[Conceptual Framework and Accounting Standards] 1

[Investment in Associates & Impairment Asset]

Module 15: Investment in Associates

& Impairment of Asset
Course Learning Outcomes:
1. Overview of Investment in Associates
2. Factors that indicates Significant Influence
3. Equity Method in Accounting for Share Investment
4. Overview of Impairment Assets
5. Recognition and Measurement of Impairment Assets

Associates
Associates is simply defined as 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. The
assessment of significant influence is a matter of judgement.

However, PAS 28, paragraph 5, provides a practical guidance to assist management in

making such assessment.

Where an entity holds 20% or more of the voting power (directly or through subsidiaries)
on an investee, it will be presumed the investor has significant influence unless it can be
clearly demonstrated that this is not the case.

If the holding is less than 20%, the entity will be presumed not to have significant
influence unless such influence can be clearly demonstrated. A substantial or majority
ownership by another investor does not necessarily preclude an entity from having
significant influence.

The existence of significant influence by an entity is usually evidenced in one or more of the
following ways:

 Representation on the board of directors or equivalent governing body of the

investee
 Participation in the policy-making process, including participation in decisions about
dividends or other distributions
 Material transactions between the entity and the investee
 Interchange of managerial personnel
 Provision of essential technical information

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[Investment in Associates & Impairment Asset]

MEASUREMENT OF INVESTMENT IN ASSOCIATES

The investment in associated is measure using the equity method. The equity method is
based on the economic relationship between the investor and the investee. The investor
and the investee are viewed as a single economic unit. The investor and the investee are
one and the same. The equity method is applicable when the investor has a significance
influence over the investee.

ACCOUNTING PROCEDURES-EQUITY METHOD

 The investment is initially recognized at cost

 The carrying amount is increased by the investor’s share of the profit of the investee
and decreased by the investor’s shares of the loss of the investee. The investor’s
share of the profit or loss of the investee is recognized as investment income.
 Dividends received from an equity investee reduce the carrying amount of the
investment.
 Note that the investment must be in ordinary shares. If the investment is
preference shares , the equity method is not appropriate regardless of the
percentage because the preference share is a nonvoting equity.
 Technically, if the investor has significant influence over the investee, the investee
said to be an associate. Accordingly under the equity method, the investment in
ordinary shares should be appropriately describe as investment in associate.
 The investment in associate accounted for using the equity method shall be reported
as noncurrent asset.

EXCESS COST OVER CARRYING AMOUNT

An accounting problem arises if the investor pays more or less for an investment than the
carrying amount of underlying net assets. For example, if the earning potential of the
investee is abnormally high, the current value of the investee’s net assets is frequently
higher than their 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

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[Investment in Associates & Impairment Asset]

If the assets is attributable to undervaluation of depreciable asset, it is amortized over the

remaining life of the depreciable asset. If the excess is attributable to undervaluation of
land, it is not amortized because the land is nondepreciable. The amount is expense when
the land is sold.
If the excess is attributable to inventory, the amount is expense 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, the entire investment in associate including
goodwill is tested for impairment at the end of each accounting period.

EXCESS OF FAIR VALUE OVER COST

PAS 28, paragraph 32, 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 the investment is acquired.

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

DISCONTINUANCE OF EQUITY METHOD

PAS 28, paragraph 22, provides that an investor shall discontinue the use of the equity
method from the date that is ceases to have significant influence over an associate.
Consequently, the investor shall account for the investment as follows:

 Financial asset at fair value through profit and loss.

 Financial asset at fair value through comprehensive income.
 Nonmarkeble investment at cost or investment in unquoted equity instrument.

PAS 28, Basis for Conclusion 18, requires an investor that continue to have significant
influence over an associate to apply the equity method even if the associate is operating
under severe long-term restrictions that significantly impair the ability to transfer funds to

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[Investment in Associates & Impairment Asset]

the investors. Significant influence must be lost before the equity method ceases to be
applicable.

MEASUREMENT AFTER LOSS OF SIGNIFICANT INFLUENCE

PAS 28, paragraph 22, provides that on the date the significant influence is lost, the
investor shall measure any retained investment in associate at fair value. The fair value of
the investment at the date it ceases to be an associate shall be regarded as the fair value on
initial recognition as a financial asset.

The difference between the carrying amount of the retained investment at the date the
significant influence is lost and the fair value of the retained investment shall be included on
profit or loss.

