Chapter 24 | INVESTMENT IN ASSOCIATE

Intercorporate Share Investment

 the purchase of equity securities of one entity by another entity

 do not give the investor an ability to influence or control the operations of the investee
 in certain circumstances, an entity may purchase enough shares of another entity in
order to exert significant influence or control the operations of the investee
Significant influence

 the power to participate in the financial and operating policy decisions of the investee
but not control or joint control over those policies
Control

 the power over the investee or to govern the financial and operating policies of an
investee so as to obtain benefits
Associate

 an entity over which the investor has significant influence

Subsidiary

 an entity controlled by another entity

Significant Influence

 assessment of significant influence is a matter of judgment

PAS 28, paragraph 5

  20% SIGNIFICANT INFLUENCE

 < 20% DOES NOT HAVE SIGNIFICANT INFLUENCE
Factors:

 Representation in the board of directors

 Participation in policy making process
 Material transactions between the investors and the investee
 Interchange of managerial personnel
 Provision of essential technical information
Potential Voting Rights
PAS 28, paragraph 7 - Existence is considered in assessing whether an entity has significant
influence

 Should be currently exercisable or convertible

 Not currently exercisable or convertible WHEN the rights cannot be exercised or
converted until a future date or occurrence of a future event
 WHEN exist, the investor’s profit or loss of the investee and of changes in the investee’s
equity is DETERMINED on the basis of “present ownership interest” and DOES NOT
reflect the possible exercise or conversion of potential voting rights

Loss of Significant Influence

 When it loses the power to participate

 Can occur with or without change in the absolute or relative ownership interest
Examples

 An associate becomes subject to control of a government, court, administrator or

regulator
 Result of a contractual agreement

Equity Method

 Based on the economic relationship between the investor and the investee
 The investor and investee are viewed as a single economic unit
 Applicable when the investor has a significance influence over the investee
Accounting Procedures

 The investment is initially recognized at cost

 The carrying amount
 increased by the investor’s share of the profit of the investee (investment
income)
 decreased by the investor’s share of the loss of the investee
 Distributions or dividends received from an equity investee reduce the carrying amount
of the investment
 Note that the investment must be in ordinary shares
 Investments in preference shares may be accounted for as at FV through P/L or at
FV through OCI or at cost
  If the investor has significant influence over the investee, the investee is said to be an
associate.
 Accordingly, under the equity method, the investment in ordinary shares should
be appropriately described as investment in associate.
 Investment in associate accounted for using the equity method shall be classified as
noncurrent asset.
 Journal Entry (net income)
Investment in associate (20% of reported income)
Investment income
 Journal Entry (net loss)
Loss on investment
Investment in associate

Excess of Cost Over Carrying Amount

 If the investor pays more than the carrying amount of the assets required, the difference
is commonly known as “excess of cost over carrying amount” and may be attributed to
the following:
a. Undervaluation of the investee’s assets, such as building, land and inventory.
b. Goodwill
 If the assets are fairly valued, accountants frequently attribute the excess of cost over
book value to goodwill
 If the excess is attributable to land, it is not amortized because the land is nondepreciable
 If the excess is attributable to inventory, the amount is expensed when the inventory is
already sold.
 If it is attributable to goodwill, it is not amortized but the entire investment in associate
is tested for impairment at the end of each reporting period. Goodwill is included in the
carrying amount.

Illustration:
If the fair value of equipment is 2,000,000 greater than its carrying amount, the investor should
decrease its investment income by 80,000(2M/5 x 20%) since the investee’s income is
overstated by 400,000 by the unrecorded depreciation of 400,000(2M/5). The share in loss of
the investor is equal 20 percent of 400,000.

Undervaluation of depreciable asset(2Mx20%) 400,000(share in FV of 2M)

Goodwill - remainder 600,000
Excess of cost over net asset acquired 1,000,000
 Journal Entry
Investment income (400000/5 years) 80000
Investment in associate 80000

Excess of Net Fair Value Over Cost

PAS 28, paragraph 32 – any excess of the investor’s share of the net fair value of the associate’s
identifiable assets and liabilities over the cost of the investment is included as income in the
determination of the investor’s share of the associate’s profit or loss in the period in which the
investment is acquired

Investee with Heavy Losses

PAS 28, paragraph 38 - if an investor’s share of losses of an associate equals or exceeds the
carrying amount of an investment, investor discontinues recognizing its share of further losses.

 The investment is reported at nil or zero value

 The carrying amount of the investment in associate also includes other-long term
interests in an associate, such as long-term receivables, loans and advances. However,
trade receivables and any long-term receivables for which adequate collateral exists,
such as secured loans, are excluded from the carrying amount of the investment in
associate

 If the associate subsequently reports income, the investor resumes including its share of
such income after its share of income equals the share of losses not recognized.

Impairment Loss

 The recoverable amount is measured as the higher between fair value less costs to sell
and value in use

 The recoverable amount is assessed for each individual associate, unless an individual
associate does not generate cash inflows from continuing use that are largely
independent of those from other assets of the reporting entity
Investee with cumulative preference shares

 When an associate has outstanding cumulative preference share, the investor shall
compute its share of earnings or losses after deducting the preference dividends,
whether or not such dividends are declared.

Investee with noncumulative preference shares

 When an associate has outstanding noncumulative preference share, the investor shall
compute its share of earnings after deducting the preference dividends only when
declared.