DipIFR-Session26 d08 Investment in Associates

7/27/2019 DipIFR-Session26 d08 Investment in Associates

1/22

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 consolidatedstatement 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


2/22



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 substantialinvestments in other entities without actually having control. Thus, a parent-subsidiaryrelationship does not exist between the two.

If the investing company can exert significant influence over the financial and operatingpolicies 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 nota passive interest.

Commentary

Including the investment at cost in the company's accounts would not fairly presentthe investing interest.

So that the investing entity (which may be a single company or a group) fairly reflectsthe nature of the interest in its accounts, the entitys interest in the net assets and resultsof the company, the associate, needs to be reflected in the entitys accounts. This isachieved through the use ofequity 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 orloss or are classified as held for trading and accounted for in accordance withIAS 39 Financial Instruments: Recognition and Measurement.

Commentary

Such investments are measured at fair value in accordance with IAS 39, withchanges 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 hassignificant influence andwhich is neither a subsidiary nor a joint venture (i.e. an economic activityundertaken by two or more parties with joint control).

Significant influence is the power to participate in the financial and operating policydecisions of the investee but is not control or joint control over those policies.

Controlis the power to govern the financial and operating policies of anentity so as to obtain benefits from its activities.


3/22



The equity methodis a method of accounting whereby the investment is initiallyrecognised at cost and adjusted thereafter for the post acquisition change in theinvestors share of net assets of the investee. The profit or loss of the investorincludes 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 inone 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 significantinfluence, unless it can be demonstrated otherwise.

Commentary

Conversely, a holding of less than 20% presumes that the holder does not havesignificant 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 atthat date is regarded as its cost on initial measurement thereafter (and will beaccounted 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 presentseparate financial statements as their only financial statements.

In the separate financial statements, the investment in the associate should beaccounted 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.


4/22



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 ofsubsidiaries.

2.2 Basic rule

An investment in an associate should be accounted for using the equitymethod.

Commentary

Associates must be accounted for using the equity method regardless of the factthat 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 exercisesignificant influence over operating and financial policies (generally throughdirect or indirect ownership of 20% to 50% of the voting rights) are recorded inthe Consolidated Financial Statements using the equity method of accounting andare initially recognized at cost.

Siemens share of its associated companies post-acquisition profits or losses isrecognized in the income statement, and its share of post-acquisition movementsin equity that have not been recognized in the associates profit or loss is recognizeddirectly 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 carryingamount is increased or decreased to recognise the investors share of the profitor loss of the investee after the date of acquisition.

Commentary

This is equivalent to taking the investors share of the net assets of theassociate at the date of the financial statements plus goodwill.


5/22



Distributions received from the associate reduce the carrying amount of theinvestment.

Adjustments to the carrying amount may also be necessary for changes in theinvestors proportionate interest in the associate arising from changes in theassociates equity that have not been recognised in the profit or loss.

Such changes include those arising from the revaluation of property, plantand equipment and from foreign exchange translation differences.

Commentary

The logical way of recognising these changes in equity would be to show theinvestors share of the changes in other comprehensive income.

The investors share of the current years profit or loss of the associate isrecognised in the investors profit or loss.

The associate is not consolidated line-by-line. Instead, the group share of theassociates net assets is included in the consolidated statement of financial

position in one line, and share of profits (after tax) in the consolidated statementof 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 groupaccounts.

In group investments, replace the investment as shown in the individual companystatement of financial position with:

the groups share of the associates net assets at the end of thereporting period; plus

the goodwill arising on acquisition.

Commentary

As for business combinations under IFRS 3, IAS 28 does not permit theamortisation of goodwill.

Do not consolidate line-by-line the associates net assets. The associate is not asubsidiary, therefore the net assets are not controlled as they are for a subsidiary.

In group reserves, include the parents share of the associates post-acquisitionreserves (the same as for subsidiary).

Cancel the investment in associate in the individual companys booksagainst the share of the associates net assets and contingent liabilitiesacquired at fair value. The difference is goodwill.


6/22



Commentary

The fair values of the associates assets and liabilities must be used incalculating goodwill. Any change in reserves, depreciation charges etc dueto 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 excessof the cost of investment, the difference is included as income in determiningthe investors share of the associates profi or loss.

