DipIFR-Session26 d08 Investment in Associates

SESSION 26 IAS 28 INVESTMENTS IN ASSOCIATES
Accountancy Tuition Centre (International Holdings) Ltd 2008 2601

Overview
Objectives
To explain the accounting treatment for associates.

EQUITY
ACCOUNTING
ACCOUNTING
TREATMENT
INTER-COMPANY
ITEMS WITH AN
ASSOCIATE
Background
Scope
Definitions
Significant influence
Separate financial statements
Relationship to a group
Basic rule
Equity accounting
Treatment in a consolidated
statement of financial position
Treatment in a consolidated statement
of comprehensive income
Recognition of losses
Accounting policies and year ends
Impairment
Exemptions to equity accounting
Inter-company trading
Dividends
Unrealised profit

DISCLOSURE
Investments in associates
Using the equity method

1 Equity accounting
1.1 Background
Where one company has a controlling investment in another company, a parent-subsidiary
relationship is formed and accounted for as a group. Companies may also have substantial
investments in other entities without actually having control. Thus, a parent-subsidiary
relationship does not exist between the two.
If the investing company can exert significant influence over the financial and operating
policies of the investee company, it will have an active interest in its net assets and results.
The nature of the relationship differs from that of a simple investment, i.e. it is not
a passive interest.

Commentary
Including the investment at cost in the company's accounts would not fairly present
the investing interest.
So that the investing entity (which may be a single company or a group) fairly reflects
the nature of the interest in its accounts, the entitys interest in the net assets and results
of the company, the associate, needs to be reflected in the entitys accounts. This is
achieved through the use of equity accounting.
1.2 Scope
IAS 28 is applied in accounting for investments in associates.
However, it does not apply to investments in associates held by:
venture capital organisations; or
mutual funds, unit trusts and similar entities including investment-
linked insurance funds,
that upon initial recognition are designated as at fair value through profit or
loss or are classified as held for trading and accounted for in accordance with
IAS 39 Financial Instruments: Recognition and Measurement.

Commentary
Such investments are measured at fair value in accordance with IAS 39, with
changes in fair value recognised in profit or loss in the period of the change.
1.3 Definitions
An associate is an entity over which an investor has significant influence and
which is neither a subsidiary nor a joint venture (i.e. an economic activity
undertaken by two or more parties with joint control).
Significant influence is the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control over those policies.
Control is the power to govern the financial and operating policies of an
entity so as to obtain benefits from its activities.
The equity method is a method of accounting whereby the investment is initially
recognised at cost and adjusted thereafter for the post acquisition change in the
investors share of net assets of the investee. The profit or loss of the investor
includes the investors share of the profit or loss of the investee.
1.4 Significant influence
The term significant influence means that an investor is involved, or has the right
to be involved, in the financial and operating policy decisions of the investee.
The existence of significant influence by an investor is usually evidenced in
one or more of the following ways:
Representation on the board of directors or equivalent governing body;
Participation in policy making processes;
Material transactions between the investor and the investee;
Interchange of managerial personnel; or
Provision of essential technical information.
A holding of 20% or more of the voting rights of the investee indicates significant
influence, unless it can be demonstrated otherwise.

Commentary
Conversely, a holding of less than 20% presumes that the holder does not have
significant influence, unless such influence can be clearly demonstrated (e.g.
representation on the board).
The existence and effect of potential voting rights that are currently exercisable or
convertible by the investor should be considered.

Commentary
Such potential voting rights may occur through holding share warrants,
share call options, debt or equity instruments (or other similar instruments)
that are convertible into ordinary shares.
When significant influence is lost, the carrying amount of the investment at
that date is regarded as its cost on initial measurement thereafter (and will be
accounted for as a financial asset in accordance with IAS 39).
1.5 Separate financial statements
Investors that are exempt from the requirement to equity account may present
separate financial statements as their only financial statements.
In the separate financial statements, the investment in the associate should be
accounted for:
under IFRS 5 if classified as held for sale; or
at cost or in accordance with IAS 39.

