INTRODUCTION
There is no existing guidance under Ind AS for the accounting of cross holdings. This article provides guidance on the accounting of cross holdings between two associate companies. Consider the following fact pattern:
Entity Ze has an associate Ve (20% of Entity Ve and significant influence).
Entity Ve has an associate Ze (20% of Entity Ze and significant influence).
Both Entity Ze’s and Entity Ve’s share capital is 200,000 shares at 1 unit each.
Entity Ze’s profit excluding its share in Ve = INR 1000; Entity Ve’s profit excluding its share in Ze = INR 1000.
ISSUES
• How does an entity account for cross holdings in associates in accordance with paragraph 27 of Ind AS 28 Investments in Associates and Joint Ventures in the Consolidated Financial Statements?
• Does an entity adjust EPS calculation for the cross holdings?
RESPONSE
References to Ind AS
Paragraph 26 of Ind AS 28 applies consolidation procedures to equity method of accounting as follows:
‘Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture.’
Paragraph 27 of Ind AS 28 states:
‘A group’s share in an associate or a joint venture is the aggregate of the holdings in that associate or joint venture by the parent and its subsidiaries. The holdings of the group’s other associates or joint ventures are ignored for this purpose. When an associate or a joint venture has subsidiaries, associates or joint ventures, the profit or loss, other comprehensive income and net assets taken into account in applying the equity method are those recognised in the associate’s or joint venture’s financial statements (including the associate’s or joint venture’s share of the profit or loss, other comprehensive income and net assets of its associates and joint ventures), after any adjustments necessary to give effect to uniform accounting policies (see paragraphs 35 and 36A).’
Paragraph B86 of Ind AS 110 Consolidated Financial Statements states:
‘Consolidated financial statements:… (c) eliminate in full intragroup assets and liabilities, equity, income, expenses and cash flows relating to transactions between entities of the group (profits or losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full).’
Paragraph 33 of Ind AS 32 Financial Instruments: Presentation states:
‘If an entity re-acquires its own equity instruments, those instruments (“treasury shares”) shall be deducted from equity. No gain or loss shall be recognised in profit or loss on the purchase, sale, issue or cancellation of an entity’s own equity instruments. Such treasury shares may be acquired and held by the entity or by other members of the consolidated group. Consideration paid or received shall be recognised directly in equity.’
GROSS APPROACH
Entity Ze’s profit and Entity Ve’s profit are dependent on each other, which can be expressed by simultaneous equations as follows:
a = INR 1000 + 0.2b
b = INR 1000 + 0.2a
Solving the simultaneous equation results in:
a = INR 1250 and b = INR 1250
Therefore, Entity Ze’s profit is INR 1250, and Entity Ve’s profit is INR 1250.
NET APPROACH
This approach ignores the cross holding and simply takes up the investor’s share of the associate’s profit, excluding the equity income arising on the cross shareholding. Thus, the additional profit in the financial statements of both Entity Ze and Entity Ve is limited to INR 200 each (1000*20%).
A literal view of paragraph 27 of Ind AS 28 is that Entity Ze recognises its share of Entity Ve’s profits, including Entity Ve’s equity accounted profits. However, in the case of cross holdings this approach results in a portion of Ze’s profits being double counted. Consequently, the net approach, which only accounts for 20% of the associate’s profit, is more appropriate. In this fact pattern, the net approach results in Entity Ze and Entity Ve both recognising profit of INR 1200 (rather than INR 1250 as per the gross approach). The difference of INR 50 represents the equity effect of the cross holdings and therefore is not recognised in profit. In other words, the INR 50 represents (with respect to the associate that is preparing its consolidated accounts) a portion of its own profit being double counted.
Additionally, the equity method of accounting employs consolidation-type procedures such as the elimination of unrealised profits. Income arising on an investment held by a subsidiary in a parent is eliminated under paragraph B86(c) of Ind AS 110 Consolidated Financial Statements. Consequently, in applying consolidation procedures in equity accounting, income arising from associate’s investment in the investor should also be eliminated.
Consequently, the net approach is the only acceptable method.
EPS CALCULATION
The number of ordinary shares on issue is adjusted using the net approach. Consequently, an adjustment reduces the entity’s equity balance and its investment in the associate by its effective 4% interest (20*20%) in its own shares. The result is similar to the treatment of treasury shares that are eliminated from equity and, accordingly, excluded in determining the EPS. In calculating earnings per share, the weighted average number of ordinary shares is reduced by the amount of the effective cross holding. Therefore, Entity Ze’s and Entity Ve’s ordinary shares are reduced to 192,000 (200,000*[100-4]; i.e. 96%) for the purpose of the earnings per share calculation.
Some may argue that the associate is not part of the group and therefore the shares held in the investor are not ‘treasury shares’ as defined in Ind AS 32. However, it may be noted that the view in the preceding paragraph does not rely on viewing the associate’s holding as treasury shares. Rather, it relies on the fact that Ind AS 28.26 states that many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in Ind AS 110. If a subsidiary holds shares in a parent, these are eliminated under paragraph B86(c) of Ind AS 110. The same procedure should therefore apply to equity accounting.
Though this issue is discussed in the context of cross holdings between associates, it will apply equally to jointly controlled entities that are equity accounted.
