HI5020

Corporate Accounting
Session 11a
Accounting for Equity Investments
 Session Learning Objectives

• Be aware of how to account for equity investments

• Be aware that investments in associates and joint
ventures must be accounted for using the equity method
of accounting, and know how to apply this method of
accounting
• Understand that , if the investor is a parent entity (that is,
it has at least one subsidiary), either the cost method of
accounting or fair value is to be used in its own individual
accounts, and the equity method in the consolidation
worksheet to account for the investments in associates
and joint ventures, and that, by contrast, if any investor is
not a parent entity (it has no subsidiaries), the equity
method of accounting is to be used in its own accounts to
account for investments in associates and joint ventures.
 Introduction to accounting for equity investments

• The lecture considers how to account for

equity investments where the investor
does not have control over the investee
• To determine the correct accounting
treatment for equity investments a number
of factors should be considered:
• What is the nature of the investor’s
operations?
• Is the investment held for trading purposes?
 Introduction to Accounting for Equity
Investments (cont.)
If the investor has significant influence over the
investee, the equity method of accounting must be
applied
Investment in an associate is increased by any post-
acquisition movements in the associate’s earnings &
reserves
An equity investment is deemed to exist where (AASB
132):
the investor has acquired an equity instrument, which
can be defined as:
any contract that evidences a residual interest in an
entity’s assets after deducting all its liabilities
 Equity Method of Accounting for Investment
Investment in H&H
Cash

Investment in H&H
Investment Revenue

Cash
Investment in H&H
 Fair value Method

Investment in H&H
Cash

Fair Value Adjustment

Unrealised Gain

Cash
Unrealised Gain
Fair Value Adjustment
Investment in H&H
Realised Gain
 Introduction to Accounting for Equity
Investments (cont.)
If the investor has significant influence over the
investee, the equity method of accounting must be
applied
Investment in an associate is increased by any post-
acquisition movements in the associate’s earnings &
reserves
An equity investment is deemed to exist where (AASB
132):
the investor has acquired an equity instrument, which
can be defined as:
any contract that evidences a residual interest in an
entity’s assets after deducting all its liabilities
 Types of Investments
Equity investments
Usually shares in an organisation
Give investor an ownership interest & therefore
share in profits
Bonds
Instrument that binds one party to repay funds to
another party at a specified time & rate
For example, debentures & unsecured notes
Can be issued at face value, discount or premium
Some can have both debt & equity characteristics,
e.g. convertible bonds
 Types of Investments (cont.)
Cash investments
Can be converted to cash at short notice
For example, interest-bearing deposits
Property investments
Various investments in physical property
For example, land & buildings
Held to earn rentals &/or capital appreciation
Can be purchased directly or through a property
trust
Also derivative instruments
Derive their value from other underlying assets
For example, futures & options
 Investments in Associates
Key terms:
Associate: investee over which the investor has
significant influence
Investee: entity in which another entity has an
ownership interest
Investor: entity/person that has an ownership
interest in another entity
Significant influence: power to participate in
investee’s financial & operating policy decisions (but
not control or joint control)
 Equity Method of Accounting

AASB 128 requires that:

where an investor does significantly influence an
investee, the investor must adopt the equity
method of accounting

Therefore, while there is a general principle that

equity investments shall be measured at fair
value, where an investor has significant
influence then we will use equity accounting to
measure the equity investment
 Equity Method of Accounting (cont.)
• AASB 128 requires:
• use of equity accounting within the financial
statements, &
• application of equity accounting to include corporate
investments & non-corporate investments
• Significant influence
• Used in determining whether the equity method is to
be applied
• Falls short of control
• Normally stems from investor’s voting power in the
investee
• Assumed to exist where investor holds 20% or more of
investee’s voting power
 Equity Method of Accounting (cont.)
• Significant influence (cont.):
• 20% is not intended as an absolute cut-off point &
significant influence may exist with an equity holding
below this rather arbitrary amount of voting power
• Other indicators
• representation on board of directors
• participation in policy-making processes
• material transactions between investor & investee
• interchange of managerial personnel
• provision of essential technical information
• If the investor subsequently ceases to have significant
influence, they must cease using equity accounting
 Application of the Equity Method of Accounting

As with the materiality application in other accounting

standards, if investments are not material, investor
not required to comply with AASB 128
Investment in associate is initially recognised at cost
Carrying amount of investment is increased or
decreased to recognise investor’s share of investee’s
post-acquisition profits
Investor’s share of investee’s profit or loss to be
included in investor’s profit or loss
Distributions (e.g. dividends) from investee reduce
the investment’s carrying amount
 Application of the Equity Method of Accounting (cont.)

• Adjustments to carrying amount also for:

• changes in investor’s proportionate interest in
investee from changes in investee’s equity not
included in investee’s profit or loss
• For example, revaluations of property, plant &
equipment & foreign exchange translation
differences
• Investor’s share of changes recognised directly in
investor’s equity
 Application of the Equity Method of Accounting (cont.)

• If investor is required to prepare consolidated financial

statements they should:
• recognise investment in associate by applying equity
method in consolidated financial statements, &
• apply cost or fair value methods in own individual
financial statements
• If investor does not prepare consolidated financial
reports they should:
• apply the equity method to their own ‘separate’
financial report
• (the above is summarised on the following slide)
THE END