Step 1: Determine the net investment in the investee
The net investment in an equity-method investee comprises two main components.
- First, the carrying amount of the investor’s equity interest in the investee that will be equity accounted.
- Second, any long-term interests (LTIs), such as preferred shares or loans to the investee for which settlement is neither planned nor likely in the foreseeable future. Those are common financing structures in the extractive and real estate sectors. The net investment excludes trade receivables and payables, or other long-term receivables for which collateral exists.
Step 2: Apply IFRS 9 to LTI component of net investment in the investee
The investor applies IFRS 94to financial instruments included in the net investment to which the equity method is not applied (i.e. the LTIs). This requirement may sound obvious because IFRS 9 provides measurement guidance, including the expected credit loss impairment model for loans (read morehere). However, it creates a loss-recognition ordering challenge in certain situations, which we explain in the example below.
Step 3: Apply the equity method to the equity interest in the investee
The investor applies the equity method in the usual way, but complications arise when the investee is loss-making. In that case, the investor recognizes its share of the losses until its equity interest is reduced to zero. Any further share of losses is allocated to the LTIs in the investee in the reverse order of seniority (after applying IFRS 9 in Step 2).
Example: Interaction of Steps 2 and 3 for a loss-making investee
The IASB’s amendments clarify how the conceptually different IFRS 9 and IAS 28 apply to the same instrument. Here we present a simplified example, in which Investor has a 40% interest in Investee, and has also given Investee a long-term loan that is not collateralized.
Assumptions are shown initalics.
