Accounting for Investments in Associates and Subsidiaries

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Accounting for Investments in Associates and
Subsidiaries
Presented by Amit Garg
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Summary - Accounting for investments in US GAAP
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ConsolidationAssociates - Definition

• Associate
• An enterprise in which the investor has
  significant influence and which is neither a
  subsidiary nor a joint venture of the investor.
• Significant Influence
• The power to participate in the financial and
  operating policy decisions of the investee but is
  not control or joint control over those policies.
  
• Significant influence is presumed to exist If an
  investor holds, directly or indirectly (eg.
  through subsidiaries), 20 per cent or more of the
  voting power of the investee unless it can be
  clearly demonstrated that this is not the case.
• Should Potential equity shares be taken into
  consideration for determining the 20 threshold?
• Under IFRS (IAS 28) Yes.
• US GAAP (APB18) and Indian GAAP (ASI 18) - No .

US GAAP does not differentiate between Associate
and JV
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ConsolidationSubsidiaries - Definition

• Indian GAAP
• Based on controlling interest, control directly
  or indirectly through subsidiary (ies), by the
  virtue of holding the majority of voting shares
  or control over the board of directors.
• IFRS
• Based on voting control or power to govern.
• The existence of currently exercisable potential
  voting rights is also taken into consideration.
  SPEs also need to be consolidated.
• US GAAP
• Controlling interest through majority ownership
  of voting shares or by contract.
• Consolidate variable interest entities (VIEs) in
  which a parent does not have voting control but
  absorbs the majority of losses or returns.

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Consolidation Accounting for
Investments in Associates
US GAAP Equity Method
Discontinue using equity method only 3 possible
circumstances
Investor loses its ability to exercise
significant influence
The percentage of voting stock in the investee
falls below 20
The associate has to be consolidated
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Equity Method

• APB Opinion Number 18 covers the accounting,
  reporting, and disclosures under the equity
  method to account for investments in other
  companies. The investor is the owner and the
  investee is the company owned.
• The equity method is used if
• An investor owns between 20 and 50 of the
  investees voting common stock.
• The investor owns less than 20 of the investees
  voting common stock but has effective control
  (significant influence).
• Significant influence may be indicated by a
  number of factors,
• including substantial intercompany transactions,
• exchanges of executives between investor and
  investee,
• investors significant input in the investees
  decision-making process,
• investors representation on the investees board
  of directors,
• investees dependence on investor (e.g.,
  operational, technological, or financial
  support), and
• substantial ownership of the investee by investor
  relative to other widely disbursed shareholder
  interests.

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Equity Method

• Applicable to corporate joint ventures and to
  investments with less than majority ownership
  (20 - 50) provided that
• The investment is long-term.
• The investor has the ability to exercise
  significant influence over the investee's
  operations and financial policies.
• The carrying amount of an investment under the
  equity method is initially recorded at cost and
  adjusted to recognize the investor's share of the
  earnings or losses of the investee subsequent to
  the date of investment.
• Dividends are applied as a reduction of the
  carrying amount of the investment.

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Equity Method

• Change in Ownership
• If ownership falls below 20, or if the investor
  loses effective control over the investee,
• the investor should stop recording the investees
  earnings.
• the equity method is discontinued, but the
  balance in the investment account is retained.
• the market value method (under FASB 115) will
  then be applied in the future.
• If the investor increases its ownership in the
  investee to 20 or more (e.g., 30),
• the equity method should be used for current and
  future years.
• the effect of using the equity method instead of
  the market value method on previous years at the
  old percentage (e.g., 10) should be recognized
  as a retroactive adjustment to retained earnings
  and other affected accounts (e.g., investment in
  investee).
• the retroactive adjustment on the investment,
  earnings, and retained earnings should be applied
  in a similar way as a step by- step acquisition
  of a subsidiary.

