Comments from ACCA to the International Accounting Standards Board, January 2012.
Investment entities have a business model and aims which differ from those of trading groups. ACCA generally agrees with the principle that the financial statements of investment entities will provide more meaningful information if they do not consolidate entities which are controlled by the investment entity, and in which the interest is held only for investment purposes.
We have, however, questioned how often an investment entity would actually control an investee.
ACCA also accepts that associates and joint ventures, where the interest is also held for investment purposes, and investment properties, should be accounted for at fair value by investment entities, in the same way as they would do for their controlled entities (by making compulsory the options currently provided by IAS28 Investments in Associates and IAS40 Investment Property). This provides a consistency of treatment across investment holdings: those holdings will generally be viewed similarly by the investors and users of the financial statements, whether they create a majority interest, or otherwise.
However, we have reservations about certain of the details in the proposals. These concerns are explained fully in the answers given below to the IASB's specific questions. A summary of the principal reservations is as follows:
a. The definition of an investment entity needs to be considered further, and preferably be based on the business model of an investing entity. Presently, the criteria are detailed and precise, in order to avoid inappropriate consequences, such as off-balance sheet accounting. Whilst ACCA agrees that such consequences must be avoided, the criteria presently exclude other structures, including those where control is more likely to occur (Question 2).
Early post-implementation reviews will assist in establishing whether the definition of an investment entity has been applied appropriately in practice.
b. ACCA does not agree that a parent, which is not an investment entity, needs to be required to consolidate the entities which its subsidiary does not consolidate, due to being an investment entity (Question 6).
c. We would prefer to see more specific disclosure requirements in the main body of the proposed Standard (Question 7).
d. We would prefer the Standard to be applied retrospectively, rather than prospectively, and believe that retrospective application will be practical for the majority of investment entities (Question 8).
e. We recommend that the accounting for fair value through the profit and loss account is reviewed as part of the wider project on the components of the Income Statement and Statement of Other Comprehensive Income. (Question 1).
Q1: Do you agree that there is a class of entities, commonly thought of as an investment entity in nature, that should not consolidate controlled entities and instead measure them at fair value through profit or loss? Why or why not?
ACCA agrees that there is a class of entities whose aim is to invest in other entities and which as part of that strategy, might hold an interest which confers control over the investee. We agree that it would be more relevant to the investor and the users of its financial statements for an exception to be granted from the requirement to consolidate such investees.
We would, however, question how often control arises. It may be more frequently the case that the level of the investment, and/or the provisions of a shareholder agreement, create an associate relationship. This latter situation is given less prominence in the Exposure Draft (ED).
There is a broader question concerning the appropriateness of accounting for fair value changes through the profit and loss account, as set out in this ED and in other existing standards. This question should be tackled as part of a future project leading to a standard on the structure of the Statement of Comprehensive Income.
Q2: Do you agree that the criteria in this exposure draft are appropriate to identify entities that should be required to measure their investments in controlled entities at fair value through profit or loss? If not, what alternative criteria would you propose, and why are those criteria more appropriate?
The criteria set out in the ED (paragraphs 2 (a) to 2 (f)) ensure that only certain companies and funds which pool the monies of outside investors (often called collective investment schemes), will meet the definition of an investment entity. Under these criteria, the investment entity usually makes multiple investments, and does so substantially for capital appreciation and / or investment income. Through the pooling of funds and the use of its professional expertise, the investment entity effectively stands between its investors and its investees.
As indicated in the IASB's discussion of question 3 in the ED, it appears to be the case that the precision involved in the criteria arises from a perceived need to avoid inappropriate off-balance sheet accounting.
Criterion 2 (d) specifies that the investment entity should have outside investors which hold a significant ownership interest. ACCA believes that it would be practical for this criterion to be relaxed in start-up situations, where the entity cannot temporarily comply whilst it attracts outside investors.