Of course, the difference between the net proceeds from disposal of part of the investment
and the carrying amount of the investment sold is recognize as gain or loss on disposal of
investment.

EQUITY METHOD NOT APPLICABLE

PAS 28, paragraph 17, provides that an investment in associate shall not be accounted for
using the equity method if the investor is a parent that is exempt from preparing
consolidated financial statements or if all the following apply:

 The investor is a wholly-owned subsidiary, or partially-owned subsidiary of another

entity and the other owners do not object to the investor not applying the equity
method.
 The investor debt and equity instruments are not traded in a public market or over
the counter market.
 The investor did not file or it is not the process of filing financial statement with the
SEC for the purpose of issuing any class of instruments in a public market.
 The ultimate or any intermediate parent of the investor produces consolidated
financial statements available for public use that comply with Philippine Financial
Reporting Standard.

In these circumstances, the investment is accounted for as follows:

 Financial asset at fair value through profit and loss.
 Financial asset at fair value through comprehensive income.
 Nonmarkeble investment at cost or investment in unquoted equity instrument.

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[Investment in Associates & Impairment Asset]

Illustration - equity method

 On January 1, 2020, an investor purchased 20,000 shares of the 100,000 outstanding

ordinary shares if another entity at P200 per share. The investment represent a 20%
equity interest and the investor has a significant influence over the investee.

Investment in associate 4,000,000

Cash 4,000,000

 The investee reported net income of P5,000,000 for 2020. The investor recognized a
share of the net income of the investee equal to 20% of P5,000,000 or P1,000,000.

Investment in associate 1,000,000

Investment income 1,000,000

 Received a 25% share divided from the investee on December 31, 2020.6.24

Memo - Received 5,000 ordinary shares as 25% share dividend on 20,000 original
shares. Shares now held, 25,000 shares.

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

 The investee reported a net loss of P1,000,000 for 2021. 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

 The investee declared and paid a cash dividend of P2,500,000 on ordinary shares on
December 21, 2021. The investor recognized a share in the cash dividend paid by the
investee equal to 20% of P2,500,000 or P500,000.

Cash 500,000
Investment in associate 500,000

Under equity method, cash dividend is not an income but reduction of

investment.

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[Investment in Associates & Impairment Asset]

Impairment of Assets
Impairment is a fall in the market value of an asset that the recoverable amount is now
less than the carrying amount in the statement of financial position.

The carrying amount is the amount at which an asset is recognized in the statement of
financial position after deducting accumulated depreciation and accumulated impairment
loss.

CORE PRINCIPLE OF IMPAIREMENT

The basic principle underlying impairment of asset is relatively straightforward. There us

an established principle that an asset shall not be carried at above the recoverable amount.
An entity shall write down the carrying amount of an asset to the recoverable amount if the
carrying amount is not recoverable in full.

If the carrying amount is higher than the recoverable amount, the asset is judged to have
suffered an impairment loss. The asset shall therefore be reduced by the amount of the
impairment.

ACCOUNTING FOR IMPAIREMENT

In this regard, there are three main accounting issues to consider, namely:

 Indication of possible impairment

 Measurement of the recoverable amount
 Recognition of impairment loss

INDICATION OF IMPAIREMENT

An entity shall assess at each reporting date whether there is any indication that an asset
may be impaired. If any such indication exists, the entity shall estimate the recoverable
amount of the asset. However, irrespective of whether there is any indication of
impairment, an entity shall test an intangible asset with an indefinite useful life or an
intangible asset not yer available for use for impairment annually by comparing the
carrying amount with the recoverable amount.

The events and changes in circumstances that lead to an impairment of asset may be
classified as external and internal source of information.

EXTERNAL SOURCES

 There are observable indications that the asset’s market value has increased significantly
during the period.

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 Significant changes with a favourable effect on the entity have taken place during the
period, or will take place in the near future, in the technological, market, economic or
legal environment in which the entity operates or in the market to which the asset is
dedicated.

 Market interest rates or other market rates of return on investments have decreased
during the period, and those decreases are likely to affect the discount rate used in
calculating the asset’s value in use and increase the asset’s recoverable amount
materially.

INTERNAL SOURCES

 Significant changes with a favourable effect on the entity have taken place during the
period, or are expected to take place in the near future, in the extent to which, or manner
in which, the asset is used or is expected to be used. These changes include costs
incurred during the period to improve or enhance the asset’s performance or restructure
the operation to which the asset belongs.

