The Annual Reporting Council (RJ) has recently published a draft of guidance by way of RJ statement 2022-9 to amend RJ 260 ‘Treatment of results of intra-group transactions in the annual accounts’. What exactly is it about?
This directive deals with sales transactions of assets between legal entities that have mutual ownership interests. The directive distinguishes between upstream, downstream and sidestream transactions. To the extent that a participating legal entity retains a direct or indirect economic interest in the transferred assets after the sale, the result of that transaction must be eliminated. The proposed changes are clarifications. On the one hand, the structure of the directive will be adapted, and on the other hand, clarifications will be proposed on three material points.
Structure of the directive
The current RJ 260 is divided into consolidated accounts on one side and separate accounts on the other. The section on the consolidated financial statements deals with both consolidated capital shares and non-consolidated capital shares. For non-consolidated capital shares, both valuation at net asset value and valuation at acquisition price or fair value are processed. The section on the separate annual accounts therefore largely consists of references to the previous section.
The draft directive has a different format. The valuation basis is leading. Section 2 deals with valuation according to the intrinsic value method (normally net value) and section 3 deals with valuation at cost price or fair value. Section 4 deals briefly with consolidation, and section 5 deals with the financial statements of the acquiring (‘buying’) equity interest. RJ aims to improve the readability and accessibility of this guide.
Presentation of elimination amounts
The current guideline only indirectly says something about how eliminated results on intra-group transactions are presented in the financial statements. This is now specified in more detail in the draft directive. The elimination can be done in the case of a downstream sale by crediting or debiting the intragroup result to be eliminated to the income statement item in which the intragroup transaction has been treated (eg net sales or other income). In the case of upstream or downstream sales, the elimination is recognized in the result of capital shares. In the balance sheet, eliminations can be recognized as accruals or by including the value in the item capital shares.
Alternatively, the elimination on upstream sales can be credited or debited to the value of the acquired asset. With a 100 percent share, the intra-group transaction does not result in a difference between the asset’s book value in the separate accounts and the asset’s book value in the consolidated accounts.
Loss and impairment
Sometimes there is a loss on an intra-group transaction. The proposed directive clarifies that the normal method of elimination also applies here. However, the loss may be an indication of a decline in the value of the share that is still (in)directly held in the asset after the sale. This is then assessed and processed further based on the guidelines on impairment (in the case of fixed assets) or lower realizable value (in the case of inventories).
For example, if a fixed asset is sold at a current market value that is less than its book value, there is no impairment if the value in use is still higher than its book value.
Elimination of negative net worth
If the intrinsic value of a capital share becomes negative, the capital share is valued at zero. Suppose the participating legal entity sells an asset at this equity interest at a profit, should this profit be eliminated anyway? On the one hand, it can be argued that the participating legal entity will no longer record further losses on this asset. Even if the asset were to be lost, no further loss would be booked on the share in the capital share, which was already valued at zero. On the other hand, the participating legal entity still has an indirect financial interest in this asset. The draft directive clarifies that even then elimination is still required.
RJ expects the final guideline to enter into force after any comments for financial years starting on or after 1 January 2024. For clarification, however, an earlier application is obvious.
Author: dr. B. (Bart) Struggle RA
This article appeared in F&A Actueel 2022, Issue 15.