Investment in Associate

Associate - is an entity, including an un-incorporated entity such as a partnership, over which

the investor has significant influence and that is neither a subsidiary nor an interest in a joint
venture.

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. Below are the features of
the definition:

1. It requires the investor to have the power, or the capacity, to affect the investee but
does not require the investor to actually exercise that power. Instead, the focus is on
the existence of the power or the capacity.
2. The specific power is that of being able to participate in the financial and operating
decisions of the investee but has no power or capacity to dominate the financial and
operating decisions.
3. In the definition of an associate and significant influence, there is no requirement for
the investor to hold any shares, or have a beneficial interest, in the associate. In other
words, if significant influence is exercised by one entity over another by virtue of an
association or contact other than from the holding of shares, then the equity method
cannot be applied in relation to the associate.
4. The level of influence is significant when the investor holds 20% up to 50% interest in
the voting power of the investee it is presumed that the investor has significant
influence over the investee. This is a rebuttable presumption because if the investor
can demonstrate that such influence does not exist, then the investee is not classified
as an associate. Further, where the investor owns less than 20% of another entity,
there is presumption that the investee is not an associate.

Measurement:
Equity method – a method of accounting whereby the investment is initially recorded at cost
and adjusted thereafter for the post-acquisition change in the investor’s share of net assets of
the investee. The profit or loss of the investor includes the investor’s share of the profit or loss
of the investee adjusted for the effect of ant fair value differences recognized on the acquisition
of the associate.

Measurement at initial recognition – at historical cost. The cost represents the fair market
value of the shares acquired or consideration issued whichever is clearly determinable and any
transaction costs incurred.
Measurement subsequent to acquisition – at the carrying value. The cost of the equity
securities is increased or decreased to recognize the investor’s share of the profit or loss of the
investee after the date of acquisition. The investor’s share of the profit or loss of the investee is
recognized in the investor’s profit or loss. Distributions received from an investee reduce the
carrying amount of the investment. Adjustment to the carrying amount may also be necessary
for changes in the investor’s proportionate interest in the investee arising from changes in the
investee’s equity that have not been recognized in the investee’s profit or loss. Such changes
include those arising from the revaluation of the property, plant and equipment, foreign
exchange translation differences, and other comprehensive income items. The investor’s share
of those changes is recognized directly in equity of the investor.

The carrying value of the investment is also affected by the recognition of the excess of the
acquirer’s interest in the net fair value of acquiree’s identifiable assets, liabilities and contingent
liabilites. The amount of excess is actually the negative goodwill.

However, if there is an indication that the investment in associate is impaired such that the
carrying amount of the investment is higher than its recoverable amount, the amount of
impairment loss should be recognized, the investment in associate account should be reported
in the balance sheet at its recoverable amount.

Exceptions:
The equity method of accounting is not applied to investments in associates classified as held
for sale in accordance with PFRS 5 “Non-current assets held for sale and discontinued
operations”. An investor measures an associate that is classified as held for sale at the lower of
its carrying amount at the date of classification as held for sale and fair value less cost to sell.
Therefore, equity method ceases once an associate is classified as held for sale.

Measurement of Income (Loss) From Investment

a. During the holding period or when held – share in the investee’s reported net profit or
loss adjusted by the amount of any understatement or overstatement of expenses on
the related assets and liabilitites of the investee, impairment of goodwill or any amount
of negative goodwill. The “Income from Investment or Equity in Earnings of Associate”
may be used to reflect the share on the earnings or loss and the related adjustments.

When an associate has outstanding cumulative preference shares that are held by
parties other than the investor and classified as equity, the investor computes its share
of earnings or losses after deducting the dividends on such shares, whether or not such
 dividends have been declared. For preference shares that are non-cumulative, the
dividends are deducted only when there is declaration.

The above discussion relates only to dividends that are classified as equity because, for
those preference shares classified as debt, the payments to the holders are treated as
interest and deducted before calculating profit or loss for the period. For preference
shares treated as equity, the payments to holders are classified as dividends and
appropriated subsequent to the calculation of profit or loss.

Also, in the calculation of the investor’s share of the profit of the associate, adjustments
must then be made to the recorded profit of the associate where that figure has been
measured based on policies that are different from those applied by the investor.

If an investor’s share of losses of an associate equals or exceeds the carrying amount of

the investment in the associate, the investor shall discontinue recognizing its share of
further losses. After the investor’s interest is reduced to zero, the investor shall
recognize additional losses by a provision only to the extent that the investor has
incurred legal or constructive obligation or has made payments on behalf of the
associate. If the associate subsequently reports profits, the investor shall resume
recognizing its share of those profits only after its share of the profits equals the share
of losses not recognized.

b. Upon derecognition or disposal – the difference of the net disposal proceeds over the
carrying value of the investment at the time of disposal is the measure of gain or loss
on disposal of investment. Any other comprehensive income recognized by the investor
in relation to the investment in associate must be recycled and included in the gain or
loss on disposal measurement.

