Cover paper (Agenda Paper 13)

The objective of the Equity Method project is to assess whether application questions with the equity method, as set out in IAS 28, can be addressed in consolidated and individual financial statements by identifying and explaining principles in IAS 28.

The purpose of this session was to ask the IASB to:

• Conclude its discussions on the application question: “How does an investor apply the equity method when purchasing an additional interest in an associate while retaining significant influence?”
• Decide which alternative (Alternative 1 ‘No elimination’ with enhanced disclosure or Alternative 2 ‘Elimination’) to propose to answer the application question: “How should an investor recognise gains or losses that arise from the sale of a subsidiary to its associate, applying the requirements in IFRS 10 and IAS 28?”
• Decide how to answer the application question: “Does an investor recognise deferred tax assets or liabilities on the differences between the fair value and the tax base of its share of the associate’s identifiable assets and liabilities?”

Purchase of an additional interest in an associate while retaining significant influence (Agenda Paper 13A)

At its April 2022 meeting, the IASB started to discuss the application question: How does an investor apply the equity method when purchasing an additional interest in an associate while retaining significant influence?

This agenda paper set out the IASB discussions in developing the answer to this application question and asked the IASB if there are any further matters it wishes to discuss in relation to the application question.

Preferred approach

At its April 2022 meeting, the IASB discussed three approaches to answer the application question and asked the staff to continue exploring the following approach (referred to as the ‘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, any difference between the cost of the additional interest and its additional share in the net fair value of the associate’s identifiable assets and liabilities as goodwill or as a bargain purchase.

Alternative approach

The IASB also asked the staff to consider the implications of applying the following second approach (referred to as the ‘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 identifiable assets and liabilities at fair value and remeasures the cost of the investment at fair value at the date of purchasing an additional interest in an associate while retaining significant influence.

Previous IASB decisions

To develop the preferred approach, the IASB reached a tentative decision on how an investor measures the cost of an investment on obtaining significant influence, when the investor holds a previous interest in the associate. In addition to answering the application question, the IASB also reached tentative decisions on how an investor retaining significant influence would apply the preferred approach:

• When purchasing an additional interest in associate that is a bargain
• To other changes in the associate’s net assets that change the investor’s ownership interest
• When the investor purchases an additional interest after reducing the carrying amount of its interest to nil
• When disposing of an interest in associate while retaining significant influence

Staff recommendation

The staff recommended that the IASB proposes to answer the application question as follows:

“An investor purchasing an additional interest in an associate, while retaining significant influence, recognises any difference between the cost of the additional interest and its additional share in the net fair value of the associate’s identifiable assets and liabilities as goodwill or as a bargain purchase.”

IASB discussion

Several IASB members stated that they like the preferred approach. One IASB member mentioned that the preferred approach faithfully represents the performance and was consistent with the underlying principle of the equity method. He also mentioned that the alternative approach requires the investor to measure the previous interest each time it acquires an additional interest and accordingly recognise a gain/ loss which is not consistent with the other standards or the overall framework.

IASB decision

All IASB members voted in favour of the staff recommendation.

Perceived conflict between IFRS 10 and IAS 28 (Agenda Paper 13B)

At its September 2022 meeting, the IASB started to discuss application questions related to ‘Transactions between an investor and its associate’, in particular it discussed four alternatives to answering the application question: How should an investor recognise gains or losses that arise from the sale of a subsidiary to its associate, applying the requirements in IFRS 10 and IAS 28?

At its January 2023 meeting, the IASB continued discussing the following four alternatives:

• Alternative 1—‘No elimination’—apply IFRS 10 to all contributions and sales
• Alternative 2—‘Elimination’—apply IFRS 10 and then IAS 28 to all contributions and sales
• Alternative 3—‘Mixture’—apply IFRS 10 depending on whether contributions and sales are an output of ordinary activities or not
• Alternative 4—‘Reviving 2014 amendment’—apply IFRS 10 for contributions and sales of businesses, and IAS 28 for sales of assets

In particular, the IASB discussed further considerations of applying the four alternatives, and feedback from the accounting firms, Accounting Standards Advisory Forum (ASAF) and Global Preparers Forum (GPF).

At that meeting, the IASB asked the staff to:

• Continue exploring two of the four alternatives discussed at its September 2022 meeting to answering the application question
• Undertake outreach with users of financial statements
• Prepare a decision-making paper

The purpose of this session was to ask the IASB to consider the staff analysis of Alternative 1 and Alternative 2, and decide which of the alternatives to propose to answer the application question.

