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 meeting was to present the staff analysis on how an investor would apply the IASB’s preferred approach from the purchase of an additional interest in the associate until the equity method is discontinued, and ask the IASB to decide on how an investor measures the portion of the carrying amount of an investment in an associate to be derecognised in a partial disposal

The staff also asked the IASB to decide on two application questions on the recognition of an investor’s share of the associate’s losses.

Applying the preferred approach after the purchase of an additional interest in an associate (Agenda Paper 13A)

The purpose of this paper was to ask the IASB how an investor would apply the ‘preferred approach’ after the purchase of an additional interest in an associate while retaining significant influence.

The purpose of the analysis in the paper was to explain the staff’s recommendation on how an investor would measure the portion of the carrying amount of the investment in the associate to be derecognised on a partial disposal, that is the disposal of an interest in an associate while retaining significant influence.

The project’s scope does not include application questions on how an investor measures its share of the associates profit or loss, or the level at which the investor assesses impairment of an associate, accordingly the paper did not include recommendations on these topics.

The IASB’s preferred approach

At its April 2022 meeting, the IASB discussed the application question of how an investor applies the equity method when purchasing an additional interest in an associate while retaining significant influence.

The IASB discussed possible approaches to the application question and expressed a preference for an approach (the preferred approach) whereby after obtaining significant influence, an investor measures purchases of an additional interests in an associate as an accumulation of purchases. Applying the preferred approach, the investor:

• Recognises, at the date of purchasing an additional interest, its additional share in the fair value of the associate’s net assets
• Measures the cost of that additional interest at the fair value of the consideration transferred
• Recognises the difference as a goodwill or bargain purchase gain

Two views of the investment in an associate

The paper considered two views of the investment in an associate:

• View A was that the investor is measuring a single investment in the associate. The cost of the investment is measured as an accumulation of purchases after obtaining significant influence. Any portion of the investment is measured as a proportion of the total investment in the associate
• View B was that the investor is measuring the layers of the investment in the associate. The investor applies the equity method of accounting to each layer therefore the monetary amounts for each layer are different and not proportionate to the total investment in the associate. After initial recognition on obtaining significant influence and for each additional purchase of an interest in an associate, the investor measures the individual layers separately while presenting them as a single amount in the statement of financial position.

View A and View B have the same measurement on initial recognition, that is on obtaining significant influence and for additional purchases of an interest in an associate.

Staff recommendation

The staff recommended that the IASB should proceed with View A, i.e., that an investor is measuring a single investment in the associate.

If the IASB agrees that View A is preferable, the staff also recommended the IASB revisit the tentative decision it made in June 2022 and require an investor applying the preferred approach to measure the portion to be derecognised in a partial disposal as a proportion of the carrying amount of the investment at the date of the disposal.

IASB discussion

All IASB members agreed with the staff recommendation of View A, that an investor is measuring a single investment in the associate.

One IASB member highlighted that this could cause complexity where a Group owns an investment in an associate, but this investment is held by two subsidiaries within the group. The result of View A may be that the amounts recognised at the subsidiary level may be different to that recognised at a group level if there were a disposal by one of the subsidiaries. However, IASB members did not think this prevented the benefits outweighing the costs.

IASB decision

The IASB voted unanimously in favour of the staff recommendation, View A.

Application question—Purchase of additional interest in an associate and share of unrecognised losses (Agenda Paper 13B)

The purpose of this paper was to ask the IASB to address the application question of whether an investor that has reduced its interest in an associate to zero ‘catches up’ unrecognised losses if it purchases an additional interest in the associate.

Staff recommendation

The staff recommended that an investor that has reduced its interest in an associate to zero does not recognise the unrecognised losses from the cost of the additional interest in the associate.

Applying the recommendation does not mean that the unrecognised losses are ignored because an investor, applying IAS 28:39, will not recognise its share of profit (including the share of profit attributable to the additional interest) until the share of profit equals the previous share of unrecognised losses.

The staff however noted that the fact pattern described in the paper occurs when the associate’s losses have exceeded its net assets. A negative net asset position may be an indicator of financial difficulty, which IAS 28:41A lists as objective evidence of impairment. The investor may need to assess if the additional interest in the associate is impaired.

The staff considered the interaction between this recommendation and the analysis in Agenda Paper 13A on applying the IASB’s preferred approach. The staff thinks that the application question in this paper is a matter of initial recognition and initial measurement, while the analysis in Agenda Paper 13A focuses on how the investor applies the preferred approach after the date of purchase of an additional interest. As noted in that paper, the initial measurement of the investment is the same under both views.

