Following the absurdity expected to arise upon the initial application of IFRS 18, an amendment to IAS 28 was swiftly completed which creates interesting reporting opportunities through the end of 2026. The amendment permits an otherwise ineligible holding company to make an election to measure associates at fair value, provided they were acquired through a subsidiary whose main business activity is investing in assets. As a result of the amendment, where an ordinary operating company wishes to move from applying the equity method to the fair value model, it can perform a corporate restructuring so that the investment in the associate is transferred to a subsidiary that invests in assets, or it can acquire the associate through such a subsidiary from the outset. This could apply, for example, in the case of an associate whose fair value is significantly higher than its carrying amount, as in the case of an investment in a start-up company.
Although IFRS 18 deals exclusively with presentation and disclosure matters, it may now have indirect implications for measurement issues under IAS 28. Last month, an amendment to IAS 28 was swiftly completed, expanding the option to elect the fair value model for investments in associates and joint ventures. The amendment was driven by two significant distortions- one historical, the other recently created. The historical distortion is the sweeping prohibition for most entities on measuring investments in associates and joint ventures at fair value, even where the investment is publicly traded and has a quoted price.
The new distortion, which will take effect at the beginning of 2027 with the initial application of IFRS 18, is a requirement that applies without exception to classify income from investments in associates and joint ventures measured using the equity method in the investing category. This requirement also applies to “integral” associates with activity similar to that of the holding company, and even where the holding constitutes a main business activity. This distortion under IFRS 18 could lead holding companies to record an operating loss, since they are required to classify overhead expenses in the operating category, while the income from the associates is classified in the investing category.
The rationale for the sweeping classification in the investing category was that there is no control over the activities of such investments, and that equity-method income includes non-operating items such as financing and taxes. However, the IASB was responsive to public criticism and sought to expand the ability to elect the fair value model, with the aim of allowing classification in the operating category where such an investment constitutes a main business activity.
It should be noted that a venture capital fund, mutual fund, and similar entities may elect, at initial recognition (or at the date of initial application of IFRS 18), to apply the fair value model to measure an investment in an associate or joint venture, instead of the equity method. The amendment clarifies that “similar entities” include entities whose main business activity is investing in assets (not necessarily in associates or joint ventures). Where such an entity holds an associate or a joint venture directly, it (and the group in which it is included) may elect the fair value option.
However, where the fair value option is elected, income and expenses arising from the change in fair value may be classified in the operating category only if the reporting entity (the direct holder or the group in which it is included, as applicable) has a main business activity of investing in associates or joint ventures. In any other case, the change in fair value must be classified in the investing category.
The technical structure of the holding viewed at the group level determines the measurement alternative- an illustration
The hastily approved amendment, which attempted to resolve the new distortion arising from classification into categories, appears to give rise to another distortion- one that, under certain circumstances, can be exploited for legitimate planning to bring an investment in associates within the scope of the fair value option. By way of illustration, assume an industrial company holds 100% of the shares of a subsidiary engaged solely in income-producing real estate. From the subsidiary’s perspective, it invests in assets as a main business activity. On the other hand, the subsidiary’s activity constitutes only 10% of the group’s overall activity. Therefore, from the group’s perspective, the investment in income-producing real estate does not constitute a main business activity.
Now, suppose the industrial company wishes to acquire 25% of a start-up company, which would grant it significant influence. In this case, if the associate is acquired directly by the industrial parent company, this would require application of the equity method. Thus, continuing equity-method losses would be recognised, while any increase in the fair value of the investment would not be reflected in the financial statements. By contrast, acquiring the associate through the subsidiary would allow the investment to be measured at fair value in the consolidated financial statements.
This is because the subsidiary has a main business activity of investing in income-producing real estate assets, and, under the amendment, it is entitled to elect to measure at fair value associates that it holds directly. Consequently, the parent company, which holds the associate through the “eligible” subsidiary, is also entitled to measure the associate at fair value in the consolidated financial statements. It should be noted that this provision maintaining the eligibility to elect the fair value option also for the holding company, differs from the provision of IFRS 10 regarding an investment entity, under which the requirement to measure subsidiaries at fair value is not maintained upward in the ownership chain.
The practical implications, and what can be done before the initial application date of IFRS 18
The proper approach should have been to open up the election to measure all associates at fair value, as this election has existed for many years under US GAAP. In the absence of such a sweeping option under IFRS, and for a group to be entitled to measure its associates at fair value, a subsidiary is required to invest in assets as a main business activity, though not necessarily in income-producing real estate assets. It is also possible for the subsidiary to invest in other assets, provided they generate a return individually and largely independently of the subsidiary’s other resources, such as a securities portfolio in certain cases.
Therefore, there appears to be no obstacle to establishing a wholly owned subsidiary today and transferring to it income-producing real estate assets or a securities portfolio, of a scale sufficient at the group level to withstand a claim of artificial restructuring. In the next stage (and before the end of 2026), associates and joint ventures can be transferred to the subsidiary, which has a main business activity of investing in assets. Finally, at the date of initial application of IFRS 18, an election can be made to measure these investments under the fair value model in the consolidated financial statements.
This restructuring may appear artificial at first glance. However, in our view it is a legitimate step, with no accounting obstacle to it under current IFRSs, especially given that it resolves a significant distortion in the measurement of associates and leads to financial statements that are more relevant to investors. Where the associate is also publicly traded with a quoted price, this solution represents a win-win situation, both in terms of cost for preparers and benefit for investors.
(*) This paper was co-authored by Shlomi Shuv and Gil Rosenstock, Partner, Head of Professional Practice, RSM Israel