Overseas Chinese Banking Corporation (OCBC Bank)

[Yoyo]

^^ why is there a gain when they bought more and convert into associate? I thought usually the principle is the lower of cost or market? Once it is associate it is no longer MTM right?

Trying to understand the accounting intricacies here because I don't remember any company booking gains when buying under GAAP... only when selling... or is this an IFRS thing?

Not a new accounting standard.

Financial Memo
Equity Method of Accounting – Investments in Associates
http://financialmemos.com/equity-method-...e-example/

Investment in Associate and Accounting Treatment
IAS 28 sets a clear framework for the way that an investment in an associate should be recorded. An example can be found below but briefly, the following points apply:
1. The investment is initially recognized at fair value which is the same as the price paid to acquire the holding in the associate company.
2. Goodwill is not separately calculated since it is already included in the fair value.
3. The statement of financial position include the initial fair value (price paid), plus the share of the post acquisition profits generated by the associate company, less the share of any impairment in the investment, less any dividends distributed by the associate company.
4. The income statement of the investing company should include the post acquisition share of profits that the associate company generated as a single line (“profits from associate”).
5. If the acquisition is made in the middle the year, then the profits should be pro-rated to only reflect the post acquisition part of the profits generated.

Equity method requires the record of investment in associate at the cost of purchase, and to track the share of post acquisition profit (+)and dividend (-), followed by any impairment made (-).

Investment in associate materialised when
a. Upright acquisition of 20% or more shareholding in one transaction
b. Piece meal acquisition resulting in the booking/recording as available for sales investment (less than 20%), and later transformed to investment in associates upon accumulation to 20% and beyond.

In this case, it is (b). However, before hitting 20%, it stay in the books as available for sales investment, and MTM apply. At the point when the investment become an associate, the fair value reserve accorded to the investment will be released to the Income Statement. (That is the latest book value will be taken to equate the fair value. Thereafter, the need to track the share of post acquisition profit, etc.

IMO - to take all the buy cost of the various share acquisition transactions at different points in time prior to attaining 20% interests, amounts to recognize the associate investment at historical cost, instead of the fair value (stipulated by the standard).

Please correct me if I am wrong.

[kikababoo]

^^^ The treatment actually determines if the MTM unrealised gains ie AFS reserve will be reversed out as a balance sheet entry:
Dr Investment in associate 150
Cr Investment in Equity Securities 200
Cr Cash 50
Dr AFS Reserve 100

or hitting the PnL:
Dr Investment in associate 250
Cr Investment in Equity Securities 200
Cr Cash 50
Dr AFS Reserve 100
Cr PnL 100

Nothing wrong with both MATHEMATICALLY but the principle will determine which is acceptable, that's why I thought it may be a new IFRS thingy

specu. your first set of entries won't work. AFS reserve is a equity account entry, debiting AFS reserve is the same as Debiting a non P&L impact of expense. so it has the same impact of reducing the overall book equity value of OCBC.

in essence, the key principle is that once it reaches associate, you have to MTM/fair value the value of your previous stakes (and that difference between the MTM/fair value amount and the existing book value will go into P&L as a form of gain. and as OCBC account for the company (prior to it becoming an associate) as a AFS securities (available for sale), so it already MTM the entity before, just that the MTM amount is not a P&L impact but other comprehensive income impact. so FRS needs you to recognise the whole MTM amount as P&L impact. which is why they recognise a one-off gain.

[specuvestor]

^^ thanks kika... FX and reval reserve changes everytime as well? It doesn't mean book value cannot be reduced?

Thanks CF and Yoyo I'll digest more as this announcement piqued my interest as i dont recall reading anything like this before

[specuvestor]

3. The statement of financial position include the initial fair value (price paid), plus the share of the post acquisition profits generated by the associate company, less the share of any impairment in the investment, less any dividends distributed by the associate company.
<snip>

Equity method requires the record of investment in associate at the cost of purchase, and to track the share of post acquisition profit (+)and dividend (-), followed by any impairment made (-).

Investment in associate materialised when
a. Upright acquisition of 20% or more shareholding in one transaction
b. Piece meal acquisition resulting in the booking/recording as available for sales investment (less than 20%), and later transformed to investment in associates upon accumulation to 20% and beyond.

