Separate Financial Statements (IAS 27)

Separate financial statements, governed by IAS 27, are distinct type of financial statements where investments in subsidiaries, joint ventures, and associates are accounted for either at cost, in accordance with IFRS 9, or using the equity method. IFRS do not mandate the preparation of separate financial statements, but IAS 27 becomes applicable when an entity chooses to, or is required to, prepare them in compliance with IFRS. This requirement often arises from local regulations and tax laws.

However, if an entity is exempted under IFRS 10.4(a) from consolidation or under IAS 28.17 from applying the equity method, it may present separate financial statements as its only financial statements (IAS 27.8). Entities without investments in subsidiaries, joint ventures, or associates do not prepare separate financial statements under IAS 27 (IAS 27.7). These statements are often called ‘individual’ financial statements. Another widely used term, ‘stand-alone’ financial statements, encompasses both separate and individual financial statements.

There may be instances where an entity is allowed, or even obliged, to apply local GAAP to separate financial statements, even while preparing consolidated financial statements in accordance with IFRS. In such scenarios, IAS 27 is not applicable. In all cases, the accounting framework to be applied is prescribed by local laws and regulations.

The IASB monitors the application of IFRS in approximately 170 jurisdictions globally, including whether IAS 27 is permitted or required for presenting separate financial statements.

Let’s delve deeper into IAS 27.

Preparation of separate financial statements

IAS 27.9 stipulates that separate financial statements must comply with all IFRS standards. This can present challenges regarding certain intra-group transactions.

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Investments in subsidiaries, joint ventures, and associates

IAS 27.10 sets out specific provisions for investments in subsidiaries, joint ventures, and associates. In separate financial statements, these investments should be accounted for using one of the following methods:

The chosen accounting method should be consistently applied to all investments within a given category. Regrettably, IAS 27 does not clarify what constitutes a ‘category’. Therefore, it is plausible to argue that subsidiaries, joint ventures, and associates can be categorised further, given these subdivisions are clearly and objectively outlined in the entity’s accounting policies. For instance, a parent may classify subsidiaries into investment and non-investment entities, applying different measurement methods to each. However, entities that apply IFRS 9 to subsidiaries or associates in consolidated financial statements should maintain this approach in separate financial statements (IAS 27.11-11B).

Classifying financial instruments as part of the investment

IAS 27 does not specify which financial instruments issued by the investee are to be considered part of the investment by the parent and accounted for under IAS 27, and which fall under IFRS 9.

A common approach is to treat instruments classified as equity by the subsidiary under IAS 32 as part of the parent’s investment. However, some instruments classified as liabilities by the subsidiary might still be considered part of the investment by the parent. For example, non-redeemable preference shares with a mandatory preference dividend expressed as a percentage of profit would be classified as a liability by the subsidiary but could be part of the investment by the parent, as returns from this instrument are dependent on the investee’s financial performance, and its economic characteristics are similar to ordinary shares.

Entities must develop their accounting policy in line with IAS 8.10-12 and exercise judgement to determine which financial instruments, classified as liabilities by the subsidiary, should be accounted for as part of the investment by the parent under IAS 27. The primary factor in making this distinction should be the similarity to ordinary shares in terms of risks and returns.

Additionally, an insightful discussion on accounting for indirect control in separate financial statements can be found in this forums topic.

Measuring cost

IAS 27 does not define ‘cost’, hence entities should develop their accounting policy according to IAS 8.10-12. The definition of cost, as provided in the IFRS glossary of terms, originates 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.’

Consideration paid

In a business combination accounted for under IFRS 3, consideration paid is measured at fair value, calculated as the sum of the acquisition-date fair values of assets transferred by the acquirer, liabilities incurred by the acquirer to the former owners of the acquiree, and equity interests issued by the acquirer. This approach is deemed most suitable for measuring consideration when determining the cost of an investment in separate financial statements.

Variable and contingent consideration

Recognition and measurement become more complex with variable and contingent consideration. IFRS 3 mandates the recognition of contingent consideration at fair value as part of the business combination accounting. Subsequent changes in fair value, arising from events post-acquisition (e.g. achieving post-acquisition performance targets), are recognised in profit or loss. Many accountants agree that this approach should be mirrored when measuring investments in separate financial statements, although this is not explicitly stipulated in IAS 27. A similar discussion regarding the acquisition of assets is also applicable.

Non-monetary consideration

IAS 27 lacks specific guidance for scenarios where investments are acquired with non-monetary assets or a mix of cash and non-monetary assets. In such cases, entities can refer to the guidelines in IAS 16.24-26, which advise entities to measure the cost of investment (asset) at fair value and recognise the difference between the fair value of the acquired investment and the carrying amount of assets surrendered, in profit or loss. IAS 16 provides additional guidance for transactions lacking commercial substance or where the fair value of neither the received nor given up asset is reliably measurable.

Transaction costs

IAS 27 does not detail the accounting for transaction costs incurred during the investment acquisition. The IFRS Interpretations Committee contemplated including transaction costs in the initial carrying amount of investments accounted for under the equity method in IAS 28. The Committee concluded that IFRS consistently require assets not carried at fair value through profit or loss to be measured at initial recognition at cost. This includes costs directly attributable to the acquisition or issuance of the asset, such as legal fees, transfer taxes, and other transaction costs. Consequently, such directly attributable expenditures are typically included in the cost of an investment in separate financial statements. Costs incurred prior to the actual investment acquisition can be recognised as prepayments and subsequently included in the initial carrying amount of the investment at the acquisition date.

