MODULE 5

PART C: INVESTMENT IN ASSOCIATES

Significant influence rather than 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 of those policies

Investee = known as an associate

Equity method is used : recognised the investor’s share of the post acquisition in net assets (i.e.
equity) of the associate

It provides more information than just recognizing the investment based on cost, but less than if the
consolidation method we used

Investment in associate is a single asset that shows:

The investor’s share of net assets of the association at acquiasition date

Any changes afterwards

This is also called “one line consolidation”

Profit or loss of investor includes a line item showing share of profit ( loss) of investee

OCI of investor includes a line item showing share of OCI of the investee

Significant influence:

If entity A hold more than 20% but less than 50% of the share of Entity B, it is assumes that entity A
has significant influence on Entity B. unless it say difference

Identifying associates:

The existence of significant influence by an entity is usually evidence in one or more of the following
ways:

a. Representation on the board of directors or equivalent governing body of the investee

b. Participation in policy making processes, including participation in decisions about dividends
or other distribution
c. Material transactions between the entity and its investee
d. Interchange of managerial personnel or
e. Provision of essential technical information

Study guide Assumption

Investor prepare consolidated financial statements

Investor account for investment in associate in its own statements using the cost method

This means that the investment account in the associate should appear in the consolidated financial
statements as if the equity method was applied to account for it

On consolidation, adjustment will be posted to adjust the accounts impacted so they reflect the
investment based on the equity method
Investment in associate will usually cause a TTD and DTL

This module does not deal with any DTL arising from investment in associate

Cost method versus equity method

Cost method are treated as dividend income

Cost Method Equity Method

Dividends are treated as dividend income Dividends form part of calculating changes in
investee equity and impact carrying amount

Recognises investment as an asset based on Recognises the amount originally invested

amount originally invested
Investor’s share of undistributed profits or
losses and OCI in periods after acquisition
Example: Cost versus equity method

Investor buys 30% of $100,000 fair value net assets

Investee made $50,000 profit and paid $15,000 dividends

Investee had OCI of $7,000 after tax

Cost method

Investment : $30,000

Dividend income: $15,000 * 30% = $4500

What s missing?

The total profit was > than dividend

$50,000 profit * 30% = $15,000

Only received $4500 of this amount

The OCI portion

Equity method:

Investment : $30,000

Profit: $50,000 * 30% = $15,000

(reduced for $4500 dividend received )

Share of OCI: $7000 * 30% = $2100

Equity = $30,000 +$15,000+$2100 - $4500 = $42600

Share of profit is not based on P&L in the accounts

Be careful

Do not look at the investor’s P&L to determine share of the profits

You need to adjust these for:

  Cummulative preference dividends (these dividends must be paid and must be paid first…
 Identifiable assets & liabilities not recorded at fair value
 Inter entity transaction between associate and investor

Example: A ltd holds 30 % of B ltd

B has cumulative preference shares owned by C ( a separate entity)

The total dividends here are $10,000

Profit after tax for B was $50,000

A’s share of B’ s profit is not $50,000 * 30% = $15,000

Adjust B’s profit to: $50,000 - $10,000 = $40,000

A ‘ s share is : $40,000 * 30% = $12,000

Profit adjustment – identifiable assets not at FV

If the identifiable asset are not recorded at fair value an adjustment is required. Otherwise it will
understated / overstated post acquisition profit

Why ?

When those assets are sold or depreciated the fair value component is realized

Inventory at carrying amount $40,000 with fair value of $50,000

When sold at $80,000 it will create a

$40,000 profit based on carrying amount

$30,000 profit based on fair value

Need to adjust for the $10,000 before recognizing

Profit adjustment – inter entity transactions

Just like with consolidations

If there are:

Upstream (associate to investor) transactions

Downstream (investor to associate) transactions

These must be eliminated to the extent of the investor’s share

Recognising initial investment at cost (includes goodwill)

If consideration transferred is different to investor’s share of fair value of the net assets

Positive = goodwill

Negative = gain on bargain purchase

Goodwill is already recognised as part of the cost in the investment ( no separate goodwill)

Webinar Task
On 1 jan 20x5, Investor purchased 54,000 shares of Associate Ltd for $85,000

Associate Ltd has 120,000 shares at a par value of $1 each

The following “selected” information is provided:

Investor Associate
Issued Share capital 150,000 120,000

Reatined earnings (1/1/20x5) 102,000 45000

Dividend paid during 20x5 (55,000) (30,000)
Profit after tax (31/12/20x5) 186,000 95,000
Retained earnings 251,000 110,000
(31/12/20x5)
a. What is the goodwill acquired or bargain purchase to this transaction?

54,000 in total 120,000 shares = 45%

Purchase price $85,000

Net assets ($120,000 + $45,000) * 45% ($74250)

Goodwill acquired $10,750

b. In the consolidated financial statements of the investor, what would be amount of the share
of associate’s profit and the investment in associate balance?

