MInvestment in Associates and Joint Ventures

M5 – Investment in Associates and Joint Ventures

• IA28: Investments in Associates and Joint Ventures
• IFRS 12: Disclosure of Interests in Other Entities

Significant Influence

• Definition: Significant influence is the power to participate in financial and operating policy decisions of an investee (associate) but is not control or joint control.
• Method of Accounting: Equity Method
  • Recognizes investor's share of post-acquisition change in net assets (equity) of the associate.
  • Provides more information than cost recognition but less than full consolidation.

Assessing Significant Influence

• Typically, less than 20% shareholding does not indicate significant influence unless other factors suggest otherwise.

Indicators of Significant Influence

• Indicators include:
  • Representation on the board or equivalent governing body.
  • Participation in policy-making processes, such as dividends.
  • Material transactions between investor and investee.
  • Interchange of managerial personnel.
  • Provision of essential technical information.

Equity Method Overview

• Balance Sheet Effect:
  • Initially recorded at cost.
  • Investment increases annually with share of profits and decreases by dividends received.
• Profit & Loss:
  • Investor reports share of associate's profits and OCI adjusted for inter-entity transactions; unaffected by dividends declared/paid by the associate.

Equity Method – Balance Sheet Details

• Recording Investment:
  • Initial cost recorded as an asset.
  • Carrying amount adjusts based on share of profits/losses.
  • Dividends reduce carrying amount.

Profit & Loss Adjustments

1. **Cumulative Preference Dividends: **

   • Adjust profits for any preference dividends that must be paid first.
   • Example calculation given to illustrate adjustment.

2. Identifiable Net Assets Not at Fair Value:

   • Adjust for any assets not recorded at fair value to avoid understatement/overstatement of profits.
   • Example provided where inventory adjustment affects profit recognition.

3. Inter-Entity Transactions:

   • Upstream and Downstream Transactions:
     • Profits on inventory sales between associate and investor are unrealized until sold externally. Adjust profits accordingly.
     • Example calculation showing the impact of unrealized profit on investor's share of profit.

Case Study on Goodwill and Share of Profits

• Scenario Overview:
  • Investor purchases shares in Associate Ltd; goodwill calculation illustrated.
  • Various transactions adjusted for dividends and profit sharing detailed.

Journal Entries Related to Investments in Associates

1. Share of Current Post-Acquisition Profit:

   • DR Investment in Associate
   • CR Share of Profit or Loss of Associates

2. Dividends from the Associate:

   • DR Bank/Dividend Receivable
   • CR Dividend Income (for income recognition, then eliminate during consolidation)
   • DR Dividend Income
   • CR Investment in Associate (to adjust for decrease in equity)

3. Share of Post-Acquisition OCI:

   • DR Investment in Associate
   • CR Share of OCI
   • If the associate incurs a loss, reduce the investment:
     • DR Share of Profits/Losses of Associates
     • CR Investment in Ordinary Shares/Preference Shares

Joint Arrangements Overview (IFRS 11)

• Definition: A joint arrangement occurs when two or more parties have joint control.
  • Characteristics:
  • Contractual arrangement binding parties.
  • Parties have joint control derived from the arrangement.
• Types:
  • Joint Operation: Rights to assets and obligations recognized directly in the financial records.
  • Joint Venture: Accounts for arrangement using the equity method, rights to net assets recognized.

Key Decision Points in Joint Arrangements

• Determining joint arrangements depends on:
  • Existing contractual agreement.
  • Control parameters and decision-making requirements.
  • Whether unique assets/entities exist between joint operators.