Accounting

Lecture 4.2 associates & JV

Topic list Syllabus reference

1 Accounting for associates and Joint Venture A5, D2
2 The equity method A5, D2
3 Statement of profit or loss and statement of financial D2
position

Introduction
In this chapter we deal with the treatment of associates in the consolidated
financial statements. As the group's share of profit in the associate appears
under profit or loss rather than other comprehensive income, we have
concentrated on the separate statement of profit or loss.

175

1
 Study guide
Intellectual level
A5 The concepts and principles of groups and consolidated financial
statements
(j) Define an associate and explain the principles and reasoning for the use of 2
equity accounting
D2 Preparation of consolidated financial statements including an associate
(a) Prepare consolidated financial statements to include a single subsidiary and 2
(b) an associate

1 Accounting for associates and Joint Venture

FAST FORWARD This is covered by MFRS 28 Investments in associates. The investing company does not have control, as
it
does with a subsidiary, but it does have significant influence.

1.1 Definitions
We looked at some of the important definitions in previous lectures; these are repeated here
with some additional important terms.
Key terms
 Associate. An entity, including an unincorporated entity such as a partnership, over which an
investor has significant influence and which 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.
 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.

We have already looked at how the status of an investment in an associate should be

determined. Go back to previous lectures to revise it. (Note. As for an investment in a
subsidiary, any potential voting rights should be taken into account in assessing whether the
investor has significant influence over the investee.)
MFRS 128 requires all investments in associates to be accounted for in the consolidated
accounts using the equity method, unless the investment is classified as 'held for sale' in
accordance with MFRS 5 in which case it should be accounted for under MFRS 5 (see year
2 lecture;), or the exemption in the paragraph below applies.
An investor is exempt from applying the equity method if:
(a) It is a parent exempt from preparing consolidated financial statements under MFRS 27, or
(b) All of the following apply:
(i) The investor is a wholly-owned subsidiary or it is a partially owned subsidiary of
another entity and its other owners, including those not otherwise entitled to vote, have
been informed about, and do not object to, the investor not applying the equity method
(ii) The investor's securities are not publicly traded
(iii) It is not in the process of issuing securities in public securities markets
(iv) The ultimate or intermediate parent publishes consolidated financial
statements that comply with International Financial Reporting Standards

176 11: Accounting for associates  Corporate reporting

2
The revised version of MFRS 128 no longer allows an investment in an associate to be
excluded from equity accounting when an investee operates under severe long-term
restrictions that significantly impair its ability to transfer funds to the investor. Significant
influence must be lost before the equity method ceases to be applicable.
The use of the equity method should be discontinued from the date that the investor
ceases to have significant influence.
From that date, the investor shall account for the investment in accordance with MFRS 9
Financial instruments. The carrying amount of the investment at the date that it ceases to be an
associate shall be regarded as its cost on initial measurement as a financial asset under MFRS
9.

1.2 Separate financial statements of the investor

If an investor issues consolidated financial statements (because it has subsidiaries), an
investment in an associate should be either:
(a) Accounted for at cost, or
(b) In accordance with MFRS 9 (at fair value)
in its separate financial statements.
If an investor that does NOT issue consolidated financial statements (ie it has no subsidiaries)
but has an investment in an associate this should similarly be included in the financial statements
of the investor either at cost, or in accordance with MFRS 9..

2 The equity method

2.1 Application of the equity method: consolidated accounts
Many of the procedures required to apply the equity method are the same as are required
for full consolidation. In particular, intra-group unrealised profits must be excluded.

2.1.1 Consolidated statement of profit or loss

The basic principle is that the investing company (X Co) should take account of its share of the
earnings of the associate, Y Co, whether or not Y Co distributes the earnings as dividends. X Co
achieves this by adding to consolidated profit the group's share of Y Co's profit after tax.
Notice the difference between this treatment and the consolidation of a subsidiary company's
results. If Y Co were a subsidiary X Co would take credit for the whole of its sales revenue, cost of
sales etc and would then make a one-line adjustment to remove any non-controlling share.
Under equity accounting, the associate's sales revenue, cost of sales and so on are NOT
amalgamated with those of the group. Instead the group share only of the associate's profit
after tax for the year is added to the group profit.

