The IASB recently issued the exposure draft Equity Method of Accounting—IAS 28 Investments in Associates and Joint Ventures.

This flows from a decision to not to undertake a fundamental review of the equity method. As set out in the basis for conclusions: “The IASB noted that the equity method is well established and fundamental changes would require significant stakeholder support. The IASB decided instead to focus on developing answers to application questions. This approach would, in a shorter time, provide preparers with solutions to long-standing application difficulties, reduce diversity in practice and lead to more comparable and understandable information for users.”

Well, maybe, but nothing will convince me that the time spent tinkering with this arbitrary and outdated methodology is superior to junking it in favour of a fair value measurement basis. It’s almost an annual tradition on this blog to write a post on that subject (for example this one or this one) and maybe I’ll take this chance to engage in some nostalgia by citing the second edition of Skinner and Milburn’s Accounting Standards In Evolution, which was a major reference point when I started out in pre-IFRS Canadian accounting. It summed up the issue this way:

• “Authoritative accounting literature has been largely silent on the conceptual basis for equity accounting. A few accountants have challenged its conceptual validity…The basis for this challenge is that accrual (of the equity interest) does not meet the concept of an “asset”…If an investor does not control the investee, it does not have the power to have assets equal to its share of the investee’s earnings remitted to it, or alternatively, to direct their use in the investee enterprise. Thus, the theoretical credentials for equity accounting on the basis of significant influence are open to question.”

They go on to say that “some accountants defend the equity basis of accounting simply as a valuation, arguing that it results in a better measure of the value of the investment than does cost” But then they were writing in 2001, before fair value accounting for financial instruments reached its later stage of evolution. It’s amazing that the methodology is still in place over twenty years later, still attracting much the same kind of criticism. This is from a recent entry on Peter Clark’s Accounting Miscellany blog:

• The equity method was invented many decades ago. At the time, it was almost universal to measure all unconsolidated equity investments on a cost basis. The equity method is one way to provide more information about the progress of some investments than a cost basis provides.
• Nowadays, IFRS Accounting Standards require companies to measure equity investments (other than investments in subsidiaries or associates) at fair value. If that requirement had already been in place many years ago, perhaps no-one would ever have felt a need to invent associates as a separate category, and to invent the equity method for that category.
• …Currently, the presence of significant influence identifies an associate and triggers the use of the equity method. I can see no reason why the presence of significant influence should change the measurement method from the method used for (almost) all other investments (fair value) to the equity method.
• So, I would eliminate the equity method for associates. Associates should be measured in the same way as all other equity investments. Making this change would:

• eliminate the need to have separate requirements covering associates.
• remove the need to define ‘significant influence’ to determine which investments are in the scope of those eliminated requirements…
• remove the arbitrary and subjective dividing line (‘significant influence’) between investments measured using the equity method and other investments.
• remove the need to gather the information needed to apply the equity method, for example information needed to eliminate some intercompany transactions with associates.
• make it easier to answer some of the many practical questions that arise on how to apply the equity method… 

Among other things. All of that being the case, I didn’t spend much time reading the exposure draft, because happily for me, I don’t need to! But for your information, it covers such secondary topics as how an investor applies the equity method to changes in its ownership interest on obtaining significant influence, and to changes in its ownership interest while retaining significant influence, and to recognizing its share of losses, among others of those aforementioned practical questions. It also proposes additional equity-method-related disclosure requirements including gains or losses from other changes in an ownership interest; gains or losses resulting from ‘downstream’ transactions with associates or joint ventures; information about contingent consideration arrangements; and a reconciliation between the opening and closing carrying amount of its investments. The last one at least seems reasonable: if an investor has to go through the rigmarole of applying the equity method, the least it can do is make it clear for readers where the numbers come from. It’s hard to imagine the other disclosure items will very often be decision-critical…

Anyway, the exposure draft is open for comment until January 20, 2025 and will of course attract thousands of pages of careful, scrupulous analysis, all of which will be diligently read and summarized and considered. I wish I thought that was a good use of anyone’s time…

The opinions expressed are solely those of the author.