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Fair value model
Extract from FRS102: Section 14.9-14.10A
14.9 When an investment in an associate is recognised initially, an investor that is not a parent, that chooses to adopt the fair value model, shall measure it at the transaction price.
14.10 At each reporting date, an investor that is not a parent, that chooses to adopt the fair value model, shall measure its investments in associates at fair value, with changes in fair value recognised in other comprehensive income in accordance with paragraphs 17.15E and 17.15F, using the fair value guidance in paragraphs 11.27 to 11.32. An investor using the fair value model shall use the cost model for any investment in an associate for which it is impracticable to measure fair value reliably without undue cost or effort.
14.10 A The investor shall recognise dividends and other distributions received from the investment as income without regard to whether the distributions are from accumulated profits of the associate arising before or after the date of acquisition.
OmniPro comment
Where the fair value model is chosen, the following rules apply:
- Fair value movements are recognised in other comprehensive income/revaluation reserve where the movement is positive unless previous devaluations have been recognisesd in the profit and loss in which case they are recognised in the profit and loss up to the amount previously recognised in the profit and loss and after that to other comprehensive income; and
- Fair value movements which are negative are first set against the revaluation reserve and where this is reduced to nil, they are then posted to the profit and loss.
All transaction costs are expensed as incurred. The revaluations should be performed on a regular basis so that the carrying amount is not materially different from its fair value. Where fair value can no longer be measured it is then stated at the carrying value at that time which is deemed to be its original cost.
Deferred tax
As there will be fair value adjustments, there will be a deferred tax impact for the differences between the tax base and the carrying amount. The deferred tax adjustment should follow the initial adjustment to reflect the new carrying amount i.e. on initial recognition the deferred tax impact will be posted to other comprehensive income. The deferred tax rate to be used will be the rate that it is expected that the investment will be settled for. Where the investment is to be held for dividend purposes then the trading tax rate should be used, however where it is expected the investment will be sold it should be measured at the capital gain tax/sales tax rate. In reality it may more than likely be the capital gains tax rate.
Fair value through the profit and loss
Section 11 provides the accounting treatment where fair value through the profit and loss is chosen. Please refer to section 11 of this website for further details.
Transition exemptions
Section 35.10(f) provides an exemption for entities that prepare separate and individual accounts and who hold an investment. This exemption allows an entity to treat the carrying amount at the date of transition to be its deemed cost. Given that under old GAAP, in the vast majority of cases it would have already been carried at cost, this exemption has no real effect. The concepts in FRS 102 are similar to old GAAP.
For consolidated financial statements there are no exemptions. Therefore where there are differences they will have to be adjusted through opening reserves at the date of transition. See discussion below on the principal transition adjustments.
Principal transition adjustments
- Associates share of losses recognised as a provision in the group financial statements
Under old GAAP where losses were incurred by an associate, and the losses had reduced the investment in the associate to nil, then the groups share of any future losses had to be included as a provision in the consolidated financial statements. Section 14 does not require this instead where losses have reduced the investment to nil then no further losses should be provided for unless the group has a constructive or legal obligation to provide for these or has made payments on behalf of the associate. Therefore where associates are in a net liability position at the date of transition an adjustment will be required to derecognise those losses previously recognised under old GAAP. Note there is no impact on the individual financial statements as this would not have been applicable as the investment would have been measured at cost less impairment.
Example 12: Derecognition of associates losses
Parent A prepares consolidated financial statements. At the date of transition, it had a 25% investment in an associate company. The associate company had net liabilities of CU100,000 on its balance sheet at the date of transition. A provision of CU25,000 was included in the consolidated financial statements of old GAAP at the date of transition to reflect the 25% ownership of these losses. A loss of CU5,000 was recognised in the 2014 accounts.
Assume the date of transition is 1 January 2014 and no deferred tax was recognised as it was not tax deductible. The journals required on transition are:
|
On 1 January 2014 |
|
|
|
|
CU |
CU |
|
Dr Provision for Losses of Associate |
25,000 |
|
|
Cr Profit and Loss Reserves |
|
25,000 |
Being journal to derecognise provision for associates share of net liabilities
Journals to be posted at 31 December 2014 assuming the above journals were posted to reserves
|
|
CU |
CU |
|
Dr Provision for Losses of Associate |
5,000 |
|
|
Cr Profit and Loss Reserves |
|
5,000 |
Being journal to derecognise provision for associate’s share of net liabilities for the 2014 year.
A similar journal would be required for the 31 December 2015 year if the consolidated financial statements have been prepared under old GAAP.
2. Investments not deemed to have significant influence under old GAAP.
Under old GAAP, in order for an entity to have a significant influence they must be actively exercising that interest. If they were not exercising, then it was not treated as an associate. Under Section 14, even where an entity does not actively exercise its significant influence it can still be classed as an associate i.e. they have the power to exercise significant influence but they are not actively enforcing this. On transition such investments would now be accounted for as associates so therefore a transition adjustment will be required. On transition the investment would need to be adjusted for the parent’s share of the associate’s profits/losses. In reality the likelihood of an adjustment in this area is remote.
