several.
we do know that the parent holds shares in the two large privates which serve as the family's holding co's for parent shares so that would account for some as well.
both of the family holdco's are private and hold collectively well over 50% of parent shares but neither over 50% individually.
either way it has something to do with owning shares in privates that hold parent shares and who technically controls the privates
family patriarch reports an 80% ownership of parent now (sum of affiliated entities) but this understates family's interest as it does not include the countless extended family members nor the directors and officers (of which the grandson who is current CEO is one)
ultimately been a game of oppressing minority into submission over very long time frame until float has been gobbled up and imo then go private to turn parent into a family office
everything i read about IFRS suggests reciprocals in this case ought to be eliminated (as always were) but my question centered around does anyone have insight into how they avoided doing so given the shares were in privates and/or not consolidated.
the larger balance is outside the closed end fund but inside the parent, in other privates but as there is no disclosure, its hard to say if just one or several.
we do know that the parent holds shares in the two large privates which serve as the family's holding co's for parent shares so that would account for some as well.
both of the family holdco's are private and hold collectively well over 50% of parent shares but neither over 50% individually.
either way it has something to do with owning shares in privates that hold parent shares and who technically controls the privates
family patriarch reports an 80% ownership of parent now (sum of affiliated entities) but this understates family's interest as it does not include the countless extended family members nor the directors and officers (of which the grandson who is current CEO is one)
ultimately been a game of oppressing minority into submission over very long time frame until float has been gobbled up and imo then go private to turn parent into a family office
everything i read about IFRS suggests reciprocals in this case ought to be eliminated (as always were) but my question centered around does anyone have insight into how they avoided doing so given the shares were in privates and/or not consolidated.
Re: IAS 28 Reciprocal interests
should add, the elimination of reciprocals that does take place has nothing to do with consolidation so that is why i think the being private is the key.
the parent holds 25% of the closed end fund and as such use the equity method to record its value at the parent based on the market price of the closed end fund. so even though its not consolidated, the directly held parent shares in the fund are eliminated as reciprocals at parent for eps.
after last years buybacks, the closed end fund directly holds just over 10% of parent now (and is now a reporting entity) and a further 6% indirectly through the private. it always seemed to me the use of the privates was intended to prevent the fund's direct holdings from crossing 10% and the fund becoming a reporting entity (another laughable loophole) despite being well over for many many years when the indirect was included.
the parent holds 25% of the closed end fund and as such use the equity method to record its value at the parent based on the market price of the closed end fund. so even though its not consolidated, the directly held parent shares in the fund are eliminated as reciprocals at parent for eps.
after last years buybacks, the closed end fund directly holds just over 10% of parent now (and is now a reporting entity) and a further 6% indirectly through the private. it always seemed to me the use of the privates was intended to prevent the fund's direct holdings from crossing 10% and the fund becoming a reporting entity (another laughable loophole) despite being well over for many many years when the indirect was included.
Re: IAS 28 Reciprocal interests
Is it 25% * 10% that is adjusted for eps purpose? Or 25% * 16%?
Re: IAS 28 Reciprocal interests
25% of the 10% which in this case is 92k shares
the 6% hiding in the private are not eliminated
the total number of proportional reciprocals however is closer to 750k so 660k go un-eliminated for eps but all 750k for nav/sh
canadian gaap required all 750k eliminated for both eps and nav/sh
the 6% hiding in the private are not eliminated
the total number of proportional reciprocals however is closer to 750k so 660k go un-eliminated for eps but all 750k for nav/sh
canadian gaap required all 750k eliminated for both eps and nav/sh
Re: IAS 28 Reciprocal interests
25% of 16% might be 147k, and where do the other 603k come from?
Re: IAS 28 Reciprocal interests
other investments in private co's that hold parent shares, unrelated to the closed end fund
some of which is the parent owning shares in the two private holdco's (cotrolled by the family) that together own over 50% of parent shares
given magnitude of reciprocals and the fact that parent shares trade at near 60% discount to IFRS nav, the reciprocal adjusted nav (old gaap style) is 10% higher than IFRS but moreover the true free float is a fraction of what is represented as reciprocals give appearance of dramatically more shares o/s than if eliminated
some of which is the parent owning shares in the two private holdco's (cotrolled by the family) that together own over 50% of parent shares
given magnitude of reciprocals and the fact that parent shares trade at near 60% discount to IFRS nav, the reciprocal adjusted nav (old gaap style) is 10% higher than IFRS but moreover the true free float is a fraction of what is represented as reciprocals give appearance of dramatically more shares o/s than if eliminated
Re: IAS 28 Reciprocal interests
the use of private's owned by either the parent directly or the closed end fund to buy shares of the parent was most likely a typically Canadian loophole that allowed the parent to effectively buy back its own shares without having to disclose it via conducting a normal course issuer bid
as i said canadian gaap saw thru that and while disclosure at time of acquiring was avoided, they were obligated to eliminate the cross ownership at reporting time
ifrs has eliminated need entirely to disclose reciprocals (other than that paltry amount directly held by the closed end fund) and it has profound impact on float and nav (given the discount).
hard to say exactly how much they have grown since 2010. they were 702k then and have grown a minimum of 20k as that is the amount the closed end fund "direct" reciprocals have grown but 750k is a conservative estimate
as i said canadian gaap saw thru that and while disclosure at time of acquiring was avoided, they were obligated to eliminate the cross ownership at reporting time
ifrs has eliminated need entirely to disclose reciprocals (other than that paltry amount directly held by the closed end fund) and it has profound impact on float and nav (given the discount).
hard to say exactly how much they have grown since 2010. they were 702k then and have grown a minimum of 20k as that is the amount the closed end fund "direct" reciprocals have grown but 750k is a conservative estimate
Re: IAS 28 Reciprocal interests
If the fund holds the 6% through a consolidated subsidiary that the fund controls, then it is strange that the 6% is not eliminated for the EPS purpose or disclosed in the footnotes in accordance with IAS 1.79. But the other 603k sound not to be a reciprocal holding because neither of the parent or the fund owns interest in the other private companies, do they? I understand from the minority's point of view, the financial statements look distorted, but a financial statement is usually prepared for the sake of shareholders as a whole, including both the controlling and non-controlling interests. So IMO the other 603k shouldn't be eliminated from the parent's accounts just because the majority of shares in the parent are held by a family.