 Evidence is available from internal reporting that indicates that the economic
performance of the asset is, or will be, better than expected.

 Evidence of obsolescence or physical damage an asset.

MEASUREMENT OF RECOVERABLE AMOUNT

After establishing evidence than an asset has been impaired, the next step is to determine
the recoverable amount preparatory to the recognition of an impairment loss. The
recoverable amount of an asset is the fair value less cost of disposal or value in use,
whichever is higher.

FAIR VALUE LESS COST OF DISPOSAL

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.

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.

Example of cost disposal include legal cost, stamp duty and similar transaction tax, cost of
removing the asset, and direct cost in bringing the asset into condition for sale.

VALUE IN USE: Value in use is the present value or discounted value of the future cash
flows expected to be derived from an asset or cash-generating unit. The cash flows and
pretax discount rate is applied in determining present value.

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CALCULATION OF VALUE IN USE

Calculating a value in use calls for estimates of future cash flows and there is the possibility
that an entity might come up with “overoptimistic” estimate of cash flows.

 Cash flow projection shall be based on reasonable and supportable assumption.

 Cash flow projection shall be based on the most recent budget on financial forecast,
usually up to a maximum period of 5 years, unless a longer period can be justified,
 The discount rate used in estimating future cash flow is the current pretax rate.

COMPOSITION OF FUTURE CASH FLOW

Estimates of future cash flows shall include:

 Projections of cash inflows from the continuing use of the asset
 Projections of cash outflows that are necessarily incurred to generate the cash
inflows from continuing use of the asset (including cash outflows to prepare the
asset for use) and can be directly attributed, or allocated on a reasonable and
consistent basis, to the asset
 Net cash flows, if any, to be received (or paid) for the disposal of the asset at the end
of its useful life

Estimates of future cash flows do not include:

 Cash inflows from assets that generate cash inflows that are largely independent of
the cash inflows from the asset under review (for example, financial assets such as
receivables)
 Cash outflows that relate to obligations that have been recognized as liabilities (for
example, payables, pensions or provisions)

RECOGNITION OF IMPAIRMENT LOSS

If the recoverable amount of an asset is less that the carrying amount, an impairment loss
has been occurred. The impairment loss shall be recognize immediately by reducing the
assets carrying amount to its recoverable value. The impairment loss is recognized in profit
or loss and presented separately in the income statement.

REVERSAL OF AN IMPAIRMENT LOSS

PAS 36, paragraph 114, an impairment loss recognized in prior periods for an asset other
than goodwill shall be reversed if, and only if, there has been a change in the estimates used
to determine the asset’s recoverable amount since the last impairment loss was recognized.

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[Investment in Associates & Impairment Asset]

In other words, if the recoverable amount of an asset that has previously been impaired
turns out to be higher than the current amount, the carrying amount of the asset shall be
increased to new recoverable amount.

PAS 36, paragraph 117, The increased carrying amount of an asset other than goodwill
attributable to a reversal of an impairment loss shall not exceed the carrying amount that
would have been determined (net of amortization or depreciation) had no impairment loss
been recognized for the asset in prior years.

The reversal of the impairment loss shall be recognized immediately in the income
statement as gain on reversal impairment loss.

But any reversal of an impairment loss on a revalued asset shall be credited to income to
the extend that it reverses a previous revaluation decrease and any excess credited directly
to revaluation surplus.

CASH GENERATING UNIT

A cash-generating unit is the smallest identifiable group of assets that generates cash
inflows that are largely independent of the cash inflows from other assets or groups of
assets.

Simply stated, a cash generating unit is segment of business that generates revenue and
cash inflows independently. In a practice, a cash generating unit may be a department, a
product line or a segment of business.

As a basic rule, the recoverable amount of an asset shall be determined for the asset
individually. However, if it is not possible to estimate the recoverable amount of the
individual asset, an entity shall determine the recoverable amount of the cash
generating unit tow which the asset belong.

CASH GENERATING UNIT WITH GOODWILL

Goodwill does not generate cash flows independently form other assets or group assets,
and therefore, the recoverable amount of goodwill as an individual asset cannot be
determined. As a consequence as an indication that good will may be impaired, recoverable
amount is determined for the cash generating unit to which goodwill belongs.

