IAS 28 and IAS 31: Comprehensive Guide to Accounting for Investments in Associates and Joint Ventures

Overview and Fundamental Definitions under IAS 28

• Definition of an Associate:

  • An associate is an entity, including an unincorporated entity such as a partnership, over which an investor has significant influence and that is neither a subsidiary nor an interest in a joint venture.

• Nature of Control vs. Significant Influence:

  • Exclusive Control: Only one entity can control another entity at a specific point in time.

  • Concurrent Significant Influence: More than one entity can possess significant influence over the same entity simultaneously.

  • Impact of Majority Shareholding: Substantial or majority ownership by another external investor does not preclude an investor from exercising significant influence.

• Definition and Concept of Significant Influence:

  • Core Definition: 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.

  • Interpretation of Power: Power refers to the baseline ability to do or effect something. Consequently, an entity possesses significant influence whenever it currently has the legal or practical ability to exercise that power, regardless of whether that significant influence is actively demonstrated or remains passive in nature.

Ownership Thresholds and Indicators of Significant Influence

• Voting Power Presumptions [IAS 28(2011).5]:

  • Presumption of Influence ($\ge 20\%$): Where an entity holds $20\%$ or more of the voting power (directly or indirectly through subsidiaries) of an investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated otherwise.

  • Presumption of Non-Influence ($< 20\%$): Where an entity holds less than $20\%$ of the voting power, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated.

  • Presence of Majority Owner: A substantial or majority ownership held by another investor does not automatically prevent an entity from having significant influence.

• Evidence of Significant Influence [IAS 28(2011).6]:

  • The existence of significant influence 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 policy-making processes, including decisions regarding dividends or other distributions.

    • Material transactions occurring between the entity and the investee.

    • Interchange of managerial personnel.

    • Provision of essential technical information.

Principles and Application of Equity Accounting

• Basic Principle [IAS 28(2011).10]:

  • Under the equity method of accounting, the investment in an associate or joint venture is recognized initially at cost.

  • Subsequent to initial recognition, the carrying amount is increased or decreased to recognize the investor's share of the post-acquisition profit or loss of the investee.

• Income Statement and Carrying Amount Adjustments:

  • Profit or Loss Recognition: The investor's share of the investee's profit or loss is recognized directly in the investor's profit or loss statement.

  • Distributions: Dividends or distributions received from an investee reduce the carrying amount of the investment.

  • Equity Adjustments: Adjustments to the carrying amount may be required for changes arising from revaluations of property, plant, and equipment, or other changes in the investor's proportionate interest in the investee.

• Scope and Exclusions (Application of IAS 28):

  • IAS 28 applies to all accounting for investments in associates.

  • Exemption for Specific Entities: The standard does not apply to investments in associates held by venture capital organizations, mutual funds, unit trusts, and similar entities (including investment-linked insurance funds) where those investments upon initial recognition are designated at Fair Value Through Profit or Loss (FVTPL) or classified as held for trading in accordance with IAS 39.

Exceptions to the Equity Method

• An investment in an associate must be accounted for using the equity method except under the following three specific circumstances:

  • Held for Sale: The investment is classified as held for sale in accordance with IFRS 5.

  • Parent Exemption: A parent is exempt from presenting consolidated financial statements under the provisions of IAS 27.

  • All Four Criteria Met: The investor is exempt from applying the equity method if all of the following conditions apply:

    • The investor is a wholly owned subsidiary, or is a partially owned subsidiary of another entity and its owners (including those not otherwise entitled to vote) have been informed about and do not object to the investor not applying the equity method.

    • The investor's debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market).

    • The investor did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory body for the purpose of issuing any class of financial 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 International Financial Reporting Standards (IFRS).

Impairment Losses and Accounting in Separate Financial Statements

• Impairment Indicators and Testing:

  • Impairment indicators set forth in IAS 39 apply to investments in associates.

  • Goodwill Treatment: Because goodwill is included within the carrying amount of the investment in an associate and is not separately recognized, it cannot be tested for impairment separately under IAS 36.

  • Total Investment Test: The entire carrying amount of the investment is tested for impairment as a single asset under IAS 36 by comparing its recoverable amount with its carrying amount.

  • Individual Assessment: Each associate must be assessed individually regarding recoverable amount, unless the associate does not generate cash inflows that are largely independent.

• Separate Financial Statements:

  • An investment in an associate is accounted for in the investor's separate financial statements in accordance with IAS 27.

Mandatory Disclosure Requirements under IAS 28 / BAS 28

• Specific Disclosures Required:

  • Fair value of investments in associates for which there are published price quotations.

