IAS 28 Equity Method and Accounting for Investments in Associates and Joint Ventures

IAS 28 is a go-to standard when it comes to accounting for investments in associates. It also applies to equity accounting for investments in joint ventures, but joint ventures in general are covered in IFRS 11. Equity accounting is applicable in consolidated financial statements. Separate financial statements are covered in IAS 27, which lists equity accounting as one of the alternatives, but accounting at cost is also allowed (and most common). However, if an investor does not have any subsidiaries, but has interest in associates and/or joint ventures, IAS 28 effectively requires to prepare financial statements where these investments are equity accounted even though such statements will not be consolidated financial statements (as there are no subsidiaries to consolidate). Such financial statements are often called ‘economic interest’ financial statements.

IAS 28 requires accounting for investments in associates or joint ventures using the equity method (‘equity accounting’), unless the exemption similar to IFRS 10.4a applies (IAS 28.17).

Additional exemption relates to investments in associates held by or through venture capital organisations, mutual fund and similar entities (IAS 28.18-19).

An associate is defined as an entity over which the investor has significant influence. Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. The concept of control is covered in IFRS 10 and joint control in IFRS 11. There is direct link between definitions of control and significant influence, because IAS 28 was not revised after IFRS 10 with new definition of control was issued.

IAS 28 states that the threshold of 20% of the voting power (held directly or indirectly through subsidiaries) normally decides whether an investor has significant influence over an investee, unless it can be clearly demonstrated that this is not the case (IAS 28.5). Paragraph IAS 28.6 lists examples of circumstances that can be considered as an evidence that significant influence exists.

Circumstances where an investor, despite holding 20%+ of the voting power, does not have significant influence, usually revolve around controlling interest of an investee that blocks the participation of the investor in question (e.g. denies a seat in the board). This will also depend on local law and corporate governance codes. It is also helpful to look at the criteria for assessment of control in IFRS 10 and apply some analogy (e.g. how other shareholders are dispersed, what is the purpose and design of the investee) to assessing significant influence in ambiguous circumstances.

When an investor holds less than 20% of the voting power, it also can be demonstrated that 20% threshold is overridden by other factors and investor is able to exercise significant influence. Again, the actions of controlling interest and local law or corporate governance codes will play important role in this assessment.

When assessing the voting power, potential voting right held by the investor and other entities should be taken into account (IAS 20.7-8). Although IAS 28 does not mention it specifically, entities can refer to IFRS 10 guidance on potential voting rights. IASB did not want to expand this aspect of equity accounting without broader review of accounting for associates and joint ventures (IAS 28.BC15-BC16).

However, investor’s share when applying equity method (see below) is determined based on existing ownership interest, i.e. potential voting rights are not taken into account unless they are an existing ownership in substance (IAS 28.12-13).

The equity method is a method of accounting where the investment is initially recognised at cost and adjusted subsequently for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income. Simply put, the equity method is a simplified form of consolidation (IAS 28.27), where items are not added line-by-line, but a single asset is recognised in the statement of financial position and single lines are presented in P/L and OCI.

As stated in paragraph IAS 28.26, many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10. When more than one subsidiary holds interest in a associate/JV, consolidated financial statements should take into accounts total interest held by the group. Specific aspects of application of equity method are discussed in subsequent sections.

Let’s start with a simplified introductory example for applying equity method:

Example: simple illustration of application of equity method

Entity A acquired 25% interest in Entity B on 1 January 20X1 for a total consideration of $50m. Entity B’s net assets as per its financial statements amounted to $150. Entity B’s assets include a real estate with a carrying amount of $20m and fair value of $35m and remaining useful life of 15 years. For other assets and liabilities, the carrying amount approximates fair value. Deferred tax is ignored in this example.

You can download an excel file for this example. Note that you can scroll the tables horizontally if they don’t fit your screen.

At the date of acquisition, Entity A recognises an investment in Entity B at cost, that is at $50m. This amount can be broken down as follows:

50Investment in Entity B at cost
$m
37.525% share in B's net assets as per its financial statements
3.7525% share in fair value adjustment relating to real estate
8.75goodwill (not presented separately and not amortised)

Goodwill in the table above was calculated as shown below:

8.7525% interest in implicit goodwill attributable to Entity A ($35m x 25%)
$m
200implicit consideration for 100% interest, taking into account $50m paid for 25% ($50m/25%)
150Entity B's net assets as per its financial statements
15fair value adjustment on real estate
35total implicit goodwill of Entity B ($200m-$150m-$15m)

During the year ended 31 December 20X1, Entity B generated net income of $10m and paid dividends of $7m. Additionally, when applying equity method, Entity A needs to account for the $0.25m of additional depreciation charge on the fair value adjustment on real estate. This is calculated as fair value adjustment on real estate / 15 years of remaining useful life *25% share of Entity A (i.e. $15m/15 years * 25% interest).

