FINANCIAL ACCOUNTING & REPORTING 1

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Other Types of Investments and Basic Concepts of Derivatives

Module 014 Investments in Associates and Joint

Ventures

An entity may conduct its business directly or through strategic investments

in other entities. Philippine Financial Reporting Standards (PFRS) broadly
distinguish three types of such strategic investment:
• entities controlled by the reporting entity (subsidiaries);
• entities jointly controlled by the reporting entity and one or more
third parties (joint arrangements classified as either joint operations
or joint ventures); and
• Entities that, while not controlled or jointly controlled by the
reporting entity, are subject to significant influence by it (associates).
At the end of this module, you will be able to:
1. Recognize the definition and treatment of associates
2. Recognize the requirements of the equity method
3. Apply the requirements of equity accounting
4. Recognize how to account for impairment
The common applications of the lessons that are under this module consist of
accounting for investments in associates using the equity method.

Introduction
Philippine Accounting Standards (PSA) 28 applies to all entities that are investors with
joint control of, or significant influence over, an investee. The objective of the standard is to
prescribe the accounting for investments in associates and to set out the requirements for
the application of the equity method when accounting for investments in associates and
joint ventures.

Significant influence
Significant influence is the power to participate in the financial and operating policy
decisions of the investee but not control or joint control over those policies. This is
usually evidenced in one or more of the following ways:
• Representation on the board of directors or equivalent governing body
• Participation in policy-making processes, including participation in decisions
about dividends or other distributions
• Material transactions between the investor and the investee
• Interchange of managerial personnel
• Provision of essential technical information

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 Lack of significant influence
The presumption of significant influence may sometimes be overcome in the
following circumstances:
• the investor has failed to obtain representation on the investee's board of
directors;
• the investee or other shareholders are opposing the investor's attempts to
exercise significant influence;
• the investor is unable to obtain timely or adequate financial information
required to apply the equity method; or
• A group of shareholders that holds the majority ownership of the investee
operates without regard to the views of the investor.

Potential voting rights

When assessing whether potential voting rights contribute to the assessment of
significant influence, the entity must examine all facts and circumstances (including
the terms of the exercise of the potential voting rights and any other contractual
arrangements) that affect potential voting rights, except the intention of
management and its financial ability to exercise or convert those potential rights.

Holdings of less than 20% of the voting power

Although there is a presumption that an investor that holds less than 20% of the
voting power in an investee cannot exercise significant influence, where
investments give rise to only slightly less than 20%, careful judgment is needed to
assess whether significant influence may still exist.
For example, an investor may still be able to exercise significant influence in the
following circumstances:
• The investor's voting power is much larger than that of any other
shareholder of the investee;
• The corporate governance arrangements may be such that the investor is
able to appoint members to the board, supervisory board, or significant
committees of the investee. The investor will need to apply judgment to the
facts and circumstances to determine whether representation on the
respective boards or committees is enough to provide significant influence;
or
• the investor has the power to veto significant financial and operating
decisions.
The Equity Method
An investment in an associate or joint venture is accounted for by using the equity
method, except (a) when a parent, with an investment in an associate and joint
venture, elects not to present consolidated financial statements (under the
exemption of paragraph 4 in PFRS 10); or (b) when all of the following apply:
• The investor is a wholly-owned subsidiary or 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.
• Its debt or equity instruments are not publicly traded.
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Other Types of Investments and Basic Concepts of Derivatives

• It does not file, nor is it in the process of filing its financial statements with a
security commission or another regulatory organization for the purpose of
issuing instruments in a public market.
• Its ultimate or any intermediate parent produces PFRS financial statements
available for public use that comply with PFRSs, in which subsidiaries are
consolidated or are measured at fair value through profit or loss in
accordance with PFRS 10.
Investments in associates or joint ventures, or portions of those investments held by
entities that are venture capital organizations, mutual funds, unit trusts, and similar
entities, including investment-linked insurance funds, may be measured at fair value
through profit or loss in accordance with PFRS 9 Financial Instruments.

