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MAICSA STUDY MANUAL

Chapter 18 FRS 128 INVESTMENT IN ASSOCIATES


1. OBJECTIVE
To prescribe the methods of accounting for investments in associates in an investor’s:

a) Consolidated financial statements; and


b) Separate financial statements.

2. WHO IS AN ASSOCIATE
a. An associate is an entity, including an unincorporated entity such as a partnership, over which
the investor has significant influence and that is neither a subsidiary nor an interest in a joint
venture.
This means that the investor’s size holding in an entity is not large enough to control, but is large
enough to give a significant influence.

b. Significant influence is the power to participate in the financial and operating policy decisions of
the investee but not control over those policies.
- If an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting
power of the investee, it is presumed that the investor does have significant influence, unless
it can be clearly demonstrated otherwise. Conversely, if the investor holds, directly or
indirectly through subsidiaries, less than 20% of the voting power of the investee, it is
presumed that the investor does not have significant influence, unless such influence can be
clearly demonstrated.
- An entity is required to consider the existence and effect of potential voting rights currently
exercisable or convertible when assessing whether it has the power to participate in the
financial and operating policy decisions of the investee.
When potential voting rights exist, the investor’s share of profit or loss of the investee

and share of changes in the investee’s equity is determined on the basis of its present

ownership interests and does not reflect the possible exercise or conversion of the

potential voting rights.

- A substantial or majority ownership by another investor does not necessarily preclude an


investor from having significant influence.
- The existence of significant influence by an investor is usually evidenced in one or more of
the following ways: -
i. representation on the board of directors or equivalent governing body of the investee;
ii. participation in policy making processes;
iii. material transactions between the investor and the investee;

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iv. interchange of managerial personnel; or


v. provision of essential technical information.
vi.
3. ACCOUNTING TREATMENT OF AN ASSOCIATED COMPANY

 The Standard clarifies that investments in associates over which the investor has significant
influence must be accounted for using the equity method whether or not the investor also has
investments in subsidiaries and prepares consolidated financial statements.

Equity method is a method of accounting whereby the investment is initially recorded at COST
and the carrying amount is increased or decreased to recognise the investor’s share of the profit
or loss of the investee after the date of acquisition.

The investor’s share of the profit or loss of the investee is recognised in the investor’s profit or
loss account.

Adjustments to the carrying amount may also be necessary for changes in the investor’s
proportionate interest in the investee arising from changes in the investee’s equity that have not
been recognised in the investee’s profit or loss, such as revaluation of property, plant and
equipment. The investor’s share of those changes is recognised directly in equity of the investor.

Exceptions to using equity method:

(a) there is evidence that the investment is acquired and held exclusively with a view to its disposal within
twelve months from acquisition date and that management is actively seeking a buyer.
However, an entity may have found a buyer for an associate, but may not have completed the sale
within twelve months because of the need for approval by regulators or others authority. The
entity is not required to apply the equity method to an investment in such an associate if the sale
is in process at the statement of financial position date and there is no reason to believe that it
will not be completed shortly after the statement of financial position date.

(b) Its parent is exempted from preparing consolidated financial statements under FRS 127, or

(c) all of the following apply:


(i) the investor is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and
its other owners, including those not otherwise entitled to vote, have been informed about, and
do not object to, the investor not applying the equity method;
(ii) the investor’s debt or equity instruments are not traded in a public market (a domestic or foreign
stock exchange or an over-the-counter market, including local and regional markets);

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(iii) the investor is not in the process of filing its financial statements with a securities commission
or other regulatory organisation; and
(iv) the ultimate or intermediate parent of the investor publishes consolidated financial
statements that comply with International Financial Reporting Standards.

4. DISCONTINUED THE USE OF EQUITY METHOD

An investor shall discontinue the use of the equity method from the date that it ceases to have
significant influence over an associate and shall account for the investment in accordance with FRS
139 from that date, provided that the associate does not become a subsidiary or a joint venture as
defined in FRS 131.

5. THE NEED FOR EQUITY METHOD OF ACCOUNTING

When an investor acquires an associate, the mere recognition of income on the basis of distribution
received may not be an adequate measure of the income earned by an investor in an associate because
the distributions received may bear little relationship to the performance of the associate.

As the investor has significant influence over the associate, the investor has a measure of
responsibility for the associate’s performance. The investor accounts for this stewardship by
extending the scope of its consolidated financial statements to include its share of results of such an
associate and so provides an analysis of earnings and investment from which more useful ratios can be
calculated. As a result, the application of the equity method provides more informative reporting of
the net assets and net income of the investor.

6. APPLYING THE EQUITY METHOD OF ACCOUNTING FOR THE ASSOCIATED COMPANY.

 Where the investor has subsidiaries as well as associated companies

A. INCOME STATEMENT

The income statement should reflect the investor’s share of the results of operations of the investee.

Consolidated Income Statement for the year………..(extract)

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$
Profit from operations (H+S) XX
Less: Finance cost (H+S-IGF) (XX)
Add: Income from Associates (H’s % of Associate’s profit AFTER tax) XX
XX
Profit before tax
Income tax (H+S) (XX)
Profit after tax XX
Attributable to:
Equity holders of the parent X
Minority interest X
XX

Summary of items in Associate Co. Income statement using EQUITY METHOD: -

Items in the Income Statement of an


Consolidated Income Statement
Associate Co.

a) Sales, Cost of Sales, Operating IGNORE. This is because to do so would be


expenses, depreciation, etc. inconsistent with the equity accounting treatment,
which brings in the result of the associated
companies as one item, as distinct from consolidation
which splits the results over separate items.

b) Profit/Loss after tax Investor’s share to be brought in separately and


suitably described as Income from Associate Co.

c) Provision for unrealised profit Should be eliminated partially to the extent of the
investor’s interest regardless of whether “upstream”
or “downstream” transactions. The reason for this
elimination is consistent with the concept of single
economic entity upon which consolidated financial
statements are based.

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d) Taxation IGNORE

e) Preference share dividends IGNORE but the Investor’s share of the Associate
co.’s profit would be AFTER deducting the
preference share dividend whether or not the
dividends have been declared.

f) Ordinary share dividend IGNORE, as the Investor’s share of the Associate co.’s
profit after tax is already included in the consolidated
income statement.

B. CONSOLIDATED STATEMENT OF FINANCIAL POSITION

Under the EQUITY METHOD, the investment in Associate Co. is initially recorded at COST and
adjusted thereafter for the POST ACQUISITION change in the investor’s share of net assets of the
investee.

Summary of Associate Co. items using EQUITY METHOD

Statement of Financial Position of Investor Consolidated Balance Sheet

NON CURRENT ASSET NON CURRENT ASSET $

(a) Investment in Associated Co. at COST Investment in Associate Co. at COST XX

Add: Share of POST ACQ. PROFITS XX

Share of POST ACQ. RESERVES XX

XX

b) Inter Company balances Are not eliminated on consolidation and should be


disclosed separately as:

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[change numbering below]

a) Loans to/from Associate Co. i) Non Current Asset together with Investment in
Associate Co. if long term, otherwise as
ii) Current Asset/Current Liabilities.

Disclose as Current Asset/Current Liabilities as


b) Normal trading balances appropriate without netting off.

Disclose as dividend receivable under Current Asset

c) Dividend receivable

 Where the investor does not have subsidiaries

If the investor does not issue consolidated financial statements because it does not have subsidiaries,
the investment in the associate should be included in the financial statement of the investor using the
EQUITY METHOD.

Income Statement of the Investor……..(extract)


$
Sales XX
Cost of sales (X)
Gross profit X
Distribution and administration cost X
Profit from operations XX
Less: Finance cost (XX)
Add: Income from Associates (H’s % of Associate’s profit after tax) XX
Profit before tax XX

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Income tax (XX)


Profit after tax XX

b) NON-COTERMINOUS YEAR-ENDS

When the reporting dates of the investor and the associate are different, the associate prepares, for
the use of the investor, financial statements as of the same date as the financial statements of the
investor unless it is impracticable to do so.

Where it is impracticable, adjustments shall be made for the effects of significant transactions or
events that occur between that date and the date of the investor’s financial statements.

The difference between the reporting date of the associate and that of the investor shall be no more
than three months. The length of the reporting periods and any difference in the reporting dates shall
be the same from period to period.

c) UNIFORM ACCOUNTING POLICIES

If an associate uses accounting policies other than those adopted by the investor, appropriate
adjustments are made to the associate’s financial statements to conform them to the investor’s
accounting policies.

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Example 1 – H Bhd. acquired 40% shares in A Bhd. on 31st December 20X2 for RM 40,000.

Statement of Financial Position at 31st December 20X2


H Bhd (RM) A Ltd ($)
Share capital of RM 1 X 50,000
Retained profit X 30,000
X 80,000

Investment in A Bhd. 40,000 -


Net assets X 80,000
X 80,000

Example 2 – As above but is now one year later

Statement of Financial Position at 31st December 20X3

H Bhd ($) A Ltd (RM)

Share capital of RM 1 X 50,000

Retained profit X 70,000

X 120,000

Investment in A Bhd 40,000 -

Net asset X 120,000

X 120,000

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Example 3 – A Bhd acquired 30% shares in C Bhd for RM35,000 when its retained profit was
RM15,000(Cr).

A Bhd’s Income Statement for the Year 2

Profit before tax 100,000

Less: Tax 40,000

Profit after tax 60,000

Proposed dividend 25,000

Retained profit 45,000

Statement of Financial Position at 31st December Year 2

A Bhd C Ltd

Share capital of RM1 X 40,000

Retained profit X 50,000

XX 90,000

Investment in C Bhd 35,000 X

Net asset X 90,000

XX 90,000

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