IAS 28 - Investments in Associates and Joint Ventures

DEFINITIONS

  • IAS 28 requires investments to be accounted for using the equity method for:

    • Associates: investments where the investor has significant influence;

    • Joint Ventures: joint arrangement where the investor has joint control, but does not have direct rights to assets or obligations for liabilities.

  • Indicators of significant influence (usually one or more):

    • representation on the board of directors, or equivalent body, of the investee;

    • participation in the decision-making process, including decisions about dividends or other distributions of profits;

    • presence of material transactions between the entity and the investee;

    • exchange of management personnel; or the provision of essential technical information.

  • If an investor holds, directly or indirectly (through subsidiaries), 20%20\% or more of the votes exercisable at the investee's shareholders' meeting, the investor is presumed to have significant influence, unless the contrary can be clearly demonstrated.

EQUITY METHOD

  • The equity method is the method of accounting whereby the investment is initially recognized at cost and, subsequent to acquisition, adjusted for changes in the investor's share of the investee's net assets.

  • The carrying amount is subsequently increased or decreased to recognize the investor's share of the investee's profit or loss, or other changes in equity, realized after the acquisition date.

  • Dividends received from an associate reduce the carrying amount of the investment (IAS 28 para. 10).

  • Step 1 to Step 6 (summary):

    • Step 1: Investment is stated as one line item, initially recognized at cost.

    • Step 2: Profit or loss of investee is adjusted for the effect of fair value adjustments recognized upon initial recognition.

    • Step 3: Profit or loss of investee is adjusted for the effects of transactions with investee.

    • Step 4: Carrying amount of the investment is adjusted to recognize investor’s share of P/L and OCI of investee after acquisition.

    • Step 5: Carrying amount of the investment is adjusted to recognize distributions received from the investee.

    • Step 6: Assess and recognize impairment, if any.

STEP 1: INVESTMENT IS STATED AS ONE LINE ITEM, INITIALLY RECOGNIZED AT COST

  • Included in cost of investment at acquisition date.

  • Transaction costs included in cost of investment.

  • Contingent consideration included in cost.

  • IAS 28 does not define cost, but it is usually understood to be the fair value of cash or other consideration paid by the purchaser.

  • COST under the equity method involves a cost accumulation approach alongside:

    • adjust for all changes in contingent consideration to the investment in the associate or joint venture;

    • account for all changes in contingent consideration in the income statement (IFRS 3).

STEP 2: PROFIT OR LOSS OF INVESTEE IS ADJUSTED FOR THE EFFECT OF FAIR VALUE ADJUSTMENTS RECOGNIZED UPON INITIAL RECOGNITION

  • Adjust for differences in policies between investor and investee at acquisition to achieve consistent accounting policies.

  • Possible FV-related adjustments include:

    • Additional depreciation for FV adjustments – PPE / IA (intangible assets);

    • Amortization for previously unrecognized identifiable assets;

    • Reversal of impairment of ‘old’ goodwill;

    • Adjustments for impairments recognized by the investee;

    • Dealing with fair value adjustments arising on acquisition.

STEP 3: PROFIT OR LOSS OF INVESTEE IS ADJUSTED FOR THE EFFECTS OF TRANSACTIONS WITH INVESTEE

  • IAS 28 does not provide guidance on eliminating profit/loss on transactions with associates.

  • Investor’s share of the investee’s profit or losses is eliminated when calculating consolidated results.

  • Realized with third parties: profits/losses are eliminated as appropriate.

  • Unrealized profits are included in assets (i.e., unrealized profits are not recognized in P/L).

  • Trading balances and loans between investor and investee are not eliminated.

STEP 4: CARRYING AMOUNT OF THE INVESTMENT IS ADJUSTED TO RECOGNIZE INVESTOR’S SHARE OF P/L AND OCI OF INVESTEE AFTER ACQUISITION

  • For profit or loss and OCI of investee after acquisition, the investor adjusts the carrying amount accordingly.