2.1.2 Consolidated statement of financial position

A figure for investment in associates is shown which at the time of the acquisition must be stated at cost. At
the end of each accounting period the group share of the retained reserves of the associate is added to the
original cost to get the total investment to be shown in the consolidated statement of financial position.

2.2 Example: associate

P Co, a company with subsidiaries, acquires 25,000 of the 100,000 $1 ordinary shares in A Co for
$60,000 on 1 January 20X8. In the year to 31 December 20X8, A Co earns profits after tax
of $24,000, from which it pays a dividend of $6,000.
How will A Co's results be accounted for in the individual and consolidated accounts of P Co
for the year ended 31 December 20X8?

Corporate reporting  11: Accounting for associates 177

3
 Solution
In the individual accounts of P Co, the investment will be recorded on 1 January 20X8 at cost. Unless there is
an impairment in the value of the investment (see below), this amount will remain in the individual statement of
financial position of P Co permanently. The only entry in P Co's individual statement of profit or loss will be to
record dividends received. For the year ended 31 December 20X8, P Co will:
DEBIT Cash $1,500
CREDIT Income from shares in associates $1,500
In the consolidated accounts of P Co equity accounting principles will be used to account for
the investment in A Co. Consolidated profit after tax will include the group's share of A Co's profit
after tax (25%  $24,000 = $6,000). To the extent that this has been distributed as dividend, it is
already included in P Co's individual accounts and will automatically be brought into the
consolidated results. That part of the group's share of profit in the associate which has not been
distributed as dividend ($4,500) will be brought into consolidation by the following adjustment.
DEBIT Investment in associates $4,500
CREDIT Share of profit of associates $4,500
The asset 'Investment in associates' is then stated at $64,500, being cost plus the
group share of post-acquisition retained profits.

3 Statement of profit or loss and statement of

financial position
3.1 Consolidated statement of profit or loss
FAST FORWARD
In the consolidated statement of profit or loss the investing group takes credit for its share of the after-
tax profits of associates whether or not they are distributed as dividends.

A consolidation schedule may be used to prepare the consolidated statement of profit or loss of
a group with associates. Note the treatment of the associate's profits in the following example.

3.2 Illustration
The following consolidation schedule relates to the P Co group, consisting of the parent company,
an 80% owned subsidiary (S Co) and an associate (A Co) in which the group has a 30% interest.

CONSOLIDATION SCHEDULE
Group P Co S Co A Co
$'000 $'000 $'000 $'000
Sales revenue 1,400 600 800 300
Cost of sales (770) (370) (400) (120)
Gross profit 630 230 400 180
Administrative expenses (290) (110) (180) ( 80)
340 120 220 100
Interest receivable 30 30 – –
370 150 220 100
Interest payable (20) – (20) –
Share of profit of associate (57 30%) 17 – –
367 150 200 100
Income tax expense
Group (145) (55) (90)
Associate – – (43)
Profit for the year 222 95 110 57
Non-controlling interest (110 20%) (22)
200

178 11: Accounting for associates  Corporate reporting

4
 Notes
1 Group sales revenue, group gross profit and costs such as depreciation etc
exclude the sales revenue, gross profit and costs etc of associated companies.
2 The group share of the associated company profits is credited to group profit or loss. If the
associated company has been acquired during the year, it would be necessary to deduct
the pre-acquisition profits (remembering to allow for tax on current year profits).
3 The non-controlling interest will only ever apply to subsidiary companies.

3.3 Pro-forma consolidated statement of profit or loss

The following is a suggested layout (using the figures given in the illustration above) for the consolidated
statement of profit or loss of a company having subsidiaries as well as associated companies.
$'000
Sales revenue 1,400
Cost of sales (770)
Gross profit 630
Other income: interest receivable 30
Administrative expenses (290)
Finance costs (20)
Share of profit of associate (57 x 30%) 17
Profit before tax 367
Income tax expense (145)
Profit for the year 222
Profit attributable to:
Owners of the parent 200
Non-controlling interest 22
222

3.4 Consolidated statement of financial position

FAST FORWARD
In the consolidated statement of financial position the investment in associates should be shown as:
 Cost of the investment in the associate; plus
 Group share of post acquisition profits; less
 Any amounts paid out as dividends; less
 Any amount written off the investment

As explained earlier, the consolidated statement of financial position will contain an asset
'Investment in associates'. The amount at which this asset is stated will be its original cost plus
the group's share of any post-acquisition profits which have not been distributed as dividends.

