Accounting by investment entities

Accounting by investment entities is about the accounting requirements in IFRS 10 for investment entities that are limited to an exception from consolidation of investments in certain subsidiaries. The exception also impacts the separate financial statements of an investment entity (if these are prepared). The table summarises the key requirements: Accounting by investment entities

Requirement

Details

Accounting for subsidiaries held as investments

  • subsidiaries held as investments are measured at fair value through profit or loss in accordance with IFRS 9 instead of being consolidated [IFRS 10 31]. This accounting is mandatory not optional. Voluntary consolidated financial statements that state compliance with IFRS are not permitted
  • IFRS 3 does not apply to the obtaining of control over an exempt subsidiary
  • the consolidation exception also applies to controlling interests in another investment entity.

Accounting for service subsidiaries

  • an investment entity is still required to consolidate subsidiaries that are not themselves investment entities and whose main purpose and activities are providing services that relate to its investment activities [IFRS 10 32]
  • IFRS 3 applies on obtaining control over a service subsidiary.

Accounting in separate financial statements

  • an investment entity’s fair value accounting for its controlled investees also applies in its separate financial statements [IAS 27 11A]
  • if the consolidation exception applies to all an investment entity’s subsidiaries throughout the current and all comparative periods (ie it has no services subsidiaries) its separate financial statements are its only financial statements [IAS 27 8A].

Accounting for subsidiaries held as investments Accounting by investment entities

Except for subsidiaries required to be consolidated under IFRS 10 32 (see section on accounting for service subsidiaries below), an investment entity shall not consolidate its subsidiaries or apply IFRS 3 when it obtains control of another entity. Instead subsidiaries held as investments are measured at fair value through profit and loss in accordance with IFRS 9.

An investment entity is not required to produce consolidated financial statements if all of its subsidiaries are required to be measured at fair value through profit or loss (see below the discussion for separate financial statements).

Indirect subsidiaries Accounting by investment entities

When accounting for subsidiaries that have subsidiaries of their own, the investment entity accounts only for the fair value of its direct subsidiary. This fair value would include the fair value of those entities the direct subsidiary controls (ie the indirect subsidiaries). This is demonstrated in the following group structure: Accounting by investment entities

Accounting by investment entities

In the above example, Investment Co would account for the fair value of both Investee Co 1 and Investee Co 2; the fair value of the subsidiary investee would be taken into account in the fair value of Investee Co 2.

Accounting for service subsidiaries Accounting by investment entities

What are service subsidiaries?

Service subsidiaries are:

  • not investment entities themselves
  • entities whose main purpose and activity is providing services relating to investment activities.

IFRS 10 does not provide a definition of these ‘services’, however refers to the guidance in IFRS 10.B85C-E for examples. These are services or activities such as:

  • investment advisory services
  • investment management
  • investment support
  • administrative services
  • management services and strategic advice to investees
  • financial support to investees (such as a loan, capital commitment or guarantee).

This list in not considered exhaustive and the services can be provided to the entity or to other parties.

As stated in Business purpose condition via this link, investment entities are allowed to perform these services and still meet the definition of an investment entity under the conditions noted. However service subsidiaries are not themselves investment entities and so the consolidation exception will not apply.

Only subsidiaries that have a clear purpose of providing services relating to investing activities which are a substantial part of their business should be consolidated.

If an investment entity has subsidiaries that are not themselves investment entities and whose main purpose and activities are providing services that relate to its investment activities, the investment entity must consolidate these in accordance with the requirements of IFRS 10. In addition, IFRS 3 needs to be applied to acquisitions of these subsidiaries [IFRS 10 32]. This requirement is demonstrated in the following group structure: Accounting by investment entities

Accounting by investment entities

Services Co provides investment support and administrative services to the group. Investment Co would therefore consolidate Services Co and account for Investee Co 1 at fair value through profit or loss.

In the above example, the accounting is clear, however, there can be some judgement required in determining whether or not a subsidiary is a service subsidiary. Accounting by investment entities

Tax optimisation – is this an investment-related service?

‘The Interpretations Committee noted that, according to paragraph BC272 of IFRS 10, the IASB thinks that fair value measurement of all of an investment entity’s subsidiaries would provide the most useful information, except for subsidiaries providing investment-related services or activities. In addition, the Interpretations Committee noted that the IASB had considered requiring an investment entity to consolidate investment entity subsidiaries that are formed for tax purposes, but had decided against this.