To calculate amounts for net assets and post-acquisition reserves, use anet assets working for the associate (the same as for the subsidiary).

The amount to be shown in the statement of financial position at the endof the reporting period will be:

$Share of net assets

(Group % Associates net assets at end of the reporting period) XGoodwill on acquisition X

_____

X_____

This is not how IAS 28 phrases it. IAS 28 says that the carrying value of theinvestment 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 assetsat the end of the reporting period.


7/22



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 18,600Less: Goodwill (1,000)

______

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

______

44,000______

Investment in Associate

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

______

20,200______

OR

40% of Associates net asset at year end (48,000 40%) 19,200Plus: 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_____


8/22



Activity 1

P owns 80% of S and 40% of A. Statements of financial position of the threecompanies 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 1,400Current assets 2,200 3,300 3,250

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

5,200 4,100 4,650 P acquired its shares in S seven years ago when Ss retained earnings were $520 andP 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


9/22



WORKINGS

(1) Group structure

(2) Net assets working

S Reporting Acquisitiondate

$ $Issued capital

Retained earnings

A Reporting Acquisitiondate

$ $Issued capital

Retained earnings

(3) Goodwill

S $Cost of investment

Net assets acquired

A $Cost of investment

Net assets acquired


10/22



(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 andapplies equally to a non-group company with an associate:

Include group share of the associates profits after tax in theconsolidated profit or loss. This replaces dividend income shownin the investing companys own profit or loss.

Do not add in the associates revenue and expenses line-by-line asthis 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 timeapportioned as the statement of financial position reflects the net assets at theend of the reporting period to be equity accounted.


11/22



Activity 2

P has owned 80% of S and 40% of A for several years. Statement ofcomprehensive income for the year ended 31 December 2007 are:

P S A

$ $ $Revenue 14,000 12,000 10,000Cost of sales (9,000) (4,000) (3,000)

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

3,000 2,000 4,000Dividend 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 taxationIncome taxes

Profit after taxation

Attributable to:Owners of P

Non-controlling interests


12/22



(1) Group structure

(2) Consolidation schedule

40%P S A Adjustment Consolidation$ $ $ $ $

RevenueCost of salesAdministration expensesIncome 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 inthe associate, the investor discontinues recognising its share of further losses.

The interest in the associate is its value under the equity method plus anylong-term interest that forms part of the investors net investment.

Commentary

Such interests may include preference shares and long-term receivables orloans but do not include trade receivables, trade payables or any long-termreceivables for which adequate collateral exists, such as secured loans.

After the investors interest is reduced to zero, additional losses are providedfor, and a liability is recognised, only to the extent that the investor has incurredlegal or constructive obligations or made payments on behalf of the associate.

If the associate subsequently reports profits, the investor resumes recognisingits share of those profits only after its share of the profits equals the share oflosses not recognised.

Commentary

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


13/22



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 theinvestment 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 thoseprofits until its share of unrecognised losses had been eliminated.

However the investor should continue to recognise losses to the extent of anyguarantees 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 evidencethat financial interests in the associate (or joint venture) other than thoseincluded 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 tothose 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 aredifferent, the associate prepares, for the use of the investor, financialstatements 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, adjustmentsmust 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 theassociate 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 thereporting periods must be the same from period to period.


14/22



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 torecognise any additional impairment loss.

Because goodwill included in the carrying amount of an investment in an associate isnot separately recognised, it is not tested for impairment separately.

Instead, the entire carrying amount of the investment is tested for impairment, bycomparing 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 tobe generated by the associate, including the cash flows from the operations ofthe associate and the proceeds on the ultimate disposal of the investment; or

the present value of the estimated future cash flows expected to arise fromdividends 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 5Non-current Assets Held for Sale and Discontinued Operations.

Commentary

Under IFRS 5, if an associate is acquired and held with a view to disposalwithin 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 presentconsolidated financial statements the investment in the associate will bemeasured at cost or in accordance with IAS 39.