Commentary
The emphasis will be on the performance of the assets as investments.
2 Accounting treatment
2.1 Relationship to a group
A group is defined as being a parent and all of its subsidiaries. An associate is not
part of a group as it is not a subsidiary, i.e. it is not controlled by the group.
As such, the accounting treatment of the associate is different to that of
subsidiaries.
2.2 Basic rule
An investment in an associate should be accounted for using the equity
method.

Commentary
Associates must be accounted for using the equity method regardless of the fact
that the investor may not have investments in subsidiaries and does not therefore
prepare consolidated financial statements.
Illustration 1

Associated companies Companies in which Siemens has the ability to exercise
significant influence over operating and financial policies (generally through
direct or indirect ownership of 20% to 50% of the voting rights) are recorded in
the Consolidated Financial Statements using the equity method of accounting and
are initially recognized at cost.
Siemens share of its associated companies post-acquisition profits or losses is
recognized in the income statement, and its share of post-acquisition movements
in equity that have not been recognized in the associates profit or loss is recognized
directly in equity.

Notes to Consolidated Financial Statements

Commentary
Under IAS 1 (as revised in 2007) any share of movements in equity should
now be recognised in other comprehensive income.
2.3 Equity accounting
The investment in an associate is initially recognised at cost and the carrying
amount is increased or decreased to recognise the investors share of the profit
or loss of the investee after the date of acquisition.

Commentary
This is equivalent to taking the investors share of the net assets of the
associate at the date of the financial statements plus goodwill.
Distributions received from the associate reduce the carrying amount of the
investment.
Adjustments to the carrying amount may also be necessary for changes in the
investors proportionate interest in the associate arising from changes in the
associates equity that have not been recognised in the profit or loss.
Such changes include those arising from the revaluation of property, plant
and equipment and from foreign exchange translation differences.

Commentary
The logical way of recognising these changes in equity would be to show the
investors share of the changes in other comprehensive income.
The investors share of the current years profit or loss of the associate is
recognised in the investors profit or loss.
The associate is not consolidated line-by-line. Instead, the group share of the
associates net assets is included in the consolidated statement of financial
position in one line, and share of profits (after tax) in the consolidated statement
of comprehensive income in one line.
2.4 Treatment in a consolidated statement of financial position
The methods described below apply equally to the financial statements of a non-
group company that has an investment in an associate as they do to group
accounts.
In group investments, replace the investment as shown in the individual company
statement of financial position with:
the groups share of the associates net assets at the end of the
reporting period; plus
the goodwill arising on acquisition.

Commentary
As for business combinations under IFRS 3, IAS 28 does not permit the
amortisation of goodwill.
Do not consolidate line-by-line the associates net assets. The associate is not a
subsidiary, therefore the net assets are not controlled as they are for a subsidiary.
In group reserves, include the parents share of the associates post-acquisition
reserves (the same as for subsidiary).
Cancel the investment in associate in the individual companys books
against the share of the associates net assets and contingent liabilities
acquired at fair value. The difference is goodwill.

Commentary
The fair values of the associates assets and liabilities must be used in
calculating goodwill. Any change in reserves, depreciation charges etc due
to fair value revaluations must be taken into account (as they are when
dealing with subsidiaries).
Where the share of the associates net assets acquired at fair value is in excess
of the cost of investment, the difference is included as income in determining
the investors share of the associates profi or loss.
To calculate amounts for net assets and post-acquisition reserves, use a
net assets working for the associate (the same as for the subsidiary).
The amount to be shown in the statement of financial position at the end
of the reporting period will be:
$
Share of net assets
(Group % Associates net assets at end of the reporting period) X
Goodwill on acquisition X

_____

X

_____

This is not how IAS 28 phrases it. IAS 28 says that the carrying value of the
investment should be:
Cost + share of associates post acquisition profit or loss
But Cost = Share of associates net assets at acquisition + Goodwill
Hence Carrying value = Share of net assets at acquisition + Goodwill
+ Share of post-acquisition profit or loss
Which = Share of net assets at end of the reporting period + Goodwill
Therefore the carrying value can easily be calculated with reference to the share of net assets
at the end of the reporting period.