3. Adjustments required to adjust carrying value in the consolidated financial statements for parent’s percent of the associates net assets under FRS 102.
The associates individual financial statements will need to be restated to comply with FRS 102 which may result in a different net asset carrying amount than was previously determined under old GAAP. As a result, an adjustment will be required on transition to show the updated carrying amount for the change in net assets. The deemed goodwill is the difference between the investing entity’s share of those adjusted carrying amounts and the cost of the investment under old GAAP.
Example 13: Updated carrying amounts as a result of associate’s transition to FRS 102
Company A has a 30% interest in Company B which cost CU10,000. Company A prepares consolidated financial statements. At 1 January 2014 the net assets of Company B was CU120,000 and the carrying amount of the investment in the consolidated financial statements under old GAAP was CU39,000 ignoring any goodwill amortisation. Assume the date of transition is 1 January 2014 and no deferred tax is recognised on the uplift as the investment will be settled through dividends which will not be subject to tax on receipt of dividends from the associate. The associates balance sheet has been restated to FRS 102 compliance figures and the new net asset figure is CU100,000.
The adjustments required on transition are:
1 January 2014
|
|
CU |
CU |
|
Dr Profit and Loss Reserves CU6,000 |
1,000 |
|
|
Cr Investment in Associate ((CU100,000* the percentage ownership of 30%=CU30,000) plus the initial cost of CU10,000 less carrying amount under old GAAP of CU3,900=CU1,000) |
|
1,000
|
Being journal to reflect the updated allocation of the associates net assets based on FRS 102 numbers
For 31 December 2014 the below journals would need to be posted depending how the net assets of the associate has moved:
|
Dr/Cr Investment in Associate |
XX |
|
Cr/Dr Share of Associates Results |
XX |
4. Deferred tax on fair value adjustment
Where investments in associates are recognised at fair value in the individual financial statements on transition to FRS 102, deferred tax will need to be recognised on transition. The deferred tax rate to be used depends on the tax rate that will be payable on settlement i.e. whether the investment is held for dividend income or for future sale. In reality it is more likely that the sales tax rate will be utilised.
Example 14: Adoption of fair value through profit and loss on transition
Company A in its individual financial statements has adopted a policy of fair valuing investments in associates through the profit and loss. Assume 1 January 2014 is the date of transition. The carrying value under old GAAP was CU100,000 at 1 January 2014 and 31 December 2014 & 2015 which represented the original cost. The fair value of the investment at 1 January 2014, 31 December 2014 and 31 December 2015 was CU120,000, CU95,000 and CU125,000 respectively. Assume a deferred tax sales rate of 20% assuming investment is held for future sale if not the dividend tax rate should be used. Consuming interest is held for future sale if not the dividend tax rate should be uilised. The adjustments required on transition to reflect the fair value policy and the related deferred tax are:
1 January 2014
|
|
CU |
CU |
|
Dr Investments in Associates (CU120,000-CU100,000) |
20,000 |
|
|
Cr Profit and Loss Reserves |
|
20,000 |
Being journal to reflect uplift in value on transition to show fair value
|
|
CU |
CU |
|
Dr Profit and Loss Reserves (CU20,000*20%) |
4,000 |
|
|
Cr Deferred Tax Liability |
|
4,000 |
Being journal to reflect deferred tax on the uplift
Journals required in the 31 December 2014 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Fair Value on movement in Associate in P&L |
25,000 |
|
|
Cr Investments in Associates (CU120,000-CU95,000) |
|
25,000 |
Being journal to reflect fall in value at 31 December 2014
|
|
CU |
CU |
|
Dr Deferred Tax Liability |
4,000 |
|
|
Cr Deferred Tax in P&L (CU20,000*20%) |
|
4,000 |
Being journal to reverse deferred tax recognised at 1 January 2014 as the investment is now stated below cost. No deferred tax asset recognised as assumed it is not probable there will be taxable profits to utilise the loss. If there was taxable profits then the deferred tax asset of CU1,000 would be recognised ((CU100,000-CU95,000)*20%)
Journals required in the 31 December 2015 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Investments in Associates (CU125,000-CU95,000) |
CU30,000 |
|
|
Cr Fair Value on movement in Associate in P&L |
|
CU30,000 |
Being journal to reflect uplift in value from 2014 to 2015
|
|
CU |
CU |
|
Dr Deferred Tax in P&L ((CU125,000-CU100,000)*20%) |
CU5,000 |
|
|
Cr Deferred Tax Liability |
|
CU5,000 |
Being journal to reflect deferred tax on the uplift. The movement of CU95,000 to CU100,000 is not recognised as the asset was not previously recognised.
