Chapter 17: Investment

in Associate
Basic Principles
Intercorporate share investment
An intercorporate share investment is the
purchase of the equity shares of one entity to
another entity.
In other words, it is a case of one entity
investing in another entity through the
acquisition of share capital
An entity may purchase enough shares of
another entity in order to exert significant
influence over the financial and operating
policies of the investee entity.
Significant Influence
 The assessment of significant influence is a matter
of judgment.
 Significance 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.
 If the investor holds, directly or indirectly through
subsidiaries 20% or more of the voting power of
the investee, it is presumed that the investor has
significant influence, unless it can be clearly
demonstrated that this is not the case.
Significant Influence
 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.
 A substantial or majority ownership by another investor does not
necessarily preclude an investor from having significant influence.
 Beyond the mere 20% threshold of ownership, PAS 28, paragraph
6, provides that the existence of significant influence is usually
evidenced by the following factors.
◦ A. Representation in the board of directors
◦ B. Participation in policy making process
◦ C. Material transactions between the investor and the investees
◦ D. Interchange of managerial personnel
◦ E. Provision of essential technical information
Potential voting rights
An entity may own share warrants, debt or
equity instruments that are convertible into
ordinary shares that have the potential, if
exercised or converted, to give the entity
additional voting power over the financial
and operating policies of another entity,
PAS 28, paragraph 7, provides that t he
existence of such potential voting rights is
considered in assessing whether an entity has
significant influence.
Potential voting rights
 The potential voting rights should be currently
exercisable or convertible.
 Potential voting rights are not currently exercisable or
convertible when the rights cannot be exercised or
converted until a future date or until the occurrence of
a future event.
 However, when potential voting rights exist, the
investors’ share of 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
 An entity loses significant influence over an investee
when it loses the power to participate in the financial
and operating policy decisions of the investee.
 The loss of significant influence can occur with or
without change in the absolute or relative ownership
interest.
 For example, the loss of significant influence could
occur when an associate becomes subject to control
of a government, court, administrator or regulator.
 The loss of significant influence could also occur as
a result of a contractual agreement.
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
A. The investment is initially recognized at cost.
B. The carrying amount is increased by the
investor’s share of the profit of the investee
and decreased by the investors’ share of the
loss of the investee.
The investor’s share of the profit or loss of the
investee is recognized as investment income.
C. Distributions or dividends received from an
equity investee reduce the carrying amount of
the investment
Accounting procedures
D. Note that the investment must be in ordinary shares.
If the investment is in preference shares, the equity method is not
appropriate regardless of the percentage because the preference
share is a nonvoting equity.
The investment in preference shares may be accounted for as it
fair value through profit or loss at fair value through other
comprehensive income at cost.
E. Technically, 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 be appropriately described as investment in associate.
F. The investment in associate accounted for using the equity
method shall be classified as noncurrent asset.
Illustration – equithy method
1. On january 1, 2019 an investor purchased
20,000 shares of the 100,000 outstanding
ordinary shares of another entity at 200 per
share.
The investment represents a 20% equity interest
and the investor has a significant influence over
the investee. The acquision cost is equal to the
acrrying amount of the net assets acquired.

Investment in associate 4,000,000

Cash 4,000,000
Illustration – equithy method
The investee reported net income of
P5,000,000 for 2019. 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 4,000,000

Investment Income 4,000,000
Illustration – equithy method
Received a 25% share dividend from the investee on
December 31, 2019
.
Memo-Received 5,000 ordinary shares as 25% share
dividend on 20,000 original shares.

Shares now held, 25,000 shares. Note that 20%

equity interest if not affected by the share dividend.
The equity interest is the same before and after the
share dividend.
Illustration – equithy method
The investee reported a net loss of
P1,000,000 for 2020. 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 4,000,000

Investment in associate 4,000,000
Illustration – equithy method
The investee declared and paid a cash dividend of
P2,500,000 on ordinary shares on December 21,
2020. The investor recognized a share in the cash
dividend paid by the investee equal to 20% of
P2,500,000 or P500,000
Cash 4,000,000
Investment in associate 4,000,000

