430 Part · Financial reporting in practice IAS 27 makes no reference to the consolidation of quasi-subsidiaries which, as we have seen in Chapter 9, is required by FRS Reporting the Substance of Transactions, in the UK However Interpretation SIC 12,43 Consolidation – Special Purpose Entities (June 1998), does require the consolidation of such entities under the control of the parent and the existence of this requirement undoubtedly boosted the standing of the IASB when the US corporation Enron collapsed in 2001 after failing to consolidate such Special Purpose Entities, a procedure which appeared not to be necessary under the voluminous US GAAP! The mechanics of consolidation specified in international accounting standards are very similar to those in the UK However IAS 22, Business Combinations, which we examined in the previous chapter, introduces a fundamental difference in the way in which assets, liabilities and minority interests are measured when using the acquisition method in consolidated financial statements which we will now explain and illustrate In this section of the chapter we have discussed the acquisition method of accounting and have, in particular, explained the need to use fair value, or more precisely in the UK context value to the business, in order to arrive at the historical cost of the separately identified assets and liabilities of a subsidiary to be included in the consolidated financial statements Although IAS 22 and FRS use the same term, ‘fair value’, IAS 22 actually requires the use of fair values while FRS Fair Values in Acquisition Accounting, requires the use of the concept known as value to the business.44 Leaving this difference on one side, FRS requires us to measure all of the assets and liabilities of a subsidiary at their fair values Any minority interest in the subsidiary will then be measured as the relevant proportion of the aggregate of those fair values While this is the allowed alternative treatment under IAS 22, it is not the benchmark treatment The benchmark treatment requires the use of fair values to the extent to which the subsidiary is owned by the group but requires that the minority interest be based upon the book values of assets and liabilities in the balance sheet of the subsidiary at the date of acquisition This is best illustrated by means of an example Let us suppose that S plc acquires a 90 per cent interest in T plc The aggregate book value of the net assets in the balance sheet of T at the date of acquisition is £400 000 and the sum of the fair values of those net assets is £600 000 In accordance with UK practice and the allowed alternative treatment of the international accounting standard, the net assets would be shown at £600 000 and the minority interest would be shown at £60 000, that is 10 per cent of £600 000 However, under the benchmark treatment of IAS 22, the net assets and minority interest would be calculated as follows: Carrying value of net assets: S’s interest 90% of £600 000 Minority interest 10% of £400 000 Minority interest at date of acquisition 10% of £400 000 43 44 £ 540 000 40 000 –––––––– 580 000 –––––––– –––––––– 40 000 ––––––– ––––––– The Standing Interpretations Committee (SIC) was formed by the IASC in January 1997 and reconstituted in December 2001 Its role is to interpret international standards and provide timely guidance on financial reporting issues and it has issued some 33 Interpretations, which carry the prefix SIC As we explained in Chapter 3, its name has now been changed to the International Financial Reporting Interpretations Committee FRS 7, Para 45 Chapter 14 · Investments and groups This benchmark treatment results in strange carrying values for the individual assets and liabilities of the subsidiary in the consolidated financial statements and makes subsequent accounting for the group extremely complicated However, it is the method which has long been part of US GAAP and became the benchmark treatment of IAS 22 in spite of considerable opposition from other countries As we explained in Chapter 13, IAS 22 is at present under review and it is hoped that the benchmark treatment of that standard will disappear There is no doubt in the minds of the authors that the allowed alternative treatment of IAS 22, that is the UK treatment, results in the provision of more sensible figures for users of consolidated financial statements Summary In this chapter, we first examined the accounting treatment of investments in the financial statements of the investing company and then looked in much more detail at the subject of accounting for subsidiaries In the first section, we identified investments which give different levels of influence over the investee These range from, at one end of the spectrum, a passive or simple investment through associates and joint ventures to investments which are sufficient to give control and hence create a parent/subsidiary relationship, We have seen that, in the UK, the rules for the treatment of all these investments in the investor’s single-entity financial statements are the same while, under international accounting standards, the present treatment varies depending upon the level of influence which the investment carries We have seen that changes in the international rules have been proposed which would prohibit the use of the equity method in the investor’s single-entity financial statements In the second section, we explored the circumstances when consolidated financial statements must be prepared and when subsidiaries must be excluded from those consolidated financial statements We then examined the mechanics of consolidation using the acquisition method of accounting We concentrated heavily on the treatment of the acquisition of a new subsidiary, with the need to use fair values to arrive at the ‘historical costs’ of the assets and liabilities acquired, and on the disposal of shares in subsidiaries We saw that the ASB and the IASB interpret the term fair values in different ways and we have pointed out that UK practice adopts the allowed alternative treatment for the use of fair values, rather than the benchmark treatment of IAS 22 Both IAS 22 and IAS 27 are being revised and, while no change to the concept of fair value is expected, it seems likely that the benchmark treatment of fair values and minority interests will not survive the reviews Recommended reading G.C Baxter and J.C Spinney, ‘A closer look at consolidated financial statement theory’, CA Magazine, January and February 1975 R Bryant, Developments in group accounts, 4th edn, Accountants Digest No 425, ICAEW, London, 2000 S.J Gray (ed.), International Group Accounting: Issues in European Harmonization, 2nd edn, Routledge, London, 1993 S.M McKinnon, Consolidated Accounts: The Seventh EEC Directive, A.D.H Newham (ed.), Arthur Young McClelland Moores, London, 1983 431 432 Part · Financial reporting in practice C Nobes, Some Practical and Theoretical Problems of Group Accounting, Deloitte Haskins & Sells, London, 1986 A Simmonds, A Mackenzie and K Wild, Accounting for Subsidiary Undertakings, Accountants Digest No 288, ICAEW, London, Autumn 1992 C Swinson, Group Accounting, Butterworths, London, 1993 P.A Taylor, Consolidated Financial Reporting, Paul Chapman, London, 1996 In addition to the above, readers are referred to the latest edition of UK and International GAAP by Ernst & Young, which provides much greater detailed coverage of this and other topics in this book At the time of writing the most recent edition is the 7th, A Wilson, M Davies, M Curtis and G Wilkinson-Riddle (eds), Butterworths Tolley, London 2001 The relevant chapters are and 14 Questions 14.1 The accountancy profession has developed a range of techniques to measure and present the effects of one company owning shares in another company Briefly describe each of these techniques and how the resulting information might best be presented (The Companies Act 1985 disclosure requirements are not required.) ACCA Level 2, The Regulatory Framework of