Chapter 14 Investments in Associates Related standard: PAS 28 Investments in Associates and Joint Ventures Learning Objectives 4. Define an investment in associate. 2. Describe the accounting requirement for investments in associates. 3. Account for the investor's share in the losses of an associate. Investment in Associate ‘An associate is “an entity over which the investor has significant influence.” (PAS 28.3) The existence of significant influence distinguishes an investment in associate from all other types of investments. Nature of Applicable Type of investment relationship with reporting investee standard Investment measured at fair Regular investor PFRS 9 value © Investment in associate Significant PAS 28 influence * — Investment in subsidiary Control PFRS 3 and PERS 10 © Investment in joint venture Joint control PFRS 11 and PAS 28 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.” (PAS 283) Significant influence is presumed to exist if the investor holds, directly or indirectly (e.g-, through subsidiaries), 20% or Scanned with CamScannermore of the voting power of the investee. Conversely, significant influence is presumed not to exist if the voting power is less than 20%. Percentage of ownership interest Type of investment Less than 20% Financial assets at fair value 20% to 50% _* Investment in associate 51% to 100% Investment in subsidiary Contractually agreed sharing of control [Investment in joint venture It should be noted that significant influence arising from ownership interest of “20% or more” of the voting rights of the investee is just a presumption, meaning it is generally held true in the absence of evidence to the contrary. An investor may have significant influence even if it has less than 20% voting power, and conversely, may not have significant influence even if it has more than 20% voting power, if these can be clearly demonstrated. Case #1: ABC Co. owns 30% of the voting shares of Alpha Co., the other 60% is held by XYZ, Inc. and all seats on the board of directors are appointed by XYZ, Inc. * In this situation, significant influence cannot be demonstrated despite the ownership interest of more than 20%. The investment shall not be accounted for under PAS 28. Case #2: ABC Co. owns 15% of the voting shares of Alpha Co., all other shares are held in very small blocks and therefore ABC Co. has many seats on the board of directors. : this situation, significant influence can be demonstrated despite ¢ ownership interest of less than 20%. The investment is accounted for under PAS 28. Scanned with CamScannerother evidences of significant influence ‘Any of the following may provide evidence of the existence of significant influence even if the percentage of ownership interest is less than 20%: ; 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 distributions; c. material transactions between the entity and its investee; d. interchange of managerial sonnel; or 8 perial pe e. provision of essential technical information. (PAS 28.6) Voting rights For significant influence to exist, the investment should provide the investor voting rights. Thus, investment in preference shares, Tegardless of the percentage of ownership, is not accounted for under PAS 28 because preference shares do not give the investor voting rights, An interest in a Partnership (unincorporated entity) is accounted for under PAS 28 if it gives the investor significant influence over the partnership. Illustration: Determining the ownership interest Case #1: On January 1, 20x1, ABC Co. acquired 30,000 shares of XYZ, Inc's 100,000 outstanding shares at P10 per share. Requirement: Compute for the percentage of ownership acquired. Solution: Number of shares acquired : 30,000 + Outstanding shares 499,000 Ownership interest 30% Scanned with CamScannerCase #2: : On January 1, 20x1, ABC Co. acquired 30,000 newly issued shares of XYZ, Inc. at P10 per share. Before the acquisition, XYZ had 100,000 ordinary shares outstanding. Requirement: Compute for the percentage of ownership acquired. Solution: Newly issued shares acquired + Outstanding shares after acquisition (100,000 + 30,000) Ownership interest Equity method 30,000 130,000 23.08% — SS Investments in associates are accounted for using the equity method. Under the equity method, the investment is initially Tecognized at cost and subsequently adjusted for the investor's share in the investee's changes in equity (eg., profit or loss, dividends and other comprehensive income). Effect on Effect on 7 . 7 ei Share in associate’s investment in A A : investment income associate a. Profit or loss ~ increase for share in profit; decrease for share in loss - increase for share in profit; decrease for share in loss b. Dividends -_decrease - no effect c. Other - comprehensive income - increase for share in gain; decrease for share in loss - no effect; the share in OCT is included in the investor’s OCI J Scanned with CamScannerIllustration: Purchase cost equal to fair value of interest acquired On January 1, 20x1, ABC Co. purchased 20,000 shares of the ‘000 total outstanding shares of XYZ, Inc. for P1,000,000. XYZ’s assets and liabilities approximate their fair values. The entry to record the purchase is as follows: Jan.1, | Investment in associate 1,000,000 cue Cash 1,000,000 - In-20x1, XYZ, Inc. reported profit of 3,000,000 and declared and paid cash dividends of ?200,000. The entry to record the share in the profit of the associate is as follows: Dec. 31, 20x1 Investment in associate 600,000 Share in profit of associate (3M x 20%*) 600,000 “Interest acquired = (20,000 shares acquired * 100,000 shares outstanding) = 20%. _ The entry to record the receipt of cash dividends is as follows: a a Cash (200,000 x 20%) 40,000 Investment in associate 40,000 * Notes: © Both the’ share in the associate’s profit and cash dividends received are recorded to the investment in associate account. * Under the equity method, cash dividends are not income but rather a deduction to the “Investment in associate” account. The carrying amount of the investment on December 31, 20x1 is determined as follows: Investment in associate 1,000,000 600,000 Y1/x1 Sh. in 20x1 profit 40,000. Cash dividends - 20x1 1,560,000 12/31/x1 Scanned with CamScannerContinuation of illustration: In 20x2, XYZ reported loss of ?2,000,000, declared and issued 199, stock dividends, and recognized gain on property revaluation gf | P500,000 and loss on exchange differences on translation of foreign operations of P100,000 in other comprehensive income. The entry to record the share in the loss of the associate is as follows: Dec. 31, | Share in loss of associate (2M x 20%) 400,000 a Investment in associate 400,000 Share in associate's other comprehensive income The entry to record the share in the associate’s other comprehensive income from property revaluation is as follows: Dec. 31, | Investment in