Entries made by Entity A at 31 December 20X1 are as follows:

DRCR
Investments in associates0.5
Share of profit of associates2.25*
Cash1.75**

* 25% share of net income of 10$ less 25% share in depreciation of fair value adjustment
** dividends received


An equity accounted investment is initially recognised at cost. The term ‘at cost’ is not defined in IAS 28 and a discussion similar to that in IAS 27 applies here as well.

When an investment becomes an associate/JV after being a consolidated subsidiary, the cost for the initial recognition purposes is the fair value of retained interest at the date when the control is lost (IFRS 10.25b).

Initial recognition gets more complicated when there is a development in opposite direction, i.e. a ‘regular’ equity investment (e.g. a 5% interest) becomes an associate/JV. The same discussion on how to determine the cost of a subsidiary when control is achieved is stages applies.

When an investment in an associate becomes an investment in a joint venture (or vice versa), the entity continues to apply the equity method and does not remeasure the retained interest (IAS 28.24).

When additional interest is acquired in an entity that already was and still is an associate/JV, the additional consideration is simply added to the carrying amount of the investment without recognition of any additional gains or losses (this is not covered in IFRS).

On acquisition of an investment in associate/JV, entities need to recognise our interest in fair value of net assets and goodwill of the associate/JV. This is similar to IFRS 10 requirements, except that all items are subsumed into one line (IAS 28.32). Similarities include additional depreciation of fair value adjustments or assets recognised only on consolidation (such as internally generated brand). As goodwill is not recognised separately from the investment, IAS 36 requirement for mandatory annual impairment test do not apply (IAS 28.42).

Fair valuation will usually be much harder to do for an associate, as significant influence will often be insufficient to obtain all the necessary valuation inputs. Therefore, approximations and estimates in greater than usual extent will often be made.

The example of an investment in associate/JV broken down into investor’s share in net assets, fair value adjustments and goodwill is included in the simple example.

IAS 28.28 requires gains and losses resulting from ‘upstream’ (sales by associate/JV to investor)  and ‘downstream’ (sales by investor to associate/JV) transactions involving assets to be recognised only to the extent of unrelated investors’ interests. The investor’s share in the investee’s gains or losses resulting from these transactions is eliminated. This is illustrated in the examples that follow.

Example: accounting for a downstream transaction

Entity A holds 20% interest in Entity B and exercises significant influence over it.  During year 20X0, Entity A sold an item of inventory to Entity B for $1m. This inventory was carried at cost in A’s books at $0.7m. During year 20X1, Entity B sold this inventory to its client for $1.5 million. Deferred tax is ignored in this example.

You can download an excel file for this example. Note that you can scroll the tables horizontally if they don’t fit your screen.

year 20X0

Entity A recognises the sale to Entity B in its books:

$mDRCR
Revenue1
Cost of sales0.7
Cash1
Inventory0.7

At the same time, Entity B recognises the purchase in its books:

$mDRCR
Cash1
Inventory1

In consolidated financial statements, Entity A recognises the following adjustment in order to eliminate the gain on sale of inventory with respect to its 20% interest in Entity B:

$mDRCR
Revenue0.2
Cost of sales0.14
Investment in Entity B0.06*

* Entity A adjusts the value of its investment in B, as the asset subject to elimination is held by B.

year 20X1

Entity B recognises the sale to a client:

$mDRCR
Revenue1.5
Cost of sales1
Cash1.5
Inventory1

In consolidated financial statements, Entity A reverses the previous entry and recognises the 20% portion of revenue and cost of sales:

$mDRCR
Revenue0.2
Cost of sales0.14
Investment in Entity B0.06

Additionally, Entity A recognises its share in gain made by Entity B:

$mDRCR
Investment in Entity B0.1
Share of profit of associates0.1

Example: accounting for an upstream transaction

Entity A holds 20% interest in Entity B and exercises significant influence over it. During year 20X0, Entity B sold an item of inventory to Entity A for $1m. This inventory was carried at cost in B’s books at $0.7m. During year 20X1, Entity A sold this inventory to its client for $1.5 million. Deferred tax is ignored in this example. Note that you can scroll the tables horizontally if they don’t fit your screen.

year 20X0

Entity B recognises the sale to Entity A in its books:

$mDRCR
Revenue1
Cost of sales0.7
Cash1
Inventory0.7

At the same time, Entity A recognises the purchase in its books:

$mDRCR
Cash1
Inventory1

In consolidated financial statements, Entity A recognises its share in gain made by Entity B:

$mDRCR
Investment in Entity B0.06
Share of profit of associates0.06

At the same time, Entity A eliminates the effect of upstream transaction with respect to its 20% interest in consolidated financial statements. There are two approaches to this step and both are acceptable and used in practice.

