Chronology
Timetable
Discussion at the March 2006 IASB Meeting
The IASB considered a proposal to prepare an amendment to IFRS 1 First-time Adoption of IFRSs to address problems in the separate financial statements of the parent.
- Initial cost. In some cases it is difficult to determine the initial cost of an investment in a subsidiary in the separate financial statements of a parent, in accordance with IAS 27 when an entity adopts IFRS for the first time. This difficulty has been highlighted by the use of merger relief accounting in the United Kingdom and other countries. Under merger relief accounting, any shares provided as consideration for the purchase of an investment in a subsidiary are recorded (for the purposes of cost) at their nominal value. This nominal value is not cost in accordance with IAS 27, which requires that the cost be stated initially at the amount of consideration paid.
- Post acquisition dividends. IAS 27 requires that the initial cost is adjusted for any dividends paid out of pre-acquisition reserves, and impairments. When the cost of investment is restated under IAS 27, on transition to IFRS, the pre-acquisition retained earnings would also need to be restated accordingly in order to determine which distributions are a recovery of the initial investment. This would require a reconstruction of pre-acquisition reserves under IFRS. Constituents argue that the related compliance burden has led to many entities choosing to prepare the separate financial statements of parent entities in local GAAP rather than in accordance with IFRS.
These issues had been raised to the IFRIC. The IFRIC referred them to the IASB on the grounds that this is not a matter of interpretation, the standards are clear and do not provide any basis for granting the relief sought.
The staff stated that preparing the amendment would not consume excessive resources. The Board concurred and agreed to add this project to its agenda. It was noted that, although an amendment to IFRS 1, the amendment would not affect the stable platform (because it applied only to separate financial statements) and would help IFRSs gain wider acceptance.
Discussion at the May 2006 IASB Meeting
At its March 2006 meeting, the Board decided to add a project to its technical agenda to resolve issues in relation to measuring the cost of a subsidiary in the separate financial statements of a parent on first time adoption of IFRSs. Constituents argue that, in some circumstances, it is difficult to determine the cost of an investment in a subsidiary in accordance with IAS 27 Consolidated and Separate Financial Statements on first time adoption of IFRSs.
Three options were considered by the Board:
- 1. Use the previous GAAP cost as deemed cost
- 2. Use the IFRSs carrying value of the net assets of the subsidiary at transition date as deemed cost
- 3. Fair value as deemed cost
Many Board members indicated a preference for option 3 and then 2. However, the Board acknowledged that IFRS 1 is a practical expedient for entities transitioning to IFRS and therefore the exception provided need not be of the highest quality. After some discussion about the exact nature of the problem, which some believe arises only where shares were issued in exchange for an interest in the subsidiary and the value of the business acquired at that date can no longer be determined, compared to a purchase of an interest (for example, by cheque) in which case some Board members believe such records should be retrievable.
It was agreed that the staff should work on developing a model that uses option 2 above to determine the cost of the subsidiary at the date of transition if the information required in IAS 27 cannot be determined. On the issue of determining pre-acquisition profits, the staff would attempt to develop a model that is independent of option 2 but ensuring that the two models are compatible.
Discussion at the September 2006 IASB Meeting
In May 2006, the Board discussed potential amendments to IFRS 1 to grant relief from determining cost in accordance with IAS 27 on first-time adoption of IFRSs and directed the staff to analyse one of those methods (the 'proposed relief') further.
The proposed relief permits a parent to use deemed cost for its investments in subsidiaries instead of restating cost in accordance with IAS 27. This deemed cost is to be calculated by reference to the underlying IFRS-compliant net asset position at the date of transition.
At this meeting the staff's recommendations were discussed.