3.5 Example: consolidated statement of financial position

On 1 January 20X6 the net tangible assets of A Co amount to $220,000, financed by 100,000
$1 ordinary shares and revenue reserves of $120,000. P Co, a company with subsidiaries,
acquires 30,000 of the shares in A Co for $75,000. During the year ended 31 December
20X6 A Co's profit after tax is $30,000, from which dividends of $12,000 are paid.
Show how P Co's investment in A Co would appear in the consolidated statement of
financial position at 31 December 20X6.

Corporate reporting  11: Accounting for associates 179

5
 Solution
CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X6 (extract)
$
Non-current assets
Investment in associated company
Cost 75,000
Group share of post-acquisition retained profits
(30%  $18,000) 5,400
80,400

Question Associate I

Set out below are the draft accounts of Parent Co and its subsidiaries and of Associate
Co. Parent Co acquired 40% of the equity capital of Associate Co three years ago when
the latter's reserves stood at $40,000.
SUMMARISED STATEMENTS OF FINANCIAL POSITION
Parent Co
& subsidiaries Associate Co
$'000 $'000
Tangible non-current assets 220 170
Investment in Associate at cost 60 –
Loan to Associate Co 20 –
Current assets 100 50
Loan from Parent Co – (20)
400 200
Share capital ($1 shares) 250 100
Retained earnings 150 100
400 200
SUMMARISED STATEMENTS OF PROFIT OR LOSS
Parent Co
& subsidiaries Associate Co
$'000 $'000
Profit before tax 95 80
Income tax expense 35 30
Net profit for the year 60 50

Required
You are required to prepare the summarised consolidated accounts of Parent Co.
Notes
1 Assume that the associate's assets/liabilities are stated at fair value.
2 Assume that there are no non-controlling interests in the subsidiary companies.

Answer
PARENT CO
CONSOLIDATED STATEMENT OF PROFIT OR LOSS
$'000
Net profit 95
Share of profits of associated company (50 × 40%) 20
Profit before tax 115
Income tax expense (35)
Profit attributable to the members of Parent Co 80

180 11: Accounting for associates  Corporate reporting

6
PARENT CO
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
$'000
Assets
Tangible non-current assets 220
Investment in associate (see note) (60 +24) 84
Loan to associate 20
Current assets 100
Total assets 424
Equity and liabilities
Share capital 250
Retained earnings (W) (150+24) 174
Total equity and liabilities 424
Note
$'000
Investment in associate
Cost of investment 60
Share of post-acquisition retained earnings (W) 24
84
Working
Parent &
Retained earnings Subsidiaries Associate
$'000 $'000
Per question 150 100
Pre-acquisition 40
Post-acquisition 60
Group share in associate
($60  40%) 24
Group retained earnings 174

Question Associate II

Alfred Co bought a 25% shareholding on 31 December 20X8 in Grimbald Co at a cost of $38,000.

During the year to 31 December 20X9 Grimbald Co made a profit before tax of $82,000 and
the taxation charge on the year's profits was $32,000. A dividend of $20,000 was paid on 31
December out of these profits.
Required
Calculate the entries for the associate which would appear in the consolidated accounts
of the Alfred group, in accordance with the requirements of MFRS 128.

Answer
CONSOLIDATED STATEMENT OF PROFIT OR LOSS
$
Group share of profit of associate (82,000  25%) 20,500
Less taxation (32,000  25%) (8,000)
Share of profit of associate 12,500
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
$
Investment in associate (W) 45,500

Corporate reporting 11: Accounting for

associates 181

7
 Working
$
Cost of investment 38,000
Share of post-acquisition retained earnings ((82,000 – 32,000 – 20,000)  25%) 7,500
45,500

The following points are also relevant and are similar to a parent-subsidiary consolidation situation.

(a) Use financial statements drawn up to the same reporting date

(b) If this is impracticable, adjust the financial statements for significant transactions/
events in the intervening period. The difference between the reporting date of the
associate and that of the investor must be no more than three months.
(c) Use uniform accounting policies for like transactions and events in similar
circumstances, adjusting the associate's statements to reflect group policies if necessary

3.6 'Upstream' and 'downstream' transactions

'Upstream' transactions are, for example, sales of assets from an associate to the investor.
'Downstream' transactions are, for example, sales of assets from the investor to an associate.
Profits and losses resulting from 'upstream' and 'downstream' transactions between an
investor (including its consolidated subsidiaries) and an associate are eliminated to the
extent of the investor's interest in the associate. This is very similar to the procedure for
eliminating intra-group transactions between a parent and a subsidiary. The important
thing to remember is that only the group's share is eliminated.

