pe club 27th september - the impact of ifrs on pe industry · • consolidation and equity...

27th September pwc

Private Equity ClubThe Impact of IFRS on the Private Equity Industry

Private Equity ClubThe Impact of IFRS on the Private Equity Industry

2IFRS & Private Equity PricewaterhouseCoopers

Agenda

• Introduction – Mark Pugh• IFRS Update – Mike Bane• IFRS – ‘Not my Problem’ – Paul Cunningham• Conclusion

27th September pwc

IFRS UpdateMike Bane

IFRS UpdateMike Bane


Overview

• Scope and current status• Components of financial statements• Consolidation and equity accounting• Importance and consequences of “fair value option”• Difficult messages for secondaries and fund of funds• Round up


IASB stable platform – recent changes

IFRS

IAS1

82 7

10

1211

14

1516

1718

192021222326 24

272829

303132

3334

3536

37 38 3940 41

1 2 3

4 5


Components of financial statements

• Similar to UK GAAP• “SOCIE” = STRGL + transactions with equity investors• “Recycling” of gains/losses different to UK• Realised gains/losses must pass through P&L


Recycling example

Year 1 Year 2 Year 3

Facts Buy 100 FV 110

FV 130 Sell 155

UK GAAP 1 Gain 10 STRGL Gain 20 STRGL Gain 25 STRGL

UK GAAP 2 Gain 10 STRGL Gain 20 STRGL Gain 25 P&L

IFRS Gain 10 Equity Gain 20 Equity Gain 55 P&LLoss 30 Equity


Consolidation and equity accounting

• Consolidation• IAS 27 – Consolidated and separate financial statements• SIC 12 – Consolidation – special purpose entities• IFRS 5 – Non-current assets held for sale• Equity accounting• IAS 28 – Investments in associates (equity accounting)• IAS 31 – Jointly controlled entities (proportional consolidation)


IAS 27

• A parent must present consolidated financial statements….• Unless all following conditions met (27p10):

– parent is a wholly-owned sub– parent’s debt/equity instruments not traded in public market– parent not in process of filing for public listing– ultimate parent produces publicly available consolidated

IFRS financial statements


Subsidiaries

• A subsidiary is an entity that is controlled by a parent• “Control is the power to govern the financial and operating

policies of an entity so as to obtain benefits from its activities” (27p4)

• THERE ARE NO EXEMPTIONS (except p10) FROM CONSOLIDATING A SUBSIDIARY…

• …unless it is “held for sale”– apply IFRS 5– Particularly no exemption “..simply because the investor is a

venture capital organisation.. or similar entity” (27p19)


Control = power

• Presumed to exist when parent owns more than half of voting power. Also exists if less than 50% when entity has power:

– over 50% voting rights via agreement with other investors– to govern policies by statute or agreement– to appoint/remove majority of board (provided board controls

the entity)– to cast majority of votes at board meetings


SIC12

• Applies to “Special Purpose Entities”• Treat as subsidiary when substance of relationship is of control• Autopilot• Majority of benefits• Exposed to majority of risks


Associates and joint ventures

• “Significant influence” test for associates• “Power to participate in the financial and operating policy

decisions of the investee but is not control or joint ownership” (28p2)

• Presumed to exist with 20% or more of voting power• STANDARDS DON’T APPLY TO ASSOCS/JVS HELD BY

INVESTMENT STRUCTURES THAT DESIGNATE INVESTMENTS AS “AT FAIR VALUE THROUGH PROFIT OR LOSS” AND ACCOUNTED FOR UNDER IAS39


IAS 39 - Classification –Financial Assets (Four categories)

1. Financial assets at fair value through profit or loss2. Loans and receivables3. Held to maturity4. Available for sale


Classification – Financial Assets (Four categories)

At fair value through profit or loss

Held for trading Designated at inception

Intention of short term profit;All derivatives except hedges.

No restrictions on designation;Irrevocable – cannot be moved.



Loans and receivables

Non-derivative financial assets.Fixed or determinable payments.

Not quoted.No intention of trading.



Available for sale

All equity securities not classified in FVTPL category.All financial assets not in another category.

Any financial assets other than those held for trading may be designated to this category at inception.


Classification – Financial Liabilities(Two categories)

1. At fair value through profit or loss

Held for trading Designated at inception

Intention of short term profit;All derivatives except hedges.

