ASBJ Short Paper Series No. 3
Equity Method of Accounting
September 2021

Perspectives on
the Equity Method of Accounting

Accounting Standards Board of Japan

Introduction
1.

The question of whether the equity method of accounting should be viewed as oneline consolidation or a measurement basis 1 has been a long-standing question.
Because the International Accounting Standards Board (IASB) has not directly
addressed this question, diversity exists under IFRS Standards in practice andquestions continue to be submitted to the IFRS Interpretations Committee.

2.

This paper proposes principles that would clarify when to focus on the aspect of oneline consolidation and when to focus on the aspect of a measurement basis to address
the current practical issues arising from applying the equity method of accounting,with the understanding that the existing requirements in IAS 28 Investments in
Associates and Joint Ventures have both aspects of one-line consolidation and ameasurement basis. Constituents in our jurisdiction note that the equity method of
accounting provides useful information but there are practical issues that cannot be
resolved under existing guidance.

Accordingly, this paper is not intended to discuss

whether the equity method of accounting should be viewed as one-line consolidation
or a measurement basis, but rather to propose principles that would address thecurrent practical issues.

Some of the existing requirements in IAS 28 would need

to be amended to incorporate the principles we propose.
3.

This paper is structured as follows:Part A: The Three Main Approaches
In Part A, we describe and present our views on the three main approaches
regarding the equity method of accounting: (1) one-line consolidation, (2) ameasurement basis and (3) a hybrid of the two approaches.
Part B: Our Proposed Principles in Applying the Hybrid Approach1

The term ‘measurement basis’ used in this paper does not refer to that term as defined in paragraph 6.1of the IASB’s Conceptual Framework for Financial Reporting but refers to that term as used by
European Financial Reporting Advisory Group (EFRAG) in EFRAG Short Discussion Series The Equity
Method: A Measurement Basis or One-Line Consolidation? issued in 2014. Paragraph 29 of the
EFRAG paper describes this view as “the equity method is about measurement of an asset rather thanbeing a one-line consolidation”.

Page 2 of 20

Concluding that the equity method of accounting should be viewed as a
hybrid of the two approaches in Part A, in Part B, we propose principles that
could be applied to the hybrid approach.
Part C: Accounting for Consolidations
In Parts A and B of this paper, we present our views based on the requirements
in current IFRS Standards related to the accounting for consolidations.
However, in Part C, we present our views on the current requirements related
to the accounting for consolidations.
4.

This paper focuses on improving how the equity method of accounting is currently
applied.

This paper does not discuss the appropriateness of the scope of entities

to which the equity method of accounting should apply.

We do not discuss

whether the equity method should be applied to both associates and joint ventures;
nor do we discuss the definitions of significant influence and joint control.

Inother words, this paper takes the scope of entities that are to apply the equity methodof accounting as currently required in IFRS Standards.

We believe this isconsistent with the IASB’s current approach to the Equity Method project.

Inaddition, this paper ignores the requirements in IAS 28 related to a venture capitalor a similar organisation.
5.

This paper refers to diversity in practice.

In observing the existence of diversity inpractice, we referred to the guidance provided by large accounting firms.

PART A: The Three Main Approaches

Overview

6.

Part A discusses whether the equity method of accounting should be viewed as oneline consolidation, a measurement basis or a hybrid of the two approaches.

Page 3 of 20

The Equity Method of Accounting as One-Line Consolidation

7.

If the equity method of accounting were to be viewed as one-line consolidation,
applying the equity method of accounting to an associate or joint venture shouldhave the exact same effect on total net assets and profit or loss as if the associate or
joint venture were consolidated.

In other words, the difference between

consolidations and the equity method of accounting can be viewed as a matter ofpresentation, where consolidated entities would present their assets, liabilities,
income and expenses on a gross basis, and entities accounted for under the equity
method of accounting would present their assets, liabilities, income and expenses
on a net basis.
8.

The current requirements under IAS 28 are inconsistent with this view in its purest
form.

Under consolidations, the parent would absorb losses beyond the carrying

value of the investment for its share in the subsidiary 2.

However, under IAS 28,

the investor would not recognise losses in excess of the carrying value of theinvestment unless the investor has legal or constructive obligations to absorb thelosses.