In this case, it is (b). However, before hitting 20%, it stay in the books as available for sales investment, and MTM apply. At the point when the investment become an associate, the fair value reserve accorded to the investment will be released to the Income Statement. (That is the latest book value will be taken to equate the fair value. Thereafter, the need to track the share of post acquisition profit, etc.

IMO - to take all the buy cost of the various share acquisition transactions at different points in time prior to attaining 20% interests, amounts to recognize the associate investment at historical cost, instead of the fair value (stipulated by the standard).

Please correct me if I am wrong.

Thats what i understand as well but u might be confused Bank of Ningbo is listed in Shenzhen so when it was MTM it was marked according to the market price and AFS adjusted as such. When it converts to associates the AFS reserve has to be reversed and replaced by the share of earnings by equity method which should generally be lower because listed equity multiplies earnings

So the fair value for associates is based on equity method (historic cost plus retained earnings) but fair value for AFS is based on market price.

[kikababoo]

3. The statement of financial position include the initial fair value (price paid), plus the share of the post acquisition profits generated by the associate company, less the share of any impairment in the investment, less any dividends distributed by the associate company.
<snip>

Equity method requires the record of investment in associate at the cost of purchase, and to track the share of post acquisition profit (+)and dividend (-), followed by any impairment made (-).

Investment in associate materialised when
a. Upright acquisition of 20% or more shareholding in one transaction
b. Piece meal acquisition resulting in the booking/recording as available for sales investment (less than 20%), and later transformed to investment in associates upon accumulation to 20% and beyond.

In this case, it is (b). However, before hitting 20%, it stay in the books as available for sales investment, and MTM apply. At the point when the investment become an associate, the fair value reserve accorded to the investment will be released to the Income Statement. (That is the latest book value will be taken to equate the fair value. Thereafter, the need to track the share of post acquisition profit, etc.

IMO - to take all the buy cost of the various share acquisition transactions at different points in time prior to attaining 20% interests, amounts to recognize the associate investment at historical cost, instead of the fair value (stipulated by the standard).

Please correct me if I am wrong.

Thats what i understand as well but u might be confused Bank of Ningbo is listed in Shenzhen so when it was MTM it was marked according to the market price and AFS adjusted as such. When it converts to associates the AFS reserve has to be reversed and replaced by the share of earnings by equity method which should generally be lower because listed equity multiplies earnings

So the fair value for associates is based on equity method (historic cost plus retained earnings) but fair value for AFS is based on market price.

actually the fair value for associates is not just based on historical book of equity + share of earnings. technically, market price of the associates can be considered an input and that can be used as the fair value. if there's no market price (meaning if its private co) then the acquirer can use some kind of valuation method to "fair value" this.

that's the detriment of fair value accounting, lots of management discretion n element of uncertainty in it.

[r0n]

3. The statement of financial position include the initial fair value (price paid), plus the share of the post acquisition profits generated by the associate company, less the share of any impairment in the investment, less any dividends distributed by the associate company.
<snip>

Equity method requires the record of investment in associate at the cost of purchase, and to track the share of post acquisition profit (+)and dividend (-), followed by any impairment made (-).

Investment in associate materialised when
a. Upright acquisition of 20% or more shareholding in one transaction
b. Piece meal acquisition resulting in the booking/recording as available for sales investment (less than 20%), and later transformed to investment in associates upon accumulation to 20% and beyond.

In this case, it is (b). However, before hitting 20%, it stay in the books as available for sales investment, and MTM apply. At the point when the investment become an associate, the fair value reserve accorded to the investment will be released to the Income Statement. (That is the latest book value will be taken to equate the fair value. Thereafter, the need to track the share of post acquisition profit, etc.

IMO - to take all the buy cost of the various share acquisition transactions at different points in time prior to attaining 20% interests, amounts to recognize the associate investment at historical cost, instead of the fair value (stipulated by the standard).

Please correct me if I am wrong.

Thats what i understand as well but u might be confused Bank of Ningbo is listed in Shenzhen so when it was MTM it was marked according to the market price and AFS adjusted as such. When it converts to associates the AFS reserve has to be reversed and replaced by the share of earnings by equity method which should generally be lower because listed equity multiplies earnings

So the fair value for associates is based on equity method (historic cost plus retained earnings) but fair value for AFS is based on market price.

actually the fair value for associates is not just based on historical book of equity + share of earnings. technically, market price of the associates can be considered an input and that can be used as the fair value. if there's no market price (meaning if its private co) then the acquirer can use some kind of valuation method to "fair value" this.

that's the detriment of fair value accounting, lots of management discretion n element of uncertainty in it.