Worked example 1

Parent acquired, during the current year, a 40% holding in Associate for $18,600.
Goodwill on acquisition was calculated as $1,000 and there has been no impairment of
goodwill during the year. The fair value of Associates net assets at the year end is
$48,000.

Required:

Calculate the investment in Associate to be included in the consolidate statement
of financial position and state the amount of Associates profits to be included in
the consolidated statement of comprehensive income for the current year.

Worked solution 1
Net assets on acquisition
$
Cost of investment 18,600
Less: Goodwill (1,000)

______

40% of Associates net assets on acquisition 17,600
Gross up to 100% 100/40

______
44,000

______

Investment in Associate
Cost of investment 18,600
Plus: 40% of post acquisition profits (48,000 44,000) 1,600
Less: Goodwill impaired ()

______
20,200

______
OR

40% of Associates net asset at year end (48,000 40%) 19,200
Plus: Goodwill not yet impaired 1,000

______
20,200

______

Income from associate included in consolidated statement of
comprehensive income.
40% of post acquisition profits (48,000 44,000) 1,600

_____

Activity 1

P owns 80% of S and 40% of A. Statements of financial position of the three
companies at 31 December 2007 are:
P S A
$ $ $
Investment: shares in S 800
Investment: shares in A 600
Other non-current assets 1,600 800 1,400
Current assets 2,200 3,300 3,250

5,200 4,100 4,650
Issued capital $1 ordinary shares 1,000 400 800
Retained earnings 4,000 3,400 3,600
Liabilities 200 300 250

5,200 4,100 4,650

P acquired its shares in S seven years ago when Ss retained earnings were $520 and
P acquired its shares in A on the 1 January 2007 when As retained earnings were
$400.
The goodwill in S was fully written off prior to 1 January 2007.
There were no indications during the year that the investment in A was impaired.

Required:

Prepare the consolidated statement of financial position at 31 December 2007.

Proforma solution
P: Consolidated statement of financial position as at 31 December 2007
$
Investment in associate
Non-current assets
Current assets

Issued capital
Retained earnings

Non-controlling interests
Liabilities

WORKINGS

(1) Group structure

(2) Net assets working
S Reporting Acquisition
date
$ $
Issued capital
Retained earnings

A Reporting Acquisition
date
$ $
Issued capital
Retained earnings

(3) Goodwill

S $
Cost of investment
Net assets acquired

A $
Cost of investment
Net assets acquired

(4) Non-controlling interests
$
S only

(5) Retained earnings
$
P from question
Share of S
Share of A
Less Goodwill

(6) Investment in associate

$
Share of net assets
Unimpaired goodwill

2.5 Treatment in a consolidated statement of
comprehensive income
Treatment is consistent with consolidated statement of financial position and
applies equally to a non-group company with an associate:
Include group share of the associates profits after tax in the
consolidated profit or loss. This replaces dividend income shown
in the investing companys own profit or loss.
Do not add in the associates revenue and expenses line-by-line as
this is not a consolidation and the associate is not a subsidiary.
Time-apportion the associates results if acquired mid-year.

Commentary
Note that the associate statement of financial position is NOT time
apportioned as the statement of financial position reflects the net assets at the
end of the reporting period to be equity accounted.
Activity 2

P has owned 80% of S and 40% of A for several years. Statement of
comprehensive income for the year ended 31 December 2007 are:
P S A
$ $ $
Revenue 14,000 12,000 10,000
Cost of sales (9,000) (4,000) (3,000)

Gross profit 5,000 8,000 7,000
Administrative expenses (2,000) (6,000) (3,000)

3,000 2,000 4,000
Dividend from associate 400

Profit before taxation 3,400 2,000 4,000
Income taxes (1,000) (1,200) (2,000)

Profit after taxation 2,400 800 2,000

Dividends (paid) 1,000 1,000

Goodwill was fully written off three years ago.