3.7 Example: downstream transaction

A Co, a parent with subsidiaries, holds 25% of the equity shares in B Co. During the year, A
Co makes sales of $1,000,000 to B Co at cost plus a 25% mark-up. At the year end, B Co
has all these goods still in inventories.

Solution
A Co has made an unrealised profit of $200,000 (1,000,000  25/125) on its sales to the
associate. The group's share (25%) of this must be eliminated:
DEBIT Cost of sales (consolidated profit or loss) $50,000 Investment
CREDIT in associate (consolidated statement of financial position) $50,000

Because the sale was made to the associate, the group's share of the unsold inventory
forms part of the investment in the associate at the year end. If the associate had made the
sale to the parent, the adjustment would have been:
DEBIT Cost of sales (consolidated profit or loss) $50,000
CREDIT Inventories (consolidated statement of financial position) $50,000

3.8 Associate's losses

When the equity method is being used and the investor's share of losses of the associate equals or exceeds
its interest in the associate, the investor should discontinue including its share of further losses. The
investment is reported at nil value. After the investor's interest is reduced to nil, additional losses should only
be recognised where the investor has incurred obligations or made payments on behalf of the associate (for
example, if it has guaranteed amounts owed to third parties by the associate).

182 11: Accounting for associates  Corporate reporting

8
 3.9 Impairment losses
MFRS 139 sets out a list of indications that a financial asset (including an associate) may
have become impaired. Any impairment loss is recognised in accordance with MFRS 36
Impairment of assets for each associate individually.
In the case of an associate, any impairment loss will be deducted from the carrying value in
the statement of financial position.
The working would be:
$
Cost of investment X
Share of post-acquisition retained earnings X
X
Impairment loss (X)
Investment in associate X
Exam focus
point It is not unusual in the exam to have both an associate and a subsidiary to account for in a consolidation.

Question Consolidated statement of financial position

The statements of financial position of J Co and its investee companies, P Co and S Co, at
31 December 20X5 are shown below.
STATEMENTS OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5
J Co P Co S Co
$'000 $'000 $'000
Non-current assets
Freehold property 1,950 1,250 500
Plant and machinery 795 375 285
Investments 1,500 – –
4,245 1,625 785
Current assets
Inventory 575 300 265
Trade receivables 330 290 370
Cash 50 120 20
955 710 655
Total assets 5,200 2,335 1,440
Equity and liabilities
Equity
Share capital – $1 shares 2,000 1,000 750
Retained earnings 1,460 885 390
3,460 1,885 1,140
Non-current liabilities
12% loan stock 500 100 –
Current liabilities
Trade payables 680 350 300
Bank overdraft 560 – –
1,240 350 300
Total equity and liabilities 5,200 2,335 1,440

Corporate reporting  11: Accounting for associates 183

9
 Additional information
(a) J Co acquired 600,000 ordinary shares in P Co on 1 January 20X0 for
$1,000,000 when the retained earnings of P Co were $200,000.
(b) At the date of acquisition of P Co, the fair value of its freehold property was
considered to be $400,000 greater than its value in P Co's statement of financial
position. P Co had acquired the property in January 20W0 and the buildings
element (comprising 50% of the total value) is depreciated on cost over 50 years.
(c) J Co acquired 225,000 ordinary shares in S Co on 1 January 20X4 for $500,000 when
the retained earnings of S Co were $150,000.
(d) P Co manufactures a component used by both J Co and S Co. Transfers are made by P
Co at cost plus 25%. J Co held $100,000 inventory of these components at 31
December 20X5. In the same period J Co sold goods to S Co of which S Co had
$80,000 in inventory at 31 December 20X5. J Co had marked these goods up by 25%.
(e) The goodwill in P Co is impaired and should be fully written off. An impairment loss of
$92,000 is to be recognised on the investment in S Co.
(f) Non-controlling interest is valued at full fair value. P Co shares were trading at $1.60
just prior to the acquisition by J Co.
Required
Prepare, in a format suitable for inclusion in the annual report of the J Group, the
consolidated statement of financial position at 31 December 20X5.