Exemption of the equity method

• An entity shall apply PFRS 5 Non-current Assets Held for Sale and
Discontinued Operations to an investment, or a portion of an investment, in
an associate or a joint venture that meets the criteria to be classified as held
for sale.
• Any retained portion of an investment in an associate or a joint venture that
has not been classified as held for sale shall be accounted for using the equity
method until disposal of the portion that is classified as held for sale takes
place. After the disposal takes place, an entity shall account for any retained
interest in the associate or joint venture in accordance with PFRS 9 unless
the retained interest continues to be an associate or a joint venture, in which
case the entity uses the equity method.
• When an investment previously classified as held for sale no longer meets
the criteria to be so classified, it must be accounted for using the equity
method retrospectively, as from the date that it was classified as held for sale.
Financial statements for the periods since classification as held for sale shall
be restated. All other investments in associates or joint ventures are to be
accounted for by using the equity method.
Under the equity method, the investment in an associate or joint venture is initially
recognized at cost, and the carrying amount is increased or decreased to recognize:
• 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
recognized in the investor’s profit or loss.
• Distributions received from an investee (they reduce the carrying amount of
the investment).
• Changes in the investee's other comprehensive income that have not been
recognized in the investee's profit or loss (such as revaluation of property,
plant, and equipment; and foreign exchange translation differences). The
investor's share in those changes is recognized in other comprehensive
income of the investor.
If the associate or joint venture has outstanding cumulative preference shares that
are held by parties other than the investor and classified as equity, then the investor
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computes its share of profits or losses after adjusting for the dividends on such
shares, whether or not the dividends have been declared.
Other key points:
• A group's share in an associate or joint venture is the aggregate of the
holdings of the parent and its subsidiaries. The holdings of the group's other
associates or joint ventures are ignored for this purpose.
• When potential voting rights exist, present ownership interests determine
the investor’s share in the equity of the investee; they do not reflect possible
exercise or conversion of the potential voting rights.
• When an associate or joint venture has subsidiaries, associates, or joint
ventures, the profits or losses, other comprehensive income, and net assets
are taken into account in applying the equity method are those recognized in
the associate's or joint venture's financial statements (including the
associate's or joint venture's share of the profits or losses and net assets of
its associates and joint ventures), after any adjustments necessary to give
effect to uniform accounting policies.
• From the date the investment ceases to be an associate or a joint venture:
➢ If the investment becomes a subsidiary, the entity shall account for
the investment in accordance with PFRS 3 Business Combinations and
PFRS 10.
➢ If the retained interest in the former associate or joint venture is a
financial asset, the fair value of the investment as of that date shall be
regarded as the fair value on initial recognition as a financial asset
under PFRS 9. The entity recognizes in profit or loss any difference
between (a) the fair value of any retained interest and any proceeds
from disposing of a part interest in the associate or joint venture; and
(b) the carrying amount of the investment at the date the equity
method was discontinued.
• If an entity discontinues the use of the equity method, the entity should
account for all amounts previously recognized in other comprehensive
income in relation to that investment on the same basis as would have been
required if the investee had directly disposed of the related assets or
liabilities.
Other topics
• Intercompany transactions
Gains or losses resulting from "upstream" transactions (such as sales of
assets from an associate or joint venture to the investor or its consolidated
subsidiaries) and "downstream" transactions (such as sales of assets from
the investor or its subsidiaries to an associate or joint venture) between the
investor (and its consolidated subsidiaries) and its associates or joint
ventures are recognized in the investor's financial statements to the extent of
unrelated investors' interests in the associate or joint ventures. The
investor's share in the associate's or joint venture's profits and losses
resulting from these transactions is eliminated.
• Goodwill
On acquisition of an investment that is an associate or joint venture, any
difference between the cost of the investment and the investor's share of the
net fair values of the associate's or joint venture's identifiable assets and
liabilities is accounted for as follows:
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Other Types of Investments and Basic Concepts of Derivatives