Approach 1:
$mDRCR
Inventory0.06
Share of profit of associates0.06
Approach 2:
$mDRCR
Investment in Entity B0.06
Share of profit of associates0.06

year 20X1

Entity A recognises the sale to a client:

$mDRCR
Revenue1.5
Cost of sales1
Cash1.5
Inventory1

Additionally, Entity A reverses the consolidation entry made in year 20X0 (see above) and includes the profit that B made on sale to A.


Similar approach should be followed on a contribution of non-monetary assets to associate/JV (IAS 28.30).

IAS 28 is silent on how to account for transactions, when there are no assets recognised as a result of them. Therefore, no adjustments/eliminations are necessary, but are allowed. Consider the following example:

Entity A has 20% interest in Entity B. During year 20X0, Entity A charges a consultancy fee of $1m on Entity B. There are two approaches to equity accounting (taxation ignored):

Approach 1:

Full amount of $1m is included in A’s P/L. At the same time, 20% of this income ($0.2m) is ‘automatically’ shown as a reduction of profit of associates accounted for using the equity method. Therefore, without any consolidation adjustments, the net impact on A’s P/L (before tax) is $0.8m.

Approach 2:

Entity A eliminates 20% of the consultancy income from its P/L and, at the same time, eliminates this expense from the line presenting profit of associates accounted for using the equity method. The net impact on P/L is the same as in Approach 1, but shown in different lines.

Share of investee’s P/L/OCI is determined based on its consolidated basis, i.e. includes investee’s consolidated subsidiaries and equity accounted investments (IAS 28.10). IAS 28 is silent on how to treat non-controlling interest in the investee’s group, but it is most reasonable for the investor to account only for the controlling interest’s share of P/L and OCI, as the investor is owner of the parent and net income attributable to non-controlling interest will never make its way to the investor in and associate-parent.

Dividends and other capital distributions received from an investee reduce the carrying amount of the investment (IAS 28.10).

IAS 28 is silent on how to account for equity transactions (i.e. transactions without impact on P/L/OCI) carried out by an associate/JV. On one hand, the definition of equity method (IAS 28.3) requires adjustments for the post-acquisition change in the investor’s share of the investee’s net assets. On the other hand, IAS 28.10 refers only to investor’s share of P/L and OCI. Various approaches are adopted in practice, as illustrated below.

Example: equity transactions of associate accounted for as deemed disposal

On 1 January 20X0, Entity A acquires 25% interest in Entity B for $150m. Entity B’s net assets as per its financial statements amount to $350m and this approximates their fair value. Additionally, Entity B has an internally generated brand (indefinite useful life) with a fair value of $100m. Deferred tax is ignored in this example. You can download an excel file for this example. Note that you can scroll the tables horizontally if they don’t fit your screen.

On 1 January 20X0, Entity A recognises its investment in Entity B at cost ($100m), which can be broken down as follows:

150Investment in Entity B at cost
$m
87.525% share in B's net assets as per its financial statements
2525% share in fair value of brand (unrecognised by B)
37.5goodwill (not presented separately and not amortised)

Goodwill in the table above was calculated as shown below:

37.525% interest in implicit goodwill held by Entity A ($150m x 25%)
$m
600implicit consideration for 100% interest, given $150m paid for 25% ($150m/25%)
350Entity B's net assets as per its financial statements
100fair value of brand (unrecognised by B)
150total implicit goodwill of Entity B ($600m-$350m-$100m)

On 2 January 20X0, Entity B issues additional shares which are not subscribed by Entity A for a total proceeds of $170m. As a result of the new issue, Entity’s A interest in B decreases to 20%, but it is still able to exercise significant influence. Such circumstances are not covered in IFRS Standards, in practice they are often referred to as ‘deemed disposals’. Because an investor loses part of its interest in associate/JV, it is widely accepted that an investor needs to account for such a deemed disposal with a resulting gain or loss recognised in P&L, as under the equity method the investment in associate/JV is ‘adjusted for the post-acquisition change in the investor’s share of the investee’s net assets.’

Entity A calculates gain on disposal on part of interest in B in the following way:

4Gain on deemed disposal
30Cost of investment disposed of ($150mx5%/25%)
34A's share in proceeds from share issue (based on interest after the share issue) ($170m x 20%)

Example: equity transactions of associate that is a parent with non-controlling interest in its consolidated financial statements

Entity A holds 20% interest in Entity B with carrying amount of $100m. Entity B has a subsidiary in which it holds 70% interest. In its consolidated financial statements, Entity B has $500m of equity attributable to owners of parent and $200 of non-controlling interest. During year 20X1, Entity B acquires remaining 30% interest in its subsidiary for $300m. This transaction is reflected in consolidated financial statements of B as follows. Deferred tax is ignored in this example.