Accounting, December 1986 (20 marks) 14.2 You are group financial accountant of a diverse group of companies The board of directors has instructed you to exclude from the consolidated financial statements the results of some loss-making subsidiaries as they believe inclusion will distort the performance of other more profitable subsidiaries You are required to write a memorandum to the board of directors explaining the circumstances when a subsidiary can be excluded and the accounting treatment of such excluded subsidiaries CIMA, Advanced Financial Accounting, November 1993 (15 marks) 14.3 Fair value is a concept underlying external financial reporting You are required (a) to explain why fair value accounting is required; (b) to explain how the fair value concept is applied; (c) to list three areas of application of fair value accounting CIMA, Advanced Financial Accounting, November 1991 14.4 Relevant balance sheets as at 31 March 1994 are set out opposite: (4 marks) (5 marks) (6 marks) (15 marks) Chapter 14 · Investments and groups Tangible fixed assets Investments Shares in Kasbah (at cost) Shares in Fortran (at cost) Current assets Stock Cash Creditors: amounts falling due within one year Net current assets Total assets less current liabilities Capital and reserves Called up share capital Ordinary £1 shares 10% £1 Preference shares Revaluation reserve Profit and loss reserve £000 Jasmin (Holdings) plc 289 400 £000 Kasbah plc 91 800 £000 Fortran plc 600 97 600 000 ––––––– 395 000 ––––––– 285 600 319 000 ––––––– 604 600 ––––––– 151 400 500 ––––––– 151 900 ––––––– 600 800 –––––– 400 –––––– 289 600 ––––––– 315 000 ––––––– ––––––– 710 000 ––––––– ––––––– 238 500 ––––––– (86 600) ––––––– ––––––– 200 ––––––– ––––––– 200 –––––– 200 –––––– –––––– 14 800 –––––– –––––– 60 000 20 000 000 10 000 40 000 610 000 ––––––– 710 000 ––––––– ––––––– (18 800) ––––––– 200 ––––––– ––––––– 200 600 –––––– 14 800 –––––– –––––– You have recently been appointed chief accountant of Jasmin (Holdings) plc and are about to prepare the group balance sheet at 31 March 1994 The following points are relevant to the preparation of those accounts (a) Jasmin (Holdings) plc owns 90% of the ordinary £1 shares and 20% of the 10% £1 preference shares of Kasbah plc On April 1993 Jasmin (Holdings) plc paid £96 million for the ordinary £1 shares and £1.6 million for the 10% £1 preference shares when Kasbah’s reserves were a credit balance of £45 million (b) Jasmin (Holdings) plc sells part of its output to Kasbah plc The stock of Kasbah plc on 31 March 1994 includes £1.2 million of stock purchased from Jasmin (Holdings) plc at cost plus one-third (c) The policy of the group is to revalue its tangible fixed assets on a yearly basis However the directors of Kasbah plc have always resisted this policy preferring to show tangible fixed assets at historical cost The market value of the tangible fixed assets of Kasbah plc at 31 March 1994 is £90 million The directors of Jasmin (Holdings) plc wish you to follow the requirements of FRS ‘Accounting for Subsidiary Undertakings’ in respect of the value of tangible fixed assets to be included in the group accounts (d) The ordinary £1 shares of Fortran plc are split into million ‘A’ ordinary £1 shares and million ‘B’ ordinary £1 shares Holders of ‘A’ shares are assigned vote and holders of ‘B’ ordinary shares are assigned votes per share On April 1993 Jasmin (Holdings) plc acquired 80% of the ‘A’ ordinary shares and 10% of the ‘B’ ordinary shares when the profit and loss reserve of Fortran plc was £1.6 million and the revaluation reserve 433 434 Part · Financial reporting in practice was £2 million The ‘A’ ordinary shares and ‘B’ ordinary shares carry equal rights to share in the company’s profit and losses (e) The fair values of Kasbah plc and Fortran plc were not materially different from their book values at the time of acquisition of their shares by Jasmin (Holdings) plc (f) Goodwill arising on acquisition is amortised over five years (g) Kasbah plc has paid its preference dividend for the current year but no other dividends are proposed by the group companies The preference dividend was paid shortly after the interim results of Kasbah plc were announced and was deemed to be a legal dividend by the auditors (h) Because of its substantial losses during the period, the directors of Jasmin (Holdings) plc wish to exclude the financial statements of Kasbah plc from the group accounts on the grounds that Kasbah plc’s output is not similar to that of Jasmin (Holdings) plc and that the resultant accounts therefore would be misleading Jasmin (Holdings) plc produces synthetic yarn and Kasbah plc produces garments Required (a) List the conditions for exclusion of subsidiaries from consolidation for the directors of Jasmin (Holdings) plc and state whether Kasbah plc may be excluded on these grounds (4 marks) (b) Prepare a consolidated balance sheet for Jasmin (Holdings) Group plc for the year ending 31 March 1994 (All calculations should be made to the nearest thousand pounds.) (18 marks) (c) Comment briefly on the possible implications of the size of Kasbah plc’s losses for the year for the group accounts and the individual accounts of Jasmin (Holdings) plc (3 marks) ACCA, Accounting and Audit Practice, June 1994 (25 marks) 14.5 Balmoral plc acquired 75% of the ordinary share capital and 30% of the preference share capital of Glenshee Ltd for £2 million on November 1994 The draft profit and loss accounts for the companies for the year ended 31 October 1998 were: Turnover Changes in stocks of finished goods and work-in-progress Own work capitalised Raw materials and consumables Staff costs Depreciation Profit before taxation Taxation Profit after taxation Balmoral plc £000 2500 200 150 (1000) (400) (350) ––––– 1100 (340) ––––– 760 ––––– ––––– Glenshee Ltd £000 800 (100) – (300) (50) (110) –––– 240 (70) –––– 170 –––– –––– Chapter 14 · Investments and groups Additional information (1) The share capital and reserves of Glenshee Ltd at November 1994 were: £000 1500 500 100 400 Ordinary shares of £1 each 10% preference shares of £1 each Share premium account Profit and loss account There have been no subsequent changes to the share capital (2) The share capital of Balmoral plc comprises £2 million of 50p ordinary shares (3) The fair value of Glenshee Ltd’s fixed assets was £200 000 higher than their net book value at November 1994 and they have a useful economic life of 10 years (4) On 31 July 1998, Glenshee Ltd sold goods to Balmoral plc for £50 000 on the basis of cost plus a mark-up of one-third By 31 October 1998, £40 000 of the goods remained in Balmoral plc’s stock (5) Neither company has paid dividends in the year but both have proposed a final ordinary dividend of 5p per share and Glenshee Ltd proposes to pay the preference dividend in full These proposed dividends are yet to be accounted for (6) Any goodwill arising is to be amortised over 10 years Requirements (a) Prepare the consolidated profit and loss account of Balmoral plc for the year ended 31 October 1998 (10 marks) (b) Discuss the benefits of consolidated accounts to the users of published financial statements (5 marks) ICAEW, Financial Reporting, December 1998 (15 marks) 14.6 Highland plc owns two subsidiaries acquired as follows: July 1991 80% of Aviemore Ltd for £5 million when the book value of the net assets of Aviemore Ltd was £4 million 30 November 1997 65% of Buchan Ltd for £2 million when the book value of the net assets of Buchan Ltd was £1.35 million The companies’ profit and loss accounts for the year ended 31 March 1998 were: Sales Cost of sales Gross profit Net operating expenses Other income Interest payable and similar charges Profit/(loss) before taxation Taxation Profit/(loss) after taxation Dividends proposed Highland plc £000 5000 (3000) –––––– 2000 (1000) 230 Aviemore Ltd £000 3000 (2300) –––––– 700 (500) – Buchan Ltd £000 2910 (2820) ––––– 90 (150) – – –––––– 1230 (300) –––––– 930 (200) –––––– 730 –––––– –––––– (50) ––––– 150 (50) ––––– 100 (50) ––––– 50 ––––– ––––– (210) ––––– (270) – ––––– (270) – ––––– (270) ––––– ––––– 435 436 Part · Financial reporting in practice Additional information (1) On April 1997, Buchan Ltd issued £2.1 million 10% loan stock to Highland plc Interest is payable twice yearly on October and April Highland plc has accounted for the interest received on October 1997 only (2) On July 1997, Aviemore Ltd sold a freehold property to Highland plc for £800 000 (land element – £300 000) The property originally cost £900 000 (land element – £100 000) on July 1987 The property’s total useful economic life was 50 years on July 1987 and there has been no change in the useful economic life since Aviemore Ltd has credited the profit on disposal to ‘Net operating expenses’ (3) The fixed assets of Buchan Ltd on 30 November 1997 were valued at £500 000 (book value £350 000) and were acquired in April 1997 The fixed assets have a total useful economic life of ten years Buchan Ltd has not adjusted its accounting records to reflect fair values (4) All companies use the straight-line method of depreciation and charge a full year’s depreciation in the year of acquisition and none in the year of disposal (5) Highland plc charges Aviemore Ltd an annual fee of £85 000 for management services and this has been included in ‘Other income’ (6) Highland plc has accounted for its dividend receivable from Aviemore Ltd in ‘Other income’ (7) It is group policy to amortise goodwill arising on acquisitions over ten years Requirement Prepare the consolidated profit and loss account for Highland plc for the year ended 31 March 1998 ICAEW, Financial Reporting, May 1998 (13 marks) 14.7 You are the management accountant of Complex plc, a listed company with a number of subsidiaries located throughout the United Kingdom Your assistant has prepared the first draft of the financial statements of the group for the year ended 31 August 1999 The draft statements show a group profit before taxation of £40 million She has written you a memorandum concerning two complex transactions which have arisen during the year The memorandum outlines the key elements of each transaction and suggests the appropriate treatment Transaction On March 1999, Complex plc purchased 75% of the equity share capital of Easy Ltd for a total cash price of £60 million The Directors of Easy Ltd prepared a balance sheet of the company at March 1999 The total of net assets as shown in this balance sheet was £66 million However, the net assets of Easy Ltd were reckoned to have a fair value to the Complex group of £72 million in total The Directors of Complex plc considered that a group reorganisation would be necessary because of the acquisition of Easy Ltd and that the cost would be £4 million This reorganisation was completed by 31 August 1999 Your assistant has computed the goodwill on consolidation of Easy Ltd shown opposite Chapter 14 · Investments and groups £ million Fair value of investment Fair value of net assets Less: reorganisation provision £ million 60 72 (4) ––– 68 ––– Group share Goodwill relating to a 75% investment 25 Goodwill relating to a 25% investment ( ––– ) 75 (51) ––– ––– –––– Your assistant has recognised total goodwill of £12 million (£9 million + £3 million) The goodwill attributable to the minority shareholders (£3 million) has been credited to the minority interest account The reorganisation costs of £4 million have been written off against the provision which was created as part of the fair value exercise Transaction On 15 May 1999, Complex plc disposed of one of its subsidiaries – Redundant Ltd Complex plc had owned 100% of the shares in Redundant Ltd prior to disposal The goodwill arising on the original consolidation of Redundant Ltd had been written off to reserves in line with the Accounting Standard in force at that time This goodwill amounted to £5 million The subsidiary acted as a retail outlet for one of the product lines of the group Following the disposal, the group reorganised the retail distribution of its products and the overall output of the group was not significantly affected The loss on disposal of the subsidiary amounted to £10 million before taxation Your assistant proposes to show this loss as an exceptional item under discontinued operations on the grounds that the subsidiary has been disposed of and its results are clearly identifiable The loss on disposal has been computed as follows: Sales proceeds Share of net assets at the date of disposal Loss on disposal £ million 15 (25) –– (10) –– Your assistant has noted that unless the goodwill had previously been written off, the loss on disposal would have been even greater Requirements Draft a reply to your assistant which evaluates the suggested treatment and recommends changes where relevant In each case, your reply should refer to the provisions of relevant Accounting Standards and explain the rationale behind such provisions The allocation of marks is as follows: Transaction (10 marks) Transaction (8 marks) CIMA, Financial Reporting, November 1999 (18 marks) 437 438 Part · Financial reporting in practice 14.8 Mull plc acquired shares in two companies as follows: Skye Ltd Ordinary shares – million acquired on June 1996 for £4.50 each Preference shares – £500000 8% redeemable preference shares acquired, at par, on June 1996 At the date of acquisition the retained profits of Skye Ltd were £10 million Arran Ltd Ordinary shares – million acquired on June 1998 for £6 each At the date of acquisition the retained profits of Arran Ltd were £5 million and the revaluation reserve was £11 million The draft balance sheets for the above companies at 31 May 1999 show: Mull plc £000 Creditors: amounts falling due within one year Bank overdraft Creditors Corporation tax payable Proposed dividends Net current assets Net assets Capital and reserves Called up share capital Ordinary shares of £1 each 8% Redeemable preference shares Revaluation reserve Profit and loss account 20 000 – 900 – – –––––– 25 900 –––––– 10 000 700 200 – – –––––– 20 900 –––––– 19 000 22 500 000 –––––– 42 500 –––––– Current assets Stock Debtors Cash in hand and at bank Arran Ltd £000 40 000 – 10 500 36 500 000 –––––– 93 000 –––––– Fixed assets Freehold property Plant and equipment Fixtures and fittings Investment in Skye Ltd Investment in Arran Ltd Skye Ltd £000 13 000 000 570 –––––– 20 570 –––––– 11 000 10 000 780 –––––– 21 780 –––––– 600 18 400 000 000 ––––––– 30 000 ––––––– 12 500 ––––––– 105 500 ––––––– ––––––– – 600 400 500 –––––– 16 500 –––––– 070 –––––– 29 970 –––––– –––––– 400 500 300 – –––––– 18 200 –––––– 580 –––––– 24 480 –––––– –––––– 50 000 – 10 600 44 900 ––––––– 105 500 ––––––– ––––––– 10 000 000 – 17 970 –––––– 29 970 –––––– –––––– 000 – 11 000 480 –––––– 24 480 –––––– –––––– Additional information (1) Skye Ltd has continued to account for its assets at their book value though their fair values on June 1996 were: Freehold land – £2.5 million above book value Fixtures and fittings – £1.5 million below book value with an estimated remaining useful economic life of years Chapter 14 · Investments and groups The fair values of all other assets and liabilities for both Skye Ltd and Arran Ltd approximated to their book values (2) Skye Ltd’s corporation tax payable at 31 May 1999 includes £1.4 million related to its year ended 31 May 1996 The company had originally provided £500 000 as the estimated liability as at 31 May 1996 Mull plc incorporated this estimate when establishing the fair values of Skye Ltd’s net assets on acquisition However, following a protracted Inland Revenue investigation, the final liability was agreed on 31 May 1999 at £1.4 million, £900 000 higher than the estimate (3) Skye Ltd paid its preference dividend during the year All proposed dividends relate to ordinary shares Mull plc has not yet accounted for any dividends receivable (4) Any goodwill arising is amortised over 10 years on the straight-line basis Requirements (a) Prepare the consolidated balance sheet of Mull plc as at 31 May 1999 (11 marks) Note: You are not required to produce any disclosure notes (b) Briefly explain your accounting treatment of items (1) and (2) above, referring to the provisions of FRS 7, Fair values in acquisition accounting, where appropriate (4 marks) ICAEW, Financial Reporting, June 1999 (15 marks) 14.9 You are the management accountant of Faith plc One of your responsibilities is the preparation of the consolidated financial statements of the company Your assistant normally prepares the first draft of the statements for your review The assistant is able to prepare the basic consolidated financial statements reasonably accurately However, he has little idea of the principles underpinning consolidation and is unsure how to account for changes in the group structure In these circumstances he asks you for guidance prior to beginning his work The profit and loss accounts of Faith plc, Hope Ltd and Charity Ltd for the year ended 30 September 2000 are given below: Turnover Cost of sales Gross profit Other operating expenses Operating profit Investment income Interest payable Profit before taxation Taxation Profit after taxation Proposed dividends Retained profit for the year Retained profit – October 1999 Retained profit – 30 September 2000 Faith plc £ million 2000 (1100) ––––– 900 (350) –––– 550 68 (80) –––– 538 (160) –––– 378 (160) –––– 218 780 –––– 998 –––– –––– Hope Ltd £ million 1000 (600) –––– 400 (150) –––– 250 (35) –––– 215 (65) –––– 150 (70) –––– 80 330 –––– 410 –––– –––– Charity Ltd £ million 1200 (600) –––– 600 (180) –––– 420 (45) –––– 375 (114) –––– 261 (100) –––– 161 526 –––– 687 –––– –––– 439 452 Part · Financial reporting in practice or Share of net assets of B Limited 25% of £64 000 Unamortised goodwill 16 000 10 000 –––––––– 26 000 –––––––– –––––––– Comparison of the way in which the investment is shown using the equity method with the balance sheet using proportional consolidation makes it clear why the equity method is often referred to as a ‘one-line consolidation’ The carrying value of the investment is equal to the appropriate proportion of the net assets of the associate plus any unamortised positive goodwill or less the balance of any negative goodwill Associates and acquisition accounting Both proportional consolidation and the equity method of accounting are subsets of acquisition accounting, which we discussed in the context of accounting for subsidiaries in Chapters 13 and 14 It follows that many of the principles that we have discussed in the context of preparing consolidated financial statements for a parent and its subsidiaries also apply in the case of accounting for associates and joint ventures We shall outline a number of such matters here Date of acquisition Under acquisition accounting, only post-acquisition profits are included in the profit and loss account Hence, when an interest in an associate or joint venture is acquired during a year, it will be necessary to calculate or estimate which revenues and expenses were preacquisition and which post acquisition Only the post-acquisition revenues and expenses should be included in the profit and loss account prepared using proportional consolidation or the equity method of accounting Consistent accounting periods and policies In order to produce meaningful aggregated amounts for the investor and investee, results for the same accounting periods using consistent accounting policies should be used In practice, this may not always be possible and accounting standards can only provide limited guidance on what should be done in such circumstances.3 Use of fair values As we explained in the previous chapter, the book values of the associate or joint venture are of no relevance in determining the ‘cost’ of assets and liabilities to the investor For this purpose it is necessary to use fair values or, more accurately in the UK context at present, value to the business of assets and liabilities The use of such values at the date of acquisition will usually have consequences for the subsequent measurement of profits or losses of the investee, most obviously in the area of depreciation and amortisation See, for example, FRS Associates and Joint Ventures, Para 31(d) Chapter 15 · Associates and joint ventures Purchased goodwill and amortisation As we saw in Chapter 13, it is now standard practice to amortise purchased goodwill over its expected useful economic life although, under FRS 10 Goodwill and Intangible Assets, there are circumstances where this is not necessary provided annual impairment reviews are conducted The same rules apply to the treatment of purchased goodwill in associates and joint ventures Unrealised intercompany profits Given the existence of significant influence of the investor over the investee, it would be wrong to include unrealised profits from intercompany trading when using proportional consolidation or the equity method of accounting The part of such unrealised profits relating to the investor’s share in the investee should be removed.4 The regulatory framework in the United Kingdom The legal background While the subject matter of SSAP was associated companies, the Companies Act 1989 subsequently provided the following definitions of ‘associated undertakings’ and ‘joint ventures’:5 An ‘associated undertaking’ means an undertaking in which an undertaking included in the consolidation has a participating interest and over whose operating and financial position it exercises a significant influence and which is not: (a) a subsidiary undertaking of the parent company, or (b) a joint venture dealt with in accordance with paragraph 19 Where an undertaking holds 20 per cent or more of the voting rights in another undertaking, it shall be presumed to exercise such an influence over it unless the contrary is shown (Paras 20(1) and 20(2)) The above definition refers to ‘a joint venture dealt with in accordance with paragraph 19’ The relevant part of this paragraph is as follows: Where an undertaking manages another undertaking jointly that other undertaking (‘the joint venture’) may, if it is not – (a) a body corporate, or (b) a subsidiary undertaking of the parent company, be dealt with in the group accounts by the method of proportional consolidation (Para 19) This is really rather bizarre drafting, and it posed considerable problems for the ASB as it attempted to prepare a sensible standard While the legal definition of associated undertakings always includes an incorporated joint venture, it includes an unincorporated joint venture only if the venturer chooses to apply the equity method of accounting rather than proportional consolidation Thus, under the provisions of the Act, if a venturer chooses to apply the equity method to an unincorporated joint venture, that joint venture is an associated undertaking while, if the venturer chooses to apply proportional consolidation to that See FRS 9, Para 31(b) The IASC Interpretation SIC – Elimination of Unrealised Profits and Losses on Transactions with Associates, issued in July 1997, explains this requirement in more detail Companies Act 1985, Schedule 4A, Paras 19 and 20 453 454 Part · Financial reporting in practice unincorporated joint venture, it is not an associated undertaking because it has fallen under the provisions of Para 19 To define a joint venture by reference to the method used to account for it posed some difficulties in attempting to develop an appropriate accounting method for joint ventures! FRS Accounting for Associates and Joint Ventures In developing standard accounting practice for associates and joint ventures, the ASB has developed an approach which distinguishes investments in entities from a joint arrangement that does not fall within its definition of an entity The crucial definition here is the FRS definition of an entity, which can only be described as arcane: A body corporate, partnership or unincorporated association carrying on a trade or business with or without a view to profit The reference to carrying on a trade or business means a trade or business of its