The Equity Method as a Measurement Basis9.

If the equity method of accounting were to be viewed as a measurement basis, theunit of account would be the investment itself, that is, the entire carrying amount of
the net investment would be accounted for as a single asset 3.

The asset may be

impaired and written down to zero, but the investor would not recognise any further
losses unless the investor has obligations to absorb such losses.

2

If non-controlling shareholders exist, those non-controlling shareholders absorb the losses for theirshare in the subsidiary.
3
We use the term 'single asset' in this paper to indicate that the equity method of accounting is appliedwith an asset representing the share of the net assets of the associate or jointly venture as a unit. We
acknowledge the following:
an interest in the associate or joint venture may comprise more than one type of equity instruments
and potential voting rights may be taken into account.

long-term interests that, in substance, form part of the entity's net investment in an associate or joint
venture are taken into account in determining the amounts to recognise losses of an associate or joint
venture; however, the financial instruments are accounted for in accordance with IFRS 9 Financial
Instruments.

Page 4 of 20

10.

The current accounting requirements in IAS 28 are inconsistent with this view in
its purest form.

Paragraph 26 of IAS 28 states that many of the procedures thatare appropriate for the application of the equity method are similar to theconsolidation procedures described in IFRS 10 Consolidated Financial Statements,
and a typical example would be the elimination of unrealised profits or losses fromupstream and downstream transactions.

If the investment were to be viewed as asingle asset, the elimination of such profits or losses would not be required.

The Equity Method as a Hybrid of the Two Approaches

11.

The previous paragraphs illustrate how the two views, in their purest forms, areinconsistent with the current requirements in IAS 28.

The question is whether IAS

28 should be amended so that the accounting would be consistent with one of thetwo approaches mentioned above, or whether IASB should accept the fact that theequity method of accounting is neither of the two views in their purest forms but ahybrid of the two approaches.
12.

We believe that the equity method of accounting is neither of these two approaches
in their purest forms but a hybrid of the two approaches.

Moreover, within the

hybrid approach, we believe that the equity method of accounting is based on oneline consolidation, with a few exceptions.

Our reasons include the following:(a) Neither significant influence nor joint control constitutes control of an investee.
Accordingly, requiring the equity method of accounting to have the same effecton total net assets and profit or loss as if the investor controlled the investee
may not result in a faithful representation of the investment.
(b) However, significant influence or joint control is not obtained by accident.
Management makes deliberate decisions to obtain significant influence or joint
control, taking into account the accounting that will follow.

While significant

influence or joint control does not constitute control of an investee, associates
and joint ventures accounted for using the equity method of accounting arecloser to the investor compared to investments accounted for in accordancewith IFRS 9 and thus warrant accounting that is closer to consolidation.
Page 5 of 20

13.

We also note that EFRAG paper noted that the equity method of accounting has
features of both a consolidation approach and a measurement basis 4.

14.

In our view, when adopting a hybrid approach (and thus the current requirementsin IAS 28) it is necessary to clarify when to place more emphasis on one approachover the other and why.

We believe that the equity method of accounting should

be consistent with one-line consolidation subject to a few exceptions for the reason
set out in paragraph 12 (b) of this paper.

Part B discusses our view on how toapply the hybrid approach.

Part B: Our Proposed Principles in Applying the Hybrid Approach

Overview

15.

Concluding that the equity method of accounting should be viewed as a hybrid of
the two approaches in Part A of this paper, in Part B, we propose principles that
could be applied to the hybrid approach.

In summary, we propose the following

principles:
Principle 1: The unit of account for the interest 5 in an associate or a joint ventureis the interest itself (that is, an investment in a single asset), rather
than the assets and liabilities of the associate or joint venture.

The

investor shall recognise an asset representing its share of the net
assets of the associate or joint venture, and income or expense
representing its share of the net profit or loss of the associate or
joint venture.
Principle 2: Impairment of the interest in the associate or joint venture shall betested against that interest in its entirety.

The carrying amount of4

See footnote 1.
We acknowledge that an interest in the associate or joint venture may comprise more than one type ofequity instruments. However, for simplicity, this paper uses the singular form and refers to a single
asset.

