Equity method: ongoing work

Some standard-setting work is not glamorous. You may think that none of it is glamorous, but at least the work being done by the International Sustainability Standards Board is making headlines. If you look at the difficult task facing the people working on the equity method, you will find no headlines. A quick Google search will lead you to the IFRS Foundation and maybe some technical departments of big accounting firms.

Digging into this technical work is not the way to the bright lights of accounting stardom, unlike a colleague of mine who writes on football finance and is never off the TV or radio news stations.

This column has previously looked at the criticisms of the equity method used in accounting for joint ventures and associates. In the consolidated statement of financial position, this one line would represent the value of the investment. In the consolidated statement of profit or loss, this line would represent the share of profit from the associate or joint venture.

While wholesale changes are unlikely, the International Accounting Standards Board (IASB) has taken a look at some of the more technical aspects of the method and has produced a list of tentative decisions that will be included in the exposure draft that it aims to produce sometime in 2024.

Consideration

The IASB has clarified that if part of the consideration paid for the associate involved contingent consideration (where an amount payable depends on future outcomes), this should be included at fair value. If this consideration is classified as equity, the subsequent settlement will be accounted for in equity. For other contingent consideration, the investor will remeasure it to fair value at each reporting period and record the movement in profit or loss.

When the associate’s net assets are recognised at fair value, any deferred tax asset or liability arising from this would be included in the carrying amount of the investment in the associate. Both of these decisions ensure that the treatment is in line with that for accounting for subsidiaries in accordance with IFRS 3, Business Combinations.

Sale of subsidiary

One of the bigger tentative decisions aims to address a perceived conflict between IFRS 10, Consolidated Financial Statements, and IAS 28, Investments in Associates and Joint Ventures. It is probably an uncommon situation, but it does appear to have an accounting mismatch.

The particular situation arises when a subsidiary is sold to an associate. This can be a partial or full disposal, but the parent would lose control of the subsidiary.

The conflict arises because IFRS 10 requires investors to recognise in full any gain or loss on the loss of control of a subsidiary, whereas IAS 28 requires an investor to restrict the gains or losses recognised to the extent of the unrelated investors’ interests in an associate. The decision was made to recognise the gain/loss in full to bring this in line with the treatment in IFRS 10.

Losses

One of the more commonly discussed issues around the equity method is the requirement to stop recognising a share of losses from the associate once the investment value has been reduced to nil. This treatment was not under discussion but did lead to some further questions.

The issue arose that if a company increased its share of the associate, would they have to ‘catch up’ unrecognised losses now that the value of the investment had increased. The decision has been made that this will not be the case.

It was also noted that when there are items affecting the statement of profit or loss and other comprehensive income that could reduce the investment value to nil, the statement of profit or loss element should be recorded first, as the profit or loss is the primary source of information about an entity’s financial performance. If an entity has one positive figure and one negative (for example, a profit of 100 but other comprehensive losses of 100), then these will be presented separately in the financial statements to provide relevant information, even if the net effect is zero.

Complex solutions

What many of us commentators sometimes see as obvious problems to solve can lead down much more complex roads in finding a solution. In arriving at some of these tentative decisions, the IASB had to consider information from IFRS 10; IFRS 3; IAS 28; IFRS 15, Revenue from Contracts with Customers; IAS 1, Presentation of Financial Statements; IAS 24, Related Party Disclosures; and the Conceptual Framework for Financial Reporting.

Trying to come up with solutions to niche and complex problems is a pretty thankless task. You will not see them on TV any time soon, but this honest work done in the accounting shadows is what underpins the financial reporting process. Not all accounting heroes wear capes.