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Consolidation — Investment Entities

Date recorded:

At the July 2012 meeting, the IASB discussed the following issues:

  • whether to extend the exception to consolidation to an insurer’s insurance investment fund subsidiaries;
  • the reassessment requirements;
  • the disclosure requirements;
  • the transition requirements and effective date;
  • other sweep issues; and
  • whether all due process steps had been followed in the Investment Entities project.

Request for extension of exception to consolidation

The Investment Entities exposure draft (‘the ED’) proposed an exception from consolidation for the controlled investees of investment entities.  Many insurance companies have controlling interests in investment funds (‘insurance investment funds’).  While many insurance companies agreed with the exception to consolidation proposed for investment entities in the ED, they also argued that insurance investment funds should qualify as investment entities and that those insurance investment funds should not consolidate their controlled investments. In addition, several insurance companies also requested an additional extension of the exception from consolidation proposed in the ED, citing that they should be required to measure their controlling interest in the actual insurance investment funds at fair value rather than consolidating them. They noted that presenting a single line item for the fair value of their interest in the insurance investment fund, along with a single line item for the current value of their liability to policyholders who receive the returns from those investment funds, would provide the most useful information.

At the June 2012 meeting, the IASB tentatively decided that the fair value accounting used by an investment entity subsidiary to account for its controlled investments should not be retained at a non-investment entity parent level. As such, following these tentative decisions and the IFRS 10 requirements, insurers would be required to a) consolidate their controlling interests in insurance investment funds and b) consolidate any controlled investees of those insurance investment funds.

While a few Board members expressed sympathy for where the insurers were coming from, the IASB tentatively agreed with the staff’s recommendation not to extend the exception to consolidation for insurers’ insurance investment fund subsidiaries as the topic was outside the scope of the Investment Entities project as the purpose of the project was to provide an exception to consolidation for investments entities.

Sweep issues

The IASB discussed the following sweep issues:

Issue: The ED proposed that an investment entity would measure controlled investees and investments in associates and joint ventures at fair value through profit or loss in accordance with IFRS 9 Financial Instruments.  However, the ED did not provide any specific guidance on the initial measurement of controlled investees and investments in associates and joint ventures;

Tentative decision: The IASB tentatively agreed with the staff’s recommendation that an investment entity should initially measure all controlled investees and investments in associates and joint ventures in accordance with IFRS 9.

Issue: measurement of all investment assets held by an investment entity

Tentative decision: The ED only provided measurement guidance for the controlled investees and investments in associates and joint ventures held by investment entities, and required investment entities to measure those investments at fair value through profit or loss in accordance with IFRS 9.  The staff noted that many constituents requested more comprehensive measurement guidance for all investments held by an investment entity.  The IASB tentatively agreed with the staff’s recommendation that the investment entities requirements should not include any measurement guidance for investments other than controlled investees and investments in associates and joint ventures as it was outside of the scope (which was to provide an exception from consolidation for investment entities) of the Investment Entities project to provide comprehensive measurement guidance for all investments held by an investment entity.

Issue: the use of a net asset value (‘NAV’) practical expedient for fair value

Tentative decision: Some constituents noted that US GAAP allows an investor in an investment company to use the reported NAV per share of that investment company as a practical expedient for fair value in certain circumstances but that IFRS 13 Fair Value Measurement did not provide such a practical expedient.  The IASB tentatively agreed with the staff’s recommendation not to introduce a NAV practical expedient for fair value measurement within the context of the Investment Entities project as: a) it is outside the scope of the Investment Entities project to provide fair value measurement guidance for investments in investment entities, b) entities that may not have controlled investees may use the definition of an investment entity to determine whether they are eligible for a NAV practical expedient and c) NAV could be calculated differently in different jurisdictions.

Issue: whether the definition of an investment entity should include a reference to existing regulatory requirements

Tentative decision: The staff noted that the FASB’s proposed Accounting Standards Update, Financial Services – Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, proposed that an entity that is regulated as an investment company under the SEC’s Investment Company Act of 1940 would be treated as an investment entity for accounting purposes and would not be required to assess the proposed criteria.  However, the ED did not have a reference to existing regulatory requirements in guidance relating to the determination of investment entity status.  The staff expressed concern that there are different regulatory requirements in different jurisdictions and these requirements could change over time and that such regulatory requirements were outside the control of the IASB.  The IASB tentatively agreed with the staff’s recommendation that the definition of an investment entity should not make reference to existing regulatory requirements (i.e., the definition should stand on its own).