  • Loss-making associates:

    • the investment is written down to zero;

    • subsequent losses are not recognized;

    • losses may be attributed to the investor’s other interests in the associate (e.g., long-term loans);

    • if profits are made in the future, the investor recognizes profits only after all unrecognized losses have been offset.

STEP 5: CARRYING AMOUNT OF THE INVESTMENT IS ADJUSTED TO RECOGNIZE DISTRIBUTIONS RECEIVED FROM THE INVESTEE

  • Dividends paid by investee > carrying amount of the investment:

    • carrying amount is reduced to nil but does not become negative;

    • a gain is recognized in P/L if there is no obligation to make payments on behalf of the investee for the remaining dividend (i.e., dividend greater than investment).

  • This step ensures the investor's carrying amount reflects distributions received and profits/losses recognized.

STEP 6: IMPAIRMENT

  • Impairment assessment under the equity method follows IAS 36 impairment testing.

  • Impairment triggers and methodology:

    • Tested as part of the equity accounting process (not as a separate asset in isolation);

    • Share of investee cash flows (CFs) is considered;

    • Impairment can be reversed in a subsequent period.

  • No allocation of impairment loss solely to the investor; impairment testing interacts with the investee’s performance and forecasted CFs.

IMPAIRMENT (DETAILED FOCUS)

  • Equity method impairment is assessed when there is objective evidence of impairment in the investee.

  • Considerations include expected future dividends and the investee’s cf-related indicators.

  • Reversals of impairment are allowed under IAS 36 when the recoverable amount increases.

EXAMPLE 1: ELIMINATION OF UPSTREAM TRANSACTIONS

  • Scenario: An entity has a 20%20\% interest in an associate. The associate sells inventory costing C300C300 to the entity for cash of C500C500. The inventory has not been sold to third parties by the balance sheet date. The associate recorded a profit of C200C200 on this transaction. The entity’s share of this profit is C40C40 (C200×20%C200 \times 20\%).

  • Required entries: Eliminate the entity’s share of the profit against the carrying amount of the investee.

    • Debit: share of profit of the associate ( Cout = C40C40 )

    • Credit: investment in the associate ( Cout = C40C40 )

  • Rationale: The entity’s share of the intercompany profit should not be recognized in consolidated financial statements until the inventory is sold to a third party.

  • If the entity sells the inventory to a third party in the following year for C500C500, reverse the prior elimination, since the unrealized profit has now crystallized.

EXAMPLE 2: ELIMINATION OF DOWNSTREAM TRANSACTIONS

  • Scenario: An entity has a 20%20\% interest in a joint venture. The entity sells inventory to the joint venture for C500C500. The original cost of the inventory was C300C300. The inventory has not been sold to a third party at the balance sheet date. The entity records a profit of C200C200. Since the sale was to a joint venture, part of this profit is unrealized and should be eliminated. The unrealized profit is C40C40 (0.20×C2000.20 \times C200).

  • Required entries: Adjustments to be made in the entity’s books:

    • Debit revenue of C100C100 (C500×20%C500 \times 20\%)

    • Credit cost of sales of C60C60 (C300×20%C300 \times 20\%) (or debit the share of profit of the joint venture by C40C40)

    • Credit the investment in the joint venture by C40C40

  • Rationale: The unrealized profit persists until the JV sells the inventory to a third party.

EXAMPLE 3: BACKGROUND – INVESTOR Y (20X3) AND ITS INVESTEE X (ASSOCIATE)

  • Background: Investor Y’s financial year-end is 31 December 20X3. X was acquired on 30 June 20X3. Relevant information (all numbers in ’000’000):

    • 1) X reported profit for 6 months ended 31 December 20X3: 14,20014{,}200.

    • 2) Profit for 6 months included impairment of goodwill: 2,0002{,}000.

    • 3) Additional depreciation for PPE: 1,1901{,}190.

    • 4) Additional amortization for intangible assets: 900900.

    • 5) Reversal of deferred tax liabilities related to fair value adjustments for 6-month period: 490490.

    • 6) After the acquisition, Investor Y sold a land plot to X for 25,00025{,}000 which had net book value 20,00020{,}000.

