17.1.04 Investment in a Group Company

Enquiry:

The query pertains to accounting treatment of an investment in a group company and whether to treat the investment as an associate under IAS – 28 or not.

Companies involved are as follows;

Holding Company A (a public unlisted company) owns 66.66% shares of Our Company B (a listed company) and 60.36% of Company C (a private company).

Company B owns 9.09% shares of Company C.

The Management (of Company B) believes that it has no influence on the financial and operating policies of the investee company (Company C) and projecting it as an associate under IAS – 28 will give wrong impression to the shareholders of the Company B (the company is listed). The query pertains to Company B’s investment in Company C.

Holding Company A has placed three non executive directors on the board of the Company B, two of them are also the non executive directors and one is an executive director of Company C.

The management of Company B understands that Company B and Company C are related parties but pleads that these are not associated undertakings under IAS-28 as no significant influence exist over the Company C and so associate accounting should not be done in the consolidated financial statements.

The management has taken its view from IAS-28 itself as it states that:

“If an investor holds, directly or indirectly (e.g. through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. (Company C does not hold 20% or more shareholding.)

Conversely, if the investor holds, directly or indirectly (e.g. through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. (It clearly states that in less than 20% holding, it should be presumed that it is not significant influence unless some factors demonstrate otherwise and Company has 9.09% shares)”

Further, Standard gives examples of factors which can give rise to significant influence when having less than 20% ownership as follows:

The existence of significant influence by an investor is usually evidenced in one or more of the following ways:

(a)    representation on the board of directors or equivalent governing body of the investee;
(Management pleads that representation on board would mean any of Company B’s employee or executive director on the board of Company C. Merely common directorship through non executive directors does not include representation on the board of directors. None of the employee or executive director of Company B is a director of Company C and therefore Company B has no representation on the Board of Company C).

(b)    participation in policy-making processes, including participation in decisions about dividends or other distributions; (No decision making rest with Company B)

(c)    material transactions between the investor and the investee;
(The only transaction is purchase of office space in the building being owned and constructed by Company C. The portion is approximately 5% of the total project. Other than that only shares have been purchased of Company C which is 9.09% of total share capital. Company C has not made any investment or any other transaction with Company B.)

(d)  interchange of managerial personnel; (There is no interchange of managerial personnel) or

(e)    provision of essential technical information. (None)

Further points to be considered:

1)     Holding Company A has placed three non executive directors on the board of the Company B, two of them are also the non executive directors and one is an executive director of Company C.

2)     Company B is a listed entity. Management believes that presenting Company C as associate in the financial statements may give a wrong information to minority shareholders.

3)    Company C is a private company but has 26% ownership from outside the group and is also bound by the debt contract with the foreign lender as the project is majorly financed by the foreign lender.

4)   Some views suggests that company C is an associate undertaking under IAS 28 based on COMMON DIRECTORSHIP and they believe that investment in group company automatically qualifies for associate accounting.

5)     Share holding of Company A in Company B and Company C includes shareholding of directors of the company A.

6)   The management of Company B has determined that it has no influence on the financial and operating policies of Company C.

Assistance of the esteemed technical committee is requested so that we can follow the treatment in our separate and consolidated financial statements.

Opinion:

Paragraph 7 (a) of IAS 28 ‘Investment in Associate’ as also reproduced in your enquiry clearly says that investor has significant influence when the investing company has representation on the board of directors of the investee.

Based on above, the Committee is of the view that Company C is an associate undertaking as per IAS 28 based on the ground of Common Directorship.

(March 1, 2012)