This Comment Letter was sent by BDO Global Coordination B.V. on behalf of BDO International, to the International Accounting Standards Board in February 2008:
Dear Sir,
Exposure Draft of Proposed Amendments to IFRS 1 First time Adoption of International Financial Reporting Standards and IAS 27 Consolidated and Separate Financial Statements:
Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate
We are pleased to have the opportunity to comment on the above Exposure Draft issued by the International Accounting Standards Board (IASB), on behalf of BDO International and also the IASB’s further willingness to address the issues which were identified in our response dated 23 May 2007 on the previous proposals.
Our responses to your specific questions are set out below.
Question 1 – Deemed Cost
The exposure draft proposes to allow an entity, at its date of transition to IFRSs in its separate financial statements, to use a deemed cost to account for an investment, subsidiary, jointly controlled entity or associate. The exposure draft proposes that an entity may choose as the deemed cost of such investments either the fair value or the previous GAAP carrying amount of the investment at the entity’s date of transition to IFRSs (see paragraphs 23A and 23B of the draft amendments to IFRS 1 and paragraphs BC8-BC13 of the Basis for Conclusions).
Do you agree with the two deemed cost options as they are described in this exposure draft? If not, why?
We agree with the two deemed cost options outlined in paragraph 23B to the proposed amendment to IFRS 1 which stipulate deemed cost being at either fair value in accordance with IAS 39 at the date of transition, or at the previous GAAP carrying amount at that date.
We believe that these two deemed cost options address those concerns that we previously expressed in our comment letter (dated 23 May 2007) on the previous exposure draft on the proposed amendments to IFRS 1.
We also consider that the proposed amendments would reduce the time and cost involved in adopting IFRS in the separate financial statements of parent companies.
Question 2 – Change in Scope
The exposure draft proposes that the deemed cost option should be available for the initial measurement of investments in jointly controlled entities and associates when an entity adopts IFRSs in its separate financial statements (see paragraph BC14 of the Basis for Conclusions).
Do you agree with the proposal to allow the deemed cost option for investments in jointly controlled entities and associates? If not, why?
We agree that the deemed cost option should be available for the initial measurement of investments in jointly controlled entities and associates, as well as subsidiaries.
We believe that the proposal will remove our specific concerns raised in this area as highlighted in our comment letter (dated 23 May 2007) on the previous exposure draft on the proposed amendments to IFRS 1.
Questions 3 and 4 – Cost Method
The exposure draft proposes to delete the definition of the ‘cost method’ from IAS 27. Additionally, the exposure draft proposes to amend IAS 27 to require an investor to recognise as income dividends received from a subsidiary, jointly controlled entity or associate in its separate financial statements. The receipt of this dividend requires the investor to test its related investment for impairment in accordance with IAS 36 Impairment of Assets (see paragraphs 4 and 37B of the draft amendments to IAS 27 and paragraphs BC15-BC20 of the Basis for Conclusions).
Do you agree with the proposal to delete the definition of the cost method from IAS 27? If not, why?
We agree that paragraph 4 of IAS 27, in its current form, should be deleted. We believe that this deletion will help to eliminate a key concern which has been prevalent in a number of jurisdictions, such as the United Kingdom.
This proposed deletion will further make accounting more straightforward in that it would no longer be necessary to identify pre-acquisition and post acquisition profits for the purpose of the treatment of the dividends in the separate financial statements of the parent company.
Please, however, note our comments in the response to question 4 below.
Do you agree with the proposed requirement for an investor to recognise as income dividends received from a subsidiary, jointly controlled entity or associate and the consequential requirement to test the related investment for impairment? If not, why?
Dividends
We agree that an investor should recognise as income dividends received from a subsidiary, jointly controlled entity or associate in accordance with the requirements of paragraph 37B of the proposed amendment to IAS 27.
Impairment testing
In our view, the requirement to perform a full impairment review each time a subsidiary receives a dividend from a subsidiary, associate or jointly controlled entity might add a significant amount of time to the preparation of financial statements on an on-going basis and could be a significant cost in terms of both preparation and external audit. This could dissuade companies from adopting IFRS in their separate financial statements.
In circumstances where a parent company has subsidiaries, associates, or jointly controlled entities that have a history of profitability, and such companies have a history of paying a reasonable level of dividends from profits, it does not appear entirely appropriate that an impairment test would have to be performed without any other indicators of impairment being present.