own and not just part of the trades or businesses of entities that have interests in it (Para 4) Under this definition, a limited company, certainly an entity using any sensible definition of the word, may or may not be an entity under FRS If the company carries on its own trade or business, it is such an entity while, if it merely carries on part of the trades or businesses of the investors, it is not such an entity The distinction which the ASB makes can only lead to confusion and undoubtedly gives rise to problems in practice in deciding whether a body corporate, partnership or unincorporated association is carrying on its own trade or business or parts of the trades and businesses of the entities which have interests in it! Nevertheless, on the basis of the above definition, FRS distinguishes investments in entities, that is associates and joint ventures, from a ‘joint arrangement that is not an entity’ Although the term is not used in the standard, the latter has, perhaps not surprisingly, attracted the acronym ‘JANE’ The standard provides definitions of the three categories of investment which it has identified and then clearly specifies the required accounting treatment for each category:6 An associate is an entity (other than a subsidiary) in which another entity (the investor) has a participating interest and over whose operating and financial policies the investor exercises a significant influence A joint venture is an entity in which the reporting entity holds an interest on a long-term basis and is jointly controlled by the reporting entity and one or more other venturers under a contractual arrangement A joint arrangement that is not an entity is a contractual arrangement under which the participants engage in joint activities that not create an entity because it would not be carrying on a trade or business of its own A contractual arrangement where all significant matters of operating and financial policy are predetermined does not create an entity because the policies are those of its participants, not of a separate entity The required accounting treatment for each of these is shown in Table 15.1 From Table 15.1, it may be seen that the ASB does not permit the use of proportional consolidation for associates and joint ventures It considers that use of such a method is wrong because FRS Associates and Joint Ventures, ASB, London, November 1997, was preceded by a Discussion Paper and an Exposure Draft FRED 11, both with the same title, in July 1994 and March 1996 respectively For definitions see FRS 9, Para 4, and for the required accounting treatment, FRS 9, Paras 18–29 Chapter 15 · Associates and joint ventures Table 15.1 Required accounting treatment of associates, joint ventures and JANEs Entities Required treatment Associate Equity method Joint venture Gross equity method Joint arrangement that is not an entity (JANE) Account for shares of individual assets, liabilities, results and cash flows it combines assets and liabilities over which the investor only has significant influence, with assets and liabilities under the full control of the investor As we shall see later in this chapter, this is not the view taken in the international accounting standard on joint ventures The difference between the gross equity method and the equity method is merely presentational in that the gross equity method provides more detailed disclosure of the share of the investee’s turnover, gross assets and gross liabilities The method specified for a JANE is to require the investor to account directly for its share of the assets, liabilities, results and cash flows of the joint arrangement This will frequently produce the same results as proportional consolidation in practice although this will not be the case where the venturer holds the individual assets and liabilities in the joint arrangement in different proportions To illustrate the approach of FRS 9, let us first take a situation where the investing company, C Limited, has subsidiaries and prepares consolidated financial statements C Limited also has an associate, D Limited, in which it holds 30 per cent of the equity shares Abbreviated consolidated financial statements for the group, excluding the incorporation of D as an associate, together with the financial statements of D Limited for the year ended 31 December 20X2 are given below Summarised profit and loss accounts for the year ended 31 December 20X2 Turnover Cost of sales Gross profit Operating expenses Operating profit Dividend received from D Limited Interest payable Profit from ordinary activities before tax Taxation Profit after tax Minority interest Dividends paid and proposed Retained profit for the year C Limited Consolidated P&L a/c £ 040 000 670 000 –––––––––– 370 000 134 000 –––––––––– 236 000 24 000 –––––––––– 260 000 50 000 –––––––––– D Limited Associate P&L a/c £ 710 000 230 000 –––––––– 480 000 170 000 –––––––– 310 000 – –––––––– 310 000 40 000 –––––––– 210 000 80 000 –––––––––– 130 000 10 000 –––––––––– 120 000 40 000 –––––––––– 80 000 –––––––––– –––––––––– 270 000 60 000 –––––––– 210 000 – –––––––– 210 000 80 000 –––––––– 130 000 –––––––– –––––––– 455 456 Part · Financial reporting in practice Movement on reserves for the year ended 31 December 20X2 Retained profits at January 20X2 Retained profit for the year Retained profits on 31 December 20X2 C Limited Consolidated accounts £ 400 000 80 000 –––––––– 480 000 –––––––– –––––––– D Limited Associate £ 240 000 130 000 –––––––– 370 000 –––––––– –––––––– The profit and loss account of C Limited, and hence the consolidated profit and loss account, includes the dividend of £24 000 receivable from D Limited and this amount has been disclosed at the net amount in accordance with standard practice Summarised balance sheets on 31 December 20X2 C Limited Consolidated accounts £ Fixed assets – at net book values Goodwill (on consolidation) Tangible assets Investment in associate: 45 000 shares (30%) at cost Net current assets less Long-term loans less Deferred taxation Share capital £1 shares Share premium Retained profits Minority interests D Limited Associate 70 000 493 000 – 420 000 97 000 280 000 –––––––– 940 000 100 000 –––––––– 840 000 80 000 –––––––– 760 000 –––––––– –––––––– – 360 000 –––––––– 780 000 150 000 –––––––– 630 000 60 000 –––––––– 570 000 –––––––– –––––––– 200 000 40 000 480 000 –––––––– 720 000 40 000 –––––––– 760 000 –––––––– –––––––– 150 000 30 000 390 000 –––––––– 570 000 – –––––––– 570 000 –––––––– –––––––– £ C Limited acquired its 30 per cent interest in D Limited on January 20X1 when the reserves of D comprised a share premium account of £30 000 and retained profits of £60 000 On the basis of the simplifying assumption that book values were equal to fair values at the date of acquisition, goodwill of £25 000 would have been recognised:7 £ Cost of investment less Share of net assets: Share capital Share premium Retained profits 30% of Purchased goodwill 150 000 30 000 60 000 –––––––– 240 000 –––––––– £ 97 000 72 000 ––––––– 25 000 ––––––– ––––––– In addition to this simplifying assumption, we are implicitly assuming that there have been no changes to share capital or share premium since acquisition Chapter 15 · Associates and joint ventures We shall assume that this goodwill, relating to the associate, had an expected useful economic life of five years and that it is being amortised over that period using the straight-line method.8 Let us focus first on the consolidated profit and loss account which, at present, includes £24 000 in respect of the dividend received or receivable from D Using the equity method, this must be removed and replaced by the share of the associate’s profit, whether or not this has been distributed Under the provisions of FRS 9, the share of profit must be included after the group operating profit and then on a line-by-line basis Operating profit Interest payable Profit from ordinary activities before tax Taxation Profit after tax D Limited £ 310 000 40 000 –––––––– 270 000 60 000 –––––––– 210 