In our previous blogs, we have covered the following topics:
- Brief overview of SAP BusinessObjects Financial Consolidation, Starter Kit for IFRS (How Starter kits Meet IFRS requirements – Introduction)
- Presentation of consolidated financial statements according to How Starter Kits meet IFRS – IAS 1 and How Starter Kits meet IFRS – IAS 7
- Translation of a foreign entity’s financial statements as part of the consolidation process following the principles set out in How Starter Kits meet IFRS – IAS 21
- Current consolidation process (How starter kits meet IFRS – IAS 27 (part 1)), loss of control (How starter kits meet IFRS – IAS 27 (part 2)) and equity transactions (How starter kits meet IFRS – IAS 27 (part 3))
Now, we will focus on the accounting for investments in associates according to IAS 28.
An associate is an entity over which the investor has significant influence and is neither a subsidiary nor an interest in a joint venture. IAS 28 often refers to IAS 27 as regards consolidation procedures and to IFRS 3 for the first consolidation of an associate.
Applying equity method
According to IAS 28, an investment in an associate must be accounted for using the equity method.
The equity method consists in replacing the carrying amount of the shares held in the associate with the corresponding portion of the associate’s shareholders’ equity. In the statement of comprehensive income, the share of the net profit of entities accounted for using equity method and the share of their other comprehensive income must be disclosed on dedicated lines.
When an associate makes losses, the parent company’s share of these is recognized until its interest in the associate is reduced to zero. Afterwards, additional losses are provided for, and a liability is recognized, but only to the extent that the parent company has incurred legal or constructive obligations or made payments on behalf of the associate.
When an associate has subsidiaries, associates, or joint ventures, the profits or losses and net assets taken into account in applying the equity method are those recognized in the associate’s consolidated statements.
In the starter kit
Associates can fill in a standard package or a more simplified one. The simplified package differs from standard package on the following points:
- It only includes information needed to automatically apply the equity method.
- It enables associates that hold subsidiaries, joint ventures or associates to enter consolidated data.
The equity method is automatically applied during the consolidation process.
When parent’s interest in an associate has been reduced to zero, a manual journal entry is necessary to stop accounting for additional shares in the associate’s losses or to reclassify the negative amount automatically recognized in “investments in associates” to liabilities (if an engagement exists).
IAS 28 requires that profits and losses resulting from internal transactions between a parent (or one consolidated subsidiary) and an associate are recognized only to the extent of unrelated investors’ interests in the associate. It means in particular that the investor’s share in the associate’s profits and losses resulting from these transactions is eliminated.
IAS 28 does not give specific guidance as to how the elimination of such unrealized profits is carried out in practice. It also does not address the case where transactions exist between associates or between an associate and a joint venture.
In the starter kit
In the starter kit, dividends paid by an associate to a consolidated entity are eliminated from P&L and reclassified to equity (same principles as for a subsidiary or a joint-venture).
Internal provisions recognized in an associate’s individual statements towards a consolidated entity or in a consolidated entity’s ledgers towards an associate are eliminated in full.
For gain or loss on internal sale of assets, the elimination is not booked automatically when the buyer or the seller is consolidated using the equity method. As the accounting scheme is not clear under IAS 28, it is better to let starter kit users configure their own rules or book manual journal entries according to their interpretation of IAS 28.
Changes in investor’s ownership interest
Loss of significant influence
Principles described in IAS 27 for loss of control over a subsidiary apply when a parent loses significant influence over an associate.
Increase / decrease in interest rate
If a parent increases its interest in an associate without achieving control (which means that the acquiree remains an associate afterwards), IFRS do not specify how to deal with this operation in the consolidated financial statements. It does not meet the criteria of an equity transaction given that no NCI (non-controlling interests) are recognized in the balance sheet. It does not meet either the definition of a business combination as no control is achieved after the transaction.
Many questions arise: should the acquisition method be applied? Should it be applied on the additional stake only or with remeasurement of the previously held interest? In this last case, should the remeasurement be recognized in profit or loss or directly to equity?
As regards partial disposals, IFRS rules are clearer. IAS 28 states that “if an investor’s ownership interest in an associate is reduced, but the investment continues to be an associate, the investor should reclassify to profit and loss only a proportionate amount of the gain or loss previously recognized in other comprehensive income”.
It can be inferred that a gain or loss should be recognized in the income statement on a partial disposal of a joint-venture or an associate.
In the starter kit
The new interest rate and the new integration rate in the associate (which changes as a consequence) are taken into account with the impact of change posted on flow F04. Additional manual entries are left up to the user to, for example, enter a new goodwill or remeasure assets and liabilities acquired (in case of an increase) or to recognize a profit or loss on disposal (including reclassification adjustments of accumulated other comprehensive income) in case of a partial disposal.
What’s next ?
In the next blog, we will focus on joint-ventures (How starter kits meet IFRS – IAS 31).