The Interpretations Committee noted that one of the characteristics of ‘tax optimisation’ subsidiaries described in the submission is “that there is no activity within the subsidiary”. Accordingly, the Interpretations Committee considers that the parent should not consolidate such subsidiaries, because they do not provide investment-related services or activities, and do not meet the requirements to be consolidated in accordance with paragraph 32 of IFRS 10. The parent should therefore account for such an intermediate subsidiary at fair value.

On the basis of the analysis above, the Interpretations Committee considered that in the light of the existing IFRS requirements, neither an interpretation nor an amendment to a Standard was necessary and consequently decided not to add the issue to its agenda.’

Accounting in separate financial statements Accounting by investment entities

An investment entity’s separate financial statements are its only financial statements if all of its subsidiaries are required to be measured at fair value through profit or loss for the current period and all the comparative periods presented. A parent that is an investment entity does not present consolidated financial statements if it is required by IFRS 10 31 to measure all of its subsidiaries at fair value through profit or loss (IFRS 10 4B).

There is also an exemption for an intermediate parent (article in link) from preparing consolidated financial statements if its parent produces financial statements, in which subsidiaries are consolidated or measured at fair value through profit or loss in accordance with IFRS 10. The following two examples demonstrate how this exemption can apply to investment entity intermediate parent companies.

Intermediate parent is an investment entity

Accounting by investment entitiesIn the following example, Investee Co 1 is an investment entity and Investment Services Co provides investment related services or activities to the group, see structure on the left.

In this example, one would expect Investee Co 1 to consolidate Investment Services Co and Investment Co to apply the consolidation exception and include Investee Co 1 at fair value through profit or loss. However, the intermediate parent is allowed to take the exemption from preparing consolidated financial statements in IFRS 10 4(a)(iv), as long as it meets the conditions described here. When preparing its separate financial statements, Investee Co 1 could account for its investment in Investment Services Co at either cost or fair value as an accounting policy choice.

Intermediate parent is not an investment entity

Accounting by investment entitiesIn the structure on the left, Investment Co is an investment entity that has a controlling interest in Entity 1 (which itself controls Entity 2). Entity 1 and Entity 2 are not investment entities or entities that provide investment related services.

As mentioned above and here, under IFRS 10.1(a)(iv), a parent entity is exempted from preparing consolidated financial statements if it meets certain criteria. One of those criteria is that: “its ultimate or any intermediate parent produces consolidated financial statements that are available for public use and comply with IFRSs”. The IASB have clarified (through the amendments to the investment entity exemption issued in December 2014) that this exemption is also available to parent entities that are subsidiaries of investment entities where the investment entity measures its investments at fair value in accordance with IFRS 10.31.

Accounting for other investments of an investment entity

Investment entities may hold, in addition to controlling interests in other entities, investments in associates, other equity investments, debt assets and investment property. The investment entity exception does not directly affect the accounting for these other investments. However, in order to qualify as an investment entity these other investments will have to be fair-valued wherever required or permitted by IFRSs. Accordingly, the entity would apply:

  • for associates the option in IAS 28 18 that permits a ‘venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds’ to measure associates and joint ventures at fair value through profit or loss in accordance with IFRS 9
  • for investment property, the fair value model in IAS 40.

Other equity and debt investments are covered by IFRS 9. When IFRS 9 is applied, the entity would measure debt investments that are managed on a fair value basis at fair value through profit or loss. It is expected that investment entities would manage their investments on such a fair value basis, although they might also have some financial assets that are not ‘investments’. Other equity investments would also be measured at fair value, although the entity could elect for fair value through other comprehensive income (which would not preclude investment entity status).

Accounting by a non-investment entity parent or investor of an investment entity

Accounting by non-investment entity parents of investment entity subsidiaries, associates and joint ventures will continue to be consolidated in the usual way. However, there can be complexities with how to account for subsidiaries, associates and joint ventures of direct investment entity subsidiaries and these are explained in this section.

Accounting by the parent of an investment entity

A (non-investment) parent entity of an investment entity will continue to consolidate its subsidiaries in the normal way, including any subsidiaries of the investment entity sub-parent. Put another way, the consolidation exception for an investment entity parent does not carry forward into the consolidated financial statements of its higher level parent unless that higher parent is also an investment entity.

Accordingly, investment entity sub-parents will need to perform fair value measurements for the purpose of their own financial statements and also provide consolidation information (for example, a consolidation package) for their higher-level parent’s group financial statements. This is illustrated in the following example:

Non-investment parent entity accounting

Consider the two group structures illustrated below. Both structures include investment entity sub-parents, which have controlling interest investments in other companies. The first group is headed by Investment Co, which is an investment entity and the second by Hold Co which is not an investment entity.

