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Section 7 – Subsidiaries, Associates, Jointly Controlled Entities and Intermediate Payment Arrangements
Section 7 deals with the recognition and measurement requirements for investments in subsidiaries, associates and joint ventures as well as providing guidance on the accounting for intermediate payment arrangements.
Investments in subsidiaries, associates and interests in jointly controlled entities
Extract FRS 105 – Section 7.2
7.2 A micro-entity shall account for any investments in subsidiaries and associates and any interests in jointly controlled entities in accordance with Section 9 Financial Instruments.
OmniPro comment
Investment in subsidiaries, associates and joint ventures (which are jointly controlled entities – see below for further details) must be carried at cost less impairment. There are no other options available. This applies to investments in shares.
Where there are long term loans to such entities the rules in Section 9 should be applied those being to carry it at transaction price less reductions for impairment or un-collectability.
Section 9.17 of FRS 105 outlines the evidence that indicates an impairment is required. These indicators are:
- significant financial difficulty of the debtor;
- a breach of contract, such as a default or delinquency in interest or principal payments;
- the creditor, for economic or legal reasons relating to the debtor’s financial difficulty, granting to the debtor a concession that the creditor would not otherwise consider;
- it has become probable that the debtor will enter bankruptcy or other financial reorganisation;
- declining market values of the asset or similar assets;
- significant changes with an adverse effect on the asset that have taken place in the technological, market, economic or legal environment; and
- the contract has become an onerous contract.
An impairment can be reversed if in a subsequent period the amount of an impairment loss decreases and the decrease can be related to an event occurring after the impairment was recognised (e.g. an improvement in the debtor’s credit rating). See Section 9 for further details in this regard.
Example 1: Investment in Subsidiary
Company A invested CU100,000 in return for the issuance of 1,000 ordinary shares in Company B which made company B a subsidiary of Company A. The carrying amount of the investment in Company B is held at CU100,000 unless an impairment arises.
At the end of year 2 an indication of an impairment arose and as a result the investment was written down to CU60,000 in the books of Company A (CU40,000 recognised as an impairment expense in the P&L).
At the end of year 4 the previous impairment had reversed. Hence the carrying amount of the investment in Company B was written back up from CU60,000 to CU100,000 at the time in the books of Company A.
The above example would be the same if it were an investment in an associate or a joint venture which is a jointly controlled entity.
For the avoidance of doubt there are three types of joint ventures namely;
- Jointly controlled operations;
- Jointly controlled assets; and
- Jointly controlled entities.
The first two above are dealt with by Section 11 of FRS 105. See Section 11 for further details. The third one is dealt with by this standard. For the avoidance of doubt, jointly controlled entities are joint ventures that involve the establishment of a corporation, partnership or other entity in which the venture has an interest and there is a contractual arrangement between the ventures’ establishing joint control over the economic activity (i.e. there is a separate legal entity).
Consolidated financial statements
Extract FRS 105 – Section 7.3
7.3 An entity that is required or chooses to present consolidated financial statements is excluded from the micro-entities regime (sections 384A(8) and 384B(2) of the Act) and shall not apply this FRS.
OmniPro comment
If an entity prepares financial statements under FRS 105 it cannot prepare consolidated financial statements. The legislative references above refer to UK law. The statutory references in the ROI are Section 280D & 280E of Companies Act 2014.
If an entity prepares consolidated financial statements it must prepare its accounts under FRS 102 in full or under FRS 102 Section 1A.
In addition a company that is consolidated into the results of a parent/ultimate parent company cannot prepare financial statements under FRS 105.
Intermediate payment arrangement
Extract FRS 105 – Section 7.4 – 7.8
7.4 Intermediate payment arrangements may take a variety of forms:
- The intermediary is usually established by the micro-entity and constituted as a trust, although other arrangements are possible.
- The relationship between the micro-entity and the intermediary may take different forms. For example, when the intermediary is constituted as a trust, the micro- entity will not have a right to direct the intermediary’s activities. However, in these and other cases the micro-entity may give advice to the intermediary or may be relied on by the intermediary to provide the information it needs to carry out its activities. Sometimes, the way the intermediary has been set up gives it little discretion in the broad nature of its activities.