Staff recommendation

The staff recommended that the IASB propose amendments to:

• IAS 28 to require an investor to recognise the full gain or loss on all transactions with its associate (Alternative 1)
• IAS 24 to require an investor to disclose the gain or loss from transactions with its associate (in addition to the amount of the transactions)

IASB discussion

Several IASB members supported Alternative 1 with a caveat that they would need to understand what the enhanced disclosures would require.

One IASB member stated that it must be ensured that the disclosure requirements are not such that they undo the benefits of applying Alternative 1. It must also be considered that access to an associate’s information is limited when drafting these requirements. Many IASB members agreed with this and mentioned that a cost-benefit analysis will be necessary when drafting the disclosure requirements. Many IASB members agreed that Alternative 1 was more cost effective than Alternative 2 and that Alternative 1 would result in cost savings, at least in the long run.

One IASB member mentioned that he can understand why elimination would make sense for certain companies but it was a narrow pattern and thus he agreed with the staff recommendation. He also mentioned that it was good that the focus of the assessment was only on associates for now.

Another IASB member who supported Alternative 1 said it was in line with the history of IAS 28 which removed proportionate consolidation and that Alternative 1 can be conceptually justified. Another IASB member supported Alternative 1 for its overall relative simplicity in application for companies over the longer term and in what information it provides for the investors.

One IASB member mentioned that he was hesitant to agree with Alternative 1 without the disclosures due to the negative effect on the earnings quality. He mentioned that if Alternative 1 is used, it would be good to see if there was any way to break out the single line in the financial statements to give better clarity, even if that is in the notes. Another IASB member pointed out that IFRS 12 already requires financial information on material associates. However, it was also pointed out by another IASB member that the post-implementation review of IFRS 10 and IFRS 12 indicated that this information was only provided for material associates and the actual output in the financial statements was not always in line with what the investors wanted.

One IASB member mentioned that they agree with Alternative 1 but a way to think further might be to use IFRS 12 as a starting point for disclosures rather than IAS 24. This is because IFRS 12 already had the right structure and split of materiality.

Another IASB member supported Alternative 1 stating that it would help reduce diversity in practice.

One IASB member pointed out that the Capital Markets Advisory Committee’s concern was understanding if these transactions are at arm’s length. In that case, it might be useful to provide gain/loss information at least for downstream transactions.

The Chair also pointed out that it would be good to consider if there was any room for improved presentation and not just disclosures. Currently, relevant information as required by IAS 28, IFRS 12, IAS 24 and others might be too scattered.

11 of the 13 IASB members directionally voted in favour of the staff recommendation, subject to the disclosure requirements.

Perceived conflict between IFRS 10 and IAS 28–feedback summary on the outreach activities undertaken with users (Agenda Paper 13C)

The purpose of this paper was to summarise feedback from the outreach with users on:

• Whether restricting gains or losses on transactions between an investor and its associate affect the quality of earnings reported when applying the equity method of accounting, and if so, how it affects users’ decision-making, and whether it would be useful if an investor disclosed the gains or losses on transactions between itself and its associate
• Which of the alternatives provides users with the most useful information

IASB discussion

This paper was not discussed separately but covered along with Agenda Paper 13B.

Initial recognition of an investment in an associate–deferred taxes (Agenda Paper 13D)

The purpose of this session was to discuss the application question: Does an investor recognises deferred tax assets or liabilities on the differences between the fair value and the tax base of its share of the associate’s identifiable assets and liabilities?

The equity method is applied from the date on which an investment becomes an associate or a joint venture. On obtaining significant influence, an investor applies paragraph 32 of IAS 28 and recognises its share of the net fair value of the investee’s identifiable assets and liabilities. This may require the investor to adjust the carrying amounts of investee’s assets and liabilities–for the purpose of this paper these adjustments are referred to as fair value asdjustments.

The application question is asking if the investor should recognise deferred tax assets or liabilities on the fair value adjustments. For example: an investor purchases a 25% interest in an entity and obtains significant influence. The investor determines that the fair value of an item of equipment is 400CU. The tax basis and the carrying amount in the investee’s financial statements is 300CU. Does the investor recognise a deferred tax liability relating to its share of the fair value adjustment of 100CU?

Staff recommendation

The staff recommended the IASB proposes the following answer to the application question:

“An investor recognises deferred tax assets or liabilities on the differences between the fair value and the tax base of its share of the associate’s identifiable assets and liabilities.”

IASB discussion

This paper was not discussed in this meeting.