5

Page 6 of 20

the interest may be written down to zero, and no additional
liabilities would be recognised unless:(a) the investor has legal or constructive obligations to absorb thelosses; or(b) the amounts that would otherwise be eliminated (in the case ofgains from downstream transactions or dividends) exceed thecarrying amount of the interest.
Principle 3: Neither significant influence nor joint control constitutes control of
an investee.

Accordingly, the accounting requirements related toconsolidations for the investor’s ownership interests based on theconcept of a group (a parent and its subsidiaries) shall not be carriedover to the accounting requirements related to the equity method.
Principle 4: For issues that are not covered by Principles 1 to 3, the accounting
requirements related to the equity method shall follow theaccounting requirements related to consolidations.
16.

The following paragraphs discuss each Principle in detail.

Principle 1

Principle 1: The unit of account for the interest in an associate or a joint ventureis the interest itself (that is, an investment in a single asset), rather
than the assets and liabilities of the associate or joint venture.

The

investor shall recognise an asset representing its share of the net
assets of the associate or joint venture, and income or expense
representing its share of the net profit or loss of the associate or
joint venture.

Page 7 of 20

Rationale for this Principle

17.

Neither significant influence nor joint control constitutes control of an investee.
Accordingly, unlike consolidation, it would be inappropriate to recognise the fullamount of the individual assets and liabilities of the associate or joint venture.

18.

Proportionate consolidation may be one alternative; however, it is questionable
whether it is appropriate for the investor to recognise its proportionate share of theassets and liabilities of the associate or joint venture that it does not control. On
the other hand, it is clear that the investor controls an interest in the associate or
joint venture.

Accordingly, such interest in an associate or joint venture should berecognised as an asset of the investor.
19.

The asset that the investor recognises represents the investor’s share of the net assetsof the associate or joint venture, and the related income or expense that the investor
recognises represents the investor’s share of the net profit or loss of the associate or
joint venture.

Accordingly, the gains or losses that would be eliminated fromupstream and downstream transactions would be the investor’s share of the gains
or losses.
Implications of this Principle

20.

The implications of Principle 1 can be summarised as follows:(a) The interest in the associate or joint venture would be recognised as a single
asset; the assets and liabilities of the associate or joint venture would not
directly be recognised by the investor.

The recognised asset represents theinvestor’s share of the net assets of the associate or joint venture.
(b) The income or expense from the investment represents the investor’s share of
the net profit or loss of the associate or joint venture.

Gains or losses thatwould be eliminated from upstream and downstream transactions would be theinvestor’s share of such gains or losses.
Potential Changes to IFRS Standards

21.

The implications of Principle 1 are fairly consistent with the current requirementsin IAS 28.
Page 8 of 20

Principle 2

Principle 2: Impairment of the interest in the associate or joint venture shall betested against that interest in its entirety.

The carrying amount of

the interest may be written down to zero, and no additional
liabilities would be recognised unless:(a) the investor has legal or constructive obligations to absorb thelosses; or(b) the amounts that would otherwise be eliminated (in the case ofgains from downstream transactions or dividends) exceed thecarrying amount of the interest.
Rationale for this Principle

22.

Following Principle 1, the interest in the associate or joint venture will be accounted
for as a single asset.

It follows that impairment would be tested against the entire

carrying amount of the net investment as a single asset.

(We assume that the

impairment test would be conducted in accordance with IAS 36 Impairment of
Assets 6.)

In addition, the losses the investor absorbs will be limited to the amountinvested unless the investor has legal or constructive obligations to absorb further
losses.

We note this is one of the main differences between consolidation and theequity method of accounting.
23.

In some cases, the amounts that would otherwise be eliminated may exceed thecarrying amount of the interest in the associate or joint venture.

Examples of suchamounts include:(a) unrealised gains from downstream transactions; and(b) dividends.

6

IAS 28 requires that IFRS 9 be applied to financial instruments that are long-term interests that, in
substance, form part of the entity’s net investment in an associate or joint venture and the entire carrying
amount of the net investment in an associate or joint venture including the long-term interest be tested for
impairment in accordance with IAS 36 as a single asset (paragraphs 14A and 42 of IAS 28).

Page 9 of 20

24.

