Accounting for Associates and Chapter 25 Accounting for Associates and Joint Ventures

Main purpose Where the size of an investment is not sufficient to give sole control, but where the investment gives the investor significant influence or joint control, then a modified form of accounting is appropriate.

Objectives By the end of this chapter, you should be able to: define an associate; incorporate an associate into the consolidated financial statements using the equity method; account for transactions between a group and its associate; define and describe a joint operation and a joint venture and prepare financial statements incorporating interests in joint operations and joint ventures.

Chapter 25 covers Associates and significant influence Treatment of associated companies in consolidated accounts The Brill Group – the equity method The treatment of provisions for unrealised profits The acquisition of an associate part-way through the year Joint arrangements.

Definitions Investor has significant influence Significant influence: But not a subsidiary Significant influence: Financial and operating policy decisions Assumed where 20% or more of voting power Subject to evidence to contrary.

Significant influence assumed Representation on board Participation in policy-making process Material transactions Interchange of management personnel Provision of essential technical information.

Treatment of associated companies in consolidated accounts Equity method used Unless acquired exclusively for disposal Management actively seeking a buyer S of F P sheet: in non-current asset section Initially at cost Yearly post-acquisition change Statement of income After profit from operations.

Brill Group example 1 January 20X0 date of acquisition Brill acquired 20% of Cod for £20,000 Retained earnings of Cod were £22,500 General reserve of Cod was £6,000.

Brill Group example (Continued) £

Brill Group example (Continued) £

Brill Group – notes 1 & 2 Adjust for post-acquisition changes in Cod’s reserves Note 2. Cod’s current account is outside the group and so is retained in the Group accounts £ ,

Brill Group – notes 3, 4 & 5

Brill Group consolidated income statement Income tax expense 27,750 6,000 27,750 Profit for period 80,690 16,500 82,790 £

Brill Group consolidated income statement (Continued)

Provision for unrealised profit Always restrict to the group’s share Not appropriate to adjust for 100%.

Acquisition part way through year Match cost with benefit Time apportion.

Puff Group example 31 March 20X0 Puff acquired 30% of shares in Blow Retained earnings of Blow were £61,500 After providing for £1,500 accrued dividend.

Puff Group example (Continued) During the year All income and expense accrued evenly On 1 October 20X0 Blow sold Puff goods for £15,000 which was cost plus 25% At end of year 75% of intragroup goods still in stock £450 of dividend received credited to investment in Blow.

Puff Group example (Continued) £ £

Puff Group – notes Note 1. The associated company’s revenues, COGS, and other income and expenses are not added on a line by line basis. The Group’s share of the Associate’s profits is added as a single entry – see note 4. Note 2. The provision for unrealised profit is deducted from the share of the Associate’s profit. - see note 4. £

Joint arrangements IFRS 11 IFRS 11 Joint Arrangements was issued in 2011. Joint arrangements are classified as either joint operations or joint ventures

Joint operations Where the parties, called joint operators, have joint control of the arrangement which gives rights to the assets, and obligations for the liabilities It is the existence of rights and obligations that is critical to determining whether a joint operation exists.

Joint ventures This is where the parties, called joint venturers, have joint control of the arrangement which gives rights to the net assets of the arrangement.

Joint control Both joint operations and joint ventures require that there should be joint control Joint control exists where there is a contractually agreed sharing of control of an arrangement under which decisions require the unanimous consent of the parties sharing control.

Joint operations – recognised in the financial statements its share of the jointly controlled assets any liabilities that it has incurred its share of any liabilities incurred jointly with the other venturers any income and expenses incurred from its share of the joint venture and any expenses that it has incurred in respect of its interest in the joint venture.

Joint ventures Interests in a joint venture are accounted for using the equity method in accordance with IAS 28 Investments in Associates and Joint Ventures.

IFRS 12 disclosure of interests in other entitities Issued in 2011 Enables users to evaluate: the nature of, and risks associated with, its interests in other entities, and the effects of those interests on its financial position, financial performance and cash flows.

Interests in joint arrangements and associates disclosures Disclose information that enables users to evaluate the nature, extent and financial effects of its interests in joint arrangements and associates, and the nature of, and changes in, the risks associated with its interests in joint ventures and associates.

Review questions Equity method The following is taken from the notes to the 1999 Chugoku Electric Power Company, consolidated financial statements. Equity method Investments in four (three in 1998) affiliated companies (20% to 50% owned) are accounted for by the equity method and, accordingly, are stated at cost adjusted for equity in undistