Equity method

Date recorded:

Cover paper (Agenda Paper 13)

The IASB has been discussing, as part of its equity method research project, the application question: How does an investor apply the equity method when purchasing an additional interest in an associate while retaining significant influence?

The IASB selected a preferred approach to the application question and asked the staff to develop further analysis applying its preferred approach. The IASB is also considering the implications for an alternative approach.

  • Preferred approach: After obtaining significant influence, an investor measures its additional interests in an associate as an accumulation of purchases. An investor recognises, at the date of purchasing an additional interest, its additional share in the fair value of the associate’s net assets and measures that additional interest at the fair value of the consideration transferred.
  • Alternative approach: After obtaining significant influence, an investor measures its investment in the associate as a single asset. An investor measures its aggregated share of the associate’s net assets at fair value and remeasures the cost of the investment at fair value at the date of acquiring an additional interest in an associate while retaining significant influence.

The purpose of this meeting was to:

  • Continue discussions from the June 2022 meeting on the disposal of an interest in an associate while retaining significant influence
  • Continue discussion on other changes in an associate’s net assets
  • Introduce the application question on transactions between an investor and its associate

At the October 2022 IASB meeting, the staff plan to ask if the IASB agrees to continue with the equity method research project, based on the project’s progress to date.

If the IASB agrees to continue with the equity method research project, the staff plan to:

  • Continue discussing application questions on the inconsistency between the requirements in IFRS 10 and those in IAS 28, and to refine its analysis and develop recommendations for decision-making at a future meeting
  • Ask the IASB to decide on the preferred or the alternative approach to applying the equity method for changes in an investor’s ownership interest in an associate while retaining significant influence
  • Present the staff analysis on other application questions within the scope of the project
  • Ask the IASB whether to extend the scope of the project to other application questions that the IASB received

There was no discussion of this paper.

Partial disposals—how to measure the portion to be derecognised  (Agenda Paper 13A)

The purpose of this paper was to discuss possible practical methods of measuring the portion of the carrying amount of an investment in associate to be derecognised to decide if the IASB should amend its tentative decision at the June 2022 meeting.

Staff recommendation

The staff recommended the IASB:

  • Retains its tentative decision from the June 2022 meeting—an investor applying the preferred approach to a partial disposal, while retaining significant influence, would measure the portion of the carrying amount of an investment in an associate to be derecognised using
    • A specific identification method, if the investor can identify the specific portion of the investment being disposed of and its cost
    • The last-in, first-out (LIFO) method, if the specific portion of the investment being disposed of cannot be identified
  • If the IASB decides to proceed to standard-setting, it considers a relief to allow the weighted average method to be used as a practical expedient on transition for an investment in an associate held at the transition date

IASB discussion

A few IASB members agreed with the conclusions drawn out in the paper and favoured the preferred approach along with a transition relief by applying the weighted average method.

However, some IASB members did not support the recommendations put forward in the paper. They said that these investments are typically viewed as a single pool of shares and the preferred approach considers them to be separate layers. One IASB member said the recommendations may be giving an option to choose which layer they sell and that could allow room for manipulation.

One IASB member pointed out that he did not support the accounting policy choice on this matter. He also asked if the weighted average method would be an option and that companies could change to weighted average if they were using other methods previously.

Some IASB members said it was important that there is a consistent approach for acquisitions and disposals of these investments and that must be factored in when deciding the way forward.

The Chair also pointed out that the IASB need to give due consideration to how subsequent measurement, specifically impairment, would be performed and whether that would consider the investment as a single unit of account or as different layers. He mentioned that it was important that there is consistency between subsequent measurement and derecognition.

A few IASB members also pointed out that the weighted average method, if implemented, should not be called a transition relief because it might not only be applicable on the date of transition but probably also when the relevant transactions take place in the future after the transition date.

Some IASB members acknowledged that it is important to understand how the stakeholders, users and preparers of the financial statements would view these investments and whether they think of this as one unit or account or as different layers within one investment. Also, it would be good to understand from the stakeholders on whether they think the recommendations are practical and achievable for all types of entities.

