Investments in associates and equity method

Associate

Entity which investor has a significant influence on but doesn’t control

20-50% of shares or demonstrated that it can affect policies through representation on board, policy impact, material transactions, interchange of personnel, provision of technical info

Investments in associates per IAS 28

Use equity method - recognize at cost then adjust for change in investor’s share of investee net assets (Investee NI and dividends)

Dr. Investment in associate / Cr. Cash

Investments in associates ASPE 3051

Choice of cost or equity method

If shares are trading on exchange only use equity or fair value

Equity method subsequent measurement

Add: proportion of Equity income and Less: proportion Dividends declared

1. + Dr. Invesment / Cr. Equity income

2. - Dr. Cash / Cr. Investment

Acquisition differential (AD)

Entity usually pays higher amount than the proportionate share of the BV of the associate’s net assets

Arises from FV differentials (If FV > BV, pay more) and goodwill (expected value of future performance)

AD Schedule

Acquisition price

Less: BV of investee’s Net Assets * ownership percentage

Equals: AD

± FV differentials (calculate as percentage * BV-FV)

Equals: Goodwill (or bargain purchase)

• Consider that goodwill does not get a journal entry - only acquisition price is recorded initially

Bargain purchase

Negative goodwill - price paid is below FV of share of investees net assets

Same AD calc must be done before recognizing as bargain purchase

Record a gain on purchase:

• Dr. Investment / Cr. Cash Cr. Gain

Amortization of FV differentials

Investment is based on BV and must be adjusted to FV at reporting time

Assume inventory is sold in the year following acquisition

Record adjustment in equity income (if FV > BC, FV differential will be a negative on the schedule and is deducted from investee net income for equity income)

Intercompany Transactions (IC)

When goods are sold up/down stream and are not sold to a 3rd party, the earnings process is incomplete - unrealized profit or loss that must be eliminated from income

Unrealized profit: Sales ending inventory X gross profit X investor %

• unrealized is deducted, realized is added

Unrealized inventory is sold in the next year

Change in ownership of associate

Change investment by same proportion as change

original - new / original

Dr. Cash (Dr. loss )/ Cr. Investment change (Cr. Gain)

Impairment of investment in associate

Asset must be written down to impaired value - loss goes into profit/loss

Test on associate book value of assets

Entire impairment recognized regardless of share of assets