Financial instrument becoming an associate:

A step acquisition also arises when an entity gains significant influence over an existing
investment upon acquisition of a further interest or due to a change in circumstances. IAS 28 is
unclear on how an investor should account for an existing investment, which is accounted for in
IAS 39, that subsequently becomes an associate that should be accounted for under the equity
method. In practice, there are three methods that are acceptable methods:

Method A (the most consistent with the principles underlying the equity method of accounting
– namely, applying consolidation and business combination principles as well as accounting for
investor’s share of associate’s results after the date of acquisition. Nevertheless, there is also
some support within IAS 28 for Method B and Method C. The method an entity selects should
however be applied consistently.

Method A – requires the investor to revert to its original cost and then recognize a “catch up”
equity method adjustment for its share of post acquisition profits and reserves since the
original acquisition date. Dividend income continues to be recognized in profit or loss up to the
date the entity becomes an associate.

IAS 28 notes that the concepts underlying the procedure used in accounting for the acquisition
of a subsidiary should also be adopted in accounting for the acquisition of an associate.
Furthermore, the standard notes that on acquisition of the investment any difference between
the cost of the investment and the investor’s share of the net fair value of the associate’s
identifiable asset, liabilities and contingent liabilities is accounted for in accordance with IFRS 3.
Although IFRS 3 only deals with business combinations that are achieved in stages it does
contain guidance that can be applied by analogy. In particular, it notes that cost should be
determined at the date of each exchange transaction irrespective of the fact that the carrying
amount has changed.

Method B – requires the investor to revert to its original cost, but not to recognize a catch up
adjustment. Dividend income continues to be recognized in profit or loss up to the date the
entity becomes an associate.

This method uses the underlying logic as Method A for determining cost and goodwill.
However, IAS 28 states that an investment in associate is accounted for using the equity
method from the date on which it becomes an associate. To avoid contradicting this specific
this specific requirement in IAS 28, Method B does not recognize a cumulative adjustment for
prior periods.

However, it should be emphasized that if the ownership interest increases further and the
investment becomes a subsidiary, the full step acquisition guidance of IFRS 3 would apply,
hence the cumulative results that are ignored by Method B would need to be recognized at that
point.

Method C – uses fair value as deemed cost and does not require recognition of a catch up
adjustment. Dividend income continues to be recognized in profit or loss up to the date the
entity becomes an associate. This may be a pragmatic approach where it is difficult to obtain
the information required for the other methods.
Under IAS 28 an entity should discontinue the use of equity method from the date it ceases to
have significant influence over an associate. Conversion of Equity Securities Carried at Cost/Fair
Value to Equity Securities Carried at Equity. The difference between the Income from
investment under the cost/fair value method (cumulative dividend income) and the income
from investment under the equity method (cumulative share in earnings/losses plus and minus
any adjustments should have been recognized had the equity method was used) is the amount
of adjustment to the investment account and to the beginning balance of the accumulated
profits and losses/retained earnings.

Accounting for Cessation – upon application of IAS 27 (as amended in 2008) and IFRS 3 as
revised in 2008): An investor shall discontinue the use of the equity method from the date
when it ceases to have significant influence over an associate and shall account for the
investment in accordance with IAS 39 from that date, provided the associate does not become
a subsidiary or a jointly controlled entity as defined in IAS 31. On loss of significant influence,
the investor shall measure at fair value any investment the investor retains in the former
associate. The investor shall recognize in profit or loss any difference between:
a) The fair value of any retained investment and any proceeds from disposing of the part
interest in the associate, and
b) The carrying amount of the investment at the date when significant influence is lost.

Therefore upon loss of significant influence there is a remeasurement to fair value of any
remaining interest that is taken to profit or loss regardless of the prospective accounting
designation under IFRS 9.

Deemed Disposal:
An investor’s interest in an associate may be reduced other than by an actual disposal. Such a
reduction in interest, which is commonly referred to as a ‘deemed disposal’ gives rise to a
‘dilution’ gain or loss. Deemed disposal may arise for a number of reasons, including:
a) The investor does not take up its full allocation in a rights issue by the associate
b) The associate declare scrip dividends which are not taken up by the investor so that its
proportional interest is diminished
c) Another party exercises its options or warrants issued by the associate; or
d) The associate issues shares to third parties

Although IASB did not explicitly consider accounting for deemed disposals of associates in
drafting IAS 28, paragraph 20 of the standard refers to the concepts underlying the procedures
used in accounting for the acquisition of a subsidiary in accounting for acquisitions of interests
in associates. Therefore, rather than relying on a literal reading of definition of the equity
method, it is more appropriate to account for deemed disposals of associates in the same way
as deemed disposals of subsidiaries. IAS 27 has been amended as part of phase II of the
business combination project so as to require that partial disposals of subsidiaries, were control
is retained, are accounted for as equity transactions. Under equity accounting an investor only
accounts for its own interest. Given that other investors’ ownership in the associate is not
reflected in the accounts of an investor there is no basis for concluding that deemed disposals
can only be treated as equity transaction.