Measurement of initial cost – the Proposed Relief
Some constituents have argued that, in some cases, it is difficult to measure the cost of an investment in a subsidiary in accordance with IAS 27 on first-time adoption of IFRSs. This is because entities adopting IFRSs may have measured the cost of an investment in a subsidiary under their previous GAAP in a manner that is not in accordance with IAS 27. Particularly, when a method of accounting other than the purchase method in accordance with IFRS 3 was used under previous GAAP, the parent would have to reconstruct the business combination using the purchase method in order to determine cost on adoption of IFRSs.
Based on its analysis, the staff recommended that IFRS 1 be amended to allow a parent to use either:
- The carrying amount of the net assets of a subsidiary (in accordance with IFRSs); or
- The fair value of a subsidiary at the date of the parent's transition to IFRSs.
The Board agreed to the staff's recommendation.
Profit distributions
In addition to measuring the initial cost of an investment, constituents have highlighted difficulties in determining the cost of an investment in a subsidiary on first-time adoption when dividends have been paid since acquisition. IAS 27 requires an assessment whether dividends received by a parent from the subsidiary relate to pre- or post-acquisition profits of the subsidiary. Under IAS 27, pre-acquisition profits received from the subsidiary reduce the investment in the subsidiary and post-acquisition profits are recognised as income. In some jurisdictions, there was no requirement to assess whether distributions were received from the pre- or post-acquisition profits of a subsidiary. In these jurisdictions a parent would have to reassess every distribution received.
The Board agreed that:
- If a parent applies the relief from restating the cost of an investment in a subsidiary in accordance with IAS 27 on transition to IFRSs, the accumulated profits of the subsidiary at that date are deemed to be pre-acquisition profits for the purposes of the cost method in IAS 27.
- If a parent does not use the relief from restating the cost of an investment in a subsidiary in accordance with IAS 27 on transition to IFRSs, the pre-acquisition accumulated profits of the subsidiary under the previous national GAAP at that date are deemed to be the pre-acquisition profits for the purpose of IAS 27.
Conclusion
No Board member indicated an intention to dissent to an Exposure Draft based on the staff's recommendations.
January 2007: Exposure Draft Issued
On 25 January 2007, the IASB published an Exposure Draft proposing exemptions from the requirements of IFRSs when they are adopted for the first time. The Exposure Draft would amend IFRS 1 First-time Adoption of International Financial Reporting Standards. The proposals respond to concerns about difficulties encountered by parent companies in measuring the cost of an investment in a subsidiary on adopting IFRSs.
At present, IFRSs require a parent to measure an investment in a subsidiary either at its cost or at fair value. In some circumstances a parent is unable to determine cost in accordance with IFRSs but is deterred from using fair value to account for the investment by the subsequent need to measure the investment at each reporting date.
The Exposure Draft proposes to allow a parent to use a 'deemed cost' to measure its investment in subsidiaries when it first adopts IFRSs. This deemed cost can be determined by reference to the parent's investment in the net assets of the subsidiary or the fair value of the parent's investment. In addition, the proposals would alleviate the need to restate the pre-acquisition accumulated profits of the subsidiary in accordance with IFRSs for the purposes of classifying dividends.
Comment deadline is 27 April 2007.
Click for Press Release (PDF 52k).
Discussion at the June 2007 IASB Meeting
Comment Letter Analysis
The staff introduced their analysis of comments received on the IASB's Exposure Draft of Proposed Amendments to IFRS 1 First-time Adoption of IFRSs – Cost of an Investment in a Subsidiary (ED). The analysis is available in the Observer Notes Section of the IASB's website (Agenda Paper 10A).
The staff was merely asking for the Board's initial views on the comments received and accordingly no decisions were made at this meeting.
Deemed cost
This exposure draft proposes to allow as deemed cost the carrying amount of the net assets calculated under IFRSs of the subsidiary or its fair value.
The option to use fair value was widely supported.
