This series of blogs describes how SAP Financial Consolidation, Starter Kit for IFRS has been configured to meet International Financial Reporting Standards (IFRS).
In our previous blogs, we have covered the following topics:
- Brief overview of SAP Financial Consolidation starter kit for IFRS (blog #1)
- Presentation of consolidated financial statements according to IAS 1 and IAS 7
- Translation of a foreign entity’s financial statements as set out in IAS 21
- Consolidation, part 1: current consolidation process
- Consolidation, part 2: incoming entity
- Consolidation, part 3: joint ventures and associates
In this last blog, we will focus on changes in ownership interests in a subsidiary that can result in:
- losing control over this subsidiary
- an increase or a decrease in the parent’s share without any consequence on control
Loss of control
According to IFRS 10, the loss of control of a subsidiary results in recognizing a gain or loss in the statement of profit or loss. When the parent company loses control but retains an interest, it triggers recognition of gain or loss on the entire interest:
- a gain or loss is recognized on the portion that has been disposed of;
- a further gain is recognized on the interest retained, being the difference between the fair value of the interest and its book value.
Both are recognized in the statement of profit or loss.
For example, if a parent company sells 80% of its former wholly-owned subsidiary S, retaining a 20% interest, gain or loss will be calculated as if the 100% interest has been sold:
When a parent loses control of a subsidiary, the parent should account for all amounts recognized in other comprehensive income in relation to that subsidiary on the same basis as would be required if the parent has directly disposed of the related assets or liabilities. Therefore, if a gain or loss previously recognized in other comprehensive income would be reclassified to profit or loss on the disposal of the related assets or liabilities, the parent reclassifies the gain or loss from equity to profit or loss (as a reclassification adjustment) when it loses control of the subsidiary (IFRS 10. B99).
If the residual interest in the former subsidiary gives a significant influence or a joint control, the acquisition method is applied as if a new associate or joint venture has been acquired.
In SAP Financial Consolidation, loss of control can result:
- in an entity leaving the scope (when the parent company does not keep any interest or when the remaining interest is under the consolidation threshold)
- in a change in consolidation method (subsidiary becoming an associate or a joint venture accounted for using equity method).
In the consolidation scope, outgoing entities are identified as “outgoing at the opening” or “outgoing during the period” depending on whether data are entered or not for the period. Data entered, if any, must correspond to the period lasting from the beginning of the year to the date when control is lost so that income and expenses of the subsidiary are included in the financial statements until the date when the parent ceases to control the subsidiary (as required by IFRS 10).
All of the outgoing company’s data at the date of the disposal (which means opening data plus movements of the period if data have been entered) are automatically reversed on a dedicated flow (F98). As regards accumulated other comprehensive income that has to be recycled (fair value reserve, hedging reserve and foreign currency translation reserve), this flow is regarded as a reclassification adjustment in the statement of comprehensive income.
After gain or loss on disposal has been calculated, a manual journal entry has to be booked to adjust the gain or loss recognized in the parent’s separate financial statements.
Changes in the consolidation method
In SAP Financial consolidation, changes in consolidation method are handled as follows:
- Opening balances are reversed on the “old method” flow (F02)
- Opening balances are reloaded on the “new method” flow (F03) with the new consolidation method applying
As regards a change from full consolidation to equity method, it means that:
- the subsidiary’s assets and liabilities are reversed and “replaced” by the line “Investments accounted for using equity method”
- the equity accounts are reversed on the old method flow and reloaded on the new method flow taking into account the consolidation rate of the associate or joint venture; allocation between group and indirect non-controlling interests (if any) is made on this flow according to the new interest rate
Any goodwill existing at opening is not reloaded on the new method flow. Indeed, it is part of the assets sold and is, therefore, taken into account to calculate the profit on “disposal”. A new goodwill has to be calculated as part of the acquisition method process of the associate or joint venture and declared by a manual journal entry using the new method flow.
Accumulated other comprehensive income at opening is automatically reclassified to retained earnings on the new method flow like incoming entities. Reclassification adjustments displayed in the comprehensive income take into account the old method flow because change in consolidation method is handled as if the subsidiary was disposed of.