- The arrangements are most commonly used to pay employees, although they are sometimes used to compensate suppliers of goods and services other than employee services. Sometimes the micro-entity’s employees and other suppliers are not the only beneficiaries of the arrangement. Other beneficiaries may include past employees and their dependants, and the intermediary may be entitled to make charitable donations.
- The precise identity of the persons or entities that will receive payments from the intermediary, and the amounts that they will receive, are not usually agreed at the outset.
- The micro-entity often has the right to appoint or veto the appointment of the intermediary’s trustees (or its directors or the equivalent).
f. The payments made to the intermediary and the payments made by the intermediary are often cash payments but may involve other transfers of value.
Examples of intermediate payment arrangements are employee share ownership plans (ESOPs) and employee benefit trusts that are used to facilitate employee shareholdings under remuneration schemes. In a typical employee benefit trust arrangement for share-based payment transactions, a micro-entity makes payments to a trust or guarantees borrowing by the trust, and the trust uses its funds to accumulate assets to pay the micro-entity’s employees for services the employees have rendered to the micro-entity.
Although the trustees of an intermediary must act at all times in accordance with the interests of the beneficiaries of the intermediary, most intermediaries (particularly those established as a means of remunerating employees) are specifically designed so as to serve the purposes of the micro-entity, and to ensure that there will be minimal risk of any conflict arising between the duties of the trustees of the intermediary and the interest of the micro-entity, such that there is nothing to encumber implementation of the wishes of the micro-entity in practice. Where this is the case, the micro-entity has de facto control.
Accounting for intermediate payment arrangements
7.5 When a micro-entity makes payments (or transfers assets) to an intermediary, there is a rebuttable presumption that the entity has exchanged one asset for another and that the payment itself does not represent an immediate expense. To rebut this presumption at the time the payment is made to the intermediary, the micro-entity must demonstrate:
(a) it will not obtain future economic benefit from the amounts transferred; or
(b) it does not have control of the right or other access to the future economic benefit it is expected to receive.
7.6 Where a payment to an intermediary is an exchange by the micro-entity of one asset for another, any assets that the intermediary acquires in a subsequent exchange transaction will also be under the control of the micro-entity. Accordingly, assets and liabilities of the intermediary shall be accounted for by the micro-entity as an extension of its own business and recognised in its financial statements. An asset will cease to be recognised as an asset of the micro-entity when, for example, the asset of the intermediary vests unconditionally with identified beneficiaries.
7.7 A micro-entity may distribute its own equity instruments, or other equity instruments, to an intermediary in order to facilitate employee shareholdings under a remuneration scheme. Where this is the case and the micro-entity has control, or de facto control, of the assets and liabilities of the intermediary, the commercial effect is that the micro-entity is, for all practical purposes, in the same position as if it had purchased the shares directly.
7.8 Where an intermediary holds the micro-entity’s equity instruments, the micro-entity shall account for the equity instruments as if it had purchased them directly. The micro- entity shall account for the assets and liabilities of the intermediary in its financial statements as follows:
(a)The consideration paid for the equity instruments of the sponsoring entity shall be deducted from equity until such time that the equity instruments vest unconditionally with employees.
(b) Other assets and liabilities of the intermediary shall be recognised as assets and liabilities of the micro-entity.
(c) No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of the micro-entity’s own equity instruments.
(d) Finance costs and any administration expenses shall be recognised on an accruals basis rather than as funding payments are made to the intermediary.
(e) Any dividend income arising on the micro-entity’s own equity instruments shall be excluded from profit or loss and deducted from the aggregate of dividends paid.
OmniPro comment
It is unlikely that many entities may come across these in practice as a result this has not been dealt with further. It has been included for information purposes. It usually applies to employee share ownership schemes.
Principal transition adjustments
1) De-recognition of investments from fair value/revaluation to cost and the related deferred tax impact (if applicable).