$mDRCR
Cash300
Non-controlling interest200
Retained earnings100

After the transaction, Entity B reports $400m equity attributable to owners of parent and $0 non-controlling interest. Although Entity A still holds 20% interest, this interest translates only to $80m of equity/net assets (20% x $400m) instead of $100m (20% x $500m) before the transaction. Entity A need to account for this change as under the equity method the investment in associate/JV is ‘adjusted for the post-acquisition change in the investor’s share of the investee’s net assets.’ There are two possible approaches to this:

Approach 1

Entity A recognises the change directly in equity as share in changes in equity of associates accounted for using the equity method. This approach stems from the fact that there is no profit or loss included in B’s financial statements to be brought to A’s P&L. IAS 28.26 states that ‘many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10.’

Approach 2

Entity A  recognises the change in net assets attributed to its holding in its P&L. Arguments in favour of this approach are as follows: Holders of non-controlling interest in Entity B were not shareholders of the Entity A (Group A), therefore the effect of transactions with them cannot be accounted for directly in equity without impact on P&L/OCI (IAS 1.109).

An investor recognises losses in an associate/JV up to the amount of its investment. In other words, when the value of investment drops to zero, investor stops recognising losses unless there is a legal or constructive obligation that require recognition of a liability. Subsequent profits of such an investee are recognised only after the unrecognised losses have been made up for (IAS 28.38-39).

It is important to note that the investment in an associate is not confined to ordinary shares held, but also includes all long-term interests (e.g. long-term financing) that, in substance, form part of the entity’s net investment in an associate/JV. If such interest exist, cumulative losses exceeding the (equity accounted) carrying amount of ordinary shares held by the investor are attributed to other components of the entity’s interest in the reverse order of their seniority (i.e. priority in liquidation). Examples of financial assets that form part of the  net investment are preference shares and long-term receivables or loans without adequate collateral (IAS 28.38).

Impairment requirements are covered in paragraphs IAS 28.40-43. Impairment testing relates to total net investment in an associate/JV, i.e. includes all long-term interests (e.g. long-term financing) that, in substance, form part of the entity’s net investment (see Loss making associate/JV above). Impairment losses recognised by associate/JV will not always be brought to the P/L of the investor in the same amount, mainly due to fair value adjustments and goodwill recognised by the investor.

May 2016 IFRIC update clarifies interaction between IAS 28 and IFRS 9 with respect to financial assets that form part of the entity’s net investment:

  • an entity accounts for long-term interests applying IFRS 9, including the impairment requirements in IFRS 9;
  • in allocating any losses of the associate or joint venture applying the requirements in paragraph 38 of IAS 28, the entity includes the carrying amount of those long-term interests (determined applying IFRS 9) as part of the net investment to which the losses are allocated;
  • the entity then assesses for impairment the net investment in the associate or joint venture, of which the long-term interests are a part, by applying the requirements in paragraphs 40 and 41A–43 of IAS 28; and
  • if an entity allocates losses or recognises impairment applying steps (b) and (c) above, the entity ignores those losses or that impairment when it accounts for long-term interests applying IFRS 9 in subsequent periods.

Discontinuing the use of the equity method is covered in paragraphs IAS 28.22-24. When an associate/JV becomes a subsidiary, it starts to be fully consolidated under IFRS 10. Previously held interest is remeasured to fair value with any gain/loss recognised in P/L. In general, IFRS 3 applies.

When the change in ownership goes in the opposite direction, i.e. the interest decreases so that the investment becomes a ‘regular’ financial asset, it is accounted at fair value under IFRS 9. The difference between fair value of retained interest, proceeds received from disposal and the carrying amount of the investment at the date the equity method was discontinued is recognised in P/L.

In both cases covered above, items previously accumulated in OCI are recycled to P/L on the same basis as if the investee had directly disposed of the related assets or liabilities.

Paragraphs IAS 28.20-21 provide specific requirements on a classification of an investment in associate/JV as an asset held for sale under IFRS 5.

Paragraph IAS 28.21 requires retrospective adjustment when an investment, or a portion of an investment, in an associate or a joint venture previously classified as held for sale no longer meets the criteria to be classified as held for sale.

Investments accounted for using the equity method should be presented as non-current assets (IAS 28.15) in a separate line in the statement of financial position (IAS 1.54e). Similarly, share of the profit or loss of associates and joint ventures accounted for using the equity method should be presented separately in P/L and OCI (IAS 1.82c).There is no guidance as to in which section of the P/L this line should go and entities have different approaches here (e.g. within operating income, just before income tax etc.).

Financial assets that, in substance, form part of the entity’s net investment in an associate/JV are accounted for under IFRS 9 and are not included in the line presenting investments accounted for using the equity method (although there is no explicit guidance in IFRS).

IFRS 12 is a comprehensive standard that covers all disclosure requirements relating to interests in other entities.

 


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Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.