Issue: whether an investment entity should be allowed to provide financial support to its investments

Tentative decision: The ED contained disclosure requirements relating to the provision of financial support but did not explicitly state whether an investment entity could provide financial support (e.g., loans, guarantees, to its investees).   The IASB tentatively decided that an investment entity should not be prohibited from providing financial support to its investees as long as the provision of financial support does not constitute a separate substantive activity of the entity.

Reassessment

The ED proposed that an entity shall reassess whether it meets the criteria to be classified as an investment entity if facts and circumstances indicate that there are changes to one of more of the criteria used to determine investment entity status. If the entity’s reassessment shows that its status has changed, the ED proposed that an entity shall account for the change prospectively from the date of the change.  The FASB’s proposed Accounting Standards Update, Financial Services—Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements proposed that an entity reassess whether it is an investment entity if the purpose and design of that entity changes.  A few constituents noted that the requirement to continuously reassess whether facts and circumstances are changing would be too onerous and stated a preference for the FASB ED ‘purpose and design’ approach.  The staff noted that the requirement to use facts and circumstances to both initially assess and subsequently reassess a particular situation is used in numerous IFRS standards, including IFRS 10 Consolidated Financial Statements and that they did not expect a change in investment entity status to occur frequently.  In addition, the staff noted that they were not aware of situations where the reassessment of facts and circumstances could be considered unduly onerous.  The IASB tentatively agreed with the staff’s recommendation to require an entity to reassess its investment entity status if facts and circumstances indicate that its status has changed.

Accounting for loss of investment entity status

The ED proposed that an entity that no longer meets the definition of an investment entity should account for the change in its status prospectively by changing the accounting for its investments from the date when the change in status occurred. This would require an entity (when that change in status occurs) to apply IFRS 3 Business Combinations to those investees that are required to be consolidated as a result of the entity no longer qualifying as an investment entity.

The staff noted that this guidance recognises the change in status as a significant economic event and accounts for the change in status as a ‘deemed acquisition’, i.e., to use the fair value of the investment at the date of the change of status of the investor as the ‘deemed’ consideration transferred and would result in the recognition of goodwill or a gain on a bargain purchase.

The IASB tentatively agreed with the staff’s recommendation to provide more explicit guidance in the final investment entities amendments regarding the accounting for controlled investees in the case when an entity loses its investment entity status (i.e., the requirements of IFRS 3 should be applied and goodwill or a bargain purchase as applicable should be recognised when an entity ceases to qualify as an investment entity).  One of the Board members noted that the change is accounted from the date when the change in status occurs which is different from IFRS 9 which accounts for the change from the beginning of the next reporting period.  The staff noted that this recommendation was consistent with IFRS 10 which accounts for the change from the date when the change in status occurs.

Accounting for loss of investment entity status by an intermediate parent

At the June 2012 meeting, the IASB tentatively decided that a non-investment entity parent should be required to consolidate all controlled investees, regardless of whether the investments are held through an investment entity subsidiary (i.e., an intermediate parent entity that qualifies as an investment entity). This decision raised an application issue when an investment entity subsidiary/intermediate parent ceases to qualify as an investment entity.  The intermediate parent would be required to consolidate its controlled investees from the date of change in status if it lost its investment entity status (per IFRS 3).  Consequently, the assets and liabilities of these newly-consolidated investees would be recognised at different amounts in the consolidated financial statements of the intermediate parent from the amounts recognised in the consolidated financial statements of the higher-level parent which could create additional costs for preparers. The staff felt that this situation would not occur frequently. Also, if an intermediate parent ceases to qualify as an investment entity, there is currently relief within the scope of IFRS 10 for intermediate parents which provides an exemption from preparing consolidated financial statements if it meets certain conditions.   As such, at the July meeting, the IASB tentatively agreed with the staff’s recommendation not to provide relief when an intermediate parent entity ceases to qualify as an investment entity.