Required:

Prepare the consolidated statement of comprehensive income for the year ended
31 December 2007.
Proforma solution
$
Revenue
Cost of sales

Gross profit
Administrative expenses
Income from associate

Profit before taxation
Income taxes

Profit after taxation

Attributable to:
Owners of P
Non-controlling interests

(1) Group structure

(2) Consolidation schedule
40%
P S A Adjustment Consolidation
$ $ $ $ $
Revenue
Cost of sales
Administration expenses
Income from assocociate
Tax

Profit after tax

S only

2.6 Recognition of losses
If an investors share of losses of an associate equals or exceeds its interest in
the associate, the investor discontinues recognising its share of further losses.
The interest in the associate is its value under the equity method plus any
long-term interest that forms part of the investors net investment.

Commentary
Such interests may include preference shares and long-term receivables or
loans but do not include trade receivables, trade payables or any long-term
receivables for which adequate collateral exists, such as secured loans.
After the investors interest is reduced to zero, additional losses are provided
for, and a liability is recognised, only to the extent that the investor has incurred
legal or constructive obligations or made payments on behalf of the associate.
If the associate subsequently reports profits, the investor resumes recognising
its share of those profits only after its share of the profits equals the share of
losses not recognised.

Commentary
The investment in the associate can be reduced to nil but no further( i.e. the
investment in associate will not be negative, even if there are post acquisition
losses of the associate).
Illustration 2

A parent company has a 40% associate, which was acquired a number of years ago for
$1m. A long-term loan was also made to the associate of $250,000

Since the acquisition the associate has made losses totalling $5m.

The parents share of those losses would be $2m.

The parent would only be required to recognise the losses to the extent of the
investment of $1m plus $250,000, the remaining share of losses ($750,000) would not
be recognised unless the parent had a present obligation to make good those losses.

If the associate then became profitable, the parent would not be able to recognise those
profits until its share of unrecognised losses had been eliminated.

However the investor should continue to recognise losses to the extent of any
guarantees made to satisfy the obligation of the associate (or joint venture).
This may require recognition of a provision in accordance with IAS 37.
Continuing losses of an associate (or a joint venture) is objective evidence
that financial interests in the associate (or joint venture) other than those
included in the carrying amount may be impaired.
2.7 Accounting policies and year ends
2.7.1 Accounting policies
If an associate uses accounting policies other than those of the investor,
adjustments must be made to conform the associates accounting policies to
those of the investor in applying the equity method.
2.7.2 Year ends
The most recent available financial statements of the associate are used by the investor.
When the ends of the reporting periods of the investor and the associate are
different, the associate prepares, for the use of the investor, financial
statements as at the same date as the financial statements of the investor.

Commentary
Unless it is impracticable to do so.
When it is not practicable to produce statements as at the same date, adjustments
must be made for the effects of significant transactions or events that occur
between that date and the date of the investors financial statements.
In any case, the difference between the end of the reporting period of the
associate and that of the investor must not be more than three months.
The length of the reporting periods and any difference in the end of the
reporting periods must be the same from period to period.
2.8 Impairment
After application of the equity method, including recognising the associates losses,
the investor applies the requirements of IAS 39 to determine whether it is necessary to
recognise any additional impairment loss.
Because goodwill included in the carrying amount of an investment in an associate is
not separately recognised, it is not tested for impairment separately.
Instead, the entire carrying amount of the investment is tested for impairment, by
comparing its recoverable amount with its carrying amount.
In determining the value in use of the investment, an entity estimates:
its share of the present value of the estimated future cash flows expected to
be generated by the associate, including the cash flows from the operations of
the associate and the proceeds on the ultimate disposal of the investment; or
the present value of the estimated future cash flows expected to arise from
dividends to be received from the investment and from its ultimate disposal.

Commentary
Under basic assumptions, both methods will give the same result.
2.9 Exemptions to equity accounting
An associate that is classified as held for sale is accounted for under IFRS 5
Non-current Assets Held for Sale and Discontinued Operations.