Note that under the equity method, cash

dividend is not an income but a return or
reduction of investment.
Excess of 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.
 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.
◦ A. Undervaluation of the investee’s assets, such as
building, land and inventory
◦ B. Goodwill
Excess of cost over carrying amount
In practice, it is often difficult to determine
which specific indentifiable assets are
undervalued.
If the assets of the investee are fairly valued,
accountants frequently attribute the excess of
cost over carrying amount of the underlying
net assets to goodwill.
If the excess is attributable to undervaluation
of depreciable asset, it is amortized over the
remaining life of the depreciable asset.
Excess of cost over carrying amount
If the excess is attributable to undervaluation
of land, it ibis not amortized because the land
is no depreciable.
The amount is expensed when the land is sold.
If the excess is attributable to inventory, the
amount if expensed when the inventory is
already sold.
If the excess is attributable to goodwill, it s
included in the carrying amount of the
investment and not amortized.
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 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 assets was
P20,000,000. The investor therefore paid P1,000,000 in
excess of the carrying amount of net assets, computed as
follows:
Illustration
Acquision Cost 5,000,000
Carrying amount of net assets acquired
(20% x 20,000,000) 4,000,000
Excess of cost over Carrying amount 1,000,000

The excess is attributable to the following :

Undervaluation of depreciable asset of investee
with remaining life 5 years (20% x P2,000,000) 400,000
Goodwill –remainder 600,000
Excess of cost over carrying amount 1,000,000
Illustration
The journal entry to amortize the “excess of cost” attributable to the
undervaluation of depreciable asset is as follows:

Investment income 80,000

Investment in associate 80,000

When the depreciable and intangible assets of the investee are

undervalued, depreciation and amortization are naturally understated
resulting to overstatement of the investee's net income. Thus, t he
investor should decrease investment income.

The “Excess of cost” attributable to goodwill is not amortized.

The goodwill is included in the carrying amount of the investment in
associate.
Excess of net 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.
 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 the fair value on the
acquisition date.
Illustration
At the beginning of the current, year an investor purchased 40% of
the ordinary shares outstanding of an investee for P15,000,000
when the net assets of the investee amounted to P30,000,000.
At acquisition date, the carrying amount of the identifiable assets
and liabilities of the investee were equal to their fair value, except
for the following.
a. Equipment whose fair value was P7,000,000 greater than
carrying amount
b. Inventory whose fair value was P2,500,000 greater than
carrying amount.
The equipment has remaining life of 4 years and the inventory was
all sold during the current year.
The investee reported net income of P20,000,000 for the current
year and paid P5,000,000 cash dividend at year-end.
Computation
Acquisition cost 15,000,000
Carrying amount of net assets acquired (40% x 30,000)
12,000,000
Excess of cost over carrying amount
3,000,000
Excess attributable to equipment (40% x P7,000,000)
( 2,800,000)
Excess attributable to inventory(40% P2,500,000)
( 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 8,000,000
3. To record the share in cash dividend:
Cash 2,000,000
Investment in associate 2,000,000
4. To record the amortization of the excess attributable to inventory:
Investment income 1,000,000
Investment in associate 1,000,000
Journal Entries
5. To record the amortization of the excess attributable to
inventory:
Investment income 1,000,000
Investment in associate 1,000,000
6. To record the “excess net fair value” as investment
income:
Investment in associate 800,000
Investment income 800,000
Determination of investment income

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

Investee with heavy losses
Pas 28, paragraph 38, provides that if an investor’s share
of losses an associate equals or exceeds the carrying
amount of an investment, the 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 is not
just the balance of the account “investment in
associate”.
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, and
investment in preference shares.
Investee with heavy losses
However, trade receivables and any long-
term receivables for which adequate
collateral exists, such as secured loans are
excluded from the carrying amount of an
investment in associate.
If the associate subsequently reports income,
the investor resumes including its share of
such income after its share of the income
equals the share of losses not recognized.
Illustration
On January 1m 2019 an investor acquired 25% of the ordinary
shares of an associate for P5,000,000.
On this date, the identifiable assets and liabilities of the associate
were measured at fair value and there is no goodwill arising
from the acquisition.
The profits and losses made by the associate over the first 5 years
of operations were:
Profit(loss) Investor’s share
2019 (1,000,000) (250,000)
2020 (10,000,000) (2,500,000)
2021 (12,000,000) (3,000,000)
2022 2,000,000 500,000
2023 2,500,000 625,000
Journal entries
2019
Loss on investment 250,000
Investment in associate 250,000
2020
Loss on investment 2,500,000
Investment in associate 2,500,000
2021
Loss on investment 2,250,000
Investment in associate 2,250,000
Journal entries
Acquisition cost 5,000,000
Loss on investment:
2019 ( 250,000)
2020 (2,500,000)
Carrying amount – January 1, 2021 2,250,000
The investor’s share in the loss of the associate for 2021 is
P3,000,000.
However the loss to be recognized cannot exceed the
carrying amount of the investment of P2,250,000. The
investment is reduced to zero.
Journal entries
2022
No entry