Your comment about fair value of associates is not accurate.

Firstly, the concept of fair value is not applicable to associates. The rest of the paragraph is applicable to financial instruments under FRS 39 but associates come under FRS 28.

Secondly, under equity accounting, there is no choice. you must pick up you share of the profit or loss of the associate.

But I agree with the rest of your discussion about fair value accounting. Basically only the auditors can challenge their modelling assumptions if they don't use Level 1 which is market price.

[specuvestor]

^^^ AFAIK if say X owns 20% of Y and Y generates zero profit but it can do a biological asset reval and result in say $1m profit then X share of profit as an associate is $0.2m

So when X account for Y it has to be share of profit base under equity accounting, but Y itself can have a reval to "fair value". The implication will not show up in balance sheet until it is actually consolidated

In fact that's one way how companies dress up their numbers: strong earnings make it a 49% associate; strong balance sheet make it a 51% consolidated.

[r0n]

^^^ AFAIK if say X owns 20% of Y and Y generates zero profit but it can do a biological asset reval and result in say $1m profit then X share of profit as an associate is $0.2m

So when X account for Y it has to be share of profit base under equity accounting, but Y itself can have a reval to "fair value". The implication will not show up in balance sheet until it is actually consolidated

In fact that's one way how companies dress up their numbers: strong earnings make it a 49% associate; strong balance sheet make it a 51% consolidated.

Specuvestor, thanks for sharing your insights. Deeply informative for people who do not really have any idea behind consolidation and equity accounting.

I would like to extend your statement further:
If the results are good because of one-offs, non-recurring or fair value gains, parking it behind an associate is better because equity accounting will disclose nothing meaningful.

On a related note, there may be companies with 49% but consolidated and 51% but equity-accounted for, it depends on whether the entity has control over the other.

[kikababoo]

Your comment about fair value of associates is not accurate.

Firstly, the concept of fair value is not applicable to associates. The rest of the paragraph is applicable to financial instruments under FRS 39 but associates come under FRS 28.

Secondly, under equity accounting, there is no choice. you must pick up you share of the profit or loss of the associate.

But I agree with the rest of your discussion about fair value accounting. Basically only the auditors can challenge their modelling assumptions if they don't use Level 1 which is market price.

oh i was just referring to the fair valuing of associates upon the entity first becoming an associate for the first time. e.g. like from step up acquisition from 14% to more than 20%. i think there's some parts in frs that states that you need to fair value the stake. then after that u do equity accounting. not 100% sure abt this actually.

[r0n]

Your comment about fair value of associates is not accurate.

Firstly, the concept of fair value is not applicable to associates. The rest of the paragraph is applicable to financial instruments under FRS 39 but associates come under FRS 28.

Secondly, under equity accounting, there is no choice. you must pick up you share of the profit or loss of the associate.

But I agree with the rest of your discussion about fair value accounting. Basically only the auditors can challenge their modelling assumptions if they don't use Level 1 which is market price.

oh i was just referring to the fair valuing of associates upon the entity first becoming an associate for the first time. e.g. like from step up acquisition from 14% to more than 20%. i think there's some parts in frs that states that you need to fair value the stake. then after that u do equity accounting. not 100% sure abt this actually.

The OCBC media release is quoted relating to the gain on increase in stake:

The 3Q14 earnings included a one-off gain of S$391 million that arose from the Group’s increased stake in Bank of Ningbo Co., Ltd (“BON”), which became a 20%-owned associated company on 30 September 2014. As a result, the Group’s initial available-for-sale 15.3% investment was deemed disposed of in accordance with accounting standards, and its related fair value reserve was recognised in the income statement as a one-off gain. Excluding the one-off gain, the Group’s core net profit rose 11%, underpinned by strong earnings from its banking operations, which grew 30% year-on-year from increased net interest income, record fee income and higher trading income.

1. The 15.3% was deemed as disposed at the rate that OCBC purchased the stake that brought it above 20%. The gain is reversed out of fair value reserve and into P/L.

2. The new 20+% associate stake is deemed to have been all acquired at the rate of the last acquisition. That is not based on fair value, but on the market value of the transaction that it became an associate. I believe the same concept is applicable when it comes to step-up acquisition to subsidiary as well.

Hope it helps.