No restrictions on designation;Irrevocable – cannot be moved.

2. Other financial liabilities


Why is classification important?

• Because it drives measurement

IFRS & Private Equity PricewaterhouseCoopers

Assets/Liabilities at fair value through profit or loss

Available for sale

Loans and receivables

Other liabilities

Subsequent measurement

At FV through profit or loss

At amortised cost

At FV through equity

Held to maturity


Amortised cost

No option to use straight line method

Amortisedcost Cash paid Principal

repayments

UnamortisedPrem/disc’t(inc interest)

Impairment= - +/- -

Requires use of effective interest rate method


Fair Value Hierarchy

Active market –Published quotations Best evidence



Active market –Published quotations

No active market –Valuation

Techniques

Best evidence

Alternative



Active market –Published quotations

No active market –Valuation

TechniquesNo active market -Equity investments

only Cost less impairment

Best evidence

Alternative

Very rare


Fair value

Consider: • Star owns 15% of shares of Moon. • Shares of Moon quoted on a local stock exchange, trading

volume indicates sufficiently active market.• The quoted market price is $100 per share.• If decided to sell entire block of shares, the price they believe

they would be able to obtain would be $80 per share

Answer: $100


Impairment

• Step 1 – Objective evidence of impairment

• Step 2 – Calculate recoverable amount/fair value

• Step 3 – Record impairment in profit & loss


Disappearanceof an

active market because of financial

difficulties

Impairment - loansObjective evidence

Significant financialdifficulty of the issuer

High probabilityof bankruptcy Granting of a

concession to the borrower

Adverse change inpayment status or factor

(eg unemployment)

Breach of contract, such as default or

delinquency ininterest or principal

And what about equities?


Impairment - equitiesObjective evidence

Adverse effect in the technological, market,

economic or legal environment

Significant or prolongeddecline in the FV of an investment

below its cost


Pros and cons of FVTPL

PRO• All gains/losses in one place• Associates/JVs out of scope• Hedging is irrelevant• No impairment testing• No splitting of FX component on

monetary instruments

CON• More natural to defer unrealised

gains in equity• Potential tax consequences• Inconsistency with investor tax

reporting• Transparency of transaction

costs


Secondaries/Fund of Funds

• Measurement of cost on partial disposals• What is fair valuea) Are underlyings IAS 39 fair valuedb) Has carry been accounted forc) Taxd) DCF modelling• Distributions in specie• Can you get a clean opinion?


Round up

• Does IFRS apply to you – if so, when?• What do your investors want?• Lots of change still in the pipeline• How can you deal with consolidation issues?• Consider the merits of FVTPL• Big problems for secondaries• …..GET HELP

27th September pwc

IFRS – ‘Not My Problem’Paul Cunningham

IFRS – ‘Not My Problem’Paul Cunningham


IFRS – “Not My Problem”

– View held by many in our industry

• “It only applies to Listed Corporates…”

– But….

• IFRS WILL be adopted as UK GAAP

• What are a large proportion of our Investors?

– Different for Captives?

• Must Comply from 01/01/05


So – I am Caught. What does it mean?

• Consolidation?– 2 Potential Problem Areas

• Investments > 50%– CONSOLIDATE

• GP/Limited Partnership Relationship• IFRS 27 - “Control is the power to govern the financial

and operating policies of an entity so as to obtain benefits from its activities”

• “Fiduciary Capacity”• Heading towards “Rebuttable Presumption” of control



• Accounting For Investments– Holding < 20%

• “Fair Value” through Reserves

• “Fair Value” Through P&L

– Holding >20%

• “Fair Value” through P&L

• Equity Account



• What is “Fair Value”?– “Willing buyer, willing seller”

• Illiquid Market

• Difficult to measure

• “Could fair value at cost” BUT– BVCA Guidelines– Investor Reporting



• Debt– Impairment

• No Real Change– Interest

• Not Straight-line

• “Constant Effective Yield”

• Earliest date could be sold/redeemed?


Other Problems Caused

• Transition Rules– Revenue “Lost Forever”– Could mitigate BUT

• Impact on Substantial Shareholding Exemption• Remuneration

– Bonus?

pe club 27th september - the impact of ifrs on pe industry · • consolidation and equity...

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