- Goodwill relating to an associate or joint venture is included in the

carrying amount of the investment and is not amortized.
- Any excess of the investor’s share of the net fair value of the associate’s or
joint venture’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 or joint venture’s profit or loss in the period in
which the investment is acquired.
• Losses
If an investor’s share of losses of an associate or joint venture equals or
exceeds its interest in the associate or joint venture, it stops recognizing its
share of further losses. The interest in an associate or joint venture is the
carrying amount of the investment in the associate or joint venture under the
equity method, together with any long-term interests that, in substance, form
part of the investor’s net investment in the associate or joint venture. This
includes items for which a settlement is neither planned nor likely to occur in
the near future.
• Reporting dates
When the end reporting period of the associate or joint venture and that of
the investor are different, the associate or joint venture must prepare
financial statements as of the same date as the investor unless it is
impractical to do so. Where the end reporting dates are different, then
adjustments shall be made for the effects of significant transactions or events
that occur between the two dates. However, the difference between the
reporting dates must not exceed three months and must be the same from
period to period.
• Accounting policies
If an associate or joint venture uses accounting policies other than those of
the investor for like transactions and events in similar circumstances,
adjustments must be made to make the associate's or joint venture's
accounting policies conform to those of the entity when the associate's or
joint venture's financial statements are used by the entity in applying the
equity method.

Application of equity method

Illustration:
1. On January 1, 2015, an investor purchased 20,000 shares of the P100,000 outstanding
ordinary shares of another entity at P200 per share.
The investment represents a 20% equity interest, and the investor has a significant
influence over the investee. The acquisition cost is equal to the carrying amount of the
net assets required.
Investment in associate 4,000,000
Cash 4,000,000
2. The investee reported a net income of P5,000,000 for 2015. The investor recognized a
share in the net income of the investee equal to 20% of P5,000,000 or P1,000,000.
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 Investment in associate 1,000,000
Investment income 1,000,000
3. Received a 25% stock dividend from the investee on December 31, 2015.
Memo- received 5,000 ordinary shares as a 25% stock dividend on 2,000 original
shares. Shares now held 25,000 shares.

Note that 20% of equity interest is not affected by the stock divided. The equity
interest is the same before and after the stock dividend.

4. The investee reported a net loss of P1,000,000 for 2016. The investor recognized a
share in the net loss of the investee equal to 20% of P1,000,000 or P200,000.
Loss on investment 200,000
Investment in associate 200,000
5. The investee declared and paid a cash dividend of P2,500,000 on ordinary shares on
December 31, 2016; The investor recognized a share in a net loss of the investee equal
to 20% of P2,500,000 or P500,000.
Cash 500,000
Investment in associate 500,000

Note that under the equity method, a cash dividend is not an income but a return or
reduction of investment.

Excess of cost over carrying amount

If the investor pays more than the carrying amount of the net assets
acquired, the difference is commonly known as “excess of cost over carrying
amount” and may be attributed to the following:
✓ Undervaluation of the investee's assets, such as building, land, and
inventory
✓ Goodwill
• If the assets of the investee are fairly valued, accountants frequently attribute
the excess cost over the carrying amount of the underlying net assets to
goodwill.
• If the excess is attributable to the undervaluation of a depreciable asset, it is
amortized over the remaining life of the depreciable asset.
• If the excess is attributable to the undervaluation of land, it is not amortized
because the land is non-depreciable.
• If the excess is attributable to inventory, the amount is expensed when the
inventory is already sold.
• If the excess is attributable to goodwill, it is included in the carrying amount
of the investment and not amortized. However, this should be tested at the
end of each reporting date.
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Other Types of Investments and Basic Concepts of Derivatives

Illustration:
At the beginning of the current year, an investor purchased 20% of the outstanding
ordinary shares of an investee for P5,000,000. The net assets of the investee on the
date of acquisition are fairly valued except for a depreciable asset for which the fair
value is P2,000,000 greater than its carrying amount. Any remaining excess is
attributable to goodwill.

The carrying amount of the investee's net asset was P20,000,000. The investor,
therefore, paid P1,000,000 in excess of the carrying amount of net assets, computed
as follows:

Acquisition cost 5,000,000

Carrying amount of net assets acquired
(20% of 20,000,000) 4,000,000
Excess of cost over carrying value 1,000,000

The excess is attributable to the following:

Undervaluation of depreciable asset of investee with
remaining life 5 years (20%xP2,000,000) 400,000
Goodwill-remainder (not amortized) 600,000
Excess of cost over carrying amount 1,000,000

The journal entry to amortize the "excess of cost"-undervaluation of a depreciable

asset is as follows:
Investment Income 80,000
Investment in associate 80,000
(400,000/5 years)

Excess of net fair value over cost

PAS 28 provides that 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 investment is acquired.
Appropriate adjustments to the investor’s share of the associate’s profit or loss after
acquisition are also made to account, for example, for depreciation of depreciable assets
based on their fair value on the acquisition date.