Changes in an associate’s net assets that change the investor’s ownership interest (Agenda Paper 13B)

At its April 2022 meeting, the IASB asked the staff to develop the analysis of its preferred approach. Based on the IASB’s tentative decisions to date, the preferred approach would require an investor:

  • To purchase an additional interest in an associate while retaining significant influence, to: (i) recognise the additional share in the fair value of the associate’s net assets at the purchase date; (ii) measure the cost of the additional interest at the fair value of the consideration transferred; (iii) recognise any difference between (i) and (ii) as goodwill or a bargain purchase gain in profit or loss
  • To make a partial disposal while retaining significant influence, to: (i) recognise the fair value of the consideration received; (ii) derecognise a portion of the carrying amount of its investment in the associate; (iii) recognise the difference between (i) and (ii) as a disposal gain or loss; and (iv) reclassify a proportion of amounts recognised in other comprehensive income to profit or loss (paragraph 25 of IAS 28)

The purpose of this paper was for the staff to illustrate how an investor could apply the preferred approach to changes in the associate’s net assets that change an investor’s ownership interest while retaining significant influence.

Staff recommendation

The staff recommended the IASB proposes that when there is a change in an associate’s net assets from the issue of equity instruments:

  • If an investor’s ownership interest increases and the investor retains significant influence, an investor applying the preferred approach recognises the increase as a purchase of an additional interest
  • If an investor’s ownership interest decreases and the investor retains significant influence, an investor applying the preferred approach recognises the decrease as a partial disposal

IASB discussion

Most IASB members agreed with the staff recommendations and that it was a logical solution to the questions raised and that these are economic events that change the entity’s investments and should go through the profit or loss statement.

One IASB member mentioned that it must be cautiously assessed if the dilution of interest is economically the same as a partial disposal because there is no consideration received, and hence if the impact should go through profit or loss. Another IASB member agreed and said that it must be considered whether this meets the definition of income and expense under the Conceptual Framework.

One IASB member suggested that in case the change is a passive event i.e. it does not change the ownership type, that the change is not measured and is explained through a disclosure.

IASB decision

10 of the 11 IASB members voted in favour of the staff recommendation.

Transactions between an investor and its associate–an acknowledged inconsistency between the requirements of IFRS 10 Consolidated Financial Statements and IAS 28 Investments in Associates and Joint Ventures (Agenda Paper 13C)

This paper introduced, as part of the equity method project, application questions related to transactions between an investor and its associate. The following application questions are in the scope of the project and relate to transactions between an investor and its associate:

  • How should an investor account for gains and losses that arise from the sale of a subsidiary to its associate, applying the requirements of IFRS 10 and IAS 28
  • In a downstream transaction, whether an investor recognises its share of a gain that exceeds the carrying amount of its investment in the associate
  • In an upstream transaction, whether an investor eliminates its share of gain or loss from the carrying amount of the investment in the associate or the acquired asset
  • Whether the provision of service and transactions, that are not transfer of assets, are subject to the requirements for upstream or downstream transactions

The staff presented 4 alternatives in their agenda paper:

  • Alternative 1—account for all contributions and sales applying IFRS 10
  • Alternative 2—apply IFRS 10 requirements and then overlay with IAS 28 requirements (overlay approach)
  • Alternative 3—apply IFRS 10 to contributions and sales of businesses and of assets depending on whether they are ordinary activities (mixture)
  • Alternative 4—account for all contributions and sales of businesses applying IFRS 10 and account for all other contributions and sales applying IAS 28 (Reviving 2014 Amendment)

The objective of this paper was to introduce how the equity method might be applied to the application question, which relates to an acknowledged inconsistency between the requirements in IFRS 10 and those in IAS 28. The IASB was not asked to make decisions at this meeting. The staff will use the feedback from this IASB meeting to refine the analysis and develop recommendations for decision-making at a future meeting.

IASB discussion

Many IASB members indicated their preference towards Alternative 2. One IASB member mentioned they preferred this alternative as it does not amend the existing IFRS 10 and IAS 28.

Two IASB members noted their concerns around Alternative 3 and Alternative 4 being complex by introducing additional aspects. Another IASB member mentioned that he did not prefer these alternatives as they created differences in how an asset is formed.

A few IASB members supported Alternative 1 and Alternative 4 as well. One IASB member asked for some time to be spent with users who have similar arrangements and transactions to understand how these would work. Another IASB member said they did not prefer Alternative 1 as it required amendments to IAS 28 and the project was not to change the existing principles.

A few IASB members mentioned that the distinction between a reporting entity and a group was not clear.

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