Regarding the option of using carrying amounts, many respondents preferred deemed cost to be the carrying amount of the net assets calculated in accordance with previous national GAAP either instead of or in conjunction with the relief offered in the ED. The main reason for opposing was that the approach in the ED does not allow for the inclusion of goodwill in the carrying amount of the net assets because to do so would be tantamount to recognising internally generated goodwill. The respondents raised the concern that this may result in a write down of the investment in subsidiaries on transition to IFRSs. This write-down may present such an adverse taxation and/or legal scenario – particularly in its effect on profits available for dividend distributions – that many entities will continue to opt out of adopting IFRSs for their separate financial statements.
The following alternative approaches to determine deemed cost were proposed by constituents:
- (a) Cost under previous national GAAP
- (b) The higher of the previous GAAP carrying amount of the investment and the net asset value (as determined under the provisions of the ED)
- (c) The net asset value of the subsidiary (as determined under IFRSs) with historical goodwill included
- (d) The net asset value of the subsidiary (including goodwill) included in the consolidated financial statements
One Board member acknowledged that the 'goodwill issue' is a valid point that should be considered further. However, the majority of Board members seemed not to support any of the alternative approaches. Particularly with regard to methods (b) and (c) one Board member noted that the reason for developing the relief was difficulties in determining cost. In his view the alternative approaches indicate that entities are in the position to determine cost and therefore these entities would not need the relief. There appeared to be general consent for this view.
Determining pre-acquisition profits
This ED proposes a simplified approach to determining the pre-acquisition accumulated profits of a subsidiary for the purpose of the cost method in IAS 27.
The staff expressed the view that many respondents consider the reason for the problem to be a fundamental flaw of IAS 27 (that is, the cost method) rather than to be a first-time adoption issue. These respondents suggest that IAS 27 be amended to permit dividends from subsidiaries to be treated as investment income, subject to an impairment test of the value of the subsidiary in the parent's accounts and consideration of whether the dividend is, in substance, a return of capital invested.
The Board accepted a proposal of senior staff to investigate whether consequential amendments to IAS 27 would be a useful approach. The staff was asked to prepare a paper for discussion at a future meeting.
Discussion at the September 2007 IASB Meeting
At the June 2007 meeting the Board discussed issues raised by constituents in response to the Exposure Draft of Proposed Amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards - Cost of an investment in a subsidiary (ED). The Board asked the staff to prepare an analysis considering the possibility of amendments to the ED and IAS 27 Consolidated and Separate Financial Statements.
Deemed cost
Regarding paragraph B5(a) of the ED respondents pointed out that in many jurisdictions entities currently show a carrying amount that reflects cost including intangible assets and goodwill not currently recognised in the subsidiary's financial statements under IFRSs. The use of the net asset option could result in a significant reduction to their initial cost on transition to IFRS because such intangible assets and goodwill would be stripped out of this cost figure. This may result in an adverse taxation and/or legal scenarios.
The Board discussed the following alternatives regarding the net asset option (in both cases the fair value at transition date option in paragraph B5(b) would be retained):
Alternative 1:
Calculate deemed cost based on the amounts of the underlying assets and liabilities of the subsidiary in the consolidated financial statements at the date of transition to IFRSs. Accordingly the deemed cost would include intangible assets and goodwill related to the subsidiary.
Alternative 2:
Calculate deemed cost based on the amounts under previous GAAP.
The Board had a thorough debate and was nearly equally split between the two alternatives.
Board members in favour of alternative1 noted that this alternative would be consistent with the exemptions provided for business combinations in IFRS 1. In addition, they believed that this alternative would not be burdensome as the amounts would have to be determined for consolidation purposes anyway. One Board member responded that this would not be the case for (intermediate) parents that do not prepare or are not included in consolidated financial statements.
Other Board members noted that alternative 2 is also consistent with the exemption provided to restating business combinations in IFRS 1. These Board members believed that it would be the simplest way to respond to the issues faced by constituents and would be readily accepted. Board members in favour of alternative1 raised the concern that alternative 2 might result in a 'cost' that has low information content, in particular in situations where nominal/par values were used to measure cost (such as the merger relief in the UK).