    • 7) Total dividends paid by X during the 6-month period: 4,0004{,}000 on ordinary shares and 2,0002{,}000 on preference shares.

EXAMPLE 3: CALCULATION OF Y’S SHARE OF PROFIT AND LOSS (20X3)

  • Step 1: Adjusted profit for the period

    • Profit for the 6-month period: 14,20014{,}200

    • Reversal of goodwill impairment: 2,0002{,}000

    • Additional depreciation - PPE: −1,190-1{,}190

    • Amortization of intangible assets: −900-900

    • Reversal of DTL related to fair value adjustments: +490+490

    • Adjusted profit for the period: 14,60014{,}600

  • Step 2: Y’s share of profit and loss (assuming 25% ownership)

    • Y’s share: 14,600imes25%=14{,}600 imes 25\% =3{,}650</p></li></ul></li><li><p>Step3:CalculationofinvestmentinXasat31December20X3</p><ul><li><p>Balanceasat30June20X3:</p></li></ul></li><li><p>Step 3: Calculation of investment in X as at 31 December 20X3</p><ul><li><p>Balance as at 30 June 20X3:27{,}000</p></li><li><p>Add:Y’sshareofprofitandloss:</p></li><li><p>Add: Y’s share of profit and loss:3{,}650</p></li><li><p>Less:Eliminationofunrealisedgainonsaleofland:</p></li><li><p>Less: Elimination of unrealised gain on sale of land:1{,}250</p></li><li><p>Less:Dividendsonordinarysharesreceived:</p></li><li><p>Less: Dividends on ordinary shares received:1{,}000</p></li><li><p>InvestmentinXat31December20X3:</p></li><li><p>Investment in X at 31 December 20X3:27{,}000 + 3{,}650 - 1{,}250 - 1{,}000 = 28{,}400</p></li></ul></li></ul><h3id="b8846123−16e7−48e7−b904−2f73301cce21"data−toc−id="b8846123−16e7−48e7−b904−2f73301cce21"collapsed="false"seolevelmigrated="true">FINALREMINDERS</h3><ul><li><p>Theequitymethodrequiresongoingadjustmentstoreflecttheinvestor’sshareofinvesteeprofits/lossesandchangesinequity,distributions,andimpairment.</p></li><li><p>Intercompanytransactions(upstreamanddownstream)requirecarefuleliminationofunrealizedprofitstoavoidoverstatingconsolidatedincomeorassets.</p></li><li><p>ImpairmentshouldbeevaluatedwithIAS36,consideringtheinvestee’sCFsandpotentialreversalsinfutureperiods.</p></li></ul><h3id="972bf38d−9d5a−4499−a465−a3ba243a3670"data−toc−id="972bf38d−9d5a−4499−a465−a3ba243a3670"collapsed="false"seolevelmigrated="true">WHYIFRSANDIAS1</h3><ul><li><p>Slidenote:"No.Becausethemajorityisvariable.Youdon′talwaysneedthesameonestomakedecisions.Thecontrolquotaallowsdecisionsmadebydifferentgroupseachtime."</p></li></ul><p></p><h4id="24aa5747−42a8−4bfe−b33f−ee45deae41ad"data−toc−id="24aa5747−42a8−4bfe−b33f−ee45deae41ad"collapsed="false"seolevelmigrated="true">DEFINITIONS</h4><ul><li><p><strong>IAS28</strong>mandatestheequitymethodforinvestmentsin<strong>associates</strong>(significantinfluence)and<strong>jointventures</strong>(jointcontrolwithoutdirectasset/liabilityrights).</p></li><li><p><strong>Significantinfluence</strong>isindicatedbyboardrepresentation,participationindecision−making,materialtransactions,managementexchange,oressentialtechnicalinformation.</p></li><li><p>Adirect/indirectholdingof</p></li></ul></li></ul><h3 id="b8846123-16e7-48e7-b904-2f73301cce21" data-toc-id="b8846123-16e7-48e7-b904-2f73301cce21" collapsed="false" seolevelmigrated="true">FINAL REMINDERS</h3><ul><li><p>The equity method requires ongoing adjustments to reflect the investor’s share of investee profits/losses and changes in equity, distributions, and impairment.