Investments in associates, jointly controlled entities and subsidiaries

4 May 2020

The economic events surrounding coronavirus will likely have a significant effect on the businesses of associates, and jointly controlled entities and subsidiaries. There is an increased likelihood of impairment and of significant changes in fair value and care will be needed to ensure this is reflected correctly from the perspective of the investor’s accounting.

What does FRS 102 say?

Measurement basis

Investments in associates and jointly controlled entities are measured at cost, fair value, or by applying the equity method of accounting, depending on accounting policy choices and whether individual or consolidated accounts are being prepared. Investments in subsidiaries are measured at cost or fair value in individual investor’s accounts as an accounting policy choice. 
For associates, jointly controlled entities and subsidiaries, measurement of fair value might be carried out using a valuation technique based on unobservable inputs. This will be challenging in the current environment when markets are volatile, and the economic outlook is uncertain.

An investor, that is not a parent, shall, in its individual financial statements, account for all of its investments in associates (and all of its jointly controlled entities) using (FRS 102 14.4, 15.9):

a) the cost model in accordance with paragraphs 14.5 to 14.6 (or 15.10 to 15.11);
b) fair value in accordance with paragraphs 14.9 to 14.10A (or 15.14 to 15.15A); or
c) fair value with changes in fair value recognised in profit or loss.

In consolidated financial statements, investments in associates and jointly controlled entities should be accounted for using the equity method, unless held as part of an investment portfolio, in which case they are measured at fair value through profit and loss. 

In the individual accounts of a parent entity the same accounting policy choice of cost or fair value applies for associates, jointly controlled entities and subsidiaries. 
Impairment

Under the equity accounting method in consolidated accounts, on acquisition of an investment in an associate or jointly controlled entity, any difference (whether positive or negative) between the cost of acquisition and the investor’s share of the fair values of the net identifiable assets of the associate results in notional fair value adjustments, including intangibles, and notional goodwill. (FRS 102.14.8c)

Post-acquisition, the share of profit or losses of the associate or jointly controlled entity is adjusted to account for the additional depreciation or amortisation of these notional assets (including goodwill). Components of the investment in the associate or jointly controlled entity, such as goodwill and intangibles, are not tested separately for impairment. Instead, the impairment test for an investment in an associate or jointly controlled entity is conducted by calculating the recoverable amount of the investment as a single asset. (FRS 102.14.8d)

When the associate or jointly controlled entity has recorded an impairment in its own books, the investor accounts for its share of this loss as part of its normal equity accounting. This does not negate the requirement to conduct an impairment review of investments in associates or jointly controlled assets as a single asset. (FRS 102.14.8)

Equity accounting in consolidated accounts

In applying the equity accounting method, investors are required to use the financial statements of the associate or jointly controlled entity as of the same date as the financial statements of the investor unless it is impracticable to do so. If it is impracticable, the investor uses the most recent available financial statements of the associate or jointly controlled entity, with adjustments made for the effects of any significant transactions or events occurring between the accounting period ends. (FRS 102.14.8f)

In applying the equity accounting method, if the associate or jointly controlled entity uses accounting policies that differ from those of the investor, the investor adjusts the associate’s or jointly controlled entity’s financial statements to reflect its own accounting policies for the purpose of applying the equity method unless it is impracticable to do so. (FRS 102.14.8g)

In applying the equity accounting method, if an investors’ share of losses of an associate or jointly controlled entity equals or exceeds the carrying amount of its investment in the associate or jointly controlled entity, the investor discontinues its share of further losses. After the investor’s interest is reduced to zero, the investor recognises additional losses by a provision only to the extent that the investor has incurred legal or constructive obligations or has made payments on behalf of the associate or jointly controlled entity. If the associate or jointly controlled entity subsequently reports profits, the investor resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised. (FRS 102.14.8h)

Fair value

Investors can measure investments in associates, jointly controlled entities and subsidiaries at fair value in their individual accounts as an accounting policy choice. Additionally, investments in associates and jointly controlled entities held as part of an investment portfolio, are required to be measured at fair value in the consolidated accounts of a parent.