Commentary
Under IFRS 5, if an associate is acquired and held with a view to disposal
within twelve months, it will be measured at the lower of its carrying value
(e.g. cost) and fair value less costs to sell.
If the investor is also a parent company that has elected not to present
consolidated financial statements the investment in the associate will be
measured at cost or in accordance with IAS 39.
The investment in the associate will be measured at cost or in accordance with
IAS 39 if all of the following apply:
the investor is a wholly-owned subsidiary (or partially-owned and
other owners do not object); and
the investors debt or equity instruments are not traded in a public
market; and
the investor does not file its financial statements with a securities
regulator; and
the ultimate (or any intermediate) parent of the investor produces
consolidated financial statements available for public use under IFRS.

Commentary
This allows investors who do not have investments in a subsidiary, but only
have an investment in an associate, to be exempt from the requirement to
equity account on the same basis as parents under IAS 27.
3 Inter-company items with an associate

Commentary
The methods described below apply equally to the financial statements of a
non-group company that has an investment in an associate as they do to
group accounts.
3.1 Inter-company trading
Members of the group can sell to or make purchases from the associate.
This trading will result in the recognition of receivables and payables in the
individual company accounts.
Do not cancel inter-company balances in the statement of financial
positionand do not adjust sales and cost of sales for trading with associate.
In consolidated statement of financial position, show balances with associate
separately from other receivables and payables.

Commentary
The associate is not part of the group. It is therefore appropriate to show
amounts owed to the group by the associate as assets and amounts owed to
the associate by the group as liabilities.
3.2 Dividends
Consolidated statement of financial position:
Ensure dividends payable/receivable are fully accounted for in
individual companies books.
Include receivable in the consolidated statement of financial
position for dividends due to group from associates.
Do not cancel inter-company balance for dividends.
Consolidated statement of comprehensive income:
Does not include dividends from the associate. Parents share of
the associates profit after tax (hence before dividends) is included
under equity accounting in the income from associate.

Commentary
It would be double-counting to include dividend in the consolidated statement
of comprehensive income as well.
3.3 Unrealised profit
If parent sells goods to associate and associate still has these goods in stock at
the year end, their carrying value will include the profit made by parent and
recorded in its books. Hence, profit is included in inventory value in
associates net assets (profit is unrealised) and parents profit or loss.
If associate sells to parent, a similar situation arises, with the profit being
included in associates profit or loss and parents inventory.
To avoid double counting when equity accounting for associate, this
unrealised profit needs to be eliminated.
Unrealised profits should be eliminated to the extent of the investors interest
in the associate.
Unrealised losses should not be eliminated if the transaction provides
evidence of an impairment in value of the asset that has been transferred.
The above treatment is similar to that prescribed by IAS 31 (see next session) in
respect of jointly controlled entities accounted for under the equity method.

Commentary
To eliminate unrealised profit, deduct the profit from associates profit before tax
and retained earnings in the net assets working before equity accounting for
associate, irrespective of whether sale is from associate to parent or vice versa.
Worked example 2

Parent has a 40% associate.

Parent sells goods to associate for $150 which originally cost parent $100. The goods
are still in associates inventory at the year end.

Required:

State how the unrealised profit will be dealt with in the consolidated accounts.

Worked solution 2
To eliminate unrealised profit:
Deduct $50 from associates profit before tax in the statement of
comprehensive income, thus dealing with the profit or loss impact.
Deduct $50 from retained earnings at end of the reporting period in net assets
working for associate, thus dealing with the impact on financial position.
Share of net assets and post acquisition profits included under equity accounting will
then be $20 (50 40%) lower.

Commentary
The simple rule to follow is that the unrealised profit will only be Parents %, $20
in this example.
Double entry for $20
Dr Consolidated retained earnings 20
Cr Investment in Associate 20

Be aware that there is more than one way of making the adjustment; this is
just one of the possible methods.

4 Disclosure
4.1 Investments in associates
The fair value of investments in associates for which there are published price
quotations.
Summarised financial information of associates (including aggregated
amounts of assets, liabilities, revenues and profit or loss).