Profit after tax (31/12/20x5) : $95,000

Share of profit of associate $42,750

(95,000 * 45%)

Cost $85,000

Add: share of profit $42,750

Less: share of dividends ($13500)

(30,000 * 45%)

Investment in associate $114,250

If we used the cost method then all we would have recorded was:

$85,000 investment asset

$13,500 dividends

Bargain Purchase
It is possible to calculate the difference between the consideration transferred and the investor’s
share of the fair value of the identifiable net assets of the associate as goodwill (if positive) or gain
on bargain purchase, otherwise known as excess on acquisition (if negative). Note that gain on
bargain purchase is not addressed in this module as it is rarely seen in practice

Goodwill must be determined on acquisition in accordance with IFRS 3. To determine the amount of
goodwill, the investor first notionally adjusts the net assets of the associate to their fair value. Any
positive difference between the cost of the investment and the investor’s share of the notionally
adjusted fair value is regarded as goodwill

Example:

On 1 jan 20x5, Investor purchased 54,000 shares of Associate Ltd for $85,000

Associate Ltd has 120,000 shares at a par value of $1 each. The tax rate is 30%

During the year the following transaction took place:

Investor sold inventory that cost $6000 to Associate for $8,000

At the end of the year, only 20 % of this inventory was on hand

Associate revalued land upwards by 15,000 which was not reflect in the cost of acquisition

Investor Associate

Issued Share capital 150,000 120,000

Reatined earnings (1/1/20x5) 102,000 45000

Dividend paid during 20x5 (55,000) (30,000)

Profit after tax (31/12/20x5) 186,000 95,000

Retained earnings 251,000 110,000
(31/12/20x5)

a. What is the goodwill acquired or bargain purchase related to this transaction?

b. In the consolidated financial statements of the investor, what would be amount of the share
of associate’sprofit and the investment in associate balance?

Downstream transaction: investor sold to Associate

$2000 unrealised profit at time of sale

At the end of the year 80% realized / 20 % unrealised. So 20% * $2000 = $400 unrealised profit

Adjusted for 30% tax ($400 * 30% = $120) the unrealised profit after tax is $280

45% of this unrealised profit is $126

Calculation:

54,000 out of 120,000 shares = 45%

Purchase price $85,000

Net assets (120 + 45 ) *45% ($74250)

Goodwill acquired $10,750

Share of profit ($95000 * 45%) $42,750

Inventory sale 280* 45% (126)

Share of profit of associate $42,624

20% of $2000 profit is unrealised ($400)

Adjusted for 30% tax of $120 this is $280

Step 1:

Sales ( $8000)

Add: COGS $6000

Step 2

Add realized portion

2000 unrealised *80% $1600

Step 3

Credit tax (400 * 30%) $120

8000 – 6000 -1600 )*30%

Land :Note: revaluation would have occurred during the year and hence would be included in the
$95,000 of profit from the associate

Question 3:
On1 jan 20x1, investor acquired 40% shares in associate ltd for $30,000. The applicable tax rate is
30%. The following information relating to Associate ltd is provided. There were no other
transactions:

What is the equity accounted share of the profit / loss in each year?

31/12/20x1 31/12/20x2 31/12/20x3

Profit / loss before tax $20,000 ($150,000) $35,000
Tax (30%) $6000 $45,000 $10,500
After tax P&L $14,000 ($105,000) $24,500
Investor share of P&L $5,600 ($42,000) $9,800
(40%)
Investor’s share of losses

In preceding examples and questions, the associate has earned a profit. Where the associate incurs a
loss, application of the equity method requires a reduction in the equity accounted amount of the
investor’s investment and recognition of the investor’s share of the associate’s loss

Where the share of the associate’s losses exceeds the investor’s interest (carrying amount of
investment in associate, preference shares and long term receivables or loan), the investor
discontinues recognizing those losses

Moreover, , when application of the equity method recommences, the inventor’s share of associate
profits can only be recognised after offsetting the investor’s share of losses not previously
recognised

Investment in 31/12/20x1 31/12/20x2 31/12/20x3

associate

1 jan 30,000 35,600 0

Share of P&L 5,600 (35,600) $3400

($42,000 limited to
balance $35,600

Closing balance 35,600 0 3400

(9800 – 6400)
Unrecognized loss ($6,400) this lost is
just sit there , do
nothing

Journal entries

Share of current post acquisition profit

Dr investment in associate

Cr Share of profit or loss of associates

Posted in the consolidation worksheet, not the investor;s book

Share of previous post acquisition profits

Dr Investment in Associate

Cr Retained earnings (opening balance)

(why? In a consolidation worksheet entries from previous periods do not carry over)

Dividends from the associate ( in the records of the investor)

Dr bank / dividend receivable

Cr Dividend income

(this recognize the revenue)

Eliminate the dividend on consolidation and adjust for reduction in equity in associate

Dr dividend income

Cr investment in associate

(dividends decrease the associate’s equity.. investor should recognize the decrease)

Invetor’ share of post acquisition OCI

Dr investment in associate

Cr share of OCI

Reduce the investor’s investment when the associate incurs a loss

Dr share of profit or losses of associate

Cr Investment in ordinary share / preference shares