Example 15: Adoption of fair value through other comprehensive income on transition
Company A in its individual financial statements has adopted a policy of fair valuing investments in associates through other comprehensive income this time assuming the previous entity carried it at cost. Assume 1 January 2014 is the date of transition. The carrying value under old GAAP was CU100,000 at 1 January 2014 and 31 December 2014 & 2015 which represented the original cost. The fair value of the investment at 1 January 2014, 31 December 2014 and 31 December 2015 was CU120,000, CU95,000 and CU125,000 respectively. Assume a deferred tax sales rate of 20%. The adjustments required on transition to reflect the fair value policy and the related deferred tax are:
The journals required would be as follows.
1 January 2014
|
|
CU |
CU |
|
Dr investments in associates (CU120,000-CU100,000) |
20,000 |
|
|
Cr revaluation reserve |
|
20,000 |
Being journal to reflect uplift in value on transition to show fair value
|
|
CU |
CU |
|
Dr Deferred Tax in Revaluation Reserve (CU20,000*20%) |
4,000 |
|
|
Cr Deferred Tax Liability |
|
4,000 |
Being journal to reflect deferred tax on the uplift
Journals required in the 31 December 2014 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Fair Value movement in Profit and Loss |
5,000 |
|
|
Dr Fair Value on movement in Associate in OCI/revaluation reserve |
20,000 |
|
|
Cr Investments in Associates (CU120,000-CU95,000) |
|
25,000 |
Being journal to reflect fall in value at 31 December 2014. The CU5,000 is posted to the profit and loss as there is nothing left in the revaluation reserve after the CU20,000 has been debited.
|
|
CU |
CU |
|
Dr Deferred Tax Liability |
4,000 |
|
|
Cr Deferred Tax in Revaluation Reserve (CU20,000*20%) |
|
4,000 |
Being journal to reverse deferred tax recognised at 1 January 2014 as the investment is now stated below cost. No deferred tax asset recognised as assumed it is not probable there will be taxable profits to utilise the loss. If there was taxable profits then the deferred tax asset of CU1000 would be recognised ((CU100,000-CU95,000)*20%).
Journals required in the 31 December 2015 year assuming the above journals are posted to reserves
|
|
CU |
CU |
|
Dr Investments in Associates (CU125,000- CU95,000) |
30,000 |
|
|
Cr Profit and Loss Fair Value movement |
|
5,000 |
|
Cr Fair Value on movement in Associate in revaluation reserve/OCI |
|
25,000 |
Being journal to reflect uplift in value on from 2014 to 2015. CU5,000 credit to profit and loss as CU5,000 had previously been debited to the profit and loss for the downward valuation
|
|
CU |
CU |
|
Dr Deferred Tax in revaluation reserve OCI ((CU125,000-CU100,000)*20%) |
5000 |
|
|
Cr deferred Tax Liability |
|
5000 |
Being journal to reflect deferred tax on the uplift. The movement of CU95,000 to CU100,000 is not recognised as the asset was not previously recorded.
5) Deferred tax recognised in the consolidated financial statements on unremitted income from an associate
Section 29 requires deferred tax to be recognised on the unremitted earnings of an associate. A timing difference arises as in the consolidated financial statements under the equity method, the income or loss for the parents share is recognised in the profit and loss account which then increases or decreases the value on the balance sheet. This income/loss is not taxable/tax deductible in the tax computation, but it may be taxable in the future when dividend is received from the associate, hence this creates the timing difference. Whether deferred tax should be recognised will depend on whether any dividend received from the parent will be taxable for the parent company. Where the associate is an Irish company no tax will be payable and therefore no deferred tax needs to be recognised assuming the expected settlement will be from dividends received and not from a sale.
Whether it will be taxable then deferred tax will need to be recognised at the passive tax rate or where the investment is held for future sale the sales tax rate should be utilised. If this is the case a transition adjustment will need to be made on transition to FRS 102. Note deferred tax should only be recognised where the decision to distribute is not within the control of the entity.
Under old GAAP, no deferred tax was required to be recognised unless the associate had a constructive obligation/binding agreement to make a dividend payment.
Example 16: Deferred tax on unremitted earnings
Company A invested CU10,000 to acquire 25% of Company B. The carrying amount at 1 January 2014 in old GAAP books was CU15,000. The date of transition is 1 January 2014. The movement was due to income recognised since acquisition for the entity’s share of the profits year on year. Assume that the dividend when made to Company A by Company B is taxable in the hands of Company A at a rate of 10%. Under old GAAP deferred tax was not recognised as Company B was not legally obliged to pay a dividend. Assume the entity does not have control over when it will be distributed. The transition adjustments required on transition are:
1 January 2014
|
|
CU |
CU |
|
Dr Profit and Loss Reserves ((CU15,000-CU10,000)*10%) |
1,500 |
|
|
Cr Deferred Tax Liability |
|
1,500 |
Being journal to reflect deferred tax on unremitted earnings
An adjustment may also be required in 31 December 2014 and 2015 year end where the parent company’s consolidated profit included its share of income/losses of the associate.
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