We observe that diversity exists in the accounting for the amounts in the preceding
paragraph 7:(a) When unrealised gains from downstream transactions exceed the carrying
amount of the interest in the associate or joint venture:(i)some entities reduce the carrying amount to zero and recognise a liability
for the amount that could not be eliminated;(ii)

other entities reduce the carrying amount to zero but do not recognise aliability; if the investee earns a profit in subsequent periods, the carrying
amount would be increased only after adjusting for the gain that had notbeen eliminated; and(iii) yet other entities reduce the carrying amount to zero but do not recognisea liability; any profit the investee earns in subsequent periods is recognised
without adjusting for the gain that had not been eliminated.
(b) When dividends from the investee exceed the carrying amount of theinvestment:(i)some entities reduce the carrying amount to zero and recognise a liability
for the amount that could not be eliminated;(ii)

other entities reduce the carrying amount to zero and do not recognise aliability but a gain for the amount that could not be eliminated; if theinvestee earns a profit in subsequent periods, the carrying amount would
be increased only after adjusting for the gain that had not been eliminated;and(iii) yet other entities reduce the carrying amount to zero and do not recognisea liability but a gain for the amount that could not be eliminated; any profit
the investee earns in subsequent periods is recognised without adjustingfor the gain that had not been eliminated.

7

In September 2014, the IASB amended IFRS 10 and IAS 28. That amendment would have required
any gain or loss resulting from a downstream transaction involving assets that constitute a businessbetween the investor and the associate or joint venture be recognised in full in the investor’s financial
statements (paragraph 31A of IAS 28). However, in December 2015, the IASB decided to defer theeffective date of this amendment indefinitely.

Page 10 of 20

25.

We think a liability should be recognised for both cases for the following reasons:(a) In the case of gains from downstream transactions, recognising a liability
would enable the entity to fully eliminate the gains from downstream
transactions.

If a liability is not recognised, profit or loss will be reduced in

the subsequent period(s).

From the perspective of faithfully representing theincome from the equity method investment, a liability should be recognised.
(b) In the case of dividends, recognising a gain is inconsistent with the notion that
dividends from equity method investments are returns of investments rather
than returns on investments.

From the perspective of faithfully representing

the income from the equity method investment, a liability should be recognised.
26.

We note that in July 2013, the IASB agreed with the IFRS Interpretation
Committee’s recommendation that the entity should eliminate the gain from adownstream transaction to the extent of related investors’ interest in the associate
or joint venture, even if the gain to be eliminated exceeds the carrying amount of
the entity’s investment in the associate or joint venture, and that the remaining gain
in excess of the carrying amount of the entity’s investment in the associate or joint
venture should be presented as a deferred gain 8.

However, in June 2015, the IASB

decided to defer further work on this topic to the Equity Method research project.
27.

We also note that those who are against recognising a liability argue that the gains
from downstream transactions would not meet the definition of a liability as definedin the IASB’s Conceptual Framework.

Implications of this Principle

28.

The implications of Principle 2 can be summarised as follows:(a) Impairment would be tested against the interest in the associate or joint venture
in its entirety (that is, the single asset).
(b) A liability should be recognised when, and only when:(i) the investor has legal or constructive obligations to absorb the losses; or

8

IASB Update July 2013

Page 11 of 20

(ii) the amounts that would otherwise be eliminated exceed the carrying
amount of the investment.
Potential Changes to IFRS Standards

29.

IAS 28 does not provide guidance on the accounting for cases where the amounts
that would otherwise be eliminated exceed the carrying amount of the investment.
Principle 2 would clarify the guidance in IAS 28 for such cases.

Principle 3

Principle 3: Neither significant influence nor joint control constitutes control of
an investee.

Accordingly, the accounting requirements related toconsolidations for the investor’s ownership interests based on theconcept of a group (a parent and its subsidiaries) shall not be carriedover to the accounting requirements related to the equity method.
Rationale for this Principle

30.

The accounting requirements in IFRS 10 and IFRS 3 Business Combinations are
based on the notion that obtaining control of another entity (that is, the investee
becoming a subsidiary and thus part of the group) is a significant economic event.
In the case of step acquisitions, this significant economic event warrants a changein accounting such that all of the investments previously made (regardless ofwhether IFRS 9 or IAS 28 had been applied) would be remeasured at fair value atthe date control is obtained, with any difference in the carrying amount being
recognised in profit or loss.