An alternative approach derives from the IFRS 9 requirements applicable to financial assets not measured at fair value, a close analogy for investments in subsidiaries, which are also financial assets. IFRS 9 dictates that only incremental costs directly attributable to the acquisition of the asset – i.e. costs that would not have been incurred had the entity not acquired the asset – should constitute transaction costs. Therefore, under the IFRS 9 analogy, expenditures such as due diligence or legal fees incurred prior to the acquisition should not be added to the cost of the investment but expensed as those services are received.

In consolidated financial statements, regardless of the approach, acquisition-related costs must be expensed as incurred.

Step acquisitions

Step acquisitions refer to the gradual acquisition of ownership in another company over time. In this process, a company does not secure a controlling interest in another entity all at once, but rather, it does so through several smaller transactions or “steps.” A question arises when the previously held interest in an investee is measured at fair value under IFRS 9: what should be done with the difference between the original cost of that investment and the fair value determined immediately before acquiring additional interest?

The IFRS Interpretations Committee examined a scenario where an entity holds an initial, minor investment in another entity (investee) and applies IFRS 9 for its accounting. Subsequently, the entity acquires additional interest, resulting in the investee becoming a subsidiary accounted for at cost under IAS 27.10.

The Committee was posed with two questions:

  1. Should the entity determine the cost of its investment in the subsidiary as the sum of:
    a) the fair value of the initial interest at the date of obtaining control, plus any consideration paid for the additional interest (‘fair value as deemed cost approach’); or
    b) the consideration paid for the initial interest (original consideration), plus any consideration paid for the additional interest (‘accumulated cost approach’)?
  2. How should the entity account for any difference between the fair value of the initial interest at the date of obtaining control and its original consideration when applying the accumulated cost approach?

Addressing the first question, the Committee observed that the two approaches arise from differing views on whether the step acquisition transaction involves:

  • the entity exchanging its initial interest (plus consideration paid for the additional interest) for a controlling interest in the investee; or
  • purchasing the additional interest while retaining the initial interest.

Following its analysis, the Committee concluded that a reasonable interpretation of the requirements in IFRS could lead to the application of either of the two approaches.

Regarding the second question, the Committee noted that any difference between the fair value of the initial interest at the date of obtaining control and its original consideration aligns with the definitions of income or expenses in the Conceptual Framework. Therefore, they concluded that, in accordance with IAS 1.88, this difference is recognised in profit or loss. This holds true regardless of whether, before obtaining control, the entity had presented subsequent changes in fair value of the initial interest in profit or loss or other comprehensive income.

Equity method

The equity method can be applied to subsidiaries, joint ventures, and associates in separate financial statements, as indicated in IAS 27.10(c). This alternative arises because laws in some countries mandate listed companies to present separate financial statements prepared in accordance with local GAAP, rather than IFRS. In certain instances, local GAAP require the use of the equity method to account for investments in subsidiaries, joint ventures, and associates. In such cases, employing the equity method represents the only difference between the separate financial statements prepared in accordance with IFRS and local GAAP (IAS 27.BC10A).

Dividends

Dividends are defined in IFRS 9 as distributions of profits to holders of equity instruments, proportional to their holdings of a particular class of capital. The principle for recognising dividends in separate financial statements is set out in IAS 27.12. Dividends are recognised in profit or loss when the right to receive the dividend is established, except when the equity method is applied. IFRIC 17 Distributions of Non-cash Assets to Owners offers additional guidance on the timing of dividend recognition, clarifying that a dividend is recognised when authorised and no longer at the entity’s discretion. Furthermore, IFRS 9.5.7.1A stipulates 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.

In some cases, equity distributions that essentially are dividends may assume a different legal form. For instance, an entity might transfer retained earnings to other equity items, which are then returned to shareholders as capital repayments. Such repayments, if representing distribution of accumulated profits in substance, should be accordingly recognised as dividend income. Conversely, distributions from an investment that constitute repayment of previously paid-in capital should be deducted from the investment’s carrying amount with no impact on profit or loss, as they don’t qualify as distributions of profits according to the definition of dividends (refer also to IFRS 9.B5.7.1). Additionally, IAS 27 doesn’t mandate an investor to differentiate between pre-acquisition and post-acquisition profits – both are recognised in profit or loss (IAS 27.BC18).

Paragraph IAS 36.12(h) outlines the conditions where recognising a dividend might indicate impairment.

Accounting for joint operations

Interest in a joint operation must be accounted for under IFRS 11 in separate financial statements as well (IFRS 11.26(a)). Consequently, even if a joint operation is structured through a separate entity, investors should adopt the ‘look-through’ approach, as discussed in Accounting for joint operations.

Disclosure

As initially noted, separate financial statements should comply with all applicable IFRS, including disclosures. If the law doesn’t necessitate the preparation of separate financial statements, entities should clarify the reason for their preparation (IAS 27.17(a)). These statements should also identify related consolidated financial statements prepared under IFRS 10, or financial statements prepared under IAS 28 or IFRS 11 (IAS 27.17). Other disclosure requirements are specified in paragraphs IAS 27.15-17.

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