Accounting Dilemma for Analysts: Associate, Subsidiary, Equity Investments

Investment relationships between companies can be complex, with numerous factors influencing the way these investments are represented in financial accounts. Accounting standards provide guidelines to ensure that the treatment of such investments is consistent and transparent, allowing stakeholders to make informed decisions.

The International Financial Reporting Standards (IFRS) are globally accepted standards that provide such guidelines. However, understanding and applying these standards to the complex scenarios encountered in real-world business relationships can be challenging. One area that often prompts questions is the accounting treatment for investments in subsidiaries, associates, and other equity investments.

This article was written to help stakeholders, from accountants to business owners and investors, understand how to apply these standards in different circumstances. By covering a range of scenarios – investments in listed and unlisted subsidiaries and associates, as well as other equity investments – the article seeks to provide a clear, comprehensive guide to the accounting treatments for various types of investments.

Sure, here is a brief guide to the accounting treatment of investments under IFRS:

1. Investments in Listed Subsidiaries

In the consolidated financial statements, a parent company is required to consolidate its subsidiaries according to IFRS 10 “Consolidated Financial Statements”.
In the parent’s standalone or separate financial statements, investments in subsidiaries can be accounted for either at cost or in accordance with IFRS 9 “Financial Instruments”, according to IAS 27 “Separate Financial Statements”.
If IFRS 9 is applied, the parent can choose to measure its investments at fair value through other comprehensive income (FVTOCI), provided these investments are not held for trading.
This decision must be made on an investment-by-investment basis upon initial recognition and is irrevocable.
Eg. Normally, If the parent company have a listed subsidiary, they have an option to opt for FVTOCI (irrevocable treatment), however in the case of Nepal, most of the company has accounted at cost and not in accordance with IFRS 09.
Eg. Kumari Bank & Kumari Capital; Shivam Cement & Shivam Holdings

2. Investments in Unlisted Subsidiaries

The treatment in consolidated financial statements is the same as for listed subsidiaries, i.e., the consolidation method is used.
In the parent’s standalone financial statements, investments in unlisted subsidiaries can also be accounted for either at cost or according to IFRS 9. (As for IAS 27)
If IFRS 9 is applied, the FVTOCI option can be used if the investment is not held for trading.
No examples of this are present in Nepal.

3. Investments in Listed Associates

Associates are generally accounted for using the equity method according to IAS 28 “Investments in Associates and Joint Ventures” in both consolidated and standalone financial statements.
However, IFRS 9 introduces an exception: an entity may choose to measure its investments in equity instruments at FVTOCI if these investments are not held for trading.
This choice is made on an investment-by-investment basis upon initial recognition and is irrevocable.
Therefore, an entity could potentially choose to measure its investments in listed associates at FVTOCI in its standalone financial statements.
This is an example of the accounting treatment of Sanima Mai Hydropower – FVTOCI

4. Investments in Unlisted Associates

In both consolidated and standalone financial statements, investments in unlisted associates are typically accounted for using the equity method as per IAS 28.
However, similar to listed associates, an entity could choose to measure its investments in unlisted associates at FVTOCI under IFRS 9 in its standalone financial statements, if these investments are not held for trading.

5. Other Equity Investments

Other equity investments (i.e., investments in companies where the investor does not have significant influence or control) are accounted for under IFRS 9.
An entity can choose, at initial recognition on an investment-by-investment basis, to measure these investments at fair value, with changes in fair value recognized either in profit or loss (FVTPL) or in other comprehensive income (FVTOCI) if the investment is not held for trading.

Remember that, in all these cases, dividends from investments measured at FVTOCI are generally recognized in profit or loss, unless they clearly represent a recovery of part of the cost of the investment. For investments under the equity method, dividends received reduce the carrying amount of the investment.

TREATMENT OF DIVIDENDS

Investments in Subsidiaries (Cost or FVTOCI in separate financial statements)
- Cash Dividends: Cash dividends received are recognized as dividend income in the income statement, thereby increasing the company’s profits. Simultaneously, the cash balance on the company’s balance sheet also increases.
- Bonus Dividends: Bonus shares received do not impact the income statement as they do not represent income. Instead, they increase the number of shares held in the subsidiary, but do not change the total cost or value of the investment. The adjustment is made within the equity section of the parent’s balance sheet.
Investments in Associates (Equity Method)
- Cash Dividends: Cash dividends received are seen as a return of investment, which reduces the carrying amount of the investment in the associate on the balance sheet. There is no impact on the income statement. However, the cash balance on the company’s balance sheet increases.
- SHARE OF PROFIT IS ADDED IN INCOME STATEMENT, ONCE THAT HAPPENS, THE OPENING RESERVE IS ALREADY INCREASED, thus to find out the investment value…we have to adjust the dividends from the opening reserve.
- Bonus Dividends: Bonus shares increase the number of shares held in the associate but do not change the carrying amount of the investment under the equity method. The adjustment is made within the equity section of the balance sheet.
Investments at FVTOCI (IFRS 9)
- Cash Dividends: Cash dividends received are recognized in profit or loss unless they clearly represent a recovery of part of the cost of the investment. This means the company’s profits on the income statement increase, and the cash balance on the balance sheet also increases.
- Bonus Dividends: The receipt of bonus shares increases the number of shares held, but this does not impact the total fair value of the investment at the time of the bonus issue. Therefore, there is no immediate impact on the income statement or on the other comprehensive income section of the equity.
Investments at FVTPL (IFRS 9) Cash Dividends: Cash dividends received are recognized in profit or loss, thereby increasing the company’s profits. The cash balance on the company’s balance sheet also increases. Bonus Dividends: The bonus shares increase the number of shares held, but the total fair value of the investment remains the same, leading to a decrease in the fair value per share. There is no immediate impact on the income statement or on the equity.

Bigyan Bhandari