Qualifying for investment entity status

The ED requires an entity that becomes an investment entity to account for the change in its status prospectively by ceasing to consolidate its controlled investments from the date when the change in status occurred.  The staff noted that recognising the change in status to an investment entity as the exchange of an investment in a subsidiary for an investment measured at fair value would result in a gain or loss on the ‘deemed disposal’. The IASB considered three alternatives for recognising this amount at the date of change in status:

Alternative 1: recognise the amount as a gain or loss in profit or loss which reflects the change in the business purpose of the investor as a significant economic event (consistent with gains and losses being recognised in profit or loss in IFRS 10 when control is lost).

Alternative 2: recognise the amount as a gain or loss in other comprehensive income which would avoid a one-off gain or loss being recognised in profit or loss when an entity changes its status.

Alternative 3: recognise the amount as a gain or loss directly through the statement of changes in equity which would also avoid recognising a one-off gain or loss when the entity changes its status.

The IASB tentatively agreed with the staff’s recommendation (Alternative 1) to provide explicit guidance in the final investment entities requirements regarding the accounting for when an entity becomes an investment entity (i.e., the entity should apply the requirements of IFRS 10 for a deemed disposal and any resulting gain or loss should be recognised in profit and loss).

Disclosures on a change in investment entity status

The ED proposed that when an entity’s status has changed, the entity should disclose the change in status and reasons for the change. If an entity becomes an investment entity, it should disclose the effect of the change in status on the financial statements for the period presented, including the effect of the change on the reported amounts of investments as of the date of the change in status and the related effects on profit or loss and total comprehensive income.  The IASB tentatively agreed with the staff’s recommendation to retain this disclosure requirement in the final standard.

Amendments to other IFRSs

As the IASB tentatively decided that in addition to accounting for controlled investees at fair value through profit or loss, an investment entity should also measure its investments in associates and joint ventures in the same way, the IASB tentatively agreed with the staff’s recommendation to draft reassessment guidance for amendments to IAS 28 Investments in Associates and Joint Ventures and IAS 27 Separate Financial Statements which is consistent with the decisions made for the reassessment guidance for IFRS 10.

Disclosures

At the July 2012 meeting, the staff was asked to clarify the scope of the disclosure requirements for Investment Entities.  The staff noted that the objective of the Investment Entities project is to provide an exception to consolidation for the controlled investees of investment entities and instead require that investment entities measure those controlled investees at fair value through profit or loss.  The staff also highlighted that the IASB had previously tentatively decided to introduce a requirement that investment entities measure their investments in associates and joint ventures at fair value through profit or loss.

However, the disclosure objective proposed in the ED required disclosure of information to enable users of an investment entity’s financial statements to evaluate the nature and financial effects of the investment activities in which it engages. The staff noted that there are two potential inconsistencies between the objective of the Investment Entities project and the scope of the disclosure objective for investment entities that was set out in the ED:

Potential inconsistency: The disclosure objective proposed in the ED would apply to all investment entities rather than just investment entities with investments in subsidiaries, associates or joint ventures.

Tentative decision: The IASB tentatively agreed with the staff’s recommendation to clarify that the disclosure requirements should only apply to investment entities with investments in subsidiaries, associates or joint ventures.

Potential inconsistency: The disclosure objective proposed in the ED would apply to all investment activities of an investment entity, rather than just those investment activities relating to an investment entity’s subsidiaries, associates, or joint ventures.

Tentative decision: The staff recommended that an investment entity with one or more subsidiaries, associates or joint ventures should provide information about all its investment activities (i.e., entity wide) rather than just about subsidiaries, associates or joint ventures as it would provide more useful information.  However, the IASB tentatively disagreed with the staff’s recommendation that an investment entity with one or more subsidiaries, associates or joint ventures should provide information about its investments.  Several Board members expressed concern of a scope creep and were not supportive of entity wide disclosures. These Board members also noted that disclosures were included in IFRS 12.

Disclosures

Due to the decision reached above where the IASB tentatively disagreed with the staff’s recommendation that an investment entity with one or more subsidiaries, associates or joint ventures should provide information about its investments, the following questions were deemed to be irrelevant and as such the IASB did not discuss or vote on the following questions.

