When a subsidiary converts to IFRS Accounting Standards later than its parent, optional exemptions apply under IFRS 1.
Once acquired by a parent reporting under IFRS Accounting Standards, the new subsidiary becomes subject to group reporting. If the subsidiary also prepares stand-alone financial statements, converting those from US GAAP to IFRS Accounting Standards may be a strategic move to streamline reporting efforts. In this article, we offer our perspectives as to why your company may want to take that leap, and the options available in IFRS Accounting Standards to maximize alignment between the subsidiary and parent books.
Dual reporting – i.e. maintaining two separate ledgers to account for transactions under both US GAAP and IFRS Accounting Standards – can be costly and arduous. The good news is that sometimes dual reporting can be avoided.
In the US, nonpublic companies have no statutory obligations to prepare a full set of US GAAP-compliant financial statements. They often do so due to contractual, operational or industry-specific regulatory requirements, such as meeting debt covenants or responding to vendor requests. However, those may not always require US GAAP. Even for US income tax filing purposes, US GAAP books and records are not required; instead, a US tax filer can reconcile from the basis of accounting it uses to keep its books and records, such as IFRS Accounting Standards, to the tax basis amounts.
Converting to IFRS Accounting Standards when it is the accounting framework of the company’s parent typically offers relief from the complexities of evaluating business transactions under two distinct accounting frameworks. The subsidiary does not need to convert at the acquisition date, but can do so later. In fact, IFRS 19, Subsidiaries without Public Accountability: Disclosures1, may prompt more qualifying US subsidiaries to convert. This new standard allows for reduced disclosures compared to the full disclosures mandated by IFRS Accounting standards or US GAAP for subsidiaries without public accountability (i.e. most nonpublic companies), if the parent already prepares consolidated financial statements under IFRS Accounting Standards.
IFRS 1 generally requires IFRS Accounting Standards be adopted retrospectively but offers several mandatory exceptions and optional exemptions to this requirement to make transition easier. A first-time adopter can choose among some IFRS 1 optional exemptions. It is therefore essential to carefully evaluate these individually and collectively.
One of these optional exemptions, referred to as ‘D16a’ for its paragraph location in IFRS 1, focuses on subsidiaries converting to IFRS Accounting Standards later than their parents. And when D16a is not available or not elected, subsidiaries can turn to other optional IFRS 1 exemptions such as the ‘deemed cost’ or the leases exemptions. The deemed cost exemption may be particularly advantageous if a subsidiary had applied pushdown accounting under US GAAP.
The D16a exemption allows a subsidiary3 to leverage some of its existing accounting records used in the parent group reporting when converting to IFRS Accounting Standards instead of starting anew. D16a explains that if a subsidiary (or an associate or joint venture) adopts IFRS Accounting Standards later than its parent, then the subsidiary can measure its assets and liabilities using the amounts included in the consolidated financial statements of the parent, based on the parent's date of transition to IFRS Accounting Standards. However, these amounts exclude the effects of consolidation procedures and the business combination in which the parent acquired the subsidiary.
D16a typically provides the most relief to subsidiaries formed by the parent, rather than acquired. This is because there are no business combination effects to unwind.
D16a may also provide relief to long-standing subsidiaries acquired before the parent adopted IFRS Accounting Standards (see illustrative transition timeline below). This is because the subsidiary went through the adoption exercise for group reporting purposes at the same time the parent did and also because the effects of the business combination may have since faded.
Finally, D16a is not available when the subsidiary was acquired after the parent adopted IFRS Accounting Standards (see illustrative transition timeline below). Instead, the subsidiary’s assets (e.g. intangible assets, property, plant and equipment) and liabilities need to be converted to IFRS Accounting Standards using the general guidance and other available optional exemptions under IFRS 1 (e.g. deemed cost – see below).
Regardless of the situation, the subsidiary cannot expect to fully eliminate the differences between its stand-alone financial statements prepared under IFRS Accounting Standards and group reporting. However, limited top-side journal entries or process changes may suffice to take care of these differences. The following are typical examples that may result in ongoing differences.
| IFRS 1 optional exemption (examples) | Summary of requirement | Key considerations to address dual reporting issues |
| Use of event-driven fair value as ‘deemed cost’ |
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| Use of ‘deemed cost’ for property, plant, and equipment, lease right-of-use assets, and investment properties (under cost model in IAS 40) |
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| Use of ‘deemed cost’ for intangible assets |
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| IFRS 1 optional exemption (examples) | Summary of requirement | Key considerations to address dual reporting issues |
| Measurement option for lease liability and right-of-use asset (other than leases of investment property measured at fair value) |
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We believe that IFRS 1 permits a subsidiary to use as deemed cost the fair values used in pushdown accounting under US GAAP, for some or all assets and liabilities. This means fair values used by the parent to account for the acquisition of the subsidiary can be used by the subsidiary to adopt IFRS Accounting Standards when those fair values have been pushed down into the US GAAP stand-alone financial statements of the subsidiary. Pushdown accounting under US GAAP does not need to be elected at the acquisition date, provided it is applied retrospectively from that date once elected. This election can come later – e.g. when considering adopting IFRS Accounting Standards – thereby offering some additional flexibility.