Fair value is measured using assumptions that market participants would use, reflecting market conditions at the measurement date. Use of hindsight or adjusting for what may be viewed as depressed pricing at the measurement date, in light of subsequent changes in market prices, is not permitted. 

The best evidence of fair value is a quoted price for an identical asset (or similar asset) in an active market but it is unlikely that such evidence will be available for investments in associates, jointly controlled entities or subsidiaries. 

When quoted prices are not available, the price in a binding sale agreement or a recent transaction for an identical asset (or similar asset) in an arm’s length transaction should be used. FRS 102 guidance specifically states that, ‘a price may not be a good estimate of fair value if there has been a significant change in economic circumstances between the date of the binding sale agreement or transaction, and the measurement date.’ 

A valuation technique is used to measure fair value in the absence of a quoted price in an active market or in a binding sale agreement or recent transaction.

Practical impact and interpretation for preparers

The outbreak of coronavirus increases the likelihood of impairment reviews and the recognition of impairment losses being required, as set out in the impairment review article.

  • If financial statements of the associate or jointly controlled entity are prepared to an earlier date than the consolidated accounts of the investor, care will be needed to ensure coronavirus’s effect on the assets and liabilities of the associate or jointly controlled entity is understood for the purpose of applying the equity accounting method in the consolidated accounts of the investor.
  • Any significant accounting effects under FRS 102, brought about by coronavirus, will need to be understood and applied to the financial statements of associates and jointly controlled entities for the purpose of applying the equity accounting method in the consolidated accounts of the investor. 
  • There is an increased likelihood that associates, and jointly controlled entities will make losses as a result of coronavirus. Care should be exercised in correctly reflecting these losses for the purpose of applying the equity method of accounting in the consolidated accounts of the investor.
  • For any fair value measurement using evidence based on a transaction before the occurrence of coronavirus, the basis of using the price will need to be reviewed carefully.
  • For reporting periods ending after the outbreak and spread of coronavirus, inputs into valuation techniques should be reviewed carefully to ensure they reflect the economic conditions at the reporting date.
  • For material investments, consideration should be given to making disclosures of any assumptions and estimates used in the measurement of the fair value of investments, unless measurement is based on a quoted price for an identical (or similar) asset in an active market.
  • Fair value is measured using assumptions that market participants would use, reflecting market conditions at the measurement date. Use of hindsight or adjusting for what may be viewed as depressed pricing at the measurement date, in light of subsequent changes in market prices, is not permitted. 
  • Careful consideration will be required of events after the reporting date related to the outbreak and spread of coronavirus to determine the impact on fair value measurement. It is likely that there will be a decline in the fair value of investments, but the measurement of fair value should be based on conditions existing at the reporting date.

Our advice

  • Entities should consider if there are any indicators that their investments in associates, jointly controlled entities and subsidiaries are impaired and ensure they have the necessary information, including the information they need from their investees, to carry out impairment testing if it is required.
  • Entities should consider what information they need to accurately account for their interests in associates and jointly controlled entities using the equity accounting method in their consolidated accounts. Additional care will be needed to ensure investors’ share of the net assets and profits or losses of their associates and jointly controlled entities are based on accurate underlying information, which reflects the accounting impact of coronavirus on their investees. 
  • When measuring fair value of their investments in associates, jointly controlled entities and subsidiaries, investors should ensure that valuations reflect market participants’ assumptions based on information available and conditions at the measurement date. Valuations should incorporate the risk premiums that will arise from the increased uncertainty and other impacts of coronavirus.
  • Entities should consider whether disclosures of key assumptions and estimates should be expanded to include anything relevant to their accounting for investments in associates, jointly controlled entities and subsidiaries, including fair value measurement. 

For further information contact

Paul Merris Paul Merris

Partner, Head of Financial Reporting Advisory

Lee Marshall Lee Marshall

Partner, Head of Accounting and Business Advisory