DETERMINATION OF IMPAIRMENT

PAS 36, paragraph 90, a cash-generating unit to which goodwill has been allocated shall be
tested for impairment annually, and whenever there is an indication that the unit may be
impaired, by comparing the carrying amount of the unit, including the goodwill, with the
recoverable amount of the unit.

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 If the recoverable amount of the unit exceeds the carrying amount of the unit, the
unit and the goodwill allocated to that unit shall be regarded as not impaired.
 If the carrying amount of the unit exceeds the recoverable amount of the unit, the
entity shall recognize the impairment loss

PAS 36, paragraph 90, provides that the carrying amount of an asset shall not be reduced
below the highest of fair value less cost of disposal, value is use and zero.

The amount of the impairment loss that would otherwise have been allocated to the asset
shall be allocated pro rata to the other assets of the unit (group of units).

REVERSAL OF AN IMPAIRMENT LOSS ON GOODWILL

PAS 36, paragraph 124, explicitly provides that an impaired loss recognized goodwill shall
not be reversed in a subsequent period.

Illustration - Cash Generating Unit

An entity has determined that a cash generating unit is impaired. The assets of the cash
generating unit at carrying amount are:

Building 2,400,000
Land 1,800,000
Equipment 1,500,000
Inventory 300,000
Carrying amount of CG 6,000,000

Most often the recoverable amount of a cash generating unit is equal to the value in use
because is not to be disposed. The entity calculated the value in use of the cash generating
unit to be P4,500,000

COMPUTATION OF IMPAIRMENT LOSS

Carrying amount of CGU 6,000,000

Value in use (4,500,000)
Impairment loss 1,500,000

PAS 36, paragraph 104, provides that when an impairment loss is recognized for a cash
generating unit, this loss shall be allocated to the assets of the unit in the following order:

a. First, to the goodwill, if any

b. Then, to all other noncash assets of the unit prorata based on their carrying amount.

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[Investment in Associates & Impairment Asset]

Since there is no goodwill, the impairment loss is allocated across the assets based on
carrying amount.

Carrying Amount Fraction Loss

Building 2,400,000 24/60 600,000
Land 1,800,000 18/60 450,000
Equipment 1,500,000 15/60 375,000
Inventory 300,000 3/60 75,000
6,000,000 1,500,000

JOURNAL ENTRY TO RECORD THE IMPAIREMENT LOSS

Impairment loss 1,500,000

Accumulated depreciation - building 600,000
Land 450,000
Accumulated depreciation - equipment 375,000
Inventory 75,000

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[Investment in Associates & Impairment Asset]

References and Supplementary Materials

Books and Journals

1. Mr. Conrado T. Valix, Mr. ; 2015 Edition; 2015 Edition Financial Accounting Volume 1;
C.M. Recto Avenue Manila; GIC ENTERPRISES AND CO., INC
2. Mr. Conrado T. Valix, Jose F. Peralta, Christian Aris Valix. ; 2020 Edition; Conceptual
Framework and Accounting Standards ; C.M. Recto Avenue Manila; GIC ENTERPRISES
AND CO., INC

Online Supplementary Reading Materials

1. Investment in Associates; Conceptual Framework for Financial Reporting;

https://core.ac.uk/reader/213938318; June 24, 2020
2. Investment in Associate;https://studylib.net/doc/25254296/chapter-24-
investment-in-associate; June 24, 2020
3. Investment in Associate; https://www.ifrs.org/issued-standards/list-of-
standards/ias-28-investments-in-associates-and-joint-ventures/; June 24, 2020
4. IAS 36 Impairment of Assets; https://www.ifrs.org/issued-standards/list-of-
standards/ias-36-impairment-of-assets/; June 24, 2020
5. IAS 36 Impairment of Assets;https://www.cpaaustralia.com.au/-
/media/corporate/allfiles/document/professional-resources/reporting/reporting-
ifrsfactsheet-impairment-of-
assets.pdf?la=en&rev=5f6fcf4245884210bdcab9d3f9362896;June 24, 2020
6. IAS 36 Impairment of Assets; https://www.studeersnel.nl/nl/document/erasmus-
universiteit rotterdam/international-financial-reporting/samenvattingen/chapter-
15-ias-36-imImpairment of Assetspairment-of-assets/2822152/view; June 24, 2020
7. Impairment of Assets;
http://app1.hkicpa.org.hk/ebook/HKSA_Members_Handbook_Master/volumeII/hka
s36.pdf; June 25, 2020

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