Share in the loss for 2021 (3,000,000)

Loss recognized in 2021 (2,250,000)
Unrecognized loss in 2021 ( 750,000)
Share in profit for 2022 500,000
Remaining unrecognized loss 250,000

If the associate subsequently reports profit, the investor resumes

recognizing its share of profit only after the share of profit equals
the share of losses not previously recognized.
Journal entries
2023
Investment in associate 375,000
Investment income 375,000

Share in profit for 2023 625,000

Remaining unrecognized loss (250,000)
Share in profit to be recognized in 2023 375,000
Impairment loss
If there is an indication that an investment in associate may be
impaired, PAS 28, paragraph 40, requires that an impairment
loss shall be recognized whenever the carrying amount of
the investment in associate exceeds recoverable amount.
The recoverable amount is measured as the higher between
fair value less cost of disposal and value in use.
Fair value is the price that would be received to sell an asset is
an orderly transaction between market participants at the
measurement date.
Value in use is the present value of the estimated future cash
flows expected to arise from the continuing use of an asset
and from its ultimate disposal.
Impairment loss
The value in use of an investment in associate is the
investor’s share in either of the following.
a. Present value of estimated future cash flow
expected to be generated by the investee, including
cash flows from operations of the investee and the
proceeds of the ultimate disposal of the investment.
b. Present value of the estimated future cash flows
expected to arise from dividends to be received
from the investment and from its ultimate disposal.
Under appropriate assumptions, both methods give
the same result.
Impairment loss
PAS 28, paragraph 42, states that since goodwill is
not separately recognized from the investment
amount, the impairment loss recognized is applied
to the investment as a whole.
The recoverable amount of an investment in
associate is assessed for each individual associate.
An exception is when 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 preference shares
When an associate has outstanding cumulative
preference shares, the investor shall compute
its share of earnings or losses after deducting
the preference dividends, whether or not
such dividends are declared.
When an associate has outstanding
noncumulative preference shares, the
investor shall compute its share of earnings
after deducting the preference dividends
when declared.
Investee with preference shares
For example, an investee reported the
following capital accounts at the
beginning of current year:
Preference share capital, 12% cumulative, P100
par, 50,000 shares issued 5,000,000
Ordinary share capital, P50 par, 500,000 shares
authorized and 200,000 shares issued 10,000,000
Retained earnings 5,000,000
Investee with preference shares
On the same date, an investor acquired
40,000 ordinary shares of the investee
representing a 20% interest for
P3,000,000. The net assets of the investee
are fairly valued.
The investee reported net income of P2,000,000 for the
current year and paid cash dividends of P500,000 to
ordinary shareholders and the preference dividends at
the preference rate.
Journal entries for current year
1.To record the investment:
Investment in associate 3,000,000
Cash 3,000,000
2.To record the share in net income:
Investment in associate 280,000
Investment income 280,000
Net Income 2,000,000
Preference dividend (12% x 5M) ( 600,000)
Net income to ordinary shares 1,400,000

Share in net income (20% x 1.4M) 280,000

3. To Record the share in cash dividend
Cash (20% x 500,000) 100,000
Investment in associate 100,000
Other changes in equity
Adjustments to the carrying amount of the investment in
associate may be necessary for changes in the
investor’s proportionate interest in the investee arising
from changes in the investee’s equity that have been
recognized in the investee’s profit or loss.
Such changes include those arising from revaluation of
property, plant and equipment and from foreign
exchange translation differences.
The investor’s share of those changes is recognized
directly in equity of the investor.
Illustration
The investment in associate is 20% as a consequence of
which the investor has significant infleunce over the
investee.
The investee reported the following for the current year:
Net income 6,000,000
Dividend paid 2,000,000
Revaluation surplus 3,000,000
Journal entries for the current year
1.Share in net income:
Investment in associate 1,200,000
Investment income 1,200,000
2. Share in dividend paid:
Cash 400,000
Investment in associate 400,000
3. Share in revaluation surplus
Investment in associate ` 600,000
Revaluation surplus-investee 600,000