No final conclusion was reached, however, eight Board members indicated that they could accept alternative 2 and six indicated that they could accept alternative 1. Two Board members were not present.
Scope of the exception
The Board unanimously agreed to extend the deemed cost exemption to initial measurement of investments in associates and interests in joint ventures on transition to IFRSs.
The cost method in IAS 27 (dividends)
Constituents suggested amending IAS 27 to permit pre- and post-acquisition dividends received from subsidiaries to be treated as investment income, subject to an impairment test of the value of the subsidiary in the parent's accounts in accordance with IAS 36 Impairment of Assets.
The Board agreed to the constituents' suggestion and decided to remove the definition of the cost method from paragraph 4 of IAS 27. Accordingly all dividends from subsidiaries would be treated as a return on investment and presented in investment income. The Board noted that under the fair value option all dividends would result in a reduction of the fair value while under the cost option a dividend would be an indication that the investment may be impaired.
Next steps
Given the extent of changes to the ED as currently drafted, the Board agreed to re-expose the ED.
The Board decided to ask the large accounting firms for informal feedback on the practicability of the intended changes. After that the staff will draft the re-exposure for discussion at a future meeting.
In addition, the amendments to IAS 27 will be exposed separately.
In July the Board directed the staff to draft an amendment to IAS 27 to clarify that paragraph 37 does not apply to the formation of a new parent entity for an existing group when there are no changes in substance resulting from the revised organisation structure. The Board decided to also expose this issue separately in the proposed amendments to IAS 27.
Follow-up From Day 1 Tuesday 18 September 2007 - Deemed cost
The board finalised their conclusion on the deemed cost alternatives regarding the net asset option (refer to IASPlus notes from day 1 of this meeting). On day 1 of the meeting eight Board members indicated that they could accept Alternative 2 to calculate deemed cost based on the amounts under previous GAAP and six indicated that they could accept Alternative 1 to calculate deemed cost based on the amounts of the underlying assets and liabilities of the subsidiary in the consolidated financial statements at the date of transition to IFRSs. However, no final conclusion was reached on day 1 as two Board members were not present. These Board members were present at the Friday session and both indicated that they could accept Alternative 2 (that is, Alternative 2 commands the support of 10 Board members).
Revised Exposure Draft Published December 2007
On 13 December 2007, the IASB published for public comment a revised exposure draft of proposed amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards and IAS 27 Consolidated and Separate Financial Statements. The exposure draft – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate – was developed in response to comments received on a related exposure draft published in January 2007. In the light of those comments and further consultation with interested parties, the IASB reconsidered and revised its original proposals.
The proposals address concern that retrospectively determining cost in accordance with IAS 27 on first-time adoption of IFRSs cannot, in some circumstances, be achieved without undue cost or effort. Consequently, this might create a barrier to entities' adoption of IFRSs in separate financial statements. Additionally, the proposals respond to enquiries received about the measurement of cost in the separate financial statements of a new parent entity.
Under the revised proposal:
- Entities, in their separate financial statements, would be allowed to use a 'deemed cost' option for determining the cost of an investment.
- That 'deemed cost' could be either fair value (determined in accordance with IAS 39 Financial Instruments: Recognition and Measurement) or the carrying amount under previous national standards.
- The 'deemed cost' option to would apply to jointly controlled entities and associates as well as subsidiaries.
- A new parent would be required to measure cost using the carrying amounts of the existing entity at the date when the new parent is formed.
Comment deadline on the revised ED is 26 February 2008. Click for Press Release (PDF 130k).
Discussion at the April 2008 IASB Meeting
Staff introduced the agenda papers for the Board meeting. The staff noted that an exposure draft of proposed amendments to IFRS 1 was released in January 2007, and following redeliberation by the Board, a revised exposure draft was released in December 2007. Comments closed in February 2008.
In summary, the staff indicated that the comment letters were broadly supportive of the proposals with the following two exceptions:
- The requirement to test for impairment; and
- The formation of a new parent.