000 –––––––– –––––––– 30% share £ 93 000 12 000 ––––––– 81 000 18 000 ––––––– 63 000 ––––––– ––––––– Inclusion of the share of these figures in the consolidated profit and loss account, together with the amortisation of goodwill, produces the following results: Summarised consolidated profit and loss account for the year ended 31 December 20X2 (including results of associate) £ Turnover Cost of sales Gross profit Operating expenses Group operating profit Share of operating profit of associate less Amortisation of goodwill Interest payable: Group Associate Profit from ordinary activities before taxation Taxation: Group Associate Minority interest Dividends paid and proposed Retained profit for the year 93 000 000 ––––––– 50 000 12 000 ––––––– 80 000 18 000 ––––––– £ 040 000 670 000 ––––––––– 370 000 134 000 ––––––––– 236 000 88 000 ––––––––– 324 000 62 000 ––––––––– 262 000 98 000 ––––––––– 164 000 10 000 ––––––––– 154 000 40 000 ––––––––– 114 000 ––––––––– ––––––––– We have brought in the share of profits amounting to £63 000 to replace the dividend receivable of £24 000 Thus we have taken credit for an extra £39 000, which is the share of the profit retained by the associate in respect of the year We have also recognised the amortisation of the goodwill of the associate It is worth noting that the goodwill which arose in respect of the purchase of subsidiaries would have already been amortised, if appropriate, in preparing the consolidated financial statements shown in the first column above 457 458 Part · Financial reporting in practice When we turn to the movement on reserves, we must include the share of the postacquisition profits retained by the associate less the accumulated amortisation of goodwill The following statement includes the relevant workings Movement on reserves for the year ended 31 December 20X2 £ Retained profits on January 20X2: Group Share of post-acquisition profits in associate: 30% × (240 000 – 60 000) less Accumulated amortisation of goodwill: year × 5000 Retained profit for the year Retained profits on 31 December 20X2 Group Share of post-acquisition profits in associate: 30% × (370 000 – 60 000) less Accumulated amortisation of goodwill: years × 5000 £ 400 000 54 000 (5 000) –––––––– 49 000 –––––––– 449 000 114 000 480 000 93 000 (10 000) –––––––– 563 000 –––––––– –––––––– –––––––– 563 000 –––––––– –––––––– By the end of the year 20X2, we have therefore increased consolidated reserves by £83 000, the share of the post-acquisition profits retained by the associate less the accumulated amortisation of purchased goodwill, and must increase the carrying value of the investment in the consolidated balance sheet by this amount to keep it in balance The carrying value therefore becomes £180 000, which is the cost of £97 000 plus £83 000 Summarised consolidated balance sheet on 31 December 20X2 £ Fixed assets Goodwill Tangible assets Investment in associate Net current assets Long-term loan Deferred taxation Share capital Share premium Reserves: per Movement on reserves Minority interest 70 000 493 000 180 000 –––––––––– 743 000 280 000 –––––––––– 023 000 100 000 –––––––––– 923 000 80 000 –––––––––– 843 000 –––––––––– –––––––––– 200 000 40 000 563 000 –––––––––– 803 000 40 000 –––––––––– 843 000 –––––––––– –––––––––– The carrying value of the investment in the associate may be analysed as follows: Chapter 15 · Associates and joint ventures £ Share of net assets in balance sheet of D: 30% × 570 000 Unamortised goodwill Cost of goodwill less Amortised – years at 5000 171 000 25 000 10 000 ––––––– 15 000 –––––––– 186 000 –––––––– –––––––– As we outlined earlier in the chapter, in order for the inclusion of these amounts to be meaningful, it is necessary for the accounting periods and policies of the associate to coincide with those of the group In addition, adjustment may be necessary to remove the effect of any unrealised profits made from trading between the group and the associate Joint ventures and the gross equity method As we explained earlier in this section, FRS requires the use of the ‘gross equity method’ for joint ventures This method is defined as follows:9 A form of equity method under which the investor’s share of the aggregate gross assets and liabilities underlying the net amount included for the investment is shown on the face of the balance sheet and, in the profit and loss account, the investor’s share of the turnover is noted Thus the method is exactly the same as the equity method except that a little more disclosure is required The additional information required is illustrated in the following pro-forma consolidated profit and loss account and balance sheet incorporating both a joint venture and an associate Headings relating to the joint venture are shown in italics Consolidated profit and loss account for the year ended 31 December 20X2 Turnover: group and share of joint venture less Share of joint venture’s turnover £ X X –– Group turnover Cost of sales X X –– X X –– X Gross profit Operating expenses Group operating profit Share of operating profit in: Joint venture Associate Interest payable Group Joint venture Associate X X –– (X) (X) (X) –– Profit on ordinary activities before tax Tax on profit on ordinary activities: Group, joint venture and associate Profit on ordinary activities after tax Minority interests Profit on ordinary activities after tax and minority interests Dividends Retained profit for group and its share of joint venture and associate FRS 9, Para £ X –– X X –– X X –– X X –– X X –– X –– –– 459 460 Part · Financial reporting in practice Consolidated balance sheet on 31 December 20X2 £ Fixed assets Tangible assets Investments Investment in joint venture: Share of gross assets Share of gross liabilities Investment in associate Current assets Stock Debtors Cash at bank and in hand Creditors: amounts due within one year Net current assets Total assets less current liabilities Creditors: amounts due after more than one year Provisions for liabilities and charges Capital and reserves Called up share capital Share premium account Profit and loss account Shareholders’ funds Minority interests £ £ X X (X) –– X X –– X X X X –– X (X) –– X –– X (X) (X) –– X –– –– X X X –– X X –– X –– –– Approach where no consolidated financial statements are prepared In the above examples we have assumed that consolidated financial statements have been prepared so that it was possible to apply the equity method or gross equity method of accounting in those consolidated statements It is, of course, possible for a company without a subsidiary to have an investment in an associate or joint venture In such a case, it is not possible to apply the equity method or gross equity method in the investing company’s financial statements and yet there are no consolidated financial statements available for that purpose In order to comply with FRS 910 the investing company: should present the relevant amounts for associates and joint ventures either by preparing a separate set of financial statements or by showing the relevant amounts, together with the effects of including them, as additional information to its own financial statements In the former case, the treatment will be as illustrated above In the the latter case, one or more supplementary notes to the company’s own financial statements will be necessary Thus there must be a note to the balance sheet showing what the carrying value of the investment would be using the equity method and, in the case of a joint venture, the share of the 10 FRS 9, Para 48 Chapter 15 · Associates and joint ventures gross assets and gross liabilities making up that value There must also be a note to the profit and loss account showing the effect of applying the equity method of accounting On the basis of the following summarised profit and loss accounts for the year ended 31 December 20X2 of E plc and F Limited, a possible note to the profit and loss account of E plc, which has 25 per cent of the shares in its associate, F Limited, is illustrated below