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Are you an Investment Entity? 

Consolidation Relief For Investment Entities

This article is published in the August issue of Institute of Singapore Chartered Accountants (ISCA) Magazine. It was first published in KPMG’s Financial Reporting Matters, December 2012.
Investment funds have long sought relief from consolidation, arguing that fair value information is more meaningful to a fund's investors. In a welcome move, the International Accounting Standards Board (IASB) has responded by issuing Investment Entities (Amendments to IFRS 10 Consolidated Financial Statements, IFRS 12 Disclosures of Interests in Other Entities and IAS 27 Separate Financial Statements) to providing an exception to consolidation for qualifying investment entities. Under the amendments, investment entities are required to recognise their investments in controlled investees in a single line item in the balance sheet, measured at fair value through profit or loss (FVTPL). We hope this article helps you better understand the amendments and assess whether your organisation qualifies as an investment entity.

On 4 February 2013, the Accounting Standards Council (ASC) in Singapore issued identical amendments to FRS 110 Consolidated Financial Statements, FRS 112 Disclosures of Interests in Other Entities and FRS 27 (2011) Separate Financial Statements, with an effective date of 1 January 2014, which coincides with the effective date of the consolidation suite in Singapore.

Two-stage approach in assessing qualification as an investment entity

In determining whether an entity qualifies as an investment entity, management needs to consider all facts and circumstances, including the purpose and design of the entity. To qualify as an investment entity, an entity needs to meet all of the essential elements of the definition of an investment entity and is expected – but not required – to display the typical characteristics of such an entity. We refer to this as the “two-stage approach”, as presented in the diagram below.

Entity is an investment 

entity

STAGE ONE

First essential element: Investment management services

An investment entity obtains funds from investors to provide those investors with investment management services. The IASB believes that providing these services is necessary to distinguish an investment entity from other types of entities. There is no further application guidance in the amendments regarding this particular requirement, but we expect assessment of this element to be generally straightforward.

Second essential element: Returns solely from capital appreciation and/or investment income
An investment entity commits to its investors that its business purpose is to invest for returns solely from capital appreciation and/or investment income. This commitment could, for example, be included in the offering memorandum, investor communications and/or other corporate or partnership documents. For an entity to show that its business purpose is to invest for returns solely from capital appreciation and/or investment income, the entity:

    1. Must document potential exit strategies for substantially all investments

  1. A documented potential exit strategy is required for substantially all investments that could be held indefinitely; this also means that debt securities with set maturities do not require exit strategies.

    The table below provides examples to illustrate this requirement.
    Investment Exit strategy required?
    Equity investments Yes
    Investment property Yes
    Debt instruments with a set maturity No
    Perpetual debt instruments Yes
    Debt instruments with equity conversion feature Yes

    Exit strategies that are put in place only for default events – such as breach of contract or non-performance – are not considered exit strategies for the purposes of this assessment.

    A potential exit strategy is not required for each investment, but rather for each type or portfolio of investments. The following are examples of exit strategies for financial and non-financial investments.

    Debt securities Equity investments Investment property
    • Private placement
    • Converting debt to equity with subsequent sale
    • Private placement
    • Initial public offering
    • Distribution of ownership interests
    • Private placement
    • Sale on the open market

    As an investment entity does not plan to hold its investments indefinitely, it is critical that the exit strategies include a substantive time frame for exiting the investments. An investment entity must therefore document both how and when it expects to exit its investments.

    2. Must not obtain other benefits from its investees that are not available to other
        parties that are not related to the investees (prohibited benefits)


  1. The amendments include examples of relationships and transactions that preclude an entity from qualifying as an investment entity because they indicate that the entity is investing to earn benefits other than capital appreciation and/or investment income.

    Examples of prohibited benefits
    • Acquiring, using, exchanging or exploiting intangible assets, technology or processes of an investee – for example, an option to buy an asset if its development is successful.
    • Participation as a joint controller in a joint arrangement, the purpose of which is to develop, produce, market or provide products or services.
    • Obtaining a guarantee or collateral from an investee over the entity's borrowings; however, this does not preclude an investment entity from using its investment in an investee as collateral for borrowings.
    • A related party of the investment entity holding an option to acquire ownership interests in the investee from the entity.
    • Other transactions:
      • with terms that are not available to investors that are not related parties;
      • that are not at fair value, or
      • that represent a significant portion of the business activities of the investee.

    The amendments also include specific guidance on certain relationships, transactions and services that are permitted or restricted.

    Entity is an investment entity
    Permitted services
    As part of its activities, an investment entity is permitted to provide investment-related services to investors. Such services could include, for example, investment advisory services, investment management, investment support and administrative services. Even if the investment-related services are substantial and are also provided to third parties, this does not preclude an entity from qualifying as an investment entity, as such services are simply an extension of an investment entity's investing activities.

    Permitted investment-related services may be provided directly or through a subsidiary. As shown in the diagram below, subsidiaries providing such services will be consolidated.

    Entity is an investment entity
    Restricted services
    However, providing management services or strategic advice to the investee, or providing financial support to the investee – for example through a loan, capital commitment or guarantee - is prohibited, unless these activities:

    • Do not represent a substantial business activity or a separate substantial source of income of the entity; and
    • Are undertaken to maximise the investment return from the investee.

    Third essential element: Measure and evaluate performance on a fair value basis Measure and evaluate performance on a fair value basis

    The final element of the definition of an investment entity is the measurement and performance evaluation of substantially all investments on a fair value basis. Therefore in addition to measuring its subsidiaries at FVTPL, an investment entity has to meet the following requirements:

    Non-investment assets – for example, own-use property and equipment under FRS 16 Property, Plant and Equipment – and financial liabilities need not be measured at fair value.

STAGE TWO

Typical characteristics
An investment entity is expected to display the following typical characteristics.
  • Holds more than one investment
  • Has more than one investor
  • Has investors that are not related parties, and
  • Has ownership interests in the form of equity or similar interests

However, it is possible for an entity to have none of these characteristics and still qualify as an investment entity. In such cases additional judgement is required by management in determining whether the entity qualifies. An investment entity is required to disclose its reasons for concluding that it is nevertheless an investment entity when one or more of these characteristics is not met.

New disclosures

For investments in subsidiaries, associates and joint ventures accounted for at FVTPL under the amendments, the following disclosures apply – FRS 107 Financial Instruments: Disclosures, FRS 112 FRS 113 Fair Value Measurement and FRS 24.

The FRS 107 disclosures are likely to be the most significant; for example, the sensitivity analysis disclosures now apply to the investee as a whole rather than to its underlying investments on a consolidated basis.

Parents of investment entities
    1. Parent is an investment entity
  1. The investment entity consolidation exception is mandatory for the parent of an investment entity that itself meets the definition of an investment entity. In addition, because the parent is an investment entity, any investments in associates and joint ventures are required to be accounted for at FVTPL.

    2. Parent is not an investment entity
  1. The consolidation exception is not carried through to the consolidated financial statements of a parent that is not itself an investment entity – that is, the parent is nevertheless required to consolidate all subsidiaries.


Effective date and transition

The effective date of the amendments is for annual periods beginning on or after 1 January 2014. Earlier application is allowed, provided FRS 110 and the rest of the consolidation suite are also applied at the same time.

An entity tests whether it is an investment entity at the "date of initial application" of the amendments which is 1 January 2014 for an entity with a calendar year end that does not early adopt. Comparative information is restated and a third balance sheet is presented, unless impracticable. However, like FRS 110, the requirement to present restated comparatives is limited to the immediately preceding period.

By Mr Ong Pang Thye, Partner, Head of Audit, KPMG in Singapore.
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