In September 2024, the International Accounting Standards Board (IASB) issued an exposure draft (ED) proposing amendments to IAS 28 Investments in Associates and Joint Ventures in response to stakeholders’ application questions on the equity method. The IASB has also taken this opportunity to reorder the standard to help entities apply it. The proposed amendments are expected to reduce diversity in practice and provide users of financial statements with more comparable and useful information. In January 2025, the Institute’s Standard Setting Department responded to the ED. The full response is available on our website.
We appreciate the IASB’s efforts to address long-standing application questions in IAS 28, thereby reducing diversity in practice and enhancing comparability and understandability of financial statements. Nevertheless, since the ED does not address the fundamental issue of the nature of equity method, certain application issues would arise. Furthermore, we have identified certain aspects of the ED that necessitate clarification and guidance.
Treatment of transaction costs
We consider that the ED lacks clarity regarding how transaction costs incurred in the purchase of an associate should be accounted for. Our respondents have expressed mixed views on this treatment. One view supports expensing transaction costs to profit or loss, considering that the ED is developed based on an approach similar to IFRS 3 Business Combinations for measuring the cost of an associate. Conversely, the other view supports capitalizing transaction costs as part of the cost of an associate. This approach is supported by the IFRS Interpretations Committee’s agenda decision made in July 2009 and paragraph 6.5 of the Conceptual Framework for Financial Reporting, which treats the purchase of an associate as a purchase of an asset, indicating that the costs incurred for acquiring an associate should be capitalized. Given the prevalence of this issue in Hong Kong and the existence of divergent views, we recommend that the IASB clarify the treatment of transaction costs in the final standard.
Cost burden and practical challenges in performing PPA
Our respondents have expressed significant concerns regarding the cost burden and practical challenges of performing Purchase Price Allocation (PPA) for each purchase of additional interest in an associate, as well as for other changes that result in an increase in ownership interests. Due to a lack of control by the investors, associates are often reluctant to share information beyond what is required to apply the equity method in the investor’s financial statements. These challenges are further compounded when measuring the fair value of contingent consideration related to purchases of unlisted associates as determining fair value requires additional information for estimating the associates’ future performance. The costs and burden could be more significant for preparers lacking valuation resources. Accordingly, we recommend that the IASB clarify that PPA is necessary only when its impact on the investor’s financial statements is material and explain how such a materiality assessment should be performed.
Recognition of a bargain purchase gain
We support recognizing bargain purchase gains in profit or loss when purchasing additional interests in an associate that includes previously recognized goodwill. We consider that this treatment aligns with the “accumulation of purchases” approach adopted throughout the ED. Nevertheless, several respondents consider that such bargain purchase gains should instead be offset against the previously recognized goodwill for practical reasons. These include the potential impact on current practices adopted by investors that are dual-listed on the stock exchanges of Hong Kong and Mainland China and the risk of overstatement of goodwill included in the investment if impairment assessments are not conducted properly. Given these concerns, we recommend the IASB:
- Provide guidance similar to IFRS 3.36 to address the possibility that a bargain purchase gain is recognized due to an inappropriate PPA;
- State in the final standard that investments in associates should be tested for impairment as a single unit of account whenever a bargain purchase gain arises; and
- Assess the impact of the proposal to jurisdictions where the majority of companies are currently applying the alternative view, and determine if any refinements to the proposal are necessary.
Deferred tax effects on purchase of an associate
The ED requires an investor to perform PPA and recognize the related deferred tax effects when accounting for purchase of an associate, without distinguishing whether an associate constitutes a business. As per IFRS 3.2(b) and paragraph 15(b) of IAS 12 Income Taxes, deferred tax is not recognized upon initial recognition of an asset or a group of assets which does not constitute a business. If the same concept applies to the purchase of an associate, it is unclear why deferred tax should be recognized for the purchase of an associate that does not constitute a business. Accordingly, we recommend that the IASB clarify whether PPA should be performed and consequently, whether the recognition of deferred tax effects should be required for purchases of all associates, including those that only hold assets and do not constitute businesses.
This article was contributed by Carrie Lau and Katherine Leung, Associate Directors of the Institute’s Standard Setting Department.