  • Summarized financial information of associates, including aggregated amounts of assets, liabilities, revenues, and profit or loss.

  • Explicit reasons why investments of less than $20\%$ are accounted for using the equity method, or why investments of $20\%$ or more are not accounted for using the equity method.

  • The reporting date of the financial statements of an associate when it differs from that of the investor, alongside the reasons for the difference.

  • The nature and extent of any significant restrictions on the ability of associates to transfer funds to the investor in the form of cash dividends, or repayments of loans or advances.

  • Unrecognized share of losses of an associate, both for the period and cumulatively, if an investor has discontinued recognition of its share of losses.

  • Reasons why an associate is not accounted for using the equity method.

  • Summarized financial information of associates (either individually or in groups) that are not accounted for using the equity method, including total assets, total liabilities, revenues, and profit or loss.

  • Classification of equity method investments as non-current assets.

  • Separate disclosure of the investor's share of profit or loss of equity method investments, as well as the carrying amount of those investments.

  • Separate disclosure of the investor's share of any discontinued operations of associates.

  • The investor's share of changes recognized directly in the associate's equity, which must be recognized directly in equity by the investor and disclosed in the statement of changes in equity as required by IAS 1 (Presentation of Financial Statements).

Case Scenarios: Assessment of Significant Influence

• Direct Shareholding Scenario:

  • Fact Pattern: Entity A owns $25\%$ of the ordinary shares carrying voting rights at a general meeting of shareholders of Entity B. Entity A neither controls nor jointly controls Entity B.

  • Assessment: In the absence of evidence to the contrary, Entity A is presumed to have significant influence over Entity B (making Entity B an associate of Entity A).

  • Role of Judgment: The determination is not automatic; judgment is required. If evidence shows Entity A lacks significant influence despite holding $25\%$ voting power, the investment is accounted for as an equity instrument under Section 11 (Basic Financial Instruments).

• Indirect Shareholding Scenario:

  • Fact Pattern: Entity A owns $100\%$ of the ordinary shares of Entity B. Entity B owns $25\%$ of the ordinary shares carrying voting rights of Entity C. The Entity A group neither controls nor jointly controls Entity C.

  • Assessment: In the absence of evidence to the contrary, Entity A is presumed to have significant influence over Entity C through its subsidiary Entity B.

  • Role of Judgment: Judgment is required. If Entity A does not possess significant influence, the investment in Entity C is accounted for as an equity instrument under Section 11 (Basic Financial Instruments).

• Complex Group Ownership Structure Scenario:

  • Fact Pattern: Entities A and B own $30\%$ and $10\%$ respectively of the ordinary shares carrying voting rights of Entity C. Entity B owns $70\%$ of the voting ordinary shares of Entity A (making Entity A a subsidiary of Entity B). Entities A and B neither control nor jointly control Entity C.

  • Assessment for Entity A: Entity A directly holds $30\%$ of voting power in Entity C. Presumed to have significant influence over Entity C ($> 20\%$ voting power); Entity C is an associate of Entity A.

  • Assessment for Entity B: Entity B holds $40\%$ total voting power in Entity C ($10\%$ directly plus $30\%$ indirectly through control of Entity A). Presumed to have significant influence over Entity C; Entity C is an associate of Entity B.

Step-by-Step Numerical Examples: Equity Method Accounting

• Numerical Example 1: Accounting for Share of Losses and Subsequent Recovery

  • Initial Acquisition: On 1 January 20X1, Entity A acquires $25\%$ of ordinary voting shares of Entity B for $\text{CU}\,100{,}000$. Purchase price equals $25\%$ of fair value of identifiable net assets.

  • 20X1 Operations: Entity B recognizes a net loss of $\text{CU}\,600{,}000$ for the year ended 31 December 20X1. Entity A has no legal or constructive obligation and has made no payments on behalf of Entity B.

    • Calculation of Share of Loss:             $25\% \times \text{CU}\,600{,}000 = \text{CU}\,150{,}000$

    • Loss Recognition Limit: Entity A limits loss recognition to its initial carrying amount of $\text{CU}\,100{,}000$.

    • Unrecognized Loss:             $\text{CU}\,150{,}000 - \text{CU}\,100{,}000 = \text{CU}\,50{,}000$

    • Carrying Amount at 31 December 20X1:             $\text{CU}\,100{,}000 - \text{CU}\,100{,}000 = \text{CU}\,0$

  • 20X2 Operations: Entity B recognizes a net profit of $\text{CU}\,800{,}000$ for the year ended 31 December 20X2. There is no published price quotation for Entity B.