Manual journal entries are necessary to:
- adjust the gain or loss recognized in the parent’s separate financial statements on the interest sold
- recognize a gain or loss on the remeasurement at fair value of the interest retained
- remeasure net identifiable assets of the new associate / joint venture to fair value (as if it was an incoming entity)
- declare goodwill
Changes in a parent’s ownership interest in a subsidiary that do not result in the parent losing control of the subsidiary are equity transactions (IFRS 10.23). The carrying amounts of the controlling and non-controlling interests should be adjusted to reflect the changes intheir relative interests in the subsidiary. Any difference between the amount by which the non-controlling interests are adjusted and the fair value of the consideration paid or received is recognized directly in equity and attributed to the owners of the parent (IFRS 10. B96).
IFRS 10 does not give detailed guidance on how to measure the amount to be allocated to the parent and non-controlling interest to reflect a change in their relative interests in the subsidiary. Main issues regard goodwill and accumulated other comprehensive income.
In its Basis for conclusions (BCZ168), IFRS 10 states that no change in the carrying amounts of the subsidiary’s assets (including goodwill) should be recognized as a result of such transactions. But it does not specify whether the allocation of goodwill between parent and non-controlling interests should be modified.
In the Basis for conclusions of IFRS 3 (BC218), the Board explains that the adjustment to the carrying amount of non-controlling interests, that will be recognized when the acquirer purchases shares held by non-controlling interests, will be affected by the choice of measurement basis for non-controlling interests at acquisition date (fair value or proportionate share of net assets). It means that, when parent acquires non-controlling interests that have been initially measured at their fair value, goodwill is included in the carrying amount of non-controlling interests that is transferred to group equity.
With partial disposals, where the parent disposes part of its interest to non-controlling interest without losing control, the question remains whether part of the parent’s goodwill should be transferred to NCI or not. Interpretations published by professional bodies differ. Some consider that goodwill is part of the transfer whereas others think that no goodwill has to be allocated to NCI (which means that principles would apply differently whether the equity transaction is an increase or a decrease of the parent’s ownership interest).
Accumulated other comprehensive income
The question is: should accumulated other comprehensive income (for example: exchange differences on foreign subsidiaries) be part of the transfer between group and non-controlling interest in case of an equity transaction?
As regards partial disposals, IAS 21 requires that “the entity shall re-attribute the proportionate share of the cumulative amount of the exchange differences recognized in other comprehensive income to the non-controlling interests in that foreign operation” (§ 48.C). IAS 39 has been amended in the same manner regarding hedging reserves.
On the other hand, IFRS are silent when it comes to an increase in parent’s ownership interest. SFAS 160 Non-Controlling Interests in Consolidated Financial Statements, which is supposed to be the US GAAP equivalent of IFRS 10, is clearer: “A change in a parent’s ownership interest
might occur in a subsidiary that has accumulated other comprehensive income. If that is the case, the carrying amount of accumulated other comprehensive income shall be adjusted to reflect the change in the ownership interest in the subsidiary through a corresponding charge or credit to equity attributable to the parent (§ 34)”.
As a consequence, we assume that accumulated other comprehensive income has to be re-allocated between group and NCI according to their new respective shares, regardless of whether there is an increase or a decrease in the parent’s ownership interest.
In the starter kit
Configuration principles are the following:
- The amount to be transferred from group’s equity to NCI (or conversely) is calculated on the basis of the subsidiary’s opening equity after deduction of dividends paid on the period (but relating to prior benefits)
- Accumulated other comprehensive income (revaluation surplus, fair value reserve, hedging reserve and foreign currency translation reserve) is part of the transfer
- This transfer is recognized on flow F92 ‘Increase / decrease in interest rate’
- If need be, the amount of goodwill to be transferred from NCI to group (or conversely depending on the interpretation of IFRS 10), is declared by manual journal entry using flow F92.
This blog was the last one of the series. For more information about how IFRS (including standards that are not addressed in this series of blogs) have been taken into account in SAP Financial Consolidation, starter kit for IFRS, a comprehensive paper is now available here.