Under FRSSE/old GAAP there was a choice to hold investments in subsidiaries, associates and joint ventures in the individual financial statements at either cost less impairment or revalued amount with movements in valuation recognised in the STRGL/revaluation unless it was considered permanent in which case it was recognised in the STRGL where a previous upward revaluation was held and then to the P&L (revaluation policy). Where a revaluation policy was adopted no deferred tax was required to be recognised.
FRS 102 offers the choices as per FRSSE/old GAAP above (only difference is that the revaluation is recognised in OCI/revaluation reserve) but in addition gives the company an option to carry the investment at fair value with movements in fair value recognised in the profit and loss account. FRS 102 also required deferred tax to be considered on any movements in fair value from cost.
FRS 105 only permits such investments to be carried at cost less impairment.
Where investments in subsidiaries/associates/joint ventures are recognised at fair value/revaluation under FRSSE/FRS 102 in the individual financial statements on transition to FRS 105, an adjustment will be required to
- derecognise the previous carrying amount to cost less impairment; and
- if applicable deferred tax will also have to be derecognised (applicable for FRS 102 only).
Where the fair value is below original cost, no adjustment will be required as this would be the cost less impairment amount also. However if deferred tax asset was recognised on the downward valuation this would need to be derecognised.
Example 2: Restatement of investment in subsidiaries/associates/joint ventures to cost less impairment (previously carried at fair value through P&L under FRS 102)
Company A in its individual financial statements under FRS 102 had adopted a policy of fair valuing investments in subsidiaries/associates/joint ventures through the profit and loss. Assume 1 January 2015 is the date of transition. The fair value of the investment at 1 January 2015, 31 December 2015 and 31 December 2016 was CU120,000, CU95,000 and CU125,000 respectively in the FRS 102 financial statements. The cost of the investment was CU100,000 at 1 January 2015 and 31 December 2015 & 2016 which represented the original cost. A deferred tax rate of 20% was used to reflect deferred tax on the uplift under FRS 102. The adjustments required on transition to restate to cost less impairment and the reversal of the related deferred tax are (note in reality the deferred tax on this fair value adjustment would likely be derecognised as one journal with deferred tax on all other timing differences as discussed in Section 24 of FRS 105, however we have shown the derecognition here for educational purposes):
|
1 January 2015 |
|
|
|
|
CU |
CU |
|
Dr Profit and Loss Reserves (CU120,000-CU100,000) |
20,000 |
|
|
Cr Investments in Subsidiaries/associates/joint ventures |
|
20,000 |
Being journal to restate the investment to cost
|
|
CU |
CU |
|
Dr Deferred Tax Liability (CU20,000*20%) |
4,000 |
|
|
Cr Profit and Loss Reserves |
|
4,000 |
Being journal to derecognise the deferred tax under FRS 105 as it cannot be recognised
Journals required in the 31 December 2015 year assuming the above journals are posted to reserves etc.
|
|
CU |
CU |
|
Dr Investments in Subsidiaries/associates/joint ventures |
20,000 |
|
|
Dr Impairment of investments in P&L |
5,000 |
|
|
CR Fair Value Movement in Subsidiaries in P&L |
|
25,000 |
Being journal to reverse previous fair value movement and just reflect the impairment from cost to CU95,000 (i.e. only CU5k debit to P&L)
|
|
CU |
CU |
|
Dr Deferred Tax in P&L |
4,000 |
|
|
Cr Deferred Tax Liability (CU20,000*20%) |
|
4,000 |
Being journal to reverse deferred tax movement recognised in the 2015 year under FRS 102
Journals required in the 31 December 2016 year assuming the above journals are posted to reserves etc.
|
|
CU |
CU |
|
Dr Fair Value Movement in Subsidiaries/associates/joint ventures in P&L |
30,000 |
|
|
Cr Reversal of impairment of investment in P&L |
|
5,000 |
|
Cr Investments in Subsidiaries/associates/joint ventures |
|
25,000 |
Being journal to reverse the fair value movement recognised in the P&L in 2016 under FRS 102 so as to restate the investment to cost and to reverse the previous impairment so as to show it at cost as the impairment has reversed.
|
|
CU |
CU |
|
Dr Deferred Tax Liability ((CU125,000-CU100,000)*20%) |
5,000 |
|
|
Cr Deferred Tax in P&L |
|
5,000 |
Being journal to reverse deferred tax movement recognised in the P&L under FRS 102.
