Standards board heeds ‘dividend trap’ critics on IAS 27

But have the new proposals gone far enough? By Nick Topazio, financial reporting specialist, CIMA.

Critics argue that once the International Accounting Standards Board (IASB) has published an exposure draft it has already made up its mind on the final standard or amendment. The relatively few changes to exposure draft proposals after a final consultation period support this argument.

But this is not the case with the comments the IASB received about its exposure draft proposals published in January 2007 on determining the cost of an investment in separate financial statements by first time IFRS adopters.

The original proposals were widely criticised for helping to create a ’dividend trap’ in which distributable reserves were locked into subsidiaries. These reserves could not then be passed up to the ultimate parent company and so were not available to support the declaration of dividends. As a consequence, many groups have not extended their adoption of IFRS to their individual financial statements. They have simply adopted IFRS for their group accounts.

The IASB noted these comments and revised its proposals. It has also exposed them again for further comment.

How do the proposals work?

Under IAS 27 now, an investor recognises income from an investment only to the extent that it receives dividends from post acquisition profits. Dividends received in excess of such profits are deemed recovery of investment and are accounted for by reducing the cost of the investment.

The January 2007 exposure draft proposed an exemption to this requirement, but this proposed relief did not receive a positive response. The new proposal is to remove the current IAS 27 requirement and replace it with a requirement that dividends received by an investor from a subsidiary, jointly controlled entity or associate should be recognised as income in the individual financial statements of the investor.

As a result of the change, entities accounting for such investments at cost must undertake an impairment test in any accounting period in which a dividend was paid, regardless of whether any indicators of impairment exist.

The exposure draft also proposes to allow an entity - on first adoption of IFRS - to use a deemed cost to account for an investment in a subsidiary, jointly controlled entity or associate.

The deemed cost can be either:

• the fair value or
• the carrying amount of an investment as determined by the previous GAAP used by the entity.

The original proposals required that the deemed cost be:

• the entity’s interest in the carrying amount of net assets of the subsidiary, based on the subsidiary’s net assets determined under IFRS; or
• the fair value of the entity’s investment in the subsidiary.

The original proposals were felt to be too onerous for entities adopting IFRS.

Your views

I am keen to hear your views on whether the new proposals answer the criticisms fully and whether your group is more likely to adopt IFRS for subsidiary accounts as a result.

You can submit comments via CIMA’s consultation database, or direct to me at nick.topazio@cimaglobal.com.

Useful links

IASB website
Financial reporting news, January 2008 Insight

February 2008

What did you think of this article? Email tim.cooper@cimaglobal.com.

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