There are some limitations though, because the subsidiary cannot recognize assets or liabilities that in themselves would not qualify for recognition under IFRS Accounting Standards in its stand-alone financial statements. As a result, goodwill, certain intangible assets and contingent liabilities recognized in business combination by the parent cannot be recognized in the stand-alone financial statements of the subsidiary prepared under IFRS Accounting Standards, even if they have been pushed down in those prepared under US GAAP. Therefore, potentially material differences compared to group reporting could remain and require initial and ongoing adjustments and/or separate record keeping.
For more details about pushdown accounting under US GAAP read chapter 27 of KPMG Handbook, Business combinations.
Suppose the subsidiary was acquired after its parent adopted IFRS Accounting Standards (i.e. D16a cannot be applied) and no event-driven fair value is available to the subsidiary, e.g. because pushdown accounting was not applied under US GAAP. In that case, the subsidiary can still avail itself of the other IFRS 1 exemptions, such as using the fair value of certain assets at the date of transition to IFRS Accounting Standards as deemed cost. Generally, the closer the subsidiary’s date of transition is to the date it was acquired by the parent, the fewer the differences may be, but at the minimum the same differences as mentioned above with group reporting will remain (e.g. for central adjustments, materiality threshold).
On November 1, 2020, Company S, a US GAAP preparer, was acquired by Parent. Parent reports under IFRS Accounting Standards. For purposes of Parent group reporting, Company S’s assets and liabilities were converted to IFRS Accounting Standards and fair valued in the purchase accounting performed at acquisition date. The following table illustrates the fair value adjustments applied to carrying amounts at the acquisition date and the goodwill recognized. Adjustments from US GAAP to IFRS Accounting Standards and deferred tax effects are ignored in the table for simplicity.
| Asset / (Liability) | Closing balance sheet for Company S stand-alone US GAAP reporting | Fair value adjustments and goodwill recognized in purchase accounting | Opening balance sheet for Parent reporting under IFRS Accounting Standards |
| Inventory | $30 | $5 | $35 |
| Lease right-of-use (RoU) asset | $20 | $5 | $25 |
| Property, plant, and equipment | $500 | $200 | $700 |
| Intangible asset (patent) | $50 | $150 | $200 |
| Goodwill | $0 | $50 | $50 |
| Lease liability | ($22) | ($3) | ($25) |
| Other assets and liabilities | ($300) | ($0) | ($300) |
| Net assets | $278 | $407 | $635 |
Company S prepared stand-alone US GAAP financial statements until December 31, 2021 but has not elected pushdown accounting. It considers converting to IFRS Accounting Standards as of December 31, 2022 (i.e. the date of transition would be January 1, 2021 to ensure a one-year comparative period).
For purposes of preparing the opening balance sheet on January 1, 2021, Company S analyzes which measurement options are available to limit differences in basis between its stand-alone financial statements prepared under IFRS Accounting Standards and its parent’s reporting.
| Asset / (Liability) | Measurement retained at the date of transition | Difference in basis | Comments |
| Inventory | $30 reduced for the inventory sold before the date of transition | Yes, but will disappear once inventory is sold | There is no available IFRS 1 exemption that would allow Company S to retain Parent’s stepped up basis of $35. However, because inventory turns quickly that difference may no longer exist by the date of transition or the date of first-time adoption (December 31, 2022). |
| Property, plant, and equipment | New fair value calculation | Generally yes, but materiality may vary | Company S can elect using fair value at the date of transition as deemed cost. It may be able to demonstrate that, in the circumstances, this amount is not materially different from the fair value determined two month prior. |
| Intangible asset (patent) | $50 | Yes | The patent meets the IAS 38 criteria for recognition but not for revaluation, because there is no active market. Therefore, the fair value at acquisition date cannot be used as deemed cost. |
| Goodwill | $0 | Yes | Internally generated goodwill is never recognized as an asset in accordance with IAS 38, so Company S cannot recognize goodwill related to its own acquisition by Parent in its stand-alone financial statements. |
| Lease liability | New calculation required | Generally yes, but materiality may vary | For purposes of its acquisition opening balance sheet, Company S had recalculated the present value of the remaining lease payments using Parent’s incremental borrowing rate as of November 1, 2020 and reset the related RoU asset to match the lease liability – i.e. $25. IFRS 1 allows Company S to recalculate the lease liability as of January 1, 2021 using its own incremental borrowing rate at that date. If the rate is similar to that of Parent’s, the amounts of lease liability in both sets of books may closely align. Further, Company S can elect to reset the RoU asset at the carrying amount of the lease liability (with some adjustments). |
| Lease RoU asset | Equal to lease liability |
In summary, Company S is able to reduce differences with Parent’s accounting records by strategically choosing the most beneficial IFRS 1 optional exemptions available in the circumstances. However, differences with respect to intangibles assets and goodwill will remain going forward.
Adopting IFRS Accounting Standards in their stand-alone financial statements can significantly streamline reporting efforts for US subsidiaries that already report to their parent under IFRS Accounting Standards. While full alignment between the subsidiary and parent books is rare when IFRS Accounting Standards are adopted, limited top-side journal entries may suffice to take care of remaining differences. And maintaining those entries with proper controls and processes is usually much easier than maintaining a dual full set of books.
Want to know if this is an option for your company? Ready to explore the many options that IFRS 1 has to offer? Reach out to your KPMG contact to start a conversation.
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