The IASB has issued Investment Entities: Applying the Consolidation Exception, an exposure draft of proposed amendments to IFRS 10 and IAS 28, with comments to be received by September 15, 2014. The exposure draft reflects issues that have arisen in applying the IASB’s important conclusion, effective since the beginning of 2014, that an investment entity doesn’t consolidate its subsidiaries or apply IFRS 3 when it obtains control of another entity; instead, such an entity measures an investment in a subsidiary at fair value through profit or loss in accordance with IFRS 9.
The investment entity exception is of course vitally important to that industry, and was crucial in allowing the Canadian Securities Administrators to conclude that investment entities could and should make the transition to reporting under IFRS, several years after most other publicly-accountable entities. The highly specific issues addressed in the exposure draft, flowing from questions originally put to the IFRS Interpretations Committee, will generally be of narrower interest, presumably affecting only a small number of investment entities.
Exemptions from consolidation
One of these issues really relates to non-investment entities, and to applying the broader exemption from presenting consolidated financial statements, provided by IFRS 10 for a parent entity meeting certain criteria. One of the criteria is that the entity’s “ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with IFRS.” It’s not necessarily clear whether an entity that’s not itself an investment entity can take advantage of the exemption when it has an investment entity parent that produces consolidated financial statements in which the entity itself and all its holdings are measured at fair value: that is, does the exemption depend on being able to demonstrate that consolidated financial statements have been prepared and made available somewhere in the structure.
The exposure draft proposes to clarify that the exemption is available in this situation. The IASB observed among other things: “when an investment entity measures its interest in a subsidiary at fair value, the disclosures required by IFRS 12 Disclosure of Interests in Other Entities are supplemented by those required in IFRS 7 Financial Instruments: Disclosures and IFRS 13 Fair Value Measurement. Accordingly, the IASB decided that this combination of information provides sufficient grounds to retain the existing exemption from presenting consolidated financial statements for subsidiaries of investment entities that are themselves parent entities. Removing the exemption so that any subsidiary of an investment entity that prepares IFRS financial statements would have to present consolidated financial statements in such circumstances could result in significant additional costs, without commensurate benefit.” The proposed changes to IAS 28 would correspondingly amend the criteria around the exemptions from preparing statements that apply the equity method of accounting.
Investment entity subsidiaries
The investment entity exception currently contains the caveat that an investment entity does consolidate a subsidiary that provides services relating to its investment activities (such as management support or advice), rather than measuring it at fair value; such a subsidiary by its nature doesn’t seem to be held to generate revenues from capital appreciation and/or investment income. Questions have arisen however about subsidiaries that provide such services while at the same time meeting the overall criteria to be measured at fair value. After all, it’s not possible to hold investments to generate revenues without getting support, advice and so on from somewhere, so such activities might be regarded, at least up to a point, as an inherent aspect of what’s covered by the investment entity exception.
The IASB now proposes to clarify the standard as follows: “If an investment entity has a subsidiary that is not itself an investment entity and whose main purpose is to support the investment entity’s investment activities by providing investment-related services or activities… it shall consolidate that subsidiary. (However)…if the subsidiary that provides the investment-related services or activities is itself an investment entity, the investment entity parent shall measure the subsidiary at fair value through profit or loss…” So if an investment entity has a subsidiary that, say, doesn’t hold any investments and that it operates as a separate source of income, for example by generating fees for various services, then such a subsidiary will fall outside the purpose of the exception, and will be consolidated.
The other proposed changes to IAS 28 address the equity-accounting requirement (applying to interests in associates and in joint ventures) to prepare financial statements using uniform accounting policies for like transactions and events in similar circumstances. The IASB proposes to clarify that notwithstanding this general rule, if an entity has an interest in an associate that’s an investment entity, then in applying the equity method it retains the fair value measurement applied by that associate to its interests in subsidiaries. On the other hand, if an entity is a joint venturer in a joint venture that’s an investment entity, then it doesn’t retain the fair value measurement applied by that investment entity joint venture to its interests in subsidiaries; instead, the entity makes adjustments to the joint venture’s accounting policies to conform to its own accounting policies, including consolidating all subsidiaries. The distinction reflects the IASB’s assessment of the differences between significant influence and joint control, including the possible different degrees of practical difficulty in obtaining the information necessary to unwind fair value information and apply the equity method, and the possible structuring opportunities that might exist when an entity has joint control over another.
The opinions expressed are solely those of the author