31.

Neither significant influence nor joint control constitutes control of an investee.
In our view, obtaining significant influence or joint control should not be viewed tobe the same as obtaining control of an investee.

Hence, the accounting

requirements related to consolidations for the investor’s ownership interests basedon the concept of a group should not be carried over to the accounting requirements
related to the equity method.

Page 12 of 20

Implications of this Principle

32.

The implications of Principle 3 can be summarised as follows:(a) When control of an investee is obtained in steps, the investments previously
made (regardless of whether IFRS 9 or IAS 28 had been applied) would be
remeasured at fair value at the date control is obtained, with any difference
recognised in profit or loss 9.

However, when significant influence or joint

control is obtained in steps, the investments previously made may not bemeasured at fair value at the date significant influence or joint control is
obtained 10.
(b) When the parent increases its interest in the subsidiary and that parent continues
to control the subsidiary, the transaction would be viewed as a transaction withowners, and any difference between the consideration paid and the noncontrolling interests reduced would be recognised in equity.

However, when

the investor increases its interest in the associate or joint venture and thatinvestor continues to have significant influence or joint control over the
associate or joint venture, the transaction would not be viewed as a transaction
with owners.
(c) When the parent reduces its interest in the subsidiary and yet that parent
continues to control the subsidiary, the transaction would be viewed as atransaction with owners, and any difference between the consideration received
and the increase in non-controlling interests would be recognised in equity.
However, when the investor reduces its interest in the associate or joint venture
and yet that investor continues to have significant influence or joint control
9

For our view regarding the accounting for consolidations, refer to Part C of this paper.
When significant influence or joint control is obtained in steps, our understanding is that more than one
approach, including (1) the accumulated cost approach and (2) the fair value as deemed cost approach, iscurrently acceptable. Under (1) the accumulated cost approach, the investments previously made would
have been measured at fair value in accordance with IFRS 9, and the changes from the initial cost would
be reversed to measure the investments previously made at their initial costs. Under (2) the fair value as
deemed cost approach, the investments previously made also would have been measured at fair value inaccordance with IFRS 9, but the fair value when significant influence or joint control is obtained isdeemed to be the cost of the investment previously made for the initial application of the equity methodof accounting. Our understanding is that (1) and (2) represent different views on how to carry over thecosts of the investments previously made when significant influence or joint control is obtained, and do
not represent a remeasurement of the previously held investments at the acquisition date fair value asrequired by paragraph 42 of IFRS 3.
10Page 13 of 20

over the associate or joint venture, the transaction would not be viewed as atransaction with owners.
(d) When the parent’s interest changes without any acquisitions or sales of interestsby the parent (for example, when the subsidiary issues new shares to third
parties) and the parent continues to control the subsidiary, any change in theparent’s interest would be recognised in equity.

However, when theinvestor’s interest changes without any acquisitions or sales of interests by theinvestor (for example, when the associate or joint venture issues new shares tothird parties) and the investor continues to have significant influence or joint
control over the associate or joint venture, any increase in the interest would be
accounted for in a manner consistent with acquisitions ((b) above) and any
decrease in the interest would be accounted for in a manner consistent withsales ((c) above).
(e) A group’s share in an investment is the aggregate of the holdings in thatinvestment by the parent and its subsidiaries (that is, the group).

The holdingsin that investment by associates and joint ventures would be ignored.
same thinking applies to investments in the entity’s own shares.

The

When aparent has a subsidiary and that subsidiary holds an interest in the parent, suchinterest would be accounted for as treasury shares when the parent prepares
consolidated financial statements.

However, when the investor has an

associate or joint venture and that associate or joint venture holds an interest in
the investor, such interest would not be accounted for as treasury shares when
the investor prepares consolidated financial statements.

Potential Changes to IFRS Standards

33.

Paragraph 26 of IAS 28 states that many of the procedures that are appropriate forthe application of the equity method are similar to the consolidation procedures
described in IFRS 10.

However, it is unclear which procedures should follow theprocedures in IFRS 10.