associate (500K x 20%) 100,000 a Share in OCI of associate — 100,000 revaluation surplus The entry to record the share in the associate’s other comprehensive income from exchange differences on translation of foreign operations is as follows: ve Share in OCI of associate - translation of | 202 foreign operation 20,000 Investment in associate (100K x 20%) 20,000) The share in the associate's other comprehensive income is Presented as a separate line item in ABC Co.'s statement of profit or loss and other comprehensive income under the caption “Sharé of other comprehensive income of associate.” The related disclosures are made in the notes, The shares in the revaluation surplus and translation nee are included as part of any revaluation surplus and ation difference tecognized in ABC’s equity. These ate presented in the statement of financial position under the tO components of equity” line item, differe transl Scanned with CamScannerObserve that all of the transactions recognized above involved either debiting or crediting the “Investment in associate” account. Associate's share dividends Share dividends do not result to a change in the total equity of the investee. Accordingly, they do not affect also the investment in associate account. Moreover, even though share dividends increase the number of shares held, they do not affect the investor’s ownership interest. This is because, in share dividends, all shareholders are given shares of stocks in Proportion to their current holdings. Thus, their ownership interests remain the same before and after the distribution of share dividends. _-The share dividend is record through memo entry as follows: “Received 2,000 ordinary shares from associate representing 10% | share dividenads on 20,000 shares originally held. Total shares now [held ave 22,000 shares. No special accounting is given to share dividends under the equity method because, theoretically, the total value of the shares held would be the same as it was before the dividend. T-account analyses are shown below: Investment in associate W1fx1 1,000,000 Sh. In 20x1 profit 600,000 40,000 Cash dividends - 20x1 400,000 Sh. In 20x2 loss Sh. in revaluation 100,000 20,000 Sh. In translation loss 1,240,000 12/31/x2 Share in profit or loss of associate - 20x2 Shain loss - 20x2 400,000 12/31/x2 Scanned with CamScannerThe December 31, 20x2 financial statements will show the following: Statement of financial position Statement of profit or loss and other comprehensive income | Noncurrent assets: Share in loss of associate (400,000) | Investment in associate 1,240,000 | Loss for the year (400,000) Share in OCI of associate 80,000 Other components of equity 80,000 Equity: Total comprehensive loss (320,000) | | Investments in associates are classified as noncurrent assets. Statement of Changes in equity Translation Share Retained Revaluation of foreign Total capital earnings surplus operations equity Total | comprehensive loss (400,000) 100,000 (20,000) (320,000) | Application of the Equity method An investor starts using the equity method from the date it obtains significant influence over an investee. On acquisition, the difference between the cost of the investment and the entity’s share in the net fair value of the investee’s identifiable assets and liabilities is accounted for as follows: > If cost is greater than the fair value of the interest acquired, the excess is goodwill. If cost is less than the fair value of the interest acquired, the deficiency is included as income in determining the entity's share in the investee’s profit or loss in the period © acquisition. > Scanned with CamScanner —Any resulting goodwill is included in the carrying amount of the investment and is not accounted for separately. Meaning, the goodwill is neither amortized nor tested for impairment tely. pars ‘Adjustments are subsequently made on the entity’s share in the investee’s profit or loss to account for the depreciation or amortization of any undervaluation or overvaluation in the investee’s identifiable assets and liabilities. If the carrying amount of an associate's asset is less than its fair value (i.e. undervalued), the investor's share on the undervaluation is recognized on a rational basis as deduction to both investment income and investment account over the remaining life of the asset. The opposite treatment is applied if the asset is overvalued. If the carrying amount of an associate's liability is less than its fair value, the investor's share on the undervaluation is Tecognized on a rational basis as addition to both investment income and investment account over the remaining term of the liability. The Opposite treatment is applied if the liability is overvalued. © Remember the following: * Share in undervaluation of | Y Deduction to both: asset a. share in the profit of associate (investment income); and b. investment in associate account Tlustration; Purchase cost exceeds fair value of interest acquired January 1, 20x1, ABC Co. purchased 25% interest in the *rdinary shares of XYZ, Inc. for P2,000,000. XYZ’s assets and liabilities approximate their fair values except for the following: ; & Inventories-with a carrying amount of 500,000. have a fair Value of 100,000. Scanned with CamScannerb. A depreciable asset with a carrying amount of 3,000,000 hasa fair value of P5,000,000. The asset has a remaining useful life of 10 years. XYZ’s net assets has a book value of P5,000,000. Jan.1, | Investment in associate 2,000,000 The entry to record the purchase is as follows: 20x1 | Cash | |. 2,000,000 The goodwill is computed as follows: Purchase cost 2,000,000 Less: Fair value of net assets acquired (1,650,000)}* Goodwill 350,000 «The fair value of the net assets acquired is computed as follows: Book value of net assets 5,000,000 Overvaluation of inventory (500K -100K) (400,000) Undervaluation of depreciable asset (5M -3M) 2,000,000 Fair value of net assets 6,600,000 Multiply by: Interest acquired 25% Fair value of net assets acquired 000 Alternative solution: The excess of purchase cost over book value of interest acquired is allocated as follows: Purchase cost 7 2,000,000 Book value of interest acquired (5M x 25%) 1,250,000) Excess of cost over book value 730,000 Share in overvaluation of inventory {(S00K — 100K) x B%} 100,000 Share in undervaluation of depreciable asset [6M - 3M) x 25%] x * Goodwill 77 *Undervaluation of asset is a deduction. Scanned with CamScannerGoodwill arising from investment in associate is included in the carrying amount of the investment and not accounted for separately. On December 31, 20x1, XYZ reported 1,200,000 profit and declared and paid dividends of P500,000. : The entries are as follows: Dec. 31, | Investment in associate 300,000 a Share in profit of associate (1.2M x 25%) 300,000 to record the share in the associate's profit Dec. 31, | Cash (600,000 x 25%) 125,000 20x1 Investment in associate 125,000 to record the cash dividends The overvaluation of inventory is accounted for as follows: Dec. 31, | Investment in associate (400K x 25%) 100,000 oe Share in profit of associate 100,000 The share in the overvaluation of inventory is recognized in full because the inventory is assumed to have been entirely sold during 20x1. The undervaluation of asset is accounted for as follows: Dec. 31, | Share in profit of associate « 50,000 20x: . : 1 Investment in associate 50,000 * 2M x 25%) +10 yrs. Notice that the effect of the undervaluation of asset is a deduction to both the “share in associate’s profit” : > J (investmen come) and “investment in associate.” : T-account analyses are shown below: Scanned with CamScannerInvestment in associate “ Jan.1 2,000,000 Sh. a ‘ofit, gross 300,000 125,000 Cash dividends Overvaluation of Undervaluation of 100,000 50,000 depreciable asset 2,225,000 Dec. 31 inventory Share in profit (loss) of associate — net 300,000 Sh. in profit, gross 50,000 100,000 Overvaluation of inventory Undervaluation of depreciable asset Dec. 31 350,000 —— % Notes: * The net change in the investment in asso share in profit of associate (net over/undervaluation) minus share in the ciate account is equal to of amortization of cash dividends. Investment, end. 2,225,000 Sh. in profit, net 350,000 Investment, beg. (2,000,000) Sh. in dividends __ (125,000) Net change 225,000 = 225,000 a = * Cash dividends affect only the investment in associate account. They do not affect the investment income or share in the profit of associate. Equity method Not applicable Equity method is Tequired when an investor has significant i influence over an investee, However, the equity method is not applicable under the f . : following: a. The investment ig classified as held for sale under PERS 3 Not eee Assets Held ‘for Sale and Discontinued Operations. The investor is a Parent that is exempted from presenting cial Statements. b. ly th > a subsidiary whose parent allows it not t0 apply the equity method; the investor's securities are no market nor the investor is in the process © Scanned with CamScannerenlisting its securities to be traded in the market; and the investor's parent produces consolidated financial Statements in accordance with PFRSs. d. The investment is held by, or is held indirectly through, an entity that is a venture capital organization, or a mutual fund, unit trust and similar entities including investment-linked insurance funds, and the entity elects to measure the investment at FVPL in accordance with PERS 9. Investments classified under (b) and (c) above are accounted for under PFRS 9. Potential voting rights In assessing whether significant influence exists, any potential voting rights held by the investor that are currently exercisable or convertible are assumed to have been exercised or converted even if management does not intend to actually exercise or convert them. If the ownership interest increases to 20% or more if the Potential voting rights are assumed to have been exercised, significant influence exists. Therefore, the equity method shall be applied. However, when computing for the investor's share in the associate's profit or loss, the present ownership interest shall be used (excluding the effect of the potential voting rights). Potential Voting rights are considered only when assessing the existence of Significant influence. Potential voting rights include (a) share warrants, (b) share call Options, and (c) debt or equity instruments that are Convertible into ordinary shares which if exercised or converted, Bive the entity additional voting power or reduce another party’s Voting power over the financial and operating policies of another entity, Potential voting rights that are not currently exercisable or Convertible are ignored in assessing the existence of significant influence. Potential voting rights are not currently exercisable or Scanned with CamScannerconvertible if they cannot be exercised or converted until a future date or until the occurrence of a future event. Illustration: Potential voting shares ABC Co. owns 15,000 shares out of the 100,000 outstanding shares of XYZ, Inc. ABC Co. also holds 20,000 stock rights which enable it to acquire additional XYZ shares on a “2 rights for 1 share” basis. The stock tights are exercisable immediately. However, ABC’s management does not intend to exercise the stock rights. XYZ does not have any other stock rights outstanding aside from those held by ABC. XYZ reports profit of P1,000,000 and declares cash dividends of P100,000. The investment has a carrying amount of P300,000 at the beginning of the period. Requirements: Compute for the following: 4. Share in the profit of the associate. b. Carrying amount of the investment at the end of the period. Solution: The existence of significant influence is assessed as follows: Shares presently held 15,000 Add: Potential voting rights assumed exercised (20,000 rights + 2 rights. per sh.) 10,000 Total shares 25,000 Divide by: Outstanding shares after exercise of rights (100,000 sh. + 10,000 sh.) 110,000 Assumed Ownership interest 2BW% The investment will be accounted for under the equity method because significant influence is assessed to exi: . st (i.e., 22.73% is ‘20% or more’). Scanned with CamScannerThe'entries are as follows: [ Dec. 31, | Investment in associate 150,000 beds Share in profit of associate (1M x 15%) 150,000 Dec. 31, | Dividend receivable (100K x 15%) 15,000 ie Investment in associate 15,000 Note that the present ownership interest (i.e. 15%) is used in computing for the share in the associate’s profit and dividends. Potential voting rights are considered only in assessing the existence of significant influence. Answers to the requirements: (a) P150,000 (refer to journal entry above) (b) Investment in Associate beg. 300,000 Sh. in profit 150,000 15,000 Dividends 435,000 end. Cumulative preference shares If the investee has outstanding cumulative preference shares that are held by parties other than the investor and classified as equity, the investor computes its share of profits or losses after deducting ‘one-year dividends on those shares, whether declared or not. If the preference shares are noncumulative, the investor deducts only the dividends that were declared. If the preference shares are classified as liability by the associate, (e.g., redeemable preference shares), no adjustment is made because the associate recognizes dividends on these shares as interest expense. Accordingly, the associate’s profit or loss is already adjusted of the interest expense. Scanned with CamScannerPreference share is Preference share is Preference share is cumulative noncumulative redeemable | = Deduct one-year | * Deduct i Do not deduct | dividend, dividends only dividends when | whether declared when declared computing for | or not, before before share in the computing the computing the associate's P/L. share in the share in the associate's P/L. associate's P/L. Illustration: Cumulative preference shares ABC Co. owns 20% of XYZ Inc.’s ordinary shares. XYZ also has outstanding cumulative 6% preference shares of P2,000,000. None of the preference shares is held by ABC. Dividends are in arrears for 3 years. XYZ reported profit of P1,000,000 and declared no dividends. a. How much is the share in the profit or loss of the associate? Answer: Profit of XYZ. 1,000,000 One-year dividend on cumulative preference shares whether declared or not (2M x 6%) (_120,000) Adjusted profit of associate 880,000 Multiply by: Ownership interest 20% Share in profit of associate 176,000 b. A ss i Mes : wz declared dividends that Pay all the dividends in » how : 2 7 f pas much is the share in the profit or loss of the Answer: 176,000. Still only one. at if “year di is sted. The s have already been consid 7 yi ividend is deducted. The arrears ha by ABC in computing its share in the associate's profit or loss in the Previous years ae Scanned with CamScannerc. What if the preference shares are non-cumulative, how much is the share in profit or loss of associate? Answer: (1M x 20%) = 200,000. No adjustment to profit is necessary because no dividends were declared. When preference shares are non-cumulative, adjustment is made only for the dividends declared. d. What if the shares are redeemable preference shares and XYZ declared 150,000 cash dividends on those shares, how much is the share in the profit or loss of the associate? Answer: 200,000. No ‘adjustment is necessary for preference shares that are considered debt instruments. The associate's profit for the year of PIM necessarily would have already been reduced by the dividends declared (i.e., as interest expense). Relationship between investment in associate account and associate's equity The foregoing concepts are based on the relationship between the investment in associate account and the associate’s equity. In theory, the investment in associate account will approximate the investor’s interest in the carrying amount of the associate’s residual equity in the long-run (ie, ‘residual equity theory’). Illustration: On January 1, 20x1, ABC Co. acquires 20% interest in XYZ for P1,000,000. The acquisition does not result to goodwill. The carrying amounts of the identifiable assets and liabilities of XYZ approximate their fair values. XYZ’s financial position as of January 1, 20x1 is shown below: Scanned with CamScannerLiabilities 5,000,000. 6% Cumulative preference shares 2,000,000 Ordinary shares 4,000,000 Retained earnings 1,000,000 Total equity 7,000,000 ABC holds none of the cumulative preference shares of XYZ, No dividends are isi arrears. On January 1, 20x1, the carrying amount of the investment approximates the investor's interest in the associate’s residual equity because the purchase cost reflects no goodwill and no dividends are in arrears. [fe equity -Jan. 1, 20x1 7,000,000 6% Cumulative preference shares (2,000,000) Residual equity of associate 5,000,000 Multiply by: Investor's interest | Investor's interest in residual equity of associate — 1.1,20x1 1,000,000 | Carrying amount t of investment in associate ~ 1.1.20x1 In 20x1, XYZ reports Profit of P1,000,000 and declares ™ dividends. The carrying amount of the investment in associate on Decemb™ 31, 20x1 is analyzed as follows: Investment in associate associate _ Jan. 1, 20x1 1,000,000 Share in profit* P 176,000 oa 31, 1,176,000 Dec. “The share in profit of associate is computed as follows: Scanned with CamScannerProfit of associate before adjustment for dividends 1,000,000 One-year dividend on cumulative preference shares (2M x 6%) (__120,000) Adjusted profit of associate 880,000 Multiply by: 20% “Share in associate’s profit - 20x1 —12Z6,000 Comparison on Dec. 31, 20x1: | Total equity - Dec. 31, 20x1 (7M + 1M profit in 20x1) 8,000,000 6% Cumulative preference shares (2,000,000) Residual equity of associate Multiply by: Investor's interest Investor's interest in residual equity of associate - 12/31/x1 6,000,000 Carrying amount of investment in associate - Dec. 31, 20x1 Difference ABC's interest in the residual equity of XYZ on December 31, 20x1 is not equal to the carrying amount of the investment in associate account. The difference is due to the dividend in arrears on the cumulative preference share (i.e., 2M x 6% = 120,000 x 20% ownership interest = 24,000 difference). In 20x2, XYZ reports profit of 1,000,000 and Pays 2-year dividends on the cumulative preference shares and P200,000 dividends on the ordinary shares. The carrying amount of the investment in associate as of December 31, 20x2 is analyzed as follows: Scanned with CamScannerInvestment in associate : Jan. 1, 20x1 1,000,000 Share in profit - 20x1 176,000 Cash dividends on ordinary shares Share in profit - 20x2* 176,000 40,000 (200,000 x 20%) 1,312,000 Dec. 31, 20x2 *The share in profit of associate in 20x2 is computed as follows: Profit of associate before adjustment for dividends - 20x2 1,000,000 One-year dividend on cumulative preference shares (2M x 6%) (120,009) Adjusted profit of associate — 20x2 880,000 Multiply by: 20% Share in associate's profit — 20x2 176,000 Comparison: Dec. 31, 20x2 Total equity - Dec. 31, 20x2 « 8,560,000 6% Cumulative preference shares (2,000,000 Residual equity of associate Multiply by: Investor's interest Investor's 6,560,000 20% __1312,000| terest 1,312,000, * 7M + 1M profit in 20x1 + 1M Profit in 20x2 - 240K PS dividends - 200K OS dividends) = 8,560,000 ABC’s interest in December 31, 20x2 is eq investment in associate ac on the cumul, the residual equity of XYZ as of ual to the carrying amount of the count because all dividends in arrears ative preference shares are paid. Scanned with CamScannerThe foregoing illustrations provide the basis for the accounting treatment of preferred dividends when determining the investor's share in the profit or loss of an associate. Discontinuance of Equity method An entity stops using the equity method from the date it loses significant influence over the investee. An entity loses significant influence over an investee when it loses the power to participate in the financial and operating policy decisions of the investee. The loss of significant influence can occur with or without a change in the percentage of ownership. For example: a. b. > When an associate becomes subject to the control of a government, court, administrator or regulator. Asa result of a contractual agreement. If the investment becomes a subsidiary, it is accounted for using PFRS 3 Business Combinations and PFRS 10 Consolidated Financial Statements. If the investment becomes a regular investment, it is accounted for using PFRS 9. The fair value of the retained interest is regarded as its fair value on initial recognition under PFRS 9. The difference between the following is recognized in profit or loss: a. the fair value of the retained interest and any proceeds from disposing part of the investment; and b. the carrying amount of the investment at the date the equity method was discontinued. Loss : of significant influence due to| . Accounting treatment * Decrease of ownership > Financial asset at fair value interest below 20%. under PFRS 9 * Increase of ownership above | > Investment in subsidiary 50% under PFRS 3 and PFRS 10 Scanned with CamScannerThe discontinuance of equity method is accounted for prospectively. Prior year financial statements are not restated to adjust previously recognized share in profits or losses, other comprehensive income and discontinued operations of the associate. Illustration: Loss of significant influence On January 1, 20x1, ABC Co. acquired 30,000 ordinary shares of XYZ, Inc., representing 30% interest, for P3,000,000. On this date, XYZ’s net assets have a carrying amount of P8,000,000 and a fair value of 10,000,000. The difference is attributable to an undervalued building with a remaining useful life of 10 years. XYZ uses the straight-line method of depreciation. In 20x1, XYZ reported profit of P1,000,000 and paid cash dividends of P600,000. XYZ shares are selling at P100 per share on December 31, 20x1. On July 1, 20x2, ABC sold 60% of its investment in XYZ shares at the prevailing market price of P120 per share. XYZ reported interim profit of P500,000 for the six months ended June 30, 20x2. On December 31, 20x2, XYZ reported total profit of P1,200,000 for the year and declared P1,000,000 cash dividend. The shares are quoted at P135 per share at year-end. The entry to record the purchase is as follows: Jan.1, | Investment in associate 3,000,000 — Cash +| 3,000,000 The compound entry to record the share in profit and receipt of cash dividends in 20x1 is as follows: Dec. | Cash (600,000 x 30%) 180,000 fe Investment in associate (squeeze) 120,000 Ie Share in profit of associate (1M x 30%) 300,000 Scanned with CamScannerThe entry to adjust the share in profit for the depreciation of the undervaluation of the building is as follows: | Dec. 31, | Share in profit of associate 60,000« 20x1 Investment in associate 60,000 * The depreciation of the undervaluation of building is computed as follows: Share in undervaluation of building [(10M - 8M) x 30%] 600,000 Divide by: Remaining life of building 10__ Annual adjustment to share in profit of associate 0,000 The entries to adjust the carrying amount of the investment prior to the sale on July 1, 20x2 are as follows: July. | Investment in associate (500K x 30%) 150,000 ) 20x2 ; ; : : | Share in profit of associate 150,000 | to record the share in the associate's profit for the six months ended June 30, 20x2 July 1, | Share in profit of associate 30,000 . Investment in associate (60K x 6/12) 30,000 | | ] to record the depreciation of undervaluation of building for the six months ended June 30, 20x2 The carrying amount of the investment on the date of sale is computed as follows: Investment in associate Jan. 1, 20x1 3,000,000 Share in profit - 20x1 300,000 Cash dividends - 20x1 Undervaluation - 20x1 Undervaluation - 20x2 Share in profit - 6/30/x2 . 3,180,000 July 1, 20x2 The entry to record the sale is as follows: July | Cash (30,000 sh. x 60% x 120) 2,160,000 ae Investment in associate (3.18M x 60%) 1,908,000 | na Gain on sale of investment (squeeze) 252,000 Scanned with CamScannerThe gain on sale is recognized in profit or loss. After the sale, the unsold portion of the investment is reclassified because it is presumed that significant influence is lost, ie. the previous interest of 30% is reduced below the 20% threshold or reduced to 12% (30% x 40%). The entry to reclassify the remaining shares is as follows: y 6 July | Held for trading securities 1,440,000¢ i Investment in associate (3.18M x 40%) 1,272,000 i Gain on reclassification 168,000 * (30,000 sh, shares originally held x 40%) = 12,000 sh. now held x P120 fair value on July 1, 20x2 = 1,440,000 fair value on reclassification date The gain on reclassification is also recognized in profit or loss. The entry to record dividend income on December 31, 20x2 is as follows: Dec. 31, | Dividend receivable (1M x 12%?) 120,000 a Dividend income 120,000 > (30% previous interest x 40% unsold portion) = 12% current interest. The entry to recognize the change in the fair value of the investment in held for trading securities is as follows: Dec, 31, | Held for trading securities 180,000¢ Unrealized gain - P/L 180,000 € [(P135 - P120) x 12,000 sh.] Total investment-related income recognized in profit or loss in 20x2 is computed as follows: Net share in profit of associate — Jan. to June (150K - 30K) 120,000 Gain on sale 252,000 Gain on reclassification 168,000 Dividend income 120,000 Unrealized gain on change in fair value 180,000. Total income recognized in profit or loss — 20x2 840,000, Scanned with CamScanner— Reclassification of cumulative other comprehensive income When the equity method is discontinued, all amounts previously - recognized in other comprehensive income in relation to the investment are either reclassified to profit or loss as a reclassification adjustment or transferred directly to retained earnings using the provisions of other PFRSs. For example, revaluation surplus is transferred directly to retained earnings while exchange differences from translating foreign operations are reclassified to profit or loss. If ownership interest is reduced but significant influence or joint control is not lost, only a proportionate amount of the OCI relating to the reduction of interest is reclassified to profit or loss or transferred directly to retained earnings, as appropriate. Illustration 1; Reclassification adjustment for OCI ABC Co. owns 30% of XYZ, Inc.’s ordinary shares. On July 1, 20x2, ABC Co. sold half of its investment for P400,000. The adjusted balances of the related accounts immediately before the sale are as follows: «Investment in associate 1,200,000 ¢. Cumulative share in associate’s exchange differences on translation of a foreign operation 500,000 Cr The remaining ownership of 15% (30% x ¥%) does not give ABC significant influence over XYZ. The entry to record the sale is as follows: July, | Cash 400,000 70:2 | Loss on sale of investment 200,000 Investment in associate (1.2M x 1/2) 600,000 The reclassification adjustment of the OC is as follows: July, | Translation of foreign operation 500,000 nae Gain on reclassification — P/L 500,000 The total cumulative share in OCI of associate is Teclassified to profit or loss because significant influence is lost. Scanned with CamScanneri i ignificant influence Illustration 2: Partial loss of signi! , 1 ae information in the preceding illustration, except that the remaining 15% ownership (30% x ¥%) still gives ABC significant influence over XYZ. The entry to record the sale is as follows: July, | Cash 400,000 202 | Loss on sale of investment 200,000 Investment in associate (1.2M x 1/2) 600,000 The reclassification adjustment of the OCT is as follows: July | Translation of foreign operation 250,000 2 Gain on reclassification (500K x %) soo Only half of the OCI is reclassified because significant influence is not lost. Illustration 3: Transfer of OCI directly in equity ABC Co. owns 30% of XYZ, Inc.’s ordinary shares. On July 1, 20x2, ABC Co. sold half of its investment for P400,000. The adjusted balances of the related accounts immediately before the sale are: ¢ Investment in associate 1,200,000 ¢ Cumulative share in associate’s revaluation increment on property 500,000 Cr The remaining ownership of 15% (30% x %) does not give ABC significant influence over XYZ, The entry to record the sale is as follows: oe L | Cash 400,000 0x2 | Loss on sale of investment 200,000 Investment in associate (1.2M x 1/2) 600,000 The entry to derecognize the cumulative OCT is as follows: ae Revaluation surplus — associate 500,000 Retained earnings 500,000 Scanned with CamScannerThe cumulative share in the OCI of associate relating to revaluation surplus is transferred directly in equity (i.e., retained earnings). Severe long-term restrictions PAS 28 does not permit an investor that continues to have significant influence over an associate not to apply the equity method when the associate is operating under severe long-term restrictions that significantly impair its ability to transfer funds to the investor. Significant influence must be lost before an entity ceases to apply the equity method. Change to equity method - Gain of significant influence Significant influence may be achieved from additional purchase of shares resulting to an increase in ownership interest. -Although, not specifically addressed in PAS 28, this type of acquisition may be accounted for by reference to PERS 3 Business Combinations particularly on the accounting for business combination achieved in stages. ; PERS 3.42 states that “In a business combination achieved in stages, the acquirer shall remeasure its previously held equity interest in the acquiree at its acquisition-date fair value and recognize the resulting gain or loss, if any, in profit or loss or other comprehensive income, as appropriate.” Illustration 1: Change from FVPL to equity method On January 1, 20x1, ABC Co. acquired 10,000 shares out of the 100,000 outstanding shares of XYZ, Inc. for 800,000. The investment was classified as held for trading securities. . In 20x1, XYZ reported profit of P5,000,000 and paid dividends of P1,000,000. The fair value of the shares on December 31, 20x1 is P85 per share. The entries in 20x1 are as follows: Scanned with CamScanner/ Jan.1, | Held for trading securities 800,000 20x1 Cash 8000 Dec. | Cash (1M x 10%) 100,000 |. A Dividend income 100,009 Dec. | Held for trading securities 50,000 ce Unrealized gain — P/L {(10K x P85) - 800K] 50,000 The carrying amount of the investment on December 31, 20x1 is P850,000, equal to fair value. On July 1, 20x2, ABC Co. acquired additional 15,000 shares at the fair value of P70 per share resulting to an increase in the ownership interest from 10% to 25%. Number of shares previously held 10,000 Additional shares purchased 15,000 ~ Total shares held 25,000 Divide by: XYZ’s outstanding shares 100,000 New ownership interest LyvA July 1, | Investment in associate (15,000 x P70) 1,050,000 The entry to record the » purchase of additional shares is as follows: 20x2 i Cash : 1,050,000 The acquisition-date fair value of the previously held investment is determined as follows: Number of shares previously held 10,000 Multiply by: Fair value per share on July 1, 20x2 P70 Acquisition-date fair value of existing investment 200,000 The previously held investment is Temeasured as follows: July 1, | Unrealized loss — P/L (850K - 700K) 150,000 20x2 Held for trading securities 150,000 to recognize loss on Temeasurement of previously held equity interest Scanned with CamScannerThe loss on remeasurement is recognized in profit or loss because the previously held equity interest was originally classified as FVPL. The previously held investment is reclassified as follows: July 1, | Investment in associate 700,000 2012 | Held for trading securities 700,000 {0 reclassify the previously held equity interest to investment in associate The carrying amount of the investment in associate on July 1, 20x2 is analyzed as follows: Purchase cost of additional shares acquired 1,050,000 Reclassification date fair value of existing investment 700,000 Carrying amount of investment in associate - 7/1/x2 1,750,000 SS Neither PAS 28 nor PFRS 3 suggests that a change to the equity method would result in a restatement of the investment account and the retained earnings account to “catch up” to what the balances would have been had the equity method used all along. This differs from the provisions of US GAAP which Tequires “catch up” adjustments to the investment and related accounts. The only evidence of a retrospective accounting under PAS 28 is when an investment in associate that was previously ; Classified as “held for sale” asset is reclassified back to “investment in associate.” In 20x2, XYZ reported profit of P6,000,000, P4,000,000 of which Was eamed in the second half of the year. In addition, XYZ leclared and paid dividends of P1,000,000 on December 31, 20x2. quoted price of XYZ shares on December 31, 20x2 is P90 per Scanned with CamScannerDec. 31, | Cash (1M x 25%) 250,000 ~ Investment in associate (squeeze) 750,000 | Share in profit of associate (4M x 25%) | 1,000,000 The equity method is applied starting on the date significant influence is. obtained. Accordingly, the share in profit of associate is computed only on the profit earned by the associate from July 1 to December 31, 20x2. Also, the fair value on December 31, 20x2 is ignored because the equity method is used. Illustration 2: Change to equity method from FVOCI Use the information in the preceding illustration except that the investment was initially classified as FVOCI. The entries on July 1, 20x2 are as follows: July] Investment in associate (15,000 x P70) 1,050,000 L Cash | 1,050,000 | 20%2 | To record the acquisition ofthe additional shares | July | Unrealized loss - OCI 150,000 L Investment in equity securities - FVOCI 150,000 | 20x2_| To remeasure the previously held equity interest ca July | Investment in associate 700,000 | 1, Investment in equity securities - FVOCI | 700,000 | 20x2 | To reclassify the previously held equity interest to | investment in associate _| July | Retained earnings 100,000 1 Unrealized gain (loss) - OCI 100,000 | 2082 | To transfer directly within equity the cumulative | | gains recognized in OCI J ©) (800K acquisition cost - 700K fair value on July 1, 20x2) = 100K net loss in OCI Illustration 3: Change to e Use the information in investment was initially the previously held equil original acquisition cost, quity method from measurement at Cost the Preceding illustration except that the measured at cost. The carrying amount of ty interest on July 1, 20x2 is P800,000, the The entries on July 1, 20x2 are as follows: Scanned with CamScannerInvestment in associate (15,000 x P70) 1,050,000 Cash 1,050,000 To record the acquisition of the additional shares Loss on remeasurement - P/L 100,000) Investment in equity securities - Cost 100,000 To remeasure the previously held equity interest Investment in associate 700,000 Investment in equity securities - Cost 700,000 To reclassify the previously held equity interest to investment in associate (& (800K acquisition cost - 700K fair value on July 1, 20x2) = 100K loss Under PERS 9, the fair value of a financial asset at initial recognition is normally equal to the transaction price. In this case, the fair value of the previously held investment is determined by reference to the acquisition price of the additional shares purchased on July 1, 20x2. Intercompany transactions with an associate Gains and losses resulting from “downstream” and “upstream” transactions between an investor and an associate are recognized in the entity’s financial statements only to the extent of unrelated investors’ interests in the associate. > “Downstream” transactions are, for example, sales of assets from the investor to an associate. > “Upstream” transactions are, for example, sales of assets from an associate to the investor. The entity’s share in the associate’s gains or losses resulting from these transactions is eliminated. If the seller is the investor, the transaction is downstream. If the seller is the investee (associate), the transaction is upstream. Investor Downstream Upstream Scanned with CamScannerWhen downstream transactions provide evidence of a reduction in the net realizable value of the assets to be sold or contributed, or of an impairment loss of those assets, recognizes those losses in full. When upstream transactions Provide evidence of a reduction in the net realizable value of the assets to be purchased or of an impairment loss of those assets, the investor Tecognizes only its share in those losses. the investor Illustration 1: Downstream sale ABC Co. owns 20% of XYZ, Inc.’s outstanding ordinary shares. On December 31, 20x1, ABC sold equipment with a historical cost of P150,000 and accumulated depreciation of P50,000 to XYZ, Inc. for P120,000, equal to the fair value of the equipment. The equipment has a remaining useful life of 10 years. Both ABC and XYZ use the straight line method of depreciation. The downstream sale is recorded as follows: Dec. 31, | Cash 120,000 oe Accumulated depreciation 50,000 Equipment 150,000 Gain 20,000 | The gain is eliminated up to extent of the entity’s interest a5 follows: Dec. 31, | Gain (20,000 x 20%) 4,000 Investment in associate 4,000 20x1 The result of the elimination is that the gain oS the entity’s financial statements is only to the extent of age investors’ interests in the associate, i.e., (20,000 x 80% = 16,000). =< 20% “ The unrelated investors’ interests in the associate is 80% (100% less 20%) Scanned with CamScannerSince gains and losses from intercompany transactions are eliminated against the carrying amount of the investment, a question now arises, “what if the carrying amount of the investment is reduced below zero after a gain is eliminated?” In this regard, the IASB opined that in such case, the excess gain shall be recognized as a deferred gain. To illustrate, let us assume that the carrying amount of the investment in associate is P3,000. The entry to eliminate the gain is as follows: Dec. 31, | Gain (20,000 x 20%) 4,000 — Investment in associate 3,000 The eliminated gain is recognized in profit or loss when the associate generates economic benefits from the transferred asset. Consequently, the deferred gain will be recognized in profit or loss as the associate depreciates the equipment or when it sells the equipment to an unrelated party. Deferred gain 1,000 } | Illustration 2: Upstream sale } Use the information in ‘Illustration 1’ except that the sale is | upstream, i.e., XYZ, Inc., the associate, is the seller. ABC Co. records the purchase as follows: Dec. 31, | Equipment 120,000 20x Cash 120,000 __ABC Co. eliminates its share in the associate’s gain as follows: Dec. 31, ] Share in profit of associate 4,000 a |__Investment in associate 4,000 Scanned with CamScannerShare in Losses The investor shares in the investee’s losses only up to the amount of its interest in the associate. > Interest in the associate includes the following: a. Carrying amount of the investment in associate b. Investment in preference shares of the associate c. Unsecured, long-term receivables or loans Interest in the associate or joint venture does not include trade receivables and payables and secured long-term receivables or loans Shares in losses are applied first to the carrying amount of the investment in associate. After the investment is zeroed-out, shares in losses are applied to the other components of the interest in the associate in the reverse order of their seniority (ie., reverse order of priority in liquidation). After the total balance of the interest in the ‘associate is zeroed-out, the investor stops sharing in further losses, except to the extent that the investor a. has incurred legal or constructive obligations or b. made payments on behalf of the associate. If the investee subsequently reports profits, the investor resumes recognizing its share in those Profits only after its share in the profits equals the share in losses not recognized. Illustration: Share in losses of associate ABC Co. owns 20% of the ordinary shares of XYZ, Inc. ABC’s tecords on December 31, 20x1 show the following information before any necessary year-end adjustments: Investment in associate 200,000 Trade accounts receivable — XYZ, 300,000 Investment in preference shares - XYZ 100,000 Advances to associate - XYZ, 50,000 Loans receivable, secured - XYZ 120,000 Scanned with CamScanner» XYZ reported loss of 1,400,000 in 20x1. The interest in the associate as of Dec. 31, 20x1 before adjustment is computed as follows: Investment in associate 200,000 Investment in preference shares — XYZ 100,000 Advances to associate - XYZ 50,000 Interest in the associate - before adjustment, 12/31/x1 _350,000 The computed balance of the “interest in the associate” is the threshold in determining the share in the losses of the associate. The share in the loss of the associate in 20x1 is computed as follows: Share in loss of associate (14M x 20%) (280,000) The share in the loss of associate is charged first to the balance of the investment in associate. Any excess loss is charged to the other components of the interest in the associate in the reverse order of liquidation or to the preference shares first then to the advances to associate (unsecured long-term receivable). The entry to recognize the share in the loss is as follows: Pee Share in loss of associate 280,000 20x1 Investment in associate 200,000 Investment in preference shares 80,000 After posting the entry above, the balances of the relevant accounts are as follows: nvestment in associate (200K - 200K) 0 Tnvestment in preference shares - XYZ (100K - 80K) 20,000 Advances to associate - XYZ 50,000 » Interest in the associate - after adjustment, Dec. 31,20x1 __70,000 Scanned with CamScannerThe remaining threshold for recognizing further losses is 70,000. > XYZ reported loss of P500,000 in 20x2. Share in loss of associate (500K x 20%) (100,000) The computed amount of P100,000 exceeds the P70,000 threshold. Thus, only P70,000 will be recognized as share in the associate's loss in 20x2. The excess of P30,000 is disclosed as “loss not recognized.” If the associate subsequently reports profits, the investor resumes recognizing its share of those profits only after its share of the profits equals the share of losses not recognized. The entry to recognize the share in the loss is as follows: Dec. | Share in loss of associate 70,000 ee, Investment in preference shares 20,000 Advances to associate 50,000 After making the entry above, the interest in the associate has a zero balance. > XYZ reported loss of P100,000 in 20x3. In addition, ABC incurred constructive obligation of P120,000 in favor of XYZ and made payments of P80,000 on behalf of XYZ. ABC will not recognize any share in the P100,000 loss because the balance of the “interest in associate” is already reduced to 2er0- The ‘should have been’ share of P20,000 (100,000 x 20%) is disclosed as “loss not recognized.” The cumulative balance of “losses not Tecognized” is 50,000 (30,000 in 20x2 plus 20,000 in 20x3). ABC will only recognize further losses arising from any legal or constructive obligation incurred and any payments made on behalf of the associate. Thus, only the P120,000 constructivé Scanned with CamScannerobligation and the P80,000 payments made on behalf of XYZ will be recognized as further losses in 20x3. The entry to recognize the additional losses is as follows: Dec. 31. | Loss on associate 200,000 20as Cash 80,000 Liability incurred on behalf of assoc. 120,000 > In 20x4, XYZ reported profit of P1,000,000. The share in the profit of the associate is computed as follows: Share in profit of associate before adjustment (1M x 20%) 200,000 Cumulative losses not recognized (_50,000) Share in profit of associate - adjusted 150,000 The entry to recognize the share in the associate's profit is as follows: Dec. 31, | Advances to associate 50,000 7x4 | Investment in preference shares 100,000 Share in profit of associate ~ 150,000 Impairment losses Goodwill included in the carrying amount of an investment in associate is not accounted for separately, meaning it is neither amortized nor tested for impairment separately. Instead, the entire investment in associate is tested for impairment under PAS 36 Impairment of Assets by comparing the investment’s recoverable amount with its carrying amount, whenever there are indications that the investment may be impaired. An impairment loss recognized in those circumstances is not allocated to any asset, even to goodwill which forms part of the carrying amount of the investment in the associate. Instead, the total impairment loss is treated as a decrease in the carrying amount of the investment, to which the goodwill is included. Scanned with CamScannerAny reversal of impairment loss is recognized mal accordance with PAS 36 to the extent that the recoverable amount of the investment subsequently increases. Recoverable amount is the amount to be recovered through use or sale of an asset. It is the higher of an asset's: a. Fair value less costs of disposal; and b. Value in use. ¢ Fair value is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” (PAS 36.6) © Costs of disposal are “incremental costs directly attributable to the disposal of an asset or cash-generating unit, excluding finance costs and income tax expense.” (PAS 36.6) © Value in use is “the present value of the future cash flows expected to be derived from an asset or cash-generating unit.” (PAS 36.6) Impairment loss is the amount by which the carrying amount of an asset exceeds its recoverable amount. Illustration: Impairment of investment in associate ABC Co. owns 40% of the ordinary shares of XYZ, Inc. The investment in associate account has a carrying amount of P1,000,000 on December 31, 20x1. ABC assessed that the investment may be impaired. After impairment testing, ABC determined the following: Fair value less costs of disposal ' 800,000 Value in use of the investment 790,000 The impairment loss is determined as follows: Recoverable amount (FVLCD - higher) 800,00" Carrying amount of investment (1,000,000) Impairment loss (_200,000) Scanned with CamScannerThe entry to recognize the impairment loss is as follows: T Dec. 31, a loss 200,00 | 20x1 Investment in associate 200,000 Chapter 14: Summary ¢ An associate is an entity over which the investor has significant influence. © 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. Significant influence is presumed to exist when ownership interest is 20% or more. ¢ Under the equity method, the investment in an associate is initially recognized at cost and subsequently adjusted for the investor's share in the changes in equity of the associate, such as (a) profit or loss, (b) other comprehensive income, and (c) results of discontinued operations. ¢ When an associate has cumulative preference shares, the investor computes its share in profit or loss after deducting one-year dividends on those shares, whether declared or not. © The investor’s share in the depreciation of an undervaluation of asset is a deduction to both the investment income (share in profit of associate) and the investment in associate account. * Share in losses of associate is recognized up to the amount of the “interest in the associate.” i * After the investor's interest in the associate is reduced to zero, s are recognized only for the following: (a) bligations; or (b) payments made on behalf of the associate. Other losses are not recognized : * If the associate subsequently reports profits, the investor resumes recognizing its share of those profits only after its share of the profits equals the share of losses not recognized. additional losse legal or constructive 0! Scanned with CamScannerInvestment in associate beg. Xxx Share in profit xx xx Dividends Share in OCI (Cr.) xXx Xx Undervaluation of asset xx end. Share in profit of associate Undervaluation of asset XX Xx Share in profit end. xX Scanned with CamScanner