Method A – the dilution gain or loss is being determined as being the difference of the carrying
value of the investment deemed disposed of (excluding any goodwill component) and the share
in contribution or any proceeds from issue of new shares. Adjusted by any amount reported in
equity before the deemed disposal that is to be recycled in profit or loss.

Method B – deemed disposal should be accounted for as true disposal, that is, the carrying
amount of the equity investment-including goodwill should be taken into account. Thus the
gain or loss on deemed disposal is the difference between the carrying value of investment
including any goodwill that has been considered deemed disposed off and the share in the
proceeds for any contribution or issue of new shares by the investee adjusted by any amount
reported in equity before the deemed disposal that is to be recycled in profit or loss.

Differences between IFRS for SMEs and FULL IFRS:

IFRS for SMEs FULL IFRS

Three measurement models are provided – Only the equity method is allowed, except for
cost, equity and fair value limited circumstances where fair value can be
utilized
Transaction costs are specifically included in No specific requirements regarding
cost under the equity method transaction costs
Goodwill identified under the equity method is Goodwill is included in the carrying amount of
treated separately and amortized the investment and is not amortized
Under the equity method, the accounting The impracticability exception is not provided
policies of the associate are adjusted to that of
the investor unless it is impracticable to do so.
In applying the equity method, the same The same requirement applies, but the
reporting dates must be used, except if it is difference in dates is limited to three months
impractical to do so. and the difference should be consistent year-
on-year
 Investment in Associates
1. On January 2, 2018, Parker Company, a medium-sized entity, acquired 25% of the equity
of each of entities. A, B and C for P100,000, P150,000 and P280,000. Parker Company
has significant influence over entities A, B and C. Transaction costs of 1% of the purchase
price of the shares were incurred by Parker Company.

On December 31, 2018 A Company declared and paid dividends of P10,000. On

December 31, 2018 B Company declared a dividend of P80,000 for the year ended 2018
which will be paid in 2019. For the year ended December 31, 2018 A Company and B
Company recognized profits of P50,000 and P180,000 respectively. However, C
Company recognized a loss of P200,000 for the year 2018.

Published price quotations do not exist for the shares of entities A, B and C. Using
appropriate valuation techniques Parker Company determined the fair value of its
investments in entities A, B and C at December 31, 2018 as P130,000, P290,000 and
P150,000 respectively. Costs to sell are estimated at 5% of the fair value of the
investments. Parker Company has no subsidiaries and therefore does not produce
consolidated financial statements.

Question 1: If Parker Company uses the cost model in measuring its investment in
associate at what amount should the investment in A, B and C, respectively be reported
on its December 31, 2018 statement of financial position?
a. P100,000, P150,000, P280,000
b. P101,000, P151,500, P282,800
c. P101,000, P151,500, P142,500
d. P123,500, P275,500, P142,500

Question 2: Assume that the shares of A, B and C are publicly traded and Parker
Company uses the fair value model to measure its investment in associates, at what
amount should the investment A, B and C, respectively, be reported in its December 31,
2018 statement of financial position?
a. P100,000, P150,000, P280,000
b. P101,000, P151,500, P282,800
c. P123,500, P275,500, P142,500
d. P130,000, P290,000, P150,000
 Question 3: Assume that Parker Company uses the equity method in measuring its
investment in associates, at what amount should the investment in A, B and C,
respectively, be reported in its December 31, 2018 statement of financial position?

a. P100,000, P150,000, P280,000

b. P101,000, P151,500, P282,800
c. P111,000, P176,500, P142,500
d. P111,000, P176,500, P232,800

2. On January 2, 2018, Marco Company purchased 20,000 shares (20%) of Polo Company’s
ordinary share for P4,500,000. The fair value of the net asset acquired is P4,200,000.
During 2018, Polo reported the following in its statement of comprehensive income a
P4,000,000 net income and a P500,000 revaluation surplus recognize at the end of the
year. Polo Company paid cash dividends of P3,000,000 on December 31, 2018.

Question 1: What is the carrying value of the investment as of December 31, 2018?
a. P4,600,000
b. P4,670,000
c. P4,770,000
d. P4,800,000

Question 2: Assuming Marco Company is a medium size enterprise, what is the carrying
value of the investment as of December 31, 2018?
a. P4,600,000
b. P4,670,000
c. P4,770,000
d. P4,800,000

3. On January 1, 2018 Shell Company acquired a 30% interest in Petron Company’s

1,000,000 outstanding shares for P15,000,000. During the year Shell Company received
P300,000 cash dividend and 300,000 share dividends. At December 31, 2018 Petron
Company reported a profit of P5,500,000. On January 2, 2019 Petron Company issued
1,000,000 new shares for P20 per share. Shell Company did not acquire of those shares.