Summarised profit and loss accounts for the year ended 31 December 20X2 Operating profit Dividends received and receivable from F Limited Taxation Profit on ordinary activities after tax Dividends paid and payable Retained profit for the year E plc £ 240 000 10 000 –––––––– 250 000 80 000 –––––––– 170 000 100 000 –––––––– 70 000 –––––––– –––––––– F Ltd £ 140 000 – –––––––– 140 000 60 000 –––––––– 80 000 40 000 –––––––– 40 000 –––––––– –––––––– A possible note to the profit and loss account might run as follows: Note to the profit and loss account of E plc The effect of applying the equity method of accounting to the investment in the associate F Limited is as follows: £ Share of profit of associate (25% of 140 000) Share of taxation of associate (25% of 60 000) add Profit of E plc Per profit and loss account less Dividends from associate 35 000 15 000 –––––––– 20 000 170 000 10 000 –––––––– Profit from ordinary activities after taxation less Dividends paid and payable Retained profit for the year Retained in investing company Retained in associate (25% × 40 000) £ 160 000 –––––––– 180 000 100 000 –––––––– 80 000 –––––––– –––––––– 70 000 10 000 –––––––– 80 000 –––––––– –––––––– Such a note could be easily expanded to provide the relevant disclosure for an investment in a joint venture Large investments in associates and joint ventures In order to ensure that users have adequate information to interpret a set of financial statements, FRS requires the disclosure of the name of each principal associate and joint venture, together with details of the proportional shareholding, its accounting period and an indication of the nature of its business The equity method is then applied to all investments 461 462 Part · Financial reporting in practice in associates and the gross equity method to all investments in joint ventures, either in the consolidated financial statements, where these are prepared, or as supplemenary information in the investing company’s own financial statements Both the equity method and the gross equity method provide only very summarised information about the results, assets and liabilities of the investee entity and, hence, when the investee is particularly large in relation to the investing group or company, FRS requires additional disclosure It lays down thresholds that attempt to capture the relative size of the investee in the context of the investing group or company and require comparison, between the investor’s share of the investee and that of the investor, of the following: ● ● ● ● gross assets gross liabilities turnover operating results on a three-year average Additional disclosure is then required in three circumstances: (i) where the aggregate of the investor’s share in its associates exceeds a 15 per cent threshold; (ii) where the aggregate of the investor’s share in its joint venture exceeds a 15 per cent threshold; (iii) where the investor’s share in any individual associate or joint venture exceeds a 25 per cent threshold Readers are referred to the standard itself for precise details of the disclosure required in each case.11 Summary of the UK position Where an investment is large enough to give the investor significant influence or joint control over the affairs of the investee, it is clearly not adequate to show that investment at cost and to take credit only for the dividends receivable Some alternative is necessary, and it is possible to identify three such alternative accounting treatments for associates and joint ventures: (a) to show the investment at its fair value and to take changes in fair value, as well as dividends receivable, to the profit and loss account; (b) to use proportional (proportionate) consolidation; (c) to use the equity method of accounting While, as we have seen in Chapter 8, the ASB is in favour of the use of fair values for many financial instruments, it recognises that the determination of the fair value of unquoted investments may be extremely difficult and unreliable in practice It also recognises that, even if the shares of the investee are quoted, accounting for the investee by the recognition of movements in the fair value of its shares is hardly the best way of measuring the performance of a long-term associate or joint venture over which the investor exercises significant influence or joint control The method of proportional consolidation is simple to understand but is rejected by the ASB on the grounds that it results in the aggregation of assets and liabilities of associates and joint ventures, which are not controlled, with the assets and liabilities of the parent company 11 FRS 9, Para 58 Chapter 15 · Associates and joint ventures and subsidiaries, which are controlled by the parent company In accordance with the provisions of Chapter of its Statement of Principles for Financial Reporting, the ASB takes the view that a consolidated balance sheet should only show the assets and liabilities under direct and indirect control, that is those of the parent and any subsidiary companies.12 As we shall see in the final section of this chapter, the IASB does not feel itself constrained in this way Having rejected the use of fair values and proportional consolidation, the ASB is left with the equity method of accounting as its preferred candidate for associates and joint ventures We have seen that, under this method, the level of detailed disclosure may be varied quite considerably and the ASB introduces its own variant of the equity method, the gross equity Does investing company/ group control investee? Yes Prepare consolidated financial statements No Is investee a joint venture? Yes Use gross equity method No Is investee an associate? Yes Use equity method No Is investee a JANE? Yes Account for share of assets liabilities and cash flows No Treat as simple fixed asset investment Figure 15.1 Treatment of fixed asset investments 12 An exception is made for JANEs where the investor is required to account directly for its share of assets, liabilities, results and cash flows 463 464 Part · Financial reporting in practice method, for joint ventures It also increases the detailed disclosure requirements for both associates and joint ventures once certain thresholds are breached The level of the thresholds and the extent of the detailed disclosure required are practical matters to which accounting theory has little to contribute at present Figure 15.1 provides a summary of the accounting treatment of fixed asset investments in the UK The international accounting standards There are two international accounting standards which are relevant to the subject matter of this chapter: ● IAS ● IAS 28 Accounting for Investments in Associates (revised 2000) 31 Financial Reporting of Interests in Joint Ventures (revised 2000) Associates IAS 28 requires the use of the equity method of accounting for associates in the consolidated financial statements of the investor There are two exceptions: first, when it is intended to dispose of the investment in the near future and, second, when the associate operates under severe long-term restrictions that significantly impair its ability to transfer funds to the investor In such circumstances, the investment should be dealt with in accordance with IAS 39 Financial Instruments: Recognition and Measurement, under which it should be shown at its fair value or, if that cannot be measured reliably, at its cost.13 The international accounting standard does not require the additional disclosure specified by FRS when certain thresholds are passed Where the investing company does not prepare consolidated financial statements, IAS 28 states that: It is appropriate that such an investor provides the same information about its investments in associates as those enterprises that issue consolidated financial statements.14 This could be taken to require that the equity method should be applied in the investor’s own financial statements While this is permitted under the international standard at present, the proposed revision of IAS 