IASB discussion

The majority of IASB members agreed with the staff recommendation, that an investor that has reduced its interest in an associate to zero does not recognise the unrecognised losses from the cost of the additional interest in the associate.

One IASB member did not agree and stated that this approach would be inconsistent with the decision made in Agenda Paper 13A. The IASB member noted that if on Day 1 it is determined that the investment, including an additional investment, is a single unit then it should be accounted for as such and the additional investment subsumed by the losses. They expressed that it could be confusing for users to account for an investment on Day 1 and have an immediate Day 2 impairment.

Some IASB members commented on the fact that sometimes facts and circumstances may indicate that the entity had a constructive obligation to fund the associate that should have been recognised. For instance, if an associate makes a loss for a period and immediately after the period end the entity makes an additional investment in the entity (for a new issue of shares) this may indicate that it is funding the associate. If this were the case, then the additional investment should offset the liability that would be required to be recognised at the period end. It was suggested that this could be explained in guidance or the Basis for Conclusions.

One IASB member noted that IAS 28:39 refers to an entity subsequently reporting profits which must equal the share of losses before profits can be recognised. Purchase of an additional investment is not a subsequent reporting of profit and therefore should not be netted down by losses.

It was noted by one IASB member that there could be an opportunity to remove complexity in IAS 28 by removing the requirement to take losses against other long-term investments which are already at their realisable value. It was agreed this would be considered further outside of the meeting.

The IASB Chair supported the analysis but noted a concern around a potential deferral in loss recognition where an entity purchases and recognises a new investment but were the entity to sell a share of that investment, it would not be able to realise the full value due to the unrecognised losses. However, some IASB members highlighted that the sale of the share would be a separate event which would trigger the loss and so any loss is not deferred but simply recognised on the occurrence of that event.

IASB decision

11 of 12 IASB members voted in favour of the staff recommendation.

Application question – Recognition of losses and components of comprehensive income (Agenda Paper 13C)

The purpose of this paper was to ask the IASB whether an investor that has reduced its interest in an investee to zero recognises each component of comprehensive income separately.

Staff recommendation

The staff recommended that:

• An investor recognises its share of comprehensive income until its interest in the associate is reduced to zero. Additional losses are provided for, and a liability is recognised, only to the extent that the investor has incurred a legal or constructive obligation or made payments on behalf of the associate
• An investor that has reduced its interest in an associate to zero recognises its share of each component of comprehensive income separately. That is an investor recognises and presents in accordance with IAS 1 two items of the same amount (one positive and one negative)
• In the circumstance of an investor’s share of comprehensive income in an associate being negative and exceeding the carrying amount of the investment, the investor recognises first its share of the associate’s profit and loss and second its share of the associate’s other comprehensive income (OCI) until its interest in the associate is reduced to zero

IASB discussion

Question 1

The IASB voted in favour of the staff recommendation, to clarify that IAS 28:38 relates to both profit or loss and OCI, without material comments.

Question 2

Two IASB members commented that they agreed with the recommendations but would want to see the impact of the positive and negative movements in OCI and P&L reflected in a movement in the investments note, rather than simply being offset.

Another IASB member highlighted that the information may be more useful where losses had not been reported before or for a long period versus the situation where there were substantial unrecognised losses from a long period. However, the IASB member indicated that there did not appear to be a benefit from creating complexity to cover these different scenarios and the staff recommendation reflected a simple solution following the principles of IAS 28.

Question 3

All IASB members supported the staff recommendation. Two IASB members raised additional application questions which could arise given the approach including how other changes in net assets are impacted by this hierarchy approach and whether there is also a hierarchy when recognising profits in the future. The staff agreed that they would consider these issues and present a summary of all decisions made at a future meeting to ensure no conflicts between decisions.

Two IASB members stated that there was not a robust conceptual argument for the position – as the Conceptual Framework does not have a decisive hierarchy – but that creating the rule presented by the staff was a simple and logical approach. One IASB member acknowledged that creation of a rule in this circumstance was open to challenge and so the rationale for the position should be made as robust as possible.

IASB decision

The IASB voted unanimously in favour of the staff recommendation for questions 1 and 3. For question 2, 11 of 12 IASB members voted in favour of the staff recommendation.