Example 3: Restatement of investment in subsidiaries/associates/joint ventures to cost less impairment (previously carried at fair value through OCI/STRGL under FRS 102/FRSSE)
If we take example 2 above and assume Company A in its individual financial statements has adopted a policy of fair valuing investments in Subsidiaries/associates/joint ventures through other comprehensive income under FRS 102 and the STRGL under FRSSE this time. The journals required would be as follows.
1 January 2015
|
|
CU |
CU |
|
Dr Revaluation Reserve |
|
20,000 |
|
Cr Investments in Subsidiaries/ associates/joint ventures (CU120,000-CU100,000) |
20,000 |
|
Being journal to restate the investment to cost
|
Below journal is only applicable if transitioning from FRS 102. Not applicable if transitioning from FRSSE) |
CU |
CU |
|
Dr Deferred Tax Liability |
4,000 |
|
|
Cr Deferred Tax in Revaluation Reserve (CU20,000*20%) |
|
4,000 |
Being journal to derecognise the deferred tax under FRS 105 as it cannot be recognised
Journals required in the 31 December 2015 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Investments in Subsidiaries/ associates/joint ventures (CU120,000-CU95,000) |
20,000 |
|
|
Dr Impairment of investments in P&L |
5,000 |
|
|
Cr Fair Value Movement in Profit and Loss |
|
5,000 |
|
Cr Fair Value Movement in Subsidiaries in OCI/STRGL/ Revaluation Reserve |
|
20,000 |
Being journal to reverse the revaluation movement and just recognise the impairment below cost in the P&L as required under FRS 105.
|
Below journal is only applicable if transitioning from FRS 102. Not applicable if transitioning from FRSSE) |
CU |
CU |
|
Dr Deferred Tax in Revaluation Reserve/OCI/STRGL (CU20,000*20%) |
4,000 |
|
|
Cr Deferred Tax Liability |
|
4,000 |
Being journal to reverse deferred tax movement recognised in the 2015 year under FRS 102/FRSSE
Journals required in the 31 December 2016 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Profit and Loss Fair Value Movement |
5,000 |
|
|
Dr Fair Value Movement in Subsidiaries/ associates/joint ventures in Revaluation Reserve/OCI/STRGL |
25,000 |
|
|
Cr Reversal of impairment of investments in P&L |
|
5,000 |
|
Cr Investments in Subsidiaries (CU125,000-CU100,000) |
|
25,000 |
Being journal to reverse the fair value movement recognised in the OCI/STRGL in 2016 under FRS 102/FRSSE so as to restate the investment to cost and to reverse the previous impairment so as to show it at cost as the impairment has reversed.
|
Below journal is only applicable if transitioning from FRS 102. Not applicable if transitioning from FRSSE) |
CU |
CU |
|
Dr Deferred Tax Liability ((CU125,000-CU100,000)*20%) |
5,000 |
|
|
Cr Deferred Tax in Revaluation Reserve/OCI/STRGL |
|
5,000 |
Being journal to reverse deferred tax movement recognised in the P&L under FRS 102/FRSSE.
Example 4: Restatement of investment in subsidiaries/associates/joint ventures to cost less impairment-no adjustment where fair value is less than cost)
Company A in its individual financial statements under FRS 102 had adopted a policy of fair valuing investments in subsidiaries/associates/joint ventures through the profit and loss or alternatively at fair value through OCI STRGL for FRS 102/FRSSE. Assume 1 January 2015 is the date of transition. The fair value of the investment at 1 January 2015, 31 December 2015 and 31 December 2016 was CU90,000, CU95,000 and CU80,000 respectively in the FRS 102/FRSSE financial statements. The cost of the investment was CU100,000 at 1 January 2015 and 31 December 2015 & 2016 which represented the original cost. Assume a deferred tax asset was not recognised under previous GAAP.
In this case no transition adjustments are required as under FRS 105 the cost less impairment value would equal the amounts booked under old GAAP/FRS 102/FRSSE.
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