Commentary
Whether accounted for using the equity method or not.
If relevant, the reason(s) why:
there is significant influence if the voting power is less than 20 per cent;
there is not significant influence if the voting power is more than 20
per cent.
If relevant, the end of the associates reporting period if different from that of
the investor, and the reason for the difference.
The nature and extent of any significant restrictions on the ability of associates
to transfer funds to the investor (e.g. cash dividends or loan repayments).
The unrecognised share of losses of an associate for the period and cumulatively.
The fact that an associate is not accounted for using the equity method when
exempt from doing so.
4.2 Using the equity method
Classification as non-current assets.
The investors share of:
profit or loss of such associates;
discontinued operations (IFRS 5);
changes recognised directly in the associates equity (IAS 1); and
contingent liabilities incurred through joint and several liability (IAS 37).
Illustration 3

All monetary amounts are expressed
in millions of Rands 2007
Restated
2006
5. INVESTMENT IN ASSOCIATE COMPANIES
5.1 Investment in associate companies

The Groups share of associate companies included in the consolidated
balance sheet is as follows:
Construction and engineering

As at beginning of year 766,2 505,4
Additions Clough Limited* 34,7 224,1
Share of post-acquisition (loss)/earnings (114,4) 0,6
Impairment of Clough Limited
(114,5)
Write off of investment in Murray & Roberts Zimbabwe (8,1)

Reversal of provision against investment in Murray & Roberts
Zimbabwe 8,1
Exchange rate adjustment 50,8 36,1
622,8 766,2

Focus
You should now be able to:
define associates;
describe and prepare accounts using equity accounting;
prepare consolidated financial statements to include a single subsidiary and
an associate.
Activity solutions
Solution 1
P Consolidated statement of financial position as at 31
December 2007

$
Investment in associate 1,880
Non-current assets (1,600 + 800) 2,400
Current assets (2,200 + 3,300) 5,500

9,780

Issued capital 1,000
Retained earnings (W5) 7,520

8,520
Non-controlling interests (W4) 760
Liabilities 500

9,780

WORKINGS

(1) Group structure

GROUP
P
S
80%
40%
A

(2) Net assets working

S Reporting Acquisition
date
$ $
Issued capital 400 400
Retained earnings 3,400 520

3,800 920

A Reporting Acquisition
date
$ $
Issued capital 800 800
Retained earnings 3,600 400

4,400 1,200

(3) Goodwill

S $

Cost of investment 800
Net assets acquired (80% 920 (W2)) (736)

64

A $

Cost of investment 600
Net assets acquired (40% 1,200 (W2)) (480)

120

$
S only (20% 3,800) 760

(5) Retained earnings
$
P from question 4,000
Share of S [80% (3,400 520) (W2)] 2,304
Share of A [40% (3,600 400) (W2)] 1,280
Less Goodwill impaired (W3 per Activity) (64)

7,520

(6) Investment in associate

$
Share of net assets (40% 4,400) 1,760
Goodwill 120

1,880

Proof
Cost 600
Share of post acquisition profits 1,280

1,832

Solution 2

P Consolidated statement of comprehensive income for the year ending 31
December 2007

$
Revenue 26,000
Cost of sales (13,000)

Gross profit 13,000
Administrative expenses (8,000)
Income from associate 800

Profit before taxation 5,800
Income taxes (2,200)

Profit after taxation 3,600

Attributable to:
Owners of P 3,440
Non-controlling interests 160

3,600

WORKINGS

(1) Group structure

P

S
A
40%
80%

(2) Consolidation schedule
40%
P S A Adjustment Consolidation
$ $ $ $ $
Revenue 14,000 12,000 26,000
Cost of sales (9,000) (4,000) (13,000)
Administration expenses (2,000) (6,000) (8,000)
Income from associate
40% 2,000 800 800
Tax group (1,000) (1,200) (2,200)

Profit after tax 800


S only 20% 800 $160

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SESSION 26 IAS 28 INVESTMENTS IN ASSOCIATES

Accountancy Tuition Centre (International Holdings) Ltd 2008 2601

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