</p></li><li><p>Intercompany transactions (upstream and downstream) require careful elimination of unrealized profits to avoid overstating consolidated income or assets.</p></li><li><p>Impairment should be evaluated with IAS 36, considering the investee’s CFs and potential reversals in future periods.</p></li></ul><h3 id="972bf38d-9d5a-4499-a465-a3ba243a3670" data-toc-id="972bf38d-9d5a-4499-a465-a3ba243a3670" collapsed="false" seolevelmigrated="true">WHY IFRS AND IAS 1</h3><ul><li><p>Slide note: "No. Because the majority is variable. You don't always need the same ones to make decisions. The control quota allows decisions made by different groups each time."</p></li></ul><p></p><h4 id="24aa5747-42a8-4bfe-b33f-ee45deae41ad" data-toc-id="24aa5747-42a8-4bfe-b33f-ee45deae41ad" collapsed="false" seolevelmigrated="true">DEFINITIONS</h4><ul><li><p><strong>IAS 28</strong> mandates the equity method for investments in <strong>associates</strong> (significant influence) and <strong>joint ventures</strong> (joint control without direct asset/liability rights).</p></li><li><p><strong>Significant influence</strong> is indicated by board representation, participation in decision-making, material transactions, management exchange, or essential technical information.</p></li><li><p>A direct/indirect holding of20\%ormoreofvotingpower<em>presumes</em>significantinfluence.</p></li></ul><h4id="2baaa52d−9620−4ea7−8053−8a766161dd44"data−toc−id="2baaa52d−9620−4ea7−8053−8a766161dd44"collapsed="false"seolevelmigrated="true">EQUITYMETHOD</h4><ul><li><p>Anaccountingmethodwhereaninvestmentisinitiallyrecognizedatcost,thenadjustedfortheinvestor′sshareoftheinvestee′snetassets,profit/loss,andotherchangesinequityafteracquisition.</p></li><li><p>Dividendsreceivedreducetheinvestment′scarryingamount.</p></li><li><p><strong>SummaryofSteps</strong>:</p><ol><li><p>Initialrecognitionatcost.</p></li><li><p>AdjustinvesteeP/Lforfairvalueadjustmentsatacquisition.</p></li><li><p>AdjustinvesteeP/Lforintercompanytransactions.</p></li><li><p>Adjustcarryingamountforinvestor′sshareofinvesteeP/LandOCI.</p></li><li><p>Adjustcarryingamountfordistributionsreceived.</p></li><li><p>Assessandrecognizeimpairment(ifany).</p></li></ol></li></ul><h4id="696f4731−cd54−4ea8−bc43−97cee2213a6c"data−toc−id="696f4731−cd54−4ea8−bc43−97cee2213a6c"collapsed="false"seolevelmigrated="true">KEYSTEPSINDETAIL</h4><h5id="d5c8dab3−fb58−4928−83ad−886db911e8d7"data−toc−id="d5c8dab3−fb58−4928−83ad−886db911e8d7"collapsed="false"seolevelmigrated="true">STEP1:INITIALRECOGNITIONATCOST</h5><ul><li><p>Costincludestransactioncostsandcontingentconsideration,usuallyunderstoodasthefairvalueofconsiderationpaid.</p></li></ul><h5id="2d498124−23dd−47b3−885f−b48bc55bf4d7"data−toc−id="2d498124−23dd−47b3−885f−b48bc55bf4d7"collapsed="false"seolevelmigrated="true">STEP2:FAIRVALUEADJUSTMENTS</h5><ul><li><p>Adjustfordifferencesinaccountingpoliciesandfairvalueadjustmentsatacquisition(e.g.,additionaldepreciation/amortization,reversalofgoodwillimpairment).</p></li></ul><h5id="2de9fffe−3e36−483b−a2ba−385d023d0e28"data−toc−id="2de9fffe−3e36−483b−a2ba−385d023d0e28"collapsed="false"seolevelmigrated="true">STEP3:INTERCOMPANYTRANSACTIONS</h5><ul><li><p>Eliminatetheinvestor′sshareofunrealizedprofits/lossesfromtransactionswithassociates/jointventuresuntilrealizedwiththirdparties.Tradingbalancesandloansarenoteliminated.