The staff suggested to the Board that they did not intend to discuss the non-controversial aspects of the exposure draft, namely; deemed cost, inclusion of associates and joint ventures in the proposals, and the elimination of the cost method in IAS 27, as they believed these aspects could be finalised with a minor editorial changes. The Board agreed.
The staff then moved on to discuss the first of the controversial issues – presentation of dividends as income and requirement to test the investment for impairment.
Staff noted that respondents were split as to whether dividend receipts should always be presented as income, however, respondents were nearly unanimous in their rejection of the Board's proposal to require impairment testing. The staff recommended to the Board to:
- Retain the proposal that an investor shall recognise as income in its separate financial statements dividends receivable from a subsidiary, jointly controlled entity or associate; and
- Modify the proposal to require an impairment test of the related investment such that the right to receive the dividend may be an indicator of impairment, particularly in situation where the amount of the dividend reduces the recoverable amount of the investment below its carrying amount in the investor's separate financial statements.
The Board agreed with the first proposal, and also agreed with the second proposal, with the exception that the second part of the sentence should be deleted as this would already be an impairment by definition. It was noted by one Board member that these proposals affect all dividends received, not just dividends from subsidiaries. The Board agreed.
The staff then moved on to discuss the second of the controversial issues - accounting for the formation of a new parent.
The staff indicated that comment letters expressed mixed views in relation to this proposal. Just over half of the comment letter supported the Board's proposal.
In light of the comments received the staff identified three approaches the Board could choose:
- Approach A – proceed with the proposal in the ED to amend IAS 27 to require entities to use the carryover basis
- Approach B – do not amend IAS 27 at this time. Wait and address the issue in the common control project.
- Approach C – amend IAS 27 to clarify that entities may use either fair value or a carryover basis until the issue is addressed in the common control project.
It was also reiterated that the issue being addressed is within the separate financial statements. From the perspective of the group nothing has changed. Staff also noted that IAS 27 is currently being interpreted by many constituents as requiring fair value on the formation of a new parent.
It was also clarified that the proposals being discussed did not impact on the ability of the parent to elect to apply IAS 39 fair value when accounting for an investment in a subsidiary. The proposals related only to how 'cost' is measured for such investments.
The Board voted in favour of Approach A (8 in favour). 4 Board members voted in favour of Approach C.
The staff then requested Board input into additional issues raised by the comment letters. The first issue raised was whether the amendment applies when preference shares (or similar securities) remain in the previous parent. A number of Board members sought clarification as to what was meant by this issue. It was clarified by the staff that in such a scenario the assets and liabilities of the group do not change and the relative ownership interests of the owners of the previous parent do not change. On the basis that it was clear that the relative ownership does not change the Board agreed.
A second issue to be addressed was whether the amendment should apply to intermediate holding companies. The staff indicated that they never intended for the amendment to apply to such entities. A number of Board members queried 'why not'? The Board did not support the staff proposal that the amendment should not apply to the formation of an intermediate parent company.
The third issue to be addressed was whether the amendment should apply when the new parent finances part of the share purchase with debt. One Board member noted that he could not see how you can finance an accounting entry. The Board agreed with the staff suggestion that the amendment not apply to the formation of a new parent that is financed partly with debt.
The Board then considered how the carryover basis should be measured when the previous parent has net liabilities or net assets less than the nominal value of the shares issued. The Board agreed that the entity should carryover whatever was recorded in the previous parent accounts.
The staff then moved on to issues relating to transition and effective date. The exposure draft proposed that all of the amendments be applied prospectively. Some respondents requested that the Board permit (but not require) entities to apply the amendments retrospectively. The Board did not agree that retrospective application for the amendments to IAS 27 was appropriate and voted to retain the proposal in the exposure draft to require prospective application.
By majority vote the Board decided that entities should be permitted to apply the amendment for new parent formations retrospectively.
The Board also decided that the effective date of the amendments should be 1 January 2009.
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