Question 1: What is the amount of loos from the dilution should Shell Company
recognize?
a. None
b. P1,250,000
c. P1,450,000
 d. P1,550,000

Question 2: What is the carrying value of the investment in associate immediately after
the recognition of loss from dilution?
a. P14,900,000
b. P14,950,000
c. P15,100,000
d. P16,350,000
4. On January 2, 2018, A Company acquired a 30% interest in B Company at a cost of
P2,000,000. Investor A Company has significant influence over B Company. During the
year ended December 31, 2018, B Company reported a post-tax profit of P800,000 and
paid of P72,000. B Company also recognized foreign exchange losses of P160,000 and
unrealized gain on equity investment of P200,000 in other comprehensive income. On
January 2, 2019, B Company has rights issue that investor A Company does not
participate in. The rights issue brings in an additional P700,000 in cash and dilutes
investor A Company’s interest in B Company to 25%. What amount of dilution gain or
loss should A Company recognize on January 2, 2019?
a. None
b. P161,400
c. P194,733
d. P196,733
5. Man Company purchased 10% of Kind Corporation’s 200,000 outstanding shares of
ordinary shares on January 2, 2017 for P2,500,000. On January 2, 2017, Man Company
purchased another 40,000 shares of Kind for P6,000,000. There was no goodwill as a
result of either acquisition Kind reported earnings of P6,000,000 and P7,000,000 for the
year ended December 31, 2017 and 2018, respectively by Kind Company. What amount
of income from investment should Man Company report in its statement of
comprehensive income related to its investment for the year ended December 31,
2018?
a. None
b. P600,000
c. P1,400,000
d. P2,100,000
6. In April 1, 2018, JJT Company acquired 15% of the 100,000 shares outstanding ordinary
shares of Trinidad Company for P1,500,000 which is equal to the prevailing market price
of Trinidad shares. For the year ended December 31, 2018 Trinidad Company reported a
comprehensive income of P3,300,000 which includes a P900,000 revaluation reserve on
its land and paid cash dividends of P1,200,000 on its ordinary share and thereafter
 issued 15% share dividend. As of December 31, 2018 the shares of Trinidad Company
are still selling in the stock market at P120 per share. On January 2, 2019 Trinidad
Company reacquired and retired 28,750 shares of other investors. During 2019, Trinidad
Company reported a net income of P3,000,0000 and paid a total dividend of P1,500,000.
At what amount should the investment account be reported in the December 31, 2019
statement of financial position?
a. P1,950,000
b. P2,025,000
c. P2,295,000
d. P2,370,000
7. Bloom Corporation acquired 30% of Gloom Company’s 100,000 voting stock on January
2, 2018 for P2,000,000 when the net assets of Gloom Company was P6,000,000. Gloom
earned P1,000,000 and P1,500,000 in 2018 and 2019, respectively. Gloom Company
paid dividends of P300,000 in 2018 and P500,000 in 2019. Market value of Gloom’s
ordinary shares is P80 on December 31, 2018 and P90 on December 31, 2019. On
January 2, 2019, Bloom Company sold 40% of its investment at the prevailing market
value of Gloom’s shares.

If after the sale Bloom Company reclassified its remaining investment to other
comprehensive income, what amount of unrealized gains or loss should be reported in
its December 31, 2019 other comprehensive income?
a. None
b. P114,000
c. P180,000
d. P280,000
8. On January 1, 2017 MC Company acquired 25% of the ordinary shares that carry voting
rights at a general meeting of shareholders of DC Company for P400,000. The purchase
price is equal to the fair value of the 25% of the fair value. DC’s identifiable assets less
25% of its identifiable liabilities. For the year ended 2017, DC Company recognized a loss
of P2,400,000. MC Company has no constructive or legal obligation in respect of its
associate and has made no payment on its behalf. For the year ended 2018, DC
Company recognized a profit of P3,200,000. What is the carrying value of MC
investment in DC as of December 31, 2018?
a. None
b. P400,000
c. P600,000
d. P800,000
9. Table owns 50% and 20% of Chair Corporation’s ordinary and preference shares,
respectively. Chair’s shares outstanding at December 31, 2018 follow:

Ordinary value P4,000,000

10% cumulative preference share 900,000

Chair reported net income of P600,000 for the year ended December 31, 2018 and
declared the current year dividend on the preference shares.

What total amount of revenue should Table Company disclose in the statement of
comprehensive income related to its investment in Chair Company for the year ended
December 31, 2018?
a. None
b. P255,000
c. P273,000
d. P300,000