    • Calculation of Share of Profit:             $25\% \times \text{CU}\,800{,}000 = \text{CU}\,200{,}000$

    • Profit Recognized in P&L: Net share of profit after recovering unrecognized 20X1 loss:             $\text{CU}\,200{,}000 - \text{CU}\,50{,}000 = \text{CU}\,150{,}000$

    • Carrying Amount at 31 December 20X2:             $\text{CU}\,100{,}000 - \text{CU}\,100{,}000 + \text{CU}\,150{,}000 = \text{CU}\,150{,}000$

• Numerical Example 2: Dividends and Impairment Evaluation

  • Initial Acquisition: On 1 January 20X1, Entity A acquires $30\%$ of ordinary voting shares of Entity B for $\text{CU}\,300{,}000$.

  • 20X1 Operations: Entity B earns a net profit of $\text{CU}\,400{,}000$ for the year ended 31 December 20X1.

  • 20X1 Dividend: On 30 December 20X1, Entity B declares and pays a dividend of $\text{CU}\,150{,}000$ for 20X1.

  • Fair Value: Fair value at 31 December 20X1 is $\text{CU}\,425{,}000$ (no published price quote).

  • Accounting Treatment:

    • Income Recognition:             $30\% \times \text{CU}\,400{,}000 = \text{CU}\,120{,}000$

    • Dividend Reduction:             $30\% \times \text{CU}\,150{,}000 = \text{CU}\,45{,}000$

    • Carrying Amount at 31 December 20X1:             $\text{CU}\,300{,}000 + \text{CU}\,120{,}000 - \text{CU}\,45{,}000 = \text{CU}\,375{,}000$

    • Impairment Evaluation: Fair value less costs to sell ($\text{CU}\,425{,}000$) exceeds carrying amount ($\text{CU}\,375{,}000$); therefore, no impairment loss is recorded under Section 27.

• Numerical Example 3: Pre-Acquisition Dividends as Impairment Indicators

  • Fact Pattern: Same facts as Example 2, except on 2 January 20X1, Entity B declared a dividend of $\text{CU}\,100{,}000$ for the year 20X0 (pre-acquisition). Fair value at 31 December 20X1 is $\text{CU}\,400{,}000$

  • Accounting Treatment:

    • Income Recognition:             $30\% \times \text{CU}\,400{,}000 = \text{CU}\,120{,}000$

    • Pre-Acquisition Dividend Reduction:             $30\% \times \text{CU}\,100{,}000 = \text{CU}\,30{,}000$

    • Current Year Dividend Reduction:             $30\% \times \text{CU}\,150{,}000 = \text{CU}\,45{,}000$

    • Carrying Amount at 31 December 20X1:             $\text{CU}\,300{,}000 + \text{CU}\,120{,}000 - \text{CU}\,30{,}000 - \text{CU}\,45{,}000 = \text{CU}\,345{,}000$

    • Impairment Evaluation: The payment of a pre-acquisition dividend on 2 January 20X1 serves as an impairment indicator triggering an impairment test under Section 27. Because fair value less costs to sell ($\text{CU}\,400{,}000$) exceeds carrying amount ($\text{CU}\,345{,}000$), no impairment loss is recognized.

Accounting for Investments in Joint Ventures (IAS 31)

• Key Definitions:

  • Joint Venture: A contractual agreement between two or more parties that undertake an economic activity subject to joint control.

  • Joint Control: The contractually agreed sharing of control over an economic activity, which exists only when strategic financial and operating decisions relating to the activity require unanimous consent of the parties sharing control.

  • Control: The power to govern the financial and operating policies of an activity so as to obtain benefits from it.

  • Venturer: A party to a joint venture who has joint control over that joint venture.

  • Investor in a Joint Venture: A party to a joint venture who does not have joint control over that venture.

• The Contractual Arrangement:

  • Mandatory Requirement: A contractual arrangement establishing joint control is essential. Without a contractual agreement, investments are not classified as joint ventures under IAS 31.

  • Forms of Agreement: Can be established via written contract, minuted discussions between venturers, or built into the articles of association of the entity.

  • Content: Typically written, outlining activity scope, board appointment processes, capital contributions, and sharing arrangements for profits and losses.

  • Core Rule: No single venturer should be in a position to unilaterally control the activities.

The Three Forms of Joint Ventures

• 1. Jointly Controlled Operations:

  • Structure: No separate corporation, partnership, or financial entity is established.

  • Operational Mechanism: Each venturer uses its own property, plant, and equipment, carries its own inventory, incurs its own liabilities and expenses, and raises its own financing.

  • Agreement Focus: Sets details regarding allocation of joint revenues and shared costs.

  • Example: Two entities collaborate to develop and manufacture a high-speed train, where one entity manufactures the engine and the other manufactures the carriages. Each bears its own costs and receives an agreed percentage of joint sales revenue.

  • Accounting Treatment: Each venturer recognizes directly in its financial statements:

    • The assets it controls and liabilities it incurs.

    • The expenses it incurs and its agreed share of income from sales of goods or services.

    • No consolidation procedures or adjustments are required.

• 2. Jointly Controlled Assets:

  • Structure: Venturers jointly control and often jointly own assets dedicated to the venture. No separate entity is established.

  • Operational Mechanism: Each venturer receives a share of output generated by the asset and bears an agreed share of operating expenses.

  • Example: Oil companies jointly owning and operating an oil transportation pipeline. Each company uses the pipeline to transport its oil and pays an agreed share of maintenance costs.

  • Accounting Treatment: Each venturer recognizes in its financial statements:

    • Its share of jointly controlled assets, classified according to asset nature.

    • Liabilities incurred directly and its share of joint liabilities.

    • Income from the sale or use of its share of output, along with its share of joint expenses and direct expenses.

    • Separate financial statements are generally not prepared for the joint venture, though expense records are maintained.

• 3. Jointly Controlled Entities:

  • Structure: Involves the establishment of a separate corporation, partnership, or legal entity in which each venturer holds an ownership interest.

  • Operational Mechanism: Operates like other entities, but a contractual agreement enforces joint control over economic activity.

  • Example: A commercial entity forming a joint venture with a foreign government to establish a separate local manufacturing enterprise.

  • Accounting Records: The separate entity maintains its own accounting records and prepares standalone financial statements.

  • Permitted Accounting Treatments under IAS 31:

    • Proportionate Consolidation: The venturer includes its share of joint assets, liabilities, income, and expenses line-by-line or as separate line items.

    • Equity Method: Accounted for as detailed under IAS 28.

  • Cessation: If joint control over a jointly controlled entity ceases, proportionate consolidation or equity method accounting must be discontinued.

Voting Thresholds and Joint Control Applications

• Case Study 1: Majority Requirement Assessment

  • Fact Pattern: Aztec holds $25\%$ equity, Matex holds $35\%$ equity, and Azure holds $40\%$ equity in an enterprise. The agreement mandates a $60\%$ majority to pass decisions, with equal representation on the management board.

  • Analysis: Any two venturers agreeing can reach or exceed the $60\%$ threshold ($25\% + 35\% = 60\%$, $35\% + 40\% = 75\%$, or $25\% + 40\% = 65\%$). Because equal representation exists and strategic combinations can govern, the entities use equity accounting or proportionate consolidation.

• Scenario Ex 1: Absence of Unanimous or Fixed Joint Control

  • Fact Pattern: Five unrelated entities (A, B, C, D, E) each own $20\%$ of voting shares of Entity Z. Strategic decisions require a simple majority ($> 50\%$).

  • Analysis: No single investor controls Z. Neither do entities A–E have joint control, because decisions do not require unanimous consent. Any combination of three investors ($60\%$) can make decisions, meaning no fixed combination shares joint control.

  • Accounting: Accounted for under Section 14 (Investments in Associates). If an investor lacks significant influence, accounted for under Section 11 (Basic Financial Instruments).

• Scenario Ex 2: Contractual Agreement Establishing Joint Control

  • Fact Pattern: Same facts as Ex 1, but entities A, B, and C enter into a formal contract to exercise joint control over Entity Z.

  • Analysis: Entities A, B, and C have joint control over Entity Z, making it a jointly controlled entity (joint venture).

  • Accounting: Accounted for under joint venture requirements (Section 15 / IAS 31). Refer to Module 9 (Consolidated and Separate Financial Statements) for detailed judgments on control.

• Scenario Ex 3: Equal Ownership Joint Control

  • Fact Pattern: Entities A and B each hold $50\%$ of voting ordinary shares of Entity Z. Decisions require a simple majority ($> 50\%$).

  • Analysis: Provided A and B have a contractual agreement establishing joint control, Entity Z is a jointly controlled entity (joint venture).

Disclosure Requirements for Joint Ventures under IAS 31

• Mandatory Disclosures:

  • Specific contingent liabilities incurred by the venturer in relation to its interests in joint ventures.

  • Capital commitments of the venturer relating to its interests in joint ventures.

  • A list and description of interests in significant joint ventures, including the proportion of ownership interest held in jointly controlled entities.

  • When line-by-line proportionate consolidation or the equity method is used: aggregate amounts of current assets, long-term assets, current liabilities, long-term liabilities, income, and expenses relating to joint venture interests.

  • The specific method utilized to recognize interests in jointly controlled entities.