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Consolidation

• FAS 94 requires all majority-owned subsidiaries
  (through direct or indirect ownership of a
  majority voting interest) to be consolidated
  unless
• Control does not rest with majority owner
• Definition of control
• the ability of an entity to direct the policies
  and management that guide the ongoing activities
  of another entity so as to increase its benefits
  and limit its losses from that other entitys
  activities
• it is decision-making ability that is not shared
  with others

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Consolidation - Minority Rights

• The issue of whether consolidation is appropriate
  when one shareholder has a controlling financial
  interest in another entity via a majority voting
  interest (over 50), but the minority shareholder
  has certain veto rights.
• It defines two types of minority rights
• Protective rights
• Substantive participating rights
• Protective rights do not overcome the presumption
  of control, whereas substantive participating
  rights do, and therefore they preclude
  consolidation

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Consolidation Exceptions to use of Equity
Method Indian GAAP
In case the associate is not consolidated, it
should be accounted for as an investment under AS
13.
Near Future means a period not exceeding 12
months unless a longer period can be justified on
the basis of facts and circumstances.
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Consolidation Exclusions from
Consolidation Subsidiaries - IFRS
DISPOSAL
LONG TERM RESTRICTION
MATERIALITY
DISSIMILAR ACTIVITIES
No exclusion Severe long term restrictions apply
to the Subsidiary, which significantly impair Ss
ability to transfer funds to P (i.e. liquidation)
No exclusion because Ss business activities are
dissimilar from those of the rest of the group
No exclusion S was bought and is being held
solely for the purpose of resale.
No exclusion applies (but IAS apply only to
material items)
Do not exclude 2 or more subsidiaries who
together are material
Excluded from consolidation only for annual
periods ending up to December 31, 2004
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Consolidation Exclusions from
Consolidation Subsidiaries - IFRS

• Under IFRS, a parent may avoid consolidation if
• the parent is a wholly owned subsidiary or a
  partially owned subsidiary of another entity and
  its other owners, including those not entitled to
  vote, have been informed about and do not object
  to the parent not preparing consolidated
  financial statements
• the parent is neither listed nor it is in the
  process of listing
• the ultimate or any intermediate parent of the
  parent produces IFRS compliant consolidated
  financial statements
• Recent Changes
• Temporary control (unless the intended period of
  holding is less than12 months) is not a
  justification for non consolidation.
• Severe long term restrictions to transfer funds
  to the parent are not a justification for non
  consolidation.
• Equity compensation plans need to be consolidated
  for annual periods beginning on or after
  January1, 2005.

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Consolidation Exclusions from
Consolidation - Subsidiaries

• Indian GAAP
• If there are severe long-term restrictions on
  transfer of funds to the parent or
• the subsidiary is acquired and held for re-sale
  i.e. temporary control.
• US GAAP
• A majority owned subsidiary shall not be
  consolidated if control does not rest with the
  majority owner, for example
• if the subsidiary is in legal reorganization or
  in bankruptcy or
• operates under foreign exchange restrictions,
  controls, or
• other governmentally imposed uncertainties so
  severe that they cast significant doubt on the
  parent's ability to control the subsidiary.

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Consolidation Fair
Value Vs. Book Value Accounting
Consolidation Goodwill IFRS 1st time
consolidation Tested for mandatory at Fair
Value impairment annually Cannot be
amortized US GAAP 1st time consolidation Teste
d for mandatory at Fair Value impairment
annually Cannot be amortized Indian
GAAP Generally Can be amortized at Book Value
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Disclosure Requirements
US GAAP
IFRS - IAS
Indian GAAP
Investments in associates accounted for using the
equity method should be classified as long-term
investments and disclosed separately in the
consolidated balance sheet. The investors share
of the profits or losses of such investments
should be disclosed separately in the
consolidated statement of profit and loss. The
investors share of any extraordinary or prior
period items should also be separately disclosed.
Investments in associates accounted for using the
equity method shall be classified as non-current
assets. The investor's share of the profit or
loss of such associates, and the carrying amount
of those investments, shall be separately
disclosed. The investor's share of any
discontinuing operations of such associates shall
also be separately disclosed.
Financial statements of an investor should
disclose , in notes to financial statements, or
in separate statements or schedules (1) the name
of each investee and percentage of ownership of
common stock, (2) the accounting policies of the
investor with respect to investments in common
stock, and (3) the difference, if any, between
the amount at which an investment is carried and
the amount of underlying equity in net assets and
the accounting treatment of the difference.
For all jointly controlled entities together the
investor should disclose certain summarised
asset, liability, income and expense information