The IASB has issued Sale or Contribution of Asset between an Investor and its Associate or Joint Venture, amendments to IFRS 10 and IAS 28, driven by questions about the appropriate accounting by an investor for a business it contributes to an equity-accounted investee. The guidance in IFRS 10 suggests that when it loses control of the business, the investor recognizes a gain or loss based on the difference between the consideration received (including measuring any retained interest in the contributed business at its fair value) and the assets and liabilities derecognized. On the other hand, prior to these amendments, IAS 28 says that an entity recognizes gains and losses resulting from “downstream” transactions with its associate or joint venture “only to the extent of unrelated investors’ interests in the associate or joint venture.” The amendments resolve the apparent inconsistency by concluding that a full gain or loss should be recognized on losing control of a business. They clarify that the above requirements in IAS 28, for only partially recognizing a gain or loss for transactions between an investor and its associate or joint venture, apply only to the gain or loss resulting from the sale or contribution of assets that don’t constitute a business.
The IASB has also amended IFRS 10, for consistency, to clarify that an entity recognizes a partial gain or loss for the loss of control in such circumstances of a subsidiary that doesn’t constitute a business. The amendments apply prospectively to the sale or contribution of assets occurring in annual periods beginning on or after January 1, 2016, with earlier application permitted.
Of course, not many entities are in a position to be regularly contributing businesses into associates or joint ventures (and investors wouldn’t likely place much weight anyway on the gain or loss reported from such transactions, given its lack of predictive value), so the amendments are of narrow applicability and significance by any measure. I would be straining to think of anything else to say about them, if not that they attracted a couple of dissents from members of the IASB, which are always interesting as an illustration of the grey zones that surround even seemingly mundane decisions. The first dissent is based on the view that whether or not the assets contributed to the investee constitute a business (which of course often involves significant judgment) shouldn’t affect the calculation of the gain or loss. The member summarizes his view through the following interesting illustration:
- An investor sells a business to a 40 per cent-owned associate accounted for using the equity method. The full gain is CU100. This gain of CU100 is reflected in the associate’s financial statements through the higher value of the net asset acquired. Over time, assuming that no goodwill or indefinite lived intangible assets are involved, the associate’s future profits or losses will be lower by CU100 as the assets are consumed and, therefore, the investor’s share of the associate’s profits or losses will be lower by CU40. Consequently, the net gain of the investor over time is CU60, not CU100.
- Accordingly, he believes that a more faithful representation of the transaction would be to recognize an immediate gain of CU60 and a deferred gain of CU40, which would be amortized into income, making it consistent with the consumption of the sold assets in the investee’s operations. He believes that it would be inappropriate to immediately recognize the full gain knowing that over time there would be lower profits to the extent of the equity interest in the investee.
It’s not too surprising though that the majority of the board resisted adding such additional bells and whistles to the inherently arbitrary contraption of equity accounting. The second dissenting view, held by two members, involves a narrower concern. They note that after the amendments, the gain or loss to be recognized by the investor will be the same whether a business contributed to the investee constitutes a separate entity or a set of assets. However, for a contribution that doesn’t constitute a business, the gain or loss will differ in the two cases: it’s recognized in full where the investor contributes assets to the investee, but only partially where those assets are contributed within a subsidiary. Where the investor retains an interest in the entity, constituting a financial instrument to be measured at fair value, the calculation of the gain or loss will differ further. Even after the amendments then, the way in which the transaction is structured might affect the accounting for it, which these two members see as a sufficient reason to dissent.
One has to admire the rigour of these latter dissenters I think, and one almost hopes that some future scandal will justify their fastidiousness. But on the other hand, if anyone can figure out a way to give themselves a meaningful advantage in life by exploiting the “structuring opportunities” in this obscure area, they probably deserve all the rewards they can get…
The opinions expressed are solely those of the author