</p></li></ul><h5id="29f6b729−3f30−422e−b636−06e549ba45d2"data−toc−id="29f6b729−3f30−422e−b636−06e549ba45d2"collapsed="false"seolevelmigrated="true">STEP4:INVESTOR’SSHAREOFP/LANDOCI</h5><ul><li><p>Theinvestoradjuststhecarryingamountforitsshareoftheinvestee′sprofitorlossandOCI.</p></li><li><p>For<strong>loss−makingassociates</strong>,theinvestmentiswrittendowntozero,andsubsequentlossesarenotrecognizedunlessattributedtootherinterests.Futureprofitsarerecognizedonlyafteroffsettingunrecognizedlosses.</p></li></ul><h5id="c5ce081e−8c43−4837−bcd3−5c5d03e602de"data−toc−id="c5ce081e−8c43−4837−bcd3−5c5d03e602de"collapsed="false"seolevelmigrated="true">STEP5:DISTRIBUTIONSRECEIVED</h5><ul><li><p>Dividendsreceivedreducethecarryingamount.Ifdividendsexceedthecarryingamount,itisreducedtonil,andagainisrecognizedinP/Lifnoobligationexistsforfurtherpayments.</p></li></ul><h5id="f9596fc0−f0ac−46dd−b1c8−eb1149fa43a6"data−toc−id="f9596fc0−f0ac−46dd−b1c8−eb1149fa43a6"collapsed="false"seolevelmigrated="true">STEP6:IMPAIRMENT</h5><ul><li><p>ImpairmentisassessedunderIAS36,consideringobjectiveevidenceandinvesteecashflows,andcanbereversedinsubsequentperiods.</p></li></ul><h4id="8b65f195−a61d−4a48−9040−5d1c300c200f"data−toc−id="8b65f195−a61d−4a48−9040−5d1c300c200f"collapsed="false"seolevelmigrated="true">ILLUSTRATIONSOFINTERCOMPANYTRANSACTIONELIMINATION</h4><ul><li><p><strong>Upstream(associatesellstoinvestor)</strong>:Investor′sshareofunrealizedprofitiseliminatedagainsttheinvestmentcarryingamount.(Example:or more of voting power <em>presumes</em> significant influence.</p></li></ul><h4 id="2baaa52d-9620-4ea7-8053-8a766161dd44" data-toc-id="2baaa52d-9620-4ea7-8053-8a766161dd44" collapsed="false" seolevelmigrated="true">EQUITY METHOD</h4><ul><li><p>An accounting method where an investment is initially recognized at cost, then adjusted for the investor's share of the investee's net assets, profit/loss, and other changes in equity after acquisition.</p></li><li><p>Dividends received reduce the investment's carrying amount.</p></li><li><p><strong>Summary of Steps</strong>:</p><ol><li><p>Initial recognition at cost.</p></li><li><p>Adjust investee P/L for fair value adjustments at acquisition.</p></li><li><p>Adjust investee P/L for intercompany transactions.</p></li><li><p>Adjust carrying amount for investor's share of investee P/L and OCI.</p></li><li><p>Adjust carrying amount for distributions received.</p></li><li><p>Assess and recognize impairment (if any).</p></li></ol></li></ul><h4 id="696f4731-cd54-4ea8-bc43-97cee2213a6c" data-toc-id="696f4731-cd54-4ea8-bc43-97cee2213a6c" collapsed="false" seolevelmigrated="true">KEY STEPS IN DETAIL</h4><h5 id="d5c8dab3-fb58-4928-83ad-886db911e8d7" data-toc-id="d5c8dab3-fb58-4928-83ad-886db911e8d7" collapsed="false" seolevelmigrated="true">STEP 1: INITIAL RECOGNITION AT COST</h5><ul><li><p>Cost includes transaction costs and contingent consideration, usually understood as the fair value of consideration paid.</p></li></ul><h5 id="2d498124-23dd-47b3-885f-b48bc55bf4d7" data-toc-id="2d498124-23dd-47b3-885f-b48bc55bf4d7" collapsed="false" seolevelmigrated="true">STEP 2: FAIR VALUE ADJUSTMENTS</h5><ul><li><p>Adjust for differences in accounting policies and fair value adjustments at acquisition (e.g., additional depreciation/amortization, reversal of goodwill impairment).