Illustration:
At the beginning of the current year, an investor purchased 40% of the ordinary
outstanding shares of an investee for P15,000,000 when the net assets of the investee
amounted to P30,000,000.

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At the acquisition date, the carrying amount of the identifiable assets and liabilities of
the investee were equal to their fair value, except for the following:
• Equipment whose fair value was P7,000,000 greater than the carrying amount
• Inventory whose fair value was P2,500,000 greater than its carrying amount.
The equipment has a remaining life of 4 years, and the inventory was all sold during the
current year. The investee reported a net income of P20,000,000 for the current year
and paid a P5,000,000 cash dividend at year-end.
Computation:
Acquisition cost 15,000,000
Carrying amount of net assets acquired (40%xP30,000,000) 12,000,000
Excess of cost over carrying amount 3,000,000
Excess attributable to equipment (40%xP7,000,000) (2,800,000)
Excess attributable to inventory (40%xP2,500,000) (1,000,000)
Excess net fair value over cost (800,000)
Journal entries
1. To record the investment:
Investment in associate 15,000,000
Cash 15,000,000
2. To record the share in net income
Investment in associate 8,000,000
Investment income (40%xP20,000,000) 8,000,000
3. . To record the share in cash dividend:
Cash (40%xP5,000,000) 2,000,000
Investment in associate 2,000,000
4. To record the amortization of the excess attributable to the equipment:
Investment income 700,000
Investment in associate 700,000
5. To record the amortization of the excess attributable to inventory:
Investment income 1,000,000
Investment in associate 1,000,000
The excess is fully “expensed” because all the inventory was already sold during the
year.
6. To record the “excess net fair value” as investment income
Investment in associate 800,000
Investment income 800,000

Computation:
Share in net income 8,000,000
Amortization of excess attributable to equipment (700,000)
Amortization of excess attributable to inventory (1,000,000)
Excess net fair value 800,000
Net investment income 7,100,000
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Other Types of Investments and Basic Concepts of Derivatives

Impairment
After applying the equity method, including recognizing the associate's or joint venture's
losses, the investor applies the requirements of PAS 39 Financial Instruments: Recognition
and Measurement to determine the necessity of recognizing any additional impairment loss
with respect to the investor's net investment in the associate or joint venture that does not
constitute part of the net investment. PAS 39 will be replaced by PFRS 9 for annual periods
beginning on or after 1 January 2018
Because goodwill included in the carrying amount of an investment in an associate or joint
venture is not separately recognized, it is not tested for impairment separately by applying
the requirements of PAS 36 Impairment of Assets.

Instead, if the application of the requirements of PAS 39 indicates that the investment
might be impaired, then PAS 36 is applied to the entire carrying amount of the investment
to determine and allocate the impairment loss.

"Value in use" for this purpose is either:

The investor’s share of the present value of the estimated future cash flows expected to be
generated by the investee; or
The present value of the estimated future cash flows to arise from dividends to be received
from the investment and from its ultimate disposal.

Impairment: objective evidence

PAS 39 requires an entity to assess, at each balance sheet date, whether there is any
objective evidence that a financial asset or group of financial assets is impaired.
Objective evidence includes:
✓ Significant financial difficulty
✓ A breach of contract
✓ The lender, for economic or legal reasons relating to the borrower's financial
difficulty, grants the borrower a concession that the lender would not
otherwise consider.
✓ The probability that the borrower will enter bankruptcy or another financial
reorganization
✓ Information about significant changes with adverse effects that have
occurred in the technological, market, economic or legal environment
✓
Measurement after the loss of significant influence
PAS 28, paragraph 22 provides that at the date the significant influence is lost, the
investor shall measure the retained interest at fair value. The entity shall recognize
in profit or loss any difference between:

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 ✓ The fair value of any retained interest and any proceeds from disposing of a
part in the associate or joint venture; and
✓ The carrying amount of the investment at the date the equity method was
discontinued
Illustration
An entity purchased 30,000 ordinary shares of the 100,000 outstanding shares of
another entity representing 30% ownership interest several years ago. At yearend,
the investment in associate has a carrying amount of P6,000,000.00.
On the same date, the investor sold 20,000 shares for net proceeds of P5,000,000,
resulting in a loss of significant influence. The quoted market price for such
investment is P260 per share on the date of sale.
Journal entries
1. To record the sale of 20,000 shares
Cash 5,000,000
Investment in associate 4,000,000
Gain on investment 1,000,000
2. To remeasure the retained investment
Investment in associate 600,000
Gain on remeasurement 600,000
Fair Value of shares retained (10,000x260) 2,600,000
Carrying amount 2,000,000
Gain on remeasurement 600,000
3. To reclassify the retained investment as a financial asset at fair value through
profit or loss.
Financial asset – FVPL 2,600,000
Investment in associate 2,600,000
Investment in associates achieved in stages
An investor-owned a 10% interest in an investee on January 1, 2015. The investor
acquired an additional 10% interest in the same investee on January 1, 2016,
enabling the investor to exercise significant influence over the investee.
In 2015, the investment was accounted for under the cost or fair value method.
However, in 2016, the investment must be accounted for under the equity method
because the investee is now an associate.
PFRS 3 provides that in a business combination achieved in stages, the acquirer
shall remeasure the previously held equity interest at fair value and recognize the
resulting gain or loss in profit or loss.
By interpretation, this “fair value approach” should be followed when an associate is
acquired in stages.
Fair Value Approach
• The existing interest in the associate is remeasured at the fair value, with any
change in fair value included in profit or loss.
• However, if the existing interest is accounted for at fair value through other
comprehensive income, any unrealized gain or loss at the date the investee
becomes an associate is reclassified to retained earnings.
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• The fair value of the existing interest plus the cost of the additional interest
acquired constitutes the total cost of the investment for the initial application
of the equity method.
• The total cost of the investment for the initial application of the equity
method minus the carrying amount of the net assets acquired at the date the
significant influence is obtained equals the excess of cost over the carrying
amount or excess net fair value.

Glossary
Associate: an entity over which the investor has significant influence
Consolidated financial statements: the financial statements of a group in which assets,
liabilities, equity, income, expenses, and cash flows of the parent and its subsidiaries are
presented as those of a single economic entity.
Equity method: method of accounting whereby the investment is initially recognized at
cost and adjusted thereafter for the post-acquisition change in the investor's share of the
investee's net assets. The investor's profit or loss includes its share of the investee's profit
or loss, and the investor's other comprehensive income includes its share of the
investee's other comprehensive income.
Joint arrangement: arrangement in which two or more parties have joint control.
Joint control: contractually agreed to share of control of an arrangement, which exists
only when decisions about the relevant activities require the unanimous consent of the
parties sharing control.
Joint venture: a joint arrangement whereby the parties that have joint control of the
arrangement have rights to the net assets of the arrangement.
Joint venturer: party to a joint venture that has joint control of that joint venture.
A significant influence: the power to participate in the financial and operating policy
decisions of the investee but is not control or joint control of those policies.

References and Supplementary Materials

1. Cabrera, M. B., & Ocampo, R. R. (n.d.). Financial Accounting & Reporting - Standards &
Application (2014-2015 ed., Vol. 2). Manila, Philippines.
2. Robles, N. S., & Empleo, P. M. (2014). Intermediate Accounting (2014 ed., Vol. 1).
Manila, Philippines.
3. Valix, C. T., Peralta, J. F., & Valix, C. M. (2017). Financial Accounting (2017 ed., Vol.
2).Manila, Philippines.
4. IAS 28 Investments in Associates and Joint Ventures
5. IAS 36 Impairment of Assets
Online Supplementary Reading Materials
1. Accounting for Investments by Means of the Equity Method;
http://open.lib.umn.edu/financialaccounting/chapter/12-3-accounting-for-
investments-by-means-of-the-equity-method/; October 23, 2017
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2. Investment in an associate; https://www.slideshare.net/cosejo/adv-acc; October 23,
2017
3. Investments in Associates and Joint Ventures;
http://www.assb.gov.sg/docs/attachments/SB-FRS_28-
Investments_in_Associates_and_Joint_Ventures.pdf; October 23, 2017
Online Instructional Videos
1. What are the Differences Between Affiliate, Associate, and Subsidiary Companies?;
http://www.investopedia.com/ask/answers/06/subsidiaries.asp; October 23, 2017
2. Explaining Affiliate, Associate, And Subsidiary;
http://www.investopedia.com/video/play/explaining-affiliate-associate-and-
subsidiary/; October 23, 2017