Answer
J GROUP CONSOLIDATED STATEMENT OF FINANCIAL POSITION AS AT 31 DECEMBER 20X5

$'000
Non-current assets
Freehold property (W2) 3,570.00
Plant and machinery (795 + 375) 1,170.00
Investment in associate (W7) 475.20
5,215.20
Current assets
Inventory (W3) 855.00
Receivables (330 + 290) 620.00
Cash (50 + 120) 170.00
1,645.00
Total assets 6,860.20
Equity and liabilities
Equity
Share capital 2,000.00
Retained earnings (W8) 1,792.20
3,792.20
Non-controlling interest (W9) 878.00
4,670.20
Non-current liabilities
12% loan stock (500 + 100) 600.00
Current liabilities (680 + 560 + 350) 1,590.00
Total equity and liabilities 6,860.20

184 11: Accounting for associates  Corporate reporting

10
Workings
1 Group structure

2 Freehold property
$'000
J Co 1,950
P Co 1,250
Fair value adjustment 400
Additional depreciation (400  50%  40)  6 years (20X0-20X5) (30)
3,570
3 Inventory
$'000
J Co 575
P Co 300
PUP (100  25/125) (W4) (20)
855
4 Unrealised profit (PUP)
$'000
On sales by P to J (parent co) 100  25/125 20.0
On sales by J to S (associate) 80  25/125  30% 4.8

5 Fair value adjustments

Difference at acquisition Difference now
$'000 $'000
Property 400 400
Additional depreciation: 200  6/40 – (30)
400 370
 Charge $30,000 to retained earnings
6Goodwill
$'000 $'000
P Co
Consideration transferred 1,000
Non-controlling interest (400  $1.60) 640
Net assets acquired
Share capital 1,000
Retained earnings 200
Fair value adjustment 400
(1,600)
Goodwill at acquisition 40
Impairment loss (40)
0
7 Investment in associate
$'000
Cost of investment 500.00
Share of post-acquisition profit (390 – 150)  30% 72.00
Less PUP (4.80)
Less impairment loss (92.00)
475.20

Corporate reporting  11: Accounting for associates 185

11
 8 Retained earnings
J P S
$'000 $'000 $'000
Retained earnings per question 1,460.0 885.0 390.0
Adjustments
Unrealised profit (W4) (4.8) (20.0)
Fair value adjustments (W5) (30.0)
Impairment loss (P) (40.0)
795.0 390.0
Less pre-acquisition reserves (200.0) (150.0)
1,455.20 595.0 240.0
P: 60%  595 357.00
S: 30%  240 72.00
Impairment loss S (92.00)
1,792.20
9 Non-controlling interest at reporting date
$'000
NCI at acquisition (W6) 640.00
Share of post-acquisition retained earnings (595 x 40%) 238.00
878.00

186 11: Accounting for associates  Corporate reporting

12
Chapter Roundup
 A company investing in an associate does not have control but it does have significant
influence. MFRS 128 requires that, in consolidated financial statements, associates should
be accounted for using equity accounting principles.
 In the consolidated statement of profit or loss the investing group takes credit for its share of
the after-tax profits of associates, whether or not they are distributed as dividends.

 In the consolidated statement of financial position, the investment in associates should be shown as:
–Cost of the investment in the associate; plus
–Group share of post-acquisition profits; less
–Any amounts paid out as dividends and any amounts written off.

Quick Quiz
1 Define an associate.
2 How should associates be accounted for in the separate financial statements of the investor?
3 What is the effect of the equity method on the consolidated statement of profit or loss and
statement of financial position?

Corporate reporting  11: Accounting for associates 187

13
 Answers to Quick Quiz
1 An entity in which an investor has a significant influence, but which is not a subsidiary
or a joint venture of the investor.
2 Either at cost or in accordance with MFRS 9
3 (a)Consolidated statement of profit or loss. Investing company includes its share of
the earnings of the associate, by adding its share of profit after tax.
(b) Consolidated statement of financial position. Investment in associates is initially
included in assets at cost. This will increase or decrease each year according
to whether the associated company makes a profit or loss.

Now try the online question below:

https://forms.gle/3Q1UXDDorCiW5Az5A

14