Accounting by investment entities

Application of requirements

For the Investment Co (left-hand) group:

  • Intermediate Investment Co will account for its controlled investments at fair value
  • Investment Co will also account for its investment in Intermediate Investment Co at fair value.

For the Hold Co (right-hand) group:

  • Intermediate Investment Co will account for its controlled investments at fair value
  • Hold Co must consolidate Intermediate Investment Co and its controlled investments.

Accounting by investors of investment entity associates or joint ventures

A (non-investment) entity will continue to account for its share in joint ventures and joint operations that are investment entities using the equity method in the usual way. Questions then arise as to how to account for indirect shares of either subsidiaries or joint ventures or associates of the investment entity joint ventures. This is illustrated in the following group structures:

investors of investment entity associates or joint ventures

In scenario one (the left hand group), Investment Co 1 would account for its investment in Investment Entity JV 1 using the equity method. Investment Entity JV 1 would account for its controlled investments using fair value through profit and loss as required by the investment entity exception. The question arises as to how Investment Co 1 should be accounting for its indirect investment in the controlled investments. As a result of the amendments published in December 2014, Investment Co 1 is allowed to retain the Investment Entity JV accounting and also account for the controlled investments at fair value through profit or loss.

In scenario two (the right hand group), Investment Co 1 would account for its investment in investment entity JV1 using the equity method. Investment Entity JV 1 would account for its associate by applying the requirement in IFRS 10 B85L(b) and electing the exemption from applying the equity method in IAS 28, and hence recognise its investment in the associate at fair value through profit or loss. Investment Co 1 can then apply IAS 28 18 and elect to apply the exemption from the equity method in IAS 28 for its indirect share in the associate. Therefore maintaining the fair value accounting made by Investment Entity JV 1.

Continuous assessment and change of status Accounting by investment entities

A parent entity should reassess whether it has become, or has ceased to be, an investment entity if relevant facts and circumstances change. A change in status is accounted for prospectively, from the date at which the change in status occurs.

Investment entity becoming a non-investment entity [IFRS 10 B100]

For subsidiaries that were measured at fair value in accordance with IFRS 10:

  • IFRS 3 is applied using the fair value of the investment on the date of the change of status as the deemed consideration transferred
  • subsidiaries are consolidated prospectively from that date (comparatives are not restated).

Non-investment entity becoming an investment entity [IFRS 10 B101]

For investments that are controlling interests in another entity:

  • consolidation ceases prospectively from the date of change of status (comparatives are not restated)
  • at that date the entity applies IFRS 10’s requirements on loss of control of a subsidiary:
    • recognises the fair value of the investment
    • records a gain or loss for the difference between this fair value and the carrying value of the previously recognised assets and liabilities (less non-controlling interests)
    • reclassifies amounts recognised in other comprehensive income where required.

Ceasing to be an investment entity Accounting by investment entities

When an investment entity ceases to meet the definition of an investment entity in accordance with IFRS 10, the date this change occurs is treated similarly to a business combination (and becomes the deemed acquisition date). IFRS 3 is applied to any subsidiary that was previously measured at fair value through profit or loss. Therefore the assets and liabilities of the subsidiary are measured at fair value and the difference between the fair value currently recorded and the fair value of the assets and liabilities is recorded as goodwill. The fair value of the subsidiary at the deemed acquisition date represents the transferred deemed consideration when measuring any goodwill (or gain from a bargain purchase) that arises from the deemed acquisition. All subsidiaries are consolidated from the deemed acquisition date and comparatives are not restated.

In the separate financial statements, the parent entity either:

  • accounts for the subsidiary at cost (using the fair value at the date of change in status as the deemed cost); or
  • continues to account for the subsidiary at fair value through profit or loss in accordance with IFRS 9.

Becoming an investment entity

When an entity becomes an investment entity, it ceases consolidation of its subsidiaries at the date of the change in status, (except for any service subsidiaries that are still consolidated). This change is prospective from the date of change in status and comparatives are not restated. The entity applies the loss of control requirements in IFRS 10 to the investment entity. This means the entity:

  • de-recognises the assets and liabilities in the consolidated financial statements
  • recognises the investment at its fair value through profit in accordance with IFRS 9
  • records a gain or loss for the difference between this fair value and the carrying value of the previously recognised assets and liabilities (less non-controlling interests) Accounting by investment entities
  • reclassifies amounts recognised in other comprehensive income where required.

In the separate financial statements, the investment entity recognises the investment at its fair value through profit in accordance with IFRS 9. The difference between the fair value and the previous carrying value is recognised as a gain or loss in profit or loss. Finally, any amounts included in other comprehensive income are recycled to profit or loss.

See also: The IFRS Foundation

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