Principle 3 would clarify the guidance in IAS 28 byfocusing on the accounting requirements for the investor’s ownership interests thatrefer to the concept of a group.
Page 14 of 20

Principle 4

Principle 4: For issues that are not covered by Principles 1 to 3, the accounting
requirements related to the equity method shall follow theaccounting requirements related to consolidations.
Rationale for this Principle

34.

The equity method of accounting is applied to associates and joint ventures when
the investor has significant influence or joint control.

Because significant

influence or joint control is not obtained by accident but only as a result of
deliberate decisions by management, the existence of such significant influence or
joint control warrants accounting that is closer to consolidation.

The existence ofsignificant influence or joint control indicates the investor’s involvement in the
management of the associate or joint venture, and that the performance of theinvestment should not merely be determined by the change in the fair value of theinvestment.
35.

As discussed earlier in this paper, the current accounting requirements in IAS 28
are inconsistent with one-line consolidation in its purest form.

Yet we are of theview that, subject to a few exceptions that are proposed in this paper, the accounting
requirements related to the equity method generally should be consistent with theaccounting requirements related to consolidations.

Principle 4 is designed tocover residual items that are not covered by other principles.

Because items

covered by Principles 1 to 3 will be relatively limited, we believe that there will bemany issues that would be covered by this principle.
36.

The equity method of accounting is a technique to recognise the investor’s share of
the increase in the net assets of the associate or joint venture as the investor’s
income, which usually comes before the investor receives dividends from theassociate or joint venture.

Prior to IFRS 9, the equity method of accounting was

a technique to recognise income or expense from equity investments earlier thanwhen such investments were measured at historical cost.

On the other hand, IFRS

9 requires equity investments to be measured at fair value (with changes in fairvalue being recognised in either profit or loss or other comprehensive income
Page 15 of 20

(OCI)) and thus the equity method of accounting may not necessarily result inrecognising income or expense from equity investments earlier.

However,

because of the investor’s involvement in the management of the associate or joint
venture, we are of the view that the equity method of accounting continues to be
relevant even after the adoption of IFRS 9.
Implications of this Principle

37.

The implications of Principle 4 can be summarised as follows 11:(a) The investor’s share of profit or loss and OCI of the associate or joint venture
would be recognised in the investor’s profit or loss and OCI, respectively.
(b) The measurement of identifiable net assets of the associate or joint venture
would follow the requirements in IFRS 3. Accordingly, the general principle
on initial recognition would be to use fair value for measurement and theexceptions to recognition and measurement will be those prescribed in IFRS 3.
This would include the requirement to measure contingent consideration at fairvalue.
(c) The concept of “measurement period” in IFRS 3 would also apply to associates
and joint ventures.
(d) Unrealised gains and losses from upstream and downstream transactions would
be eliminated.
(e) Receivables and payables (including loans and borrowings) between theinvestor and the associate or joint venture would be eliminated.
(f) Income and expenses that do not involve the transfer of assets between theinvestor and the associate or joint venture would be eliminated.
(g) When eliminating the unrealised gains from upstream transactions, the carrying
amount of the asset (and not the carrying amount of the equity method
investment) that is held by the investor would be adjusted.

11

For simplicity, the following discussions ignore any tax effects that may arise from the transactions.

Page 16 of 20

(h) When Entity A holds an interest in Entity B and Entity B concurrently holds
an interest in Entity A, such reciprocal interests would be eliminated when theequity method of accounting is applied to either Entity A or Entity B.
38.

Regarding paragraph 37(d) of this paper, in the case of upstream transactions, theeffects on profit or loss attributable to the parent would be the same forconsolidations and the equity method of accounting.

However, in the case ofdownstream transactions, the effects on profit or loss attributable to the parent
would be different.
39.

Regarding paragraph 37(e) of this paper, we observe that the guidance provided bylarge accounting firms suggest that receivables and payables (including loans andborrowings) between the investor and the associate or joint venture should not be
eliminated.

Some note that associates and joint ventures do not form part of thegroup and thus balances against entities outside of the group should not be
eliminated.
40.

However, we are of the view that the investor’s share of the loans or borrowings
should be eliminated against the carrying amount of the investment in the associate
or joint venture.

If we follow the argument in the previous paragraph, transactions

with associates and joint ventures that give rise income and expenses also should
not be eliminated, which would be inconsistent with the view that many hold,including the large accounting firms.
41.