The investment in the associate will be measured at cost or in accordance withIAS 39 ifallof the following apply:

the investor is a wholly-owned subsidiary (or partially-owned andother owners do not object); and

the investors debt or equity instruments are not traded in a publicmarket; and

the investor does not file its financial statements with a securitiesregulator; and

the ultimate (or any intermediate) parent of the investor producesconsolidated financial statements available for public use under IFRS.


15/22



Commentary

This allows investors who do not have investments in a subsidiary, but onlyhave an investment in an associate, to be exempt from the requirement toequity 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 anon-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 theindividual company accounts.

Do notcancel inter-company balances in the statement of financialpositionand do not adjust sales and cost of sales for trading with associate.

In consolidated statement of financial position, show balances with associateseparately from other receivables and payables.

Commentary

The associate is not part of the group. It is therefore appropriate to showamounts owed to the group by the associate as assets and amounts owed tothe associate by the group as liabilities.

3.2 Dividends

Consolidated statement of financial position:

Ensure dividends payable/receivable are fully accounted for inindividual companies books.

Include receivable in the consolidated statement of financial

position for dividends due togroup from associates.

Do not cancel inter-company balance for dividends.

Consolidated statement of comprehensive income:

Does not include dividends from the associate. Parents share ofthe associates profit after tax (hence before dividends) is includedunder equity accounting in the income from associate.

Commentary

It would be double-counting to include dividend in the consolidated statementof comprehensive income as well.


16/22



3.3 Unrealised profit

If parent sells goods to associate and associate still has these goods in stock atthe year end, their carrying value will include the profit made by parent andrecorded 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 beingincluded in associates profit or loss and parents inventory.

To avoid double counting when equity accounting for associate, thisunrealised profit needs to be eliminated.

Unrealised profits should be eliminated to the extent of the investors interestin 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) inrespect of jointly controlled entities accounted for under the equity method.

Commentary

To eliminate unrealised profit, deduct the profit from associates profit before taxand retained earnings in the net assets working before equity accounting forassociate, 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 goodsare 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 ofcomprehensive income, thus dealing with the profit or loss impact.

Deduct $50 from retained earnings at end of the reporting period in net assetsworking 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.


17/22



Commentary

The simple rule to follow is that the unrealised profit will only be Parents %, $20in this example.

Double entry for $20

Dr Consolidated retained earnings 20Cr Investment in Associate 20

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

4 Disclosure

4.1 Investments in associates

The fair value of investments in associates for which there are published pricequotations.

Summarised financial information of associates (including aggregatedamounts 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 ofthe investor, and the reason for the difference.

The nature and extent of any significant restrictions on the ability of associatesto 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 whenexempt 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).


18/22



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

FocusYou should now be able to:

define associates;

describe and prepare accounts using equity accounting;

prepare consolidated financial statements to include a single subsidiary andan associate.


19/22



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) 2,400Current assets (2,200 + 3,300) 5,500

9,780

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

8,520

Non-controlling interests (W4) 760Liabilities 500

9,780

WORKINGS

(1) Group structure

GROUP

P

S

80% 40%

A


20/22



(2) Net assets working

S Reporting Acquisitiondate

$ $

Issued capital 400 400Retained earnings 3,400 520

3,800 920

A Reporting Acquisitiondate$ $

Issued capital 800 800Retained 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 600Net 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)] 1,280Less Goodwill impaired (W3 per Activity) (64)

7,520


21/22



(6) Investment in associate

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

1,880

ProofCost 600Share of post acquisition profits 1,280

1,832

Solution 2

P Consolidated statement of comprehensive income for the year ending 31

December 2007

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

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

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

Profit after taxation 3,600

Attributable to:Owners of P 3,440

Non-controlling interests 160

3,600


22/22


WORKINGS

(1) Group structure

P

SA

40%80%

(2) Consolidation schedule

40%P S A Adjustment Consolidation$ $ $ $ $

Revenue 14,000 12,000 26,000Cost of sales (9,000) (4,000) (13,000)Administration expenses (2,000) (6,000) (8,000)Income from associate

40% 2,000 800 800Tax group (1,000) (1,200) (2,200)

Profit after tax 800


S only 20% 800 $160

Documents

DipIFR-Session26 d08 Investment in Associates