ACCA believes that the criteria for qualifying as an investment entity should be based on a business model, rather than a set of specific conditions. The level of precision set out with respect to the characteristics of the investing entity creates a risk that certain investing structures might be excluded, for example, investors who whilst aiming ultimately for capital appreciation and / or income, and having an exit strategy (as discussed in paragraph B11 on the business purpose of an investment entity), need to run the investee's business for a period (including to a varying extent over time).
Other investing entities, apparently not envisaged by the ED, could be considered as part of other IASB projects, such as IFRS for Small and Medium-sized Entities. For example, a small holding company, owned by a limited number of people, and which controls one or two trading subsidiaries, gains little through having to perform, in accordance with IFRS10 Consolidated Financial Statements, a consolidation which is in addition to the individual financial statements prepared by the individual companies. Relevant group information might be more usefully provided via additional disclosures in the individual financial statements of the parent.
Early post-implementation reviews should be able to establish whether the definition set by the IASB is robust (so that misuse is avoided), but also sufficiently comprehensive.
Q3: Should an entity still be eligible to qualify as an investment entity if it provides (or holds an investment in an entity that provides) services that relate to:
a. its own investment activities?
b. the investment activities of entities other than the reporting entity?
ACCA believes that an entity should still be eligible to qualify as an investment entity if it provides services relating to its own investment activities, either by itself, or through an investee. This is because these services are consistent with the primary investing purpose of the entity (paragraph 2 (a)) and its functions of managing its investments and providing information to investors (paragraphs 2 (e) and 2 (f)).
By contrast, an entity which provides services relating to the investment activities of other entities would not meet the criteria set out in section 2 of the ED, if it is in the business of investment management to a greater extent than the pursuit of investment gain and / or investment income.
Q4:
a. Should an entity with a single investor unrelated to the fund manager be eligible to qualify as an investment entity? Why or why not?
b. If yes, please describe any structures/examples that in your view should meet this criterion and how you would propose to address the concerns raised by the Board in paragraph BC16.
In general, as explained below, ACCA believes that an entity with a single investor unrelated to the fund manager should not be eligible to qualify as an investment entity, due to the risks entailed.
The pooling of investor funds (paragraph 2 (d) of the ED) is one of the criteria set out for eligibility as an investment entity. This cannot happen where there is a single investor. Paragraph BC16 reflects the concerns that ownership can be manipulated by related entities, in order to appear to meet the pooling requirement. By implication, it is pivotal that a single investor should be genuinely unrelated to the investment entity. We believe that inter-entity relationships can similarly be adapted, so that a single investor entity might strictly meet the criteria of being unrelated, when this is not in fact the case.
Q5: Do you agree that investment entities that hold investment properties should be required to apply the fair value model in IAS40, and do you agree that the measurement guidance otherwise proposed in the exposure draft need apply only to financial assets, as defined in IFRS9 and IAS39 Financial Instruments: Recognition and Measurement? Why or why not?
We believe that an investment entity which holds investment properties would do so with the same aims as for other investments. It is therefore appropriate that the same treatment should apply to investment properties as to other investments. This would mean that the fair value option in IAS40 Investment Property becomes compulsory, where the property is held by an investment entity.
The ED applies the fair value requirement to assets held by an investment entity for capital appreciation and / or investment income. Consequently, we agree that all financial assets held for this purpose should be measured at fair value.
Q6: Do you agree that the parent of an investment entity that is not itself an investment entity should be required to consolidate all of its controlled entities including those which it holds through subsidiaries that are investment entities? If not, why not and how would you propose to address the Board's concerns?
ACCA does not agree that a parent, which is not an investment entity, should be required to consolidate the entities which its subsidiary does not consolidate, due to being an investment entity. The relationship between the investment entity and its investees does not change because the investment entity itself is controlled by another entity.
The IASB Board is concerned that unless the parent, which is not an investment entity, consolidates all entities under its control, abuses could occur, such as the issue of shares by that parent to a non-consolidated investee in order to give the impression of a stronger group capital base (paragraph BC20). ACCA believes that this concern could be addressed by requiring appropriate additional disclosures for situations such as this.
