IAS 27 - Improving comparability

Recent amendments to IAS 27 address an area of significant divergence in practice, explain Amanda Quiring and Alan Teixeira.

In the February edition we provided a summary of the major revisions to

IFRS 3, Business Combinations ('A combination of changes', p78). In this article, we focus on the amendments to IAS 27, Consolidated and Separate Financial Statements, which were published by the International Accounting Standards Board (IASB) at the same time in January. The amendments will improve comparability among entities applying International Financial Reporting Standards (IFRS) by addressing an area of significant divergence in practice. The publication of equivalent requirements in the US will also improve comparability worldwide.

The last major amendment to

IAS 27 was made in 2003, when the IASB concluded that, on the basis of the definitions of liabilities and equity in its Framework, non-controlling interests are part of a group's equity. At the time, the board acknowledged that IAS 27 did not include requirements on how to account for changes in the interests of the parent relative to the non-controlling interests.

The board decided that, because it was already discussing partial acquisitions and the initial recognition of non-controlling interests as part of the second phase of its business combinations project, it would be best to also consider the subsequent accounting for non-controlling interests within the scope of that project.

Changes in the relative proportion of controlling and non-controlling interests

After a parent has control of a subsidiary, it might increase its holding by buying additional shares from the non-controlling interests, or reduce its holding by selling some shares. A parent's relative interest in a subsidiary will also change if the subsidiary issues shares to a party other than the parent.

The absence of guidance in

IAS 27 on how to account for these transactions led to at least six methods being accepted in practice.

The board decided that transactions between the parent and non-controlling interests should be accounted for on the same basis as any other transactions between equity holders - within equity. Not only is this one of the simplest of the six methods but, more importantly, it is the only method that leads to the appropriate reporting of income and equity (as explained in the illustrative example).

Despite a clear need to reduce diverging practice, this was one of the most debated aspects of the business combinations project. Many respondents perceived that, by accounting for such transactions within equity, the board was moving to an accounting model that focuses on the reporting entity to the detriment of the parent's shareholders.

The board did not debate the economic entity and parent perspectives as part of the business combinations project. Given the urgent need for guidance, it decided that providing amendments based on the existing Framework would significantly improve the usefulness and comparability of financial statements.

The board has committed to having a more comprehensive discussion of the economic entity and parent perspectives in its projects on consolidations or the conceptual framework. To acknowledge the importance of the parent shareholders, the board decided to improve the related disclosures by requiring entities to present a separate schedule showing the effects on their equity of transactions with non-controlling interests.

Attribution of losses

IAS 27 has been amended to require entities to attribute total comprehensive income to the owners of the parent and the non-controlling interests, even if this results in the non-controlling interests having a deficit balance. Previously, excess losses were allocated to the owners of the parent, unless the non-controlling interests were obliged, and able, to make an additional investment to cover the losses.

The board made this change because the previous requirement was inconsistent with the classification of non-controlling interests as equity.

Loss of control

One of the concepts underlying the revised

IFRS 3 is the importance of control. Achieving control is a fundamental change in the nature of one entity's interest in another. A parent-subsidiary relationship differs significantly from an investor-investee relationship. For example, when an entity steps up from a 10% interest in a business to having a controlling interest, it obtains control over, and therefore begins reporting, the underlying assets, liabilities, equity and results of operations of the acquired business (instead of an investment asset).

This concept extends to when a parent loses control of a subsidiary but retains an ownership interest. Because the parent-subsidiary relationship ceases, the parent stops recognising the assets, liabilities and equity instruments of the subsidiary and begins recognising an investment asset.

The amended

IAS 27 requires entities to measure that investment at fair value at the date when control is lost. That requirement is consistent with the general principle in IFRSs that financial assets are measured at fair value at initial recognition. Previously, IAS 27 required that the investment be recognised at its carrying amount at the date when control was lost. This change also affects the gain or loss recognised on disposal of the subsidiary.

Amanda Quiring is a project manager and Alan Teixeira is a senior project manager at the IASB.

The IASB website has information about the project and about how to obtain the standards. Visit www.iasb.org/business-combinations.

ILLUSTRATIVE EXAMPLE

The amended

IAS 27 requires entities to account for changes in the relative proportion of the controlling and non-controlling interests in a subsidiary as equity transactions. This example demonstrates, for the disposal of some shares in a subsidiary, why the accounting is appropriate. FACTS

Suppose that a parent owns all of the shares in a subsidiary and decides to sell 30% of those shares for cash of £600. At that date, the recorded net assets of the subsidiary (including goodwill) are £1,800. Assume that the difference between the consideration received and the carrying amount of the non-controlling interests is because an asset with a carrying amount of £300 has a fair value of £500.

BENCHMARK CASE

If the subsidiary had sold the asset with the unrecognised value for cash immediately before the parent sells the shares, the entity would recognise a gain on disposal of £200. All of this gain would be allocated to the parent. Then, when the parent sells its shares, the group would recognise an increase in cash of £600 and non-controlling interests of £600. This accounting seems uncontroversial.

ANALYSIS OF ALTERNATIVES

To evaluate the two most commonly applied alternatives of accounting for a disposal of shares, suppose that the subsidiary sells the asset with the unrecognised value immediately after the parent sells 30% of its shares. It seems intuitive that the overall effect on income and equity should be the same as in the benchmark case.

AMENDED IAS 27

When the parent sells 30% of its shares, it would recognise the cash received of £600 and an increase in equity of £600. £60 of that increase (30% of the £200 unrecognised value in the asset) will be credited to the parent (within equity), with the remaining £540 credited to the non-controlling interests.

When the subsidiary sells the asset with the unrecognised value, it would recognise a gain of £200. Of that gain, £140 (70%) would be allocated to the parent and £60 (30%) to the non-controlling interests.

The overall effect of the transactions is consistent with the benchmark case. The entity recognises an increase in the parent's interest in the subsidiary of £200 (£60 + £140) and non-controlling interests of £600 (£540 + £60). The gain reported in profit or loss is £200, which is intuitive because it represents the realised gain on disposal of the asset.

ALTERNATIVE METHOD

Some respondents suggested an alternative method of accounting in which the parent would recognise a gain of £60 when it sells its shares, rather than allocating the £60 to the parent within equity.

This method has the same overall effect on the statement of financial position, but leads to the group reporting a cumulative profit of £260, as compared to profit of £200 in the benchmark case. Put simply, the alternative method double-counts the profit of the group by recognising the profit related to the asset twice - when the non-controlling interests are created and again when the asset is sold.

ADDITIONAL EXAMPLES

The IASB's website includes additional examples that explain why the board concluded that the required accounting is appropriate for increases and decreases in a parent's interest in a subsidiary. See www.iasb.org/business-combinations.

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