Separate financial statements are covered in IAS 27 and are defined as financial statements in which investments in subsidiaries, joint ventures and associates and accounted either at cost, in accordance with IFRS 9 or using the equity method.
When an entity does not have investments in subsidiaries, joint ventures or associates, it does not prepare separate financial statements as defined by IAS 27 (IAS 27.7). Such financial statements are often labelled as ‘individual’ or ‘standalone’ financial statements. In any case, IAS 27 does not require preparing separate financial statements. It is the local law that usually requires entities to do so.
Preparation of separate financial statements
Separate financial statements should be prepared in accordance with all applicable IFRS, except for separate provisions of IAS 27 relating to investments in subsidiaries, joint ventures and associates which should be accounted for either (IAS 27.9-10):
- at cost,
- in accordance with IFRS 9, or
- using the equity method as described in IAS 28.
The choice of accounting basis should be applied to all investments in a given category. Entities applying IFRS 9 to subsidiaries or associates in consolidated financial statements, should do so also in separate financial statements (IAS 27.11-11B).
Definition of ‘at cost’
‘At cost’ is not defined by IAS 27 and therefore general definition of cost should be applied. Cost is defined in the IFRS glossary of terms and this definition derives from IAS 16 and IAS 38: ‘the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction, or, when applicable, the amount attributed to that asset when initially recognised in accordance with the specific requirements of other IFRS, e.g. IFRS 2.’
Transaction costs for assets measured at cost are generally included in the ‘at cost’ value. Following the definition included in IFRS 9 applicable to financial assets not measured at fair value (the closest analogy for investments in subsidiaries), transaction costs should constitute only incremental costs that are directly attributable to the acquisition of the asset, i.e. costs that would not have been incurred if the entity had not acquired the asset. Therefore, under IFRS 9 analogy, expenses like due diligence or legal fees prior to acquisition should not be added to the cost of investment. As this matter is not directly addressed by IAS 27, some preparers adopted an approach to transaction costs similar to IAS 16/IAS 38, where all directly attributable costs, such as due diligence, are included in the cost of an asset. This approach is also supported by July 2009 IFRIC update which stated that cost includes ‘the purchase price and other costs directly attributable to the acquisition or issuance of the asset such as professional fees for legal services, transfer taxes and other transaction costs.’
Both approaches to determining the scope of transaction costs to be included in the cost of an investment are acceptable.
In any case, transaction costs are expensed in P/L in consolidated financial statements as required by IFRS 3.
Variable and contingent consideration
It gets more complicated when it comes to variable and contingent consideration. IFRS 3 requires to recognise contingent consideration at fair value as a part of business combination. Subsequent changes in fair value resulting from events after the acquisition date (e.g. meeting post-acquisition performance targets) are recognised in P/L. I believe that the same approach should be followed when measuring investments in separate financial statements, but this is not explicitly covered in IAS 27. See also a similar discussion relating to acquisition of assets.
Acquisition achieved in stages
Another challenge in determining the cost of an investment comes when an entity increases its shareholding e.g. from 15% to over 50%. When the previously held interest is measured at fair value, the question arises what to do with the difference between the original cost and fair value immediately before the acquisition of additional interest. Consider the following example:
Example: Acquisition achieved in stages
Entity A acquires 15% shareholding in Entity B in 20X0 for $150m. This shareholding is carried at fair value through P/L under IFRS 9. In 20X5 Entity A acquires additional 70% in Entity B for $1,400m (fair value). The previous 15% is carried at fair value of $300m immediately before the acquisition of the additional 70%. As a result of these two transactions, Entity A has 85% shareholding in Entity B, for which it paid a total of $1,550m ($150m + $1,400m). As Entity B became a subsidiary, Entity A chooses to carry it at cost in its separate financial statements.
The cost is determined as $1,550m, i.e. the amount paid in these two transactions. The increase in fair value of $150m recognised on the 15% shareholding is reversed through P/L when Entity B becomes a subsidiary carried at cost.
The cost is determined as $1,700m, , the fair value of 15% shareholding determined immediately before the acquisition is treated as deemed cost when Entity A obtains control over Entity B.
Approach 1 literally follows the definition of cost discussed above (‘the amount of cash or cash equivalents paid…’)
Approach 2 follows the logic that there is no economic substance in reversing previously recognised changes in fair value as the fair value did not change. Some make also reference to IFRS 3.42 where the previously held interest in an entity that becomes a subsidiary is remeasured to fair value any the fair value is treated as a part of consideration given for the control over the target company (IFRS 3.32).
Both approaches are acceptable and it is a choice of accounting policy to be made by an entity as IFRS do not cover such instances. IFRIC is aware of this inconsistency in practice and recommended the IASB to take this matter on the agenda (July 2010 IFRIC update), but IASB has not done it so far.
Equity method in separate financial statements can be applied to subsidiaries, joint ventures and associates. This alternative was reintroduced to IAS 27 effective from 2016 because the law in some countries require listed companies to present separate financial statements prepared in accordance with local regulations, and those local regulations require the use of the equity method to account for investments in subsidiaries, joint ventures and associates and, in most cases, the use of the equity method would be the only difference between the separate financial statements prepared in accordance with IFRS and those prepared in accordance with local regulations (IAS 27.BC10A).
Application of equity method is covered in IAS 28.
Accounting for joint operations
Interest in a joint operation must be accounted for under IFRS 11 in separate financial statements as well (IFRS 11.26a). Therefore, even if a joint operation is structured through a separate entity, this investment will not be visible as a separate asset in the statement of financial position.
Dividends are defined in IFRS 9 as distributions of profits to holders of equity instruments in proportion to their holdings of a particular class of capital. The general principle for recognition of dividends in separate financial statements is set out in paragraph IAS 27.12. Dividends are recognised in P/L (unless equity method is applied) when right to receive the dividend is established. IFRIC 17 Distributions of Non-cash Assets to Owners provides further guidance regarding timing of dividend recognition. According to IFRIC 17.10, a dividend is recognised when it is appropriately authorised and is no longer at the discretion of the entity, i.e. when the dividend is approved by the relevant authority (such as shareholders) if such approval is necessary according to the law. IFRS 22.214.171.124A adds that it must be probable that the economic benefits associated with the dividend will flow to the entity and the amount can be measured reliably.
It may happen that equity distributions that are in substance dividends will take a different legal form. For example, an entity may systematically transfer retained earnings to other items of equity, and then these items are returned to shareholders as repayments of capital (legally speaking). Such repayments, if they in substance represent distribution of accumulated profits, should be recognised accordingly as dividend income. On the other hand, if distributions from an investment represent a repayment of previously paid-in capital, they should be deducted from the carrying amount of the investment without any impact on P/L, as they are not distribution of profits as per definition of dividends (see also paragraph IFRS 9.B5.7.1). However, IAS 27 does not require an investor to distinguish between pre-acquisition and post-acquisition profits, i.e. both are recognised in P/L (IAS 27.BC18).
Paragraph IAS 36.12h specifies circumstances under which recognition of dividend may trigger an impairment indicator.
As mentioned at the beginning, separate financial statements should be prepared in accordance with all applicable IFRS, so disclosures required by all IFRS should be included in separate financial statements as well. If separate financial statements are not required to be prepared by law, entities should explain why they have been prepared (IAS 27.17a). Separate financial statements should also identify (reference to) related consolidated financial statements prepared under IFRS 10, or financial statements prepared under IAS 28 of IFRS 11 (IAS 27.17).
Other disclosure requirements as set out in paragraphs IAS 27.15-17.