INVESTMENT IN ASSOCIATES
IFRS: An associate is an entity over which the investor has significant influence – that is, the power to participate in, but not control, an associate’s financial and operating policies. Participation by an investor in the entity’s financial and operating policies via representation on the entity’s board demonstrates significant influence. A 20% or more interest by an investor in an entity’s voting rights leads to a presumption of significant influence.
US GAAP: Similar to IFRS, although the term ‘equity investment’ rather than ‘associate’ is used. US GAAP does not include unincorporated entities, although these would generally be accounted for in a similar way.
IFRS: An investor accounts for an investment in an associate using the equity method. The investor presents its share of the associate’s post-tax profits and losses in the income statement. The investor recognizes in equity its share of changes in the associate’s equity that have not been recognized in the associate’s profit or loss.
The investor, on acquisition of the investment, accounts for the difference between the cost of the acquisition and investor’s share of fair value of the net identifiable assets as goodwill. The goodwill is included in the carrying amount of the investment. The investor’s investment in the associate is stated at cost, plus its share of post-acquisition profits or losses, plus its share of post-acquisition movements in reserves, less dividends received.
Losses that reduce the investment to below zero are applied against any long-term interests that, in substance, form part of the investor’s net investment in the associate – for example, preference shares and long-term receivables and loans. Losses recognized in excess of the investor’s investment in ordinary shares are applied to the other components in reverse order of priority in a winding up. Further losses are provided for as a liability only to the extent that the investor has incurred legal or constructive obligations to make payments on behalf of the associate.
Disclosure of information is required about the revenues, profits or losses, assets and liabilities of associates. Investments in associates held by venture capital organizations, mutual funds, unit trusts and similar entities including investment-linked insurance funds can be carried at fair value through profit or loss.
US GAAP: Similar to IFRS if the equity method is applied. In addition, an entity can elect to adopt the fair value option for any of its equity method investments. If elected, equity method investments are presented at fair value at each reporting period, with changes in fair value being reflected in the income statement.
IFRS: An investor’s financial statements are prepared using uniform accounting policies for like transactions and events; adjustments are made to the associate’s policies to conform to that of the investor.
US GAAP: The investor’s financial statements do not have to be adjusted if the associate follows an acceptable alternative US GAAP treatment, although it would be acceptable to do so.
IFRS: If the investor has objective evidence of one of the indicators of impairment set out in IAS 39.59 for example, significant financial difficulty impairment is tested as prescribed under IAS 36, Impairment of Assets. The entire carrying amount of the investment is tested by comparing its recoverable amount (higher of value in use and fair value less costs to sell) with its carrying amount. In the estimation of future cash flows for value in use, the investor may use either: its share of future net cash flows expected to be generated by the investment (including the cash flows from its operations) together with the proceeds on ultimate disposal of the investment; or the cash flows expected to arise from dividends to be received from the associate together with the proceeds on ultimate disposal of the investment.
US GAAP: The impairment test under US GAAP is different to IFRS. Equity investments are considered impaired if the decline in value is considered to be other than temporary. As such, it is possible for the fair value of the equity method investment to be below its carrying amount, as long as that decline is temporary. If an other-than-temporary impairment is determined to exist, the investment is written down to fair value.
Investments in Joint Ventures
IFRS: A joint venture is defined as a contractual agreement whereby two or more parties undertake an economic activity that is subject to joint control. Joint control is the contractually agreed sharing of control of an economic activity. Unanimous consent of the parties sharing control is required.
US GAAP: A corporate joint venture is defined as a corporation owned and operated by a small group of businesses as a separate and specific business or project for the mutual benefit of the members of the group.
Types of Joint Venture
IFRS: Distinguishes between three types of joint venture:
- jointly controlled entities – the arrangement is carried on through a separate entity (company or partnership);
- jointly controlled operations – each venturer uses its own assets for a specific project;
- jointly controlled assets – a project carried on with assets that are jointly owned.
US GAAP: Only refers to jointly controlled entities, where the arrangement is carried on through a separate corporate entity.
Jointly Controlled Entities
IFRS: Either the proportionate consolidation method or the equity method is allowed. Proportionate consolidation requires the venturer’s share of the assets, liabilities, income and expenses to be either combined on a line-by-line basis with similar items in the venturer’s financial statements, or reported as separate line items in the venturer’s financial statements.
US GAAP: Prior to determining the accounting model, an entity first assesses whether the joint venture is a VIE. If the joint venture is a VIE, the accounting model discussed in the above section, “Special purpose entities”, is applied. If the joint venture is not a VIE, venturers apply the equity method to recognize the investment in a jointly controlled entity. Proportionate consolidation is generally not permitted except for unincorporated entities operating in certain industries.
Contributions to a Jointly Controlled Entity
IFRS: A venturer that contributes non-monetary assets, such as shares or non-current assets, to a jointly controlled entity in exchange for an equity interest in the jointly controlled entity recognises in its consolidated income statement the portion of the gain or loss attributable to the equity interests of the other venturers, except when:
- the significant risks and rewards of the contributed assets have not been transferred to the jointly controlled entity;
- the gain or loss on the assets contributed cannot be measured reliably; or
- the contribution transaction lacks commercial substance.
US GAAP: As a general rule, an investor (venturer) records its contributions to a joint venture at cost (i.e.: the amount of cash contributed and the book value of other non-monetary assets contributed). Sometimes, appreciated non-cash assets are contributed to a newly formed joint venture in exchange for an equity interest when others have invested cash or other ‘hard assets’. It is sometimes argued that the investor contributing appreciated non-cash assets has effectively realized part of the appreciation as a result of its interest in the venture to which others have contributed cash and that immediate recognition of a gain would be appropriate. Practice and existing literature vary in this area. As a result, the specific facts and circumstances affect gain recognition and require careful analysis.
Jointly Controlled Operations
IFRS: Requirements are similar to jointly controlled entities without an incorporated structure. A venturer recognises in its financial statements:
- the assets that it controls;
- the liabilities it incurs;
- the expenses it incurs;
- its share of income from the sale of goods or services by the joint venture.
US GAAP: Equity accounting is appropriate for investments in unincorporated joint ventures. The investor’s pro-rata share of assets, liabilities, revenues and expenses are included in their financial statements in specific cases where the investor owns an undivided interest in each asset of a non-corporate joint venture.
Jointly Controlled Assets
IFRS: A venturer accounts for its share of the jointly controlled assets, liabilities, income and expenses, and any liabilities and expenses it has incurred.
US GAAP: Not specified. However, proportionate consolidation is used in certain industries to recognize investments in jointly controlled assets.(REFERENCES: IFRS: IAS 1, IAS 28, IAS 31, SIC-13, IAS 36, IAS 39. US GAAP: APB 18, FAS 153, FIN 35).