This article was first published in the April 2012 UK edition of Accounting and Business magazine
At the acquisition date, ABC and the non-controlling interest (NCI) shareholder (‘the NCI shareholder’) entered into an agreement whereby the NCI shareholder could require ABC to purchase and ABC could require the NCI shareholder to sell – a put and call option – the NCI. Both options are exercisable three years after the acquisition date, with the price, payable in cash, being the NCI’s fair value at exercise date. How should ABC account for the put and call option?
The put and call options here are symmetrical, so the contract is in substance a forward contract – that is, ABC will be required to purchase the NCI shareholder’s 25% interest at the determined date. In accordance with paragraph 23 of IAS 32, Financial Instruments: Presentation, an entity that enters into a contract that contains an obligation for the entity to deliver cash for its own equity shares is a financial liability. The 25% of DEF held by the NCI shareholder is classified as equity in ABC’s consolidated financial statements, and it is ‘own equity’. The put option meets the definition of a financial liability, as ABC does not have an unconditional right to avoid delivering cash. This is the case even though the payment is conditional on the option actually being exercised by the holder. A financial liability is recorded on the balance sheet at the date of the acquisition and is recognised at the present value of the amount payable. The discount is subsequently unwound as a finance charge through ABC’s income statement over the contract period, up to the final amount payable. Any adjustment to the liability for the changes in estimated cashflows for the amount payable (that is, changes in the eventual exercise price), in accordance with IAS 39, Financial Instruments: Recognition and Measurement, paragraph AG8, is recognised in the income statement. ABC also needs to consider the treatment of the NCI, including its recognition and allocation of profits and dividends.
ABC has an investment in a listed associate whose market value has significantly declined in the economic downturn. Management is performing its annual impairment review: how should it test the associate for impairment?
ABC should apply IAS 39 to identify potential impairment indicators in its associate accounted for under IAS 28, Investments in Associates. If any indicators exist, the investment is subject to an impairment test under IAS 36, comparing the asset’s carrying amount to its recoverable amount. These requirements are applied to the investor’s equity interest in the associate and other long-term interests that form part of the investor’s net investment in the associate, all of which are financial interests in the associate.
The carrying amount is not automatically written down to the current share price. The price decline is an indicator and establishes the fair value less costs to sell (FVLCTS) of the associate. However, IAS 36 requires the recoverable amount to be established; this is the higher of value in use (VIU) or the FVLCTS.
VIU is estimated with assumptions of cashflows, taking into account the economic environment. The associate might be unwilling to provide a cashflow forecast to a single investor or might be prohibited from doing so by legislation. ABC may therefore need to create its own estimated cashflows using publicly available data or possibly analysts’ forecasts. The future expected dividend streams from the investment in the associate could also be used in measuring the associate’s VIU. Both cashflow sources should in principle produce a similar result.
This month’s solutions were compiled by Michelle Amjad, Harivadan Patel and Peter Holgate of PwC’s Accounting Consulting Services.