27, which encompasses the treatment of investments in subsidiaries, associates and joint ventures in the separate financial statements of the investing company, would prohibit this treatment in future.15 Neither UK company law nor FRS permit the use of the equity method in an investor’s individual financial statements and, hence, the proposed amendment to the international standard would bring UK and international practice closer together Joint ventures The definition of joint venture in IAS 31 is much wider than that of FRS IAS 31 defines a joint venture in terms of contractual arrangements and distinguishes between jointly con13 14 15 IAS 28 Accounting for Investments in Associates (revised 2000), Para Ibid., Para 15 See Chapter 14, pp 406–7 Chapter 15 · Associates and joint ventures trolled operations, jointly controlled assets and jointly controlled entities As we have seen, FRS restricts the term joint venture to an entity and deals separately with joint arrangements that are not entities (JANEs) The benchmark treatment of joint ventures under IAS 31 is proportionate, what we have called proportional, consolidation while the allowed alternative treatment is the equity method of accounting However, the international standard makes it very clear that the IASB, or more precisely the IASC, considers the equity method to be very much second best:16 This Standard does not recommend the use of the equity method because proportionate consolidation better reflects the substance and economic reality of a venturer’s interest in a jointly controlled entity, that is control over the venturer’s share of the future economic benefits This proportionate method may be applied using one of two possible formats along the lines of those that we have illustrated earlier in the chapter Thus the venturer may either combine its share of each asset, liability, revenue and expense of the jointly controlled entity with similar items in its consolidated financial statements on a line-by-line basis or, alternatively, include its share of each class of assets, liabilities, revenue and expenses as separate lines in the consolidated financial statements As we saw, FRS requires the use of the equity method, in its gross equity variant, for joint ventures so, here again, the UK standard requires application of the allowed alternative treatment, rather than the benchmark treatment, of the international accounting standard Given the aversion of the ASB to the use of proportional consolidation and the aversion of the IASB to the use of the equity method for joint ventures, it is not easy to see how convergence will be achieved in this area Proposed changes The exposure draft, issued by the IASB as part of its improvements project in May 2002, proposes a number of changes to the above We have already drawn attention to some of these proposed changes in both Chapter 14 and this chapter but will draw attention to two proposals here First, the exposure draft proposes to exclude from the scope of IAS 28 and IAS 31 investments, which would otherwise be classified as associates and joint ventures, when these are held by venture capital organisations, mutual funds, unit trusts and similar entities It considers that, in the case of such investors, it is more appropriate to measure investments in associates and joint ventures at their fair values, in accordance with the provisions of IAS 39, Financial Instruments: Recognition and Measurement, where these are well established in the particular industry Second, it proposes to tighten up the situations where investments in associates and joint ventures should be excluded from treatment using the equity method of accounting or proportionate consolidation At present, both IAS 28 and IAS 31 state that investments should not be accounted for using the equity method and proportionate consolidation in two situations:17 (a) when the investment is acquired and held exclusively with a view to its subsequent disposal in the near future; or 16 17 IAS 31 Financial Reporting of Interests in Joint Ventures (revised 2000), Para 33 See IAS 28, Para 8, and IAS 31, Para 35 465 466 Part · Financial reporting in practice (b) where it operates under severe long-term restrictions that significantly impair its ability to transfer funds to the investor The IASB now proposes that such investments should only be excluded where the investment is acquired and held exclusively with a view to its subsequent disposal within twelve months from acquisition It takes the view that, where an associate or joint venture operates under severe long-term restrictions, it is unlikely that significant influence over the investee actually exists While the time horizon for the exclusion of temporary associates and joint ventures would be tightened to 12 months, there would be no change resulting from the proposals in respect of long-term restrictions: investments subject to severe long-term restrictions would still be excluded, albeit on the basis of a different criterion, and shown at fair values in accordance with the provisions of IAS 39 Summary In this chapter, we looked at accounting for investments which carry significant influence over or joint control over another entity, namely associates and joint ventures For such investments, it is not sufficient to show them at cost or, except in special circumstances, at fair value It is certainly not possible merely to take credit for dividends receivable when the level of those dividends may be influenced by the investor We also looked at what FRS calls Joint Arrangements which are Not Entities (JANEs) although these fall within the definition of a joint venture under IAS 31 The two methods of accounting which standard setters consider to be appropriate for investments which carry significant influence or joint control are proportional (proportionate) consolidation or the equity method of accounting We therefore explored each of these methods and demonstrated the similarities and differences between them We next examined the rather unhelpful provisions of UK company law in this area and saw how FRS requires the use of the equity method to account for associates and the use of the gross equity method to account for joint ventures, while requiring something akin to proportional consolidation for JANEs FRS requires more detailed disclosure from joint ventures, i.e it requires the gross equity method, and even more disclosure in respect of both associates and joint ventures, once certain size thresholds are crossed Finally, we examined the relevant international accounting standards, IAS 28 and IAS 31 These require the use of the equity method for associates and favour the use of proportionate consolidation for joint ventures While IAS 31 does permit the use of the equity method for joint ventures as an allowed alternative treatment, the standard makes it very clear that the IASB (or, more precisely, its predecessor, the IASC) considers this method to be very much second best Thus we have seen that, although the required UK and international treatment of associates is similar, the preferred treatment of joint ventures is rather different Recommended reading J.R Edwards, A history of financial accounting, Routledge, London 1989 T Grundy, ‘Acquisitions, joint ventures, alliances and divestment’, Business Digest, issue 036, ICAEW, May 2000 R Ma, R.H Parker and G Whittred, Consolidated accounting, Longman, Cheshire, 1991 ... that, in the UK, the rules for the treatment of all these investments in the investor’s single-entity financial statements are the same while, under international accounting standards, the present... throughout the United Kingdom Your assistant has prepared the first draft of the financial statements of the group for the year ended 31 August 1999 The draft statements show a group profit before... is the preparation of the consolidated financial statements of the company Your assistant normally prepares the first draft of the statements for your review The assistant is able to prepare the