Consider the following example.
CU1,000.

The net assets of the associate are valued at

The investor holds a 30% interest in the associate, valued at CU300.

The investor also has a loan to the associate, valued at CU100.
42.

For those entities that eliminate the receivables and payables between the investor
and the associate or joint venture, the loan balance would be reduced by CU30
(CU100x30%).

Because this would increase the net assets of the associate, thecarrying amount of the associate would increase by CU30.
43.

When an entity eliminates the receivables and payables between the investor andthe associate or joint venture, the investor’s receivables (payables) will decrease

Page 17 of 20

and the carrying amount of the investment in the associate or joint venture will
increase (decrease) by the same amount.
44.

Regarding paragraph 37(f) of this paper, we observe that diversity exists in practice
regarding the elimination of income and expenses that do not involve the transfer
of assets between the investor and the associate or joint venture.

Typical examples

include interest and services. Some entities eliminate the investor’s share of theincome (expense) against the investor’s share of the profit or loss of the associate
or joint venture.
45.

Other entities do not make this adjustment.

Consider the following example.
CU1,000.

The net assets of the associate are valued at

The investor holds a 30% interest in the associate, valued at CU300.

The investor receives services from the associate and incurs expenses valued at
CU100.
46.

For those entities that eliminate the income and expenses between the investor andthe associate or joint venture, the investor’s expenses would be reduced by CU30
(CU100x30%).

Because this would decrease the service revenue and thus the

profit or loss of the associate, the investor’s share in the profit or loss of theassociate would decrease by CU30.
47.

Applying the principles we propose in this paper, the adjustment will be made.

48.

Regarding paragraph 37(g) of this paper, we observe that diversity exists in practice
regarding how the unrealised gains from upstream transactions are eliminated.

In

an upstream transaction, the unrealised gain is included in the carrying amount of
the asset held by the investor. Some entities eliminate the investor’s share of theunrealised gains against the asset (such as inventory or property, plant andequipment) it purchased from the associate or joint venture.

Other entities

eliminate the investor’s share of the unrealised gains against the carrying amountof the investment in the associate or joint venture.
49.

Consider the following example.

The investor holds a 30% interest in theassociate, valued at CU300. The investor purchases property from the associate,
which includes unrealised gains valued at CU100.

Page 18 of 20

50.

For those entities that adjust the carrying amount of the asset that the investor
purchased from the associate or joint venture , the carrying amount of the property
is reduced by CU30 (CU100x30%).

For those entities that adjust the carrying

amount of the investment in the associate or joint venture, the carrying amount isreduced by CU30.
51.

Applying the principles we propose in this paper, the carrying amount of the asset
purchased from the associate or joint venture will be adjusted.

Potential Changes to IFRS Standards

52.

Principle 4 would clarify the guidance in IAS 28 by stating that, unless Principles
1 to 3 apply, the equity method of accounting should follow the accounting
requirements related to consolidations.

While many entities currently may noteliminate the investor’s share of the loans or borrowings against the carrying
amount of the investment in the associate or joint venture, elimination would beconsistent with our view.

Part C: Accounting for Consolidations
53.

In Parts A and B of this paper, we have taken the requirements related to theaccounting for consolidations as granted.

However, in Part C, we present ourviews on the current requirements related to the accounting for consolidations.
54.

As noted in paragraph 30 of this paper, the requirements in IFRS 10 and IFRS 3 arebased on the notion that obtaining control of another entity (that is, the investee
becoming a subsidiary) is a significant economic event that warrants a change inaccounting such that all of the investments previously made would be remeasured
at fair value at the acquisition date, with any difference recognised in profit or loss.

55.

We do not believe this accounting treatment represents the event faithfully, because
the required accounting would have the same effect as if the entity sells theinvestments previously made at fair value at the acquisition date. The fact is thatthe investments previously made have not been sold.

It would be difficult to say

Page 19 of 20

that the faithful representation of an additional purchase of shares would involve
the accounting for the sales of the previously held shares.
56.

Accordingly, in the case of step acquisitions, we are of the view that investments
previously made should not be remeasured when the investor obtains control.
Instead, we think that the carrying amounts of the investments should be carried
over.

[End of Document]

Page 20 of 20