Safeguards are provided in any event by the required criteria for an investment entity (paragraph 2) and the guidance on which activities would be inappropriate for such entities (paragraph B6). These envisage that related parties will not subject the investment entity to the types of action about which the Board has concerns. An example given of an inappropriate activity is the situation where an affiliate holds an option to purchase, from the investment entity, interests in an investee (paragraph B6 (g)).
Q7: a. Do you agree that it is appropriate to use this disclosure objective for investment entities rather than including additional specific disclosure requirements?
Paragraph 9 of the ED gives a general statement that an investment entity shall provide information to enable users to evaluate the nature and financial effects of the investment activities in which it engages. Other than in respect of certain generally non-routine situations (paragraph 10), specific disclosures are set out not as requirements in the body of the ED itself, but in the Application Guidance (paragraphs B18 and B19).
The disclosure objective stated in paragraph 9 is likely to be too general to achieve, by itself, a consistency of disclosure between investment entities. These entities may find a set of detailed requirements more helpful.
Otherwise, investment entities will need to have regard to the suggestions in paragraph B19 of the Application Guidance. These may not be applied consistently between entities, as they are not compulsory. The differing ways of application might range from full adoption of paragraph B19 as if a set of standard requirements, to amending the suggested disclosures, or omitting a number altogether. It would provide clarity if instead, detailed disclosures are set out as requirements in the main body of the standard.
b. Do you agree with the proposed application guidance on information that could satisfy the disclosure objective? If not, why not and what would you propose instead?
As paragraph B18 sets out disclosures which are required, through the use of the words “shall disclose”, we believe that it should not remain in a Guidance section. This point may also be applicable to other Standards, and so might be tackled as part of a general project on the disclosure framework for financial statements.
We are in agreement with the range of disclosures in guidance paragraph B19, and which are for adoption in appropriate circumstances. However, the disclosures in paragraph B19 are principally on a per share basis, whilst the disclosure in paragraph B18 is on a proportionate basis (of ownership and voting rights). As a result, it does not appear to be the case that the absolute amount of the investor's income can be readily ascertained.
Q8: Do you agree with applying the proposals prospectively and the related proposed transition requirements? If not, why not? What transition arrangements would you propose instead and why?
We believe that at least some information should be provided for the previous period, through disclosure. However, the significance of the change from consolidation to non-consolidation implies that retrospective application would be the most meaningful course of action for preparers and users of the financial statements.
IAS8 Accounting Policies, Changes in Accounting Estimates and Errors provides the safeguard that retrospective application is not required where impracticable. However, the problem of impracticality is unlikely to arise for investment entities, which by their nature, will be monitoring and reporting on the fair value of their investments over time (in accordance with the criteria set out in paragraph 2 (e) of the ED).
Q9: a. Do you agree that IAS 28 should be amended so that the measurement exemption would apply only to investment entities as defined in the exposure draft? If not, why not?
b. As an alternative, would you agree with an amendment to IAS 28 that would make the measurement exemption mandatory for investment entities as defined in the exposure draft and voluntary for other venture capital organisations, mutual funds, unit trusts and similar entities, including investment-linked insurance funds? Why or why not?
Investment entities
We believe that the current (irrevocable) option in IAS28 Investments in Associates, to measure investments in associates and joint ventures at fair value, should be made a requirement for investment entities. This accounting treatment then matches the measurement basis which will be required for the entities which are controlled by the investment entity.
Entities which are not investment entities, as defined (but which are venture capital organisations, mutual funds, unit trusts and similar entities, including investment-linked insurance funds)
These entities will be required to consolidate any entity which they control, and so may well prefer to account for associates under the equity method, as they can do at present. No concerns are apparent about these entities retaining the option to measure their investment in associates at fair value through the profit and loss account.
Consequently, ACCA supports option (b).