Retained Interests after Deconsolidation: Navigating Post-Deconsolidation Accounting

15.6 Retained Interests after Deconsolidation

In the realm of consolidated financial statements and business combinations, deconsolidation represents a significant shift in the reporting entity’s structure and financial presentation. When a parent company loses control over a subsidiary, it must deconsolidate the subsidiary’s financial statements from its own. However, the story doesn’t end there. Often, the parent company retains an interest in the former subsidiary, which introduces complexities in accounting and financial reporting. This section delves into the nuances of accounting for retained interests after deconsolidation, providing a comprehensive guide for Canadian accounting professionals and exam candidates.

Understanding Deconsolidation

Deconsolidation occurs when a parent company loses control over a subsidiary, which can happen due to various reasons such as selling a portion of its ownership interest, changes in contractual arrangements, or the subsidiary issuing new shares to third parties. The loss of control triggers the need to remove the subsidiary’s assets, liabilities, and non-controlling interests from the parent company’s consolidated financial statements.

Key Concepts in Deconsolidation

• Control: Control is defined under IFRS 10 as the power to govern the financial and operating policies of an entity to obtain benefits from its activities. Losing control necessitates deconsolidation.
• Derecognition: Upon deconsolidation, the parent derecognizes the subsidiary’s assets, liabilities, and any non-controlling interests.
• Gain or Loss on Deconsolidation: The parent recognizes a gain or loss on deconsolidation, calculated as the difference between the fair value of consideration received and the carrying amount of the subsidiary’s net assets.

Accounting for Retained Interests

When a parent retains an interest in a former subsidiary after deconsolidation, the retained interest must be accounted for appropriately. The accounting treatment depends on the level of influence the parent retains over the former subsidiary.

Levels of Influence and Accounting Treatment

1. Significant Influence (Equity Method): If the parent retains significant influence, typically indicated by holding 20% to 50% of the voting power, the retained interest is accounted for using the equity method. Under this method, the investment is initially recognized at fair value and subsequently adjusted for the parent’s share of the former subsidiary’s profits or losses.

2. No Significant Influence (Financial Instruments): If the parent does not retain significant influence, the retained interest is accounted for as a financial instrument under IFRS 9 or ASPE Section 3856. The investment is measured at fair value through profit or loss (FVTPL) or fair value through other comprehensive income (FVOCI), depending on the business model and contractual cash flow characteristics.

3. Joint Control (Joint Arrangements): If the parent retains joint control, the retained interest is accounted for as a joint arrangement under IFRS 11, either as a joint operation or a joint venture.

Initial Recognition and Measurement

Upon deconsolidation, the retained interest is initially recognized at its fair value. The fair value serves as the new cost basis for subsequent accounting. This initial recognition is crucial as it impacts future financial reporting and potential impairment assessments.

Practical Example: Retained Interest Accounting

Consider a scenario where Company A owns 60% of Subsidiary B. Company A sells 30% of its interest, resulting in a loss of control over Subsidiary B. After the sale, Company A retains a 30% interest in Subsidiary B.

• Deconsolidation: Company A derecognizes Subsidiary B’s assets, liabilities, and non-controlling interests from its consolidated financial statements.
• Gain or Loss Calculation: Company A calculates the gain or loss on deconsolidation based on the fair value of the consideration received and the carrying amount of Subsidiary B’s net assets.
• Retained Interest Accounting: Company A assesses whether it has significant influence over Subsidiary B. If so, it accounts for the retained 30% interest using the equity method.

Fair Value Measurement

The fair value measurement of retained interests is critical and can be challenging. It requires the application of valuation techniques that are consistent with IFRS 13 Fair Value Measurement. The fair value hierarchy prioritizes the inputs used in valuation techniques, ranging from observable market data to unobservable inputs.

Valuation Techniques

• Market Approach: Uses prices and other relevant information generated by market transactions involving identical or comparable assets.
• Income Approach: Converts future amounts (e.g., cash flows or income and expenses) to a single current (discounted) amount.
• Cost Approach: Reflects the amount that would be required currently to replace the service capacity of an asset.

Implications on Financial Statements

The accounting for retained interests after deconsolidation affects several areas of the financial statements:

• Statement of Financial Position: The retained interest is presented as an investment, either as an equity-accounted investment or a financial asset.
• Statement of Profit or Loss: Depending on the accounting method, the parent recognizes its share of the former subsidiary’s profits or losses or changes in fair value.
• Statement of Cash Flows: The deconsolidation transaction impacts cash flows from investing activities, and subsequent cash flows related to the retained interest are classified based on the nature of the investment.

Regulatory and Compliance Considerations

Canadian accounting standards, including IFRS as adopted in Canada and ASPE, provide guidance on accounting for retained interests after deconsolidation. It is essential for accounting professionals to stay updated with any changes in these standards and ensure compliance with disclosure requirements.

Disclosure Requirements

• Nature and Financial Effects: Disclose the nature and financial effects of deconsolidation, including the gain or loss recognized.
• Retained Interest Details: Provide information about the retained interest, including its fair value and the accounting method applied.
• Significant Judgments and Estimates: Disclose any significant judgments and estimates made in determining the fair value of the retained interest and assessing control or significant influence.

Challenges and Best Practices

Accounting for retained interests after deconsolidation presents several challenges, including fair value measurement, determining the level of influence, and ensuring compliance with disclosure requirements. To address these challenges, consider the following best practices:

• Engage Valuation Experts: Utilize the expertise of valuation professionals to ensure accurate fair value measurements.
• Regularly Review Influence Levels: Continuously assess the level of influence over the former subsidiary to determine the appropriate accounting treatment.
• Enhance Disclosure Practices: Provide comprehensive and transparent disclosures to meet regulatory requirements and inform stakeholders.

Case Study: Deconsolidation and Retained Interest

Let’s explore a case study to illustrate the practical application of these concepts:

Background: Company X owns 70% of Subsidiary Y. Due to strategic realignment, Company X sells 40% of its interest in Subsidiary Y, losing control but retaining a 30% interest.

Accounting Steps:

1. Deconsolidation: Company X removes Subsidiary Y’s assets, liabilities, and non-controlling interests from its consolidated financial statements.
2. Gain or Loss Recognition: Company X calculates the gain or loss on deconsolidation based on the fair value of the consideration received and the carrying amount of Subsidiary Y’s net assets.
3. Retained Interest Accounting: Company X assesses its level of influence over Subsidiary Y. With a 30% interest, it applies the equity method.
4. Fair Value Measurement: Company X determines the fair value of the retained interest using appropriate valuation techniques.
5. Disclosure: Company X provides detailed disclosures about the deconsolidation and retained interest, including the nature and financial effects of the transaction.

Conclusion

Accounting for retained interests after deconsolidation is a complex yet essential aspect of financial reporting in business combinations. By understanding the levels of influence, applying appropriate accounting methods, and ensuring compliance with regulatory requirements, accounting professionals can navigate this challenging area effectively. As you prepare for the Canadian Accounting Exams, focus on mastering these concepts and applying them to real-world scenarios to enhance your understanding and readiness.

Ready to Test Your Knowledge?