  1. Objective and other statement – the staff recommended that:
    1. The disclosure objective should be retained unchanged;
    2. A statement should be included allowing investment entities to make the required disclosures by cross-reference to some other statement that is available to users of the financial statements, on the same terms as the financial statements, and at the same time.
  2. Fair value disclosure
    1. The staff recommended that fair values for individual investments of an investment entity should be included in the list of examples that might be appropriate to meet the disclosure objective.
  3. Leverage disclosures
    1. The staff recommended that the leverage ratio, leverage value and method of calculating the leverage ratio be included in the list of examples that might be appropriate to meet the disclosure objective.

The IASB tentatively agreed that in relation to IFRS 7, 12, and 13 that:

  • An investment entity should be required to provide the disclosures required by IFRS 7 and 13 in addition to the disclosures requirements for Investments Entities.
  • The ‘interests in subsidiaries’ disclosures in IFRS 12 should only apply to consolidated investments of investment entities, except for paragraphs 14 and 16, which should still apply to an investment entity.
  • Investment entities with joint ventures and associates accounted for using the fair value method do not need to apply paragraphs 21(b), 21(c), 22(b) and 22(c) of IFRS 12.
  • Paragraph B20 should be deleted as it was not necessary to state that disclosures need not be duplicated.

The IASB also tentatively agreed with the staff’s recommendation that an investment entity should be required to disclose that it is an investment entity and as such has not consolidated controlled investees, and how it has met the definition and characteristics to be an investment entity, with specific reasons given if it has not met one or more characteristics.

Transition guidance

The ED proposed prospective application of the exception from consolidation requirements and provided transition guidance for when a reporting entity applies the proposals for the first time.

Developing transition guidance based on retrospective application

The IASB tentatively agreed with the staff’s recommendation to develop transition guidance based on a retrospective approach, consistent with the approach used in the existing IFRS 10 transition guidance.  This represents a change from the ED.

The IASB tentatively agreed with the staff’s recommendations to:

  • Require retrospective application for all investees, subject to the existing impracticability exception.
  • Require, for the purposes of transition, the assessment of investment entity status only at the date of initial application of the investment entity requirements.
  • Allow investment entities to retain the previous accounting for investees disposed of in the comparative period(s).
  • Allow the use of fair value that is consistent with fair value as defined by IFRS prior to the effective date of IFRS 13.
  • Limit the requirement to present adjusted comparatives to the annual period immediately preceding the date of application of these investment entity requirements, with any unadjusted comparatives being clearly identified.

The IASB tentatively agreed with the staff’s recommendation to draft transition guidance for amendments to IAS 28 Interests in Associates and Joint Ventures and IAS 27 Separate Financial Statements that is consistent with the decisions made for the transition guidance for IFRS 10.

The IASB tentatively agreed with the staff’s recommendations:

  • To require retrospective application for all investees, subject to an impracticability exception and IFRS 13 exception.
  • To require the assessment of investment entity status at the date of transition to IFRS.
  • To allow first-time adopters to apply the consolidation exception in IFRS 10 early, together with the other requirements of IFRSs 10-12.

The IASB tentatively decided that this transition guidance was temporary and would not be necessary for those first time adopters who would have sufficient time to adopt the ED.  The IASB also tentatively decided that an entity would also need to adopt IFRS 10, 11, 12 and IAS 27 and 28 as a package.

Effective date

The IASB tentatively decided that 1 January 2014 would be the effective date for the final amendment with early adoption permitted.  The IASB noted that it wanted to emphasise in the Basis for Conclusions  that a 1 January 2014 effective date would result in a gap between the final amendment and IFRS 10 which is effective for annual periods beginning on or after 1 January 2013.  However, as the final amendment’s requirements will not be finalised till Q2 2012, the IASB felt that sufficient lead time should be provided but noted that early adoption could minimise this gap and improve comparability.  The staff noted that they did not expect investment entities to have difficulty in adopting the amendment as they would typically already have the required fair value information.

Due process considerations

The IASB tentatively agreed that it had performed all the mandatory due process steps (e.g., publishing an exposure draft, reviewing comments made within a reasonable time, and consulting with the Advisory Council) and that it had performed sufficient additional due process steps (e.g., outreach activities, public round tables). The IASB tentatively decided that none of the amendments require re-exposure.

Next steps

The IASB tentatively decided to proceed to ballot the investment entity requirements.  No Board members plan to dissent from the investment entity requirements.

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