We therefore believe that management should initially exercise judgement in terms of determining whether or not the payment of a dividend means that there has been a trigger event for an impairment in the carrying value of an interest in a subsidiary, associate or jointly controlled entity. A mandatory test would mean that even the payment of a very small dividend would automatically trigger an impairment review, which we consider to be an inappropriate, rules based approach.
We also do not believe that the receipt of a dividend should be viewed any differently to certain other transactions between a parent company and its subsidiaries, associates and jointly controlled entities, an example being management charges levied by the parent.
We believe that our suggested approach to impairment would allow the preparer of the financial statements to exercise judgement when considering whether a potential impairment has arisen and that this approach could make the implementation of the proposed changes in the exposure draft less costly.
If it is decided to retain the requirement for a mandatory impairment test on the payment of dividend by a subsidiary, associate or jointly controlled entity then reference should also be made to the approach in IAS 36 paragraph 99, which allows use of the most recent detailed calculation in a preceding period to be used in certain circumstances in order to avoid incurring unnecessary costs.
Question 5 – Formation of a New Parent
The exposure draft proposes that in applying paragraph 37(a) of IAS 27 to the formation of a new parent, the new parent should measure cost using the carrying amounts in the separate financial statements of the existing entity at the date of the formation (see paragraph 37A of the draft amendments to IAS 27 and paragraphs BC21 and BC 22 of the Basis for Conclusions).
Do you agree with the proposed requirement that, in applying paragraph 37(a) of IAS 27, a new parent should measure cost using the carrying amounts of the existing entity? If not, why?
We agree with the observations in BC22 in that the matters surrounding the formation of a new parent are unique, and that equity, assets and liabilities of the group do not change as a result of the re-organisation. We note that in such circumstances the shareholders will normally be required to give consent to the formation of the new parent (and therefore to the consequent re-organisation which arises) and that the new parent in such circumstances is also being used as a conduit which facilitates an exchange of shares.
However, we do not agree with the proposed approach. We are concerned that the proposals mandate a cost of investment that is not consistent with the principles expressed in other standards and the framework. In consequence, we propose that the exposure draft of IAS 27 is amended so that on the formation of a new parent, that new parent would be allowed a choice of either recording the cost of investment at either the fair value of the equity instruments issued to effect the combination, or at the carrying amounts of equity, assets and liabilities of the existing entity.
Use of the carrying amounts of equity, assets and liabilities of the existing entity
We believe that the proposed requirement to use the carrying amounts of equity, assets and liabilities of the existing entity as the basis of measuring cost of investment within the new parent is not clear in terms of defining the appropriate measurement basis.
It is also not clear whether the treatment proposed in paragraph 37A of the proposed amendment to IAS 27, in conjunction with the views expressed in BC 22 could lead to a negative cost of investment, where for example the existing entity had net liabilities.
If the investment were required to be recorded at zero, on the basis of paragraph 37A to the proposed IAS 27, we believe that this could potentially cause a problem in jurisdictions where it is a legal requirement to record at least the nominal value of the shares issued by the new parent when it has issued shares to the owners of the existing entity. Although IFRSs are global standards, and therefore do not consider specific jurisdictional regulations, the Board might consider permitting a minimum carrying value in such circumstances, being the nominal value of shares issued in exchange for the subsidiary.
Question 6 – Transition
The exposure draft proposes that the amendments to IFRS 1 and IAS 27 shall be applied prospectively.
Do you agree that prospective application of the proposed amendments to IFRS 1 and IAS 27 is appropriate? If not, why?
We agree that the proposed amendments to IFRS 1 and IAS 27 should be applied prospectively.
We hope that our comments and suggestions are helpful. Should you wish to discuss any of the points we have raised please contact Helen Thomson of BDO Global Coordination B.V. on +32 2 778 01 30.
Yours faithfully,
BDO Global Coordination B.V.
1BDO International is a world wide network of public accounting firms, called BDO Member Firms, serving international clients. Each BDO Member Firm is an independent legal entity in its own country.
The network is coordinated by BDO Global Coordination B.V., incorporated in the Netherlands, with an office in Brussels, Belgium, where the Global Coordination Office is located.
IASB Exposure Draft: Proposed Amendments to IFRS 1 and IAS 27