</p></li></ul><h5 id="2de9fffe-3e36-483b-a2ba-385d023d0e28" data-toc-id="2de9fffe-3e36-483b-a2ba-385d023d0e28" collapsed="false" seolevelmigrated="true">STEP 3: INTERCOMPANY TRANSACTIONS</h5><ul><li><p>Eliminate the investor's share of unrealized profits/losses from transactions with associates/joint ventures until realized with third parties. Trading balances and loans are not eliminated.</p></li></ul><h5 id="29f6b729-3f30-422e-b636-06e549ba45d2" data-toc-id="29f6b729-3f30-422e-b636-06e549ba45d2" collapsed="false" seolevelmigrated="true">STEP 4: INVESTOR’S SHARE OF P/L AND OCI</h5><ul><li><p>The investor adjusts the carrying amount for its share of the investee's profit or loss and OCI.</p></li><li><p>For <strong>loss-making associates</strong>, the investment is written down to zero, and subsequent losses are not recognized unless attributed to other interests. Future profits are recognized only after offsetting unrecognized losses.</p></li></ul><h5 id="c5ce081e-8c43-4837-bcd3-5c5d03e602de" data-toc-id="c5ce081e-8c43-4837-bcd3-5c5d03e602de" collapsed="false" seolevelmigrated="true">STEP 5: DISTRIBUTIONS RECEIVED</h5><ul><li><p>Dividends received reduce the carrying amount. If dividends exceed the carrying amount, it is reduced to nil, and a gain is recognized in P/L if no obligation exists for further payments.</p></li></ul><h5 id="f9596fc0-f0ac-46dd-b1c8-eb1149fa43a6" data-toc-id="f9596fc0-f0ac-46dd-b1c8-eb1149fa43a6" collapsed="false" seolevelmigrated="true">STEP 6: IMPAIRMENT</h5><ul><li><p>Impairment is assessed under IAS 36, considering objective evidence and investee cash flows, and can be reversed in subsequent periods.</p></li></ul><h4 id="8b65f195-a61d-4a48-9040-5d1c300c200f" data-toc-id="8b65f195-a61d-4a48-9040-5d1c300c200f" collapsed="false" seolevelmigrated="true">ILLUSTRATIONS OF INTERCOMPANY TRANSACTION ELIMINATION</h4><ul><li><p><strong>Upstream (associate sells to investor)</strong>: Investor's share of unrealized profit is eliminated against the investment carrying amount. (Example:C40eliminationforelimination forC200profit,profit,20\%interest).</p></li><li><p><strong>Downstream(investorsellstojointventure)</strong>:Theentity′sunrealizedprofitshareiseliminatedbyadjustingrevenue,costofsales,andtheinvestmentbalance.(Example:interest).</p></li><li><p><strong>Downstream (investor sells to joint venture)</strong>: The entity's unrealized profit share is eliminated by adjusting revenue, cost of sales, and the investment balance. (Example:C40eliminationforelimination forC200profit,profit,20\%$$ interest).

    FINAL REMINDERS

    • The equity method requires continuous adjustments for P/L, equity changes, distributions, and impairment.

    • Proper elimination of unrealized intercompany profits is crucial.

    • Impairment analysis follows IAS 36, considering investee cash flows.

    WHY IFRS AND IAS 1

    • The statement "No. Because the majority is variable. You don't always need the same ones to make decisions. The control quota allows decisions made by different groups each time." highlights the flexibility in decision-making authority under certain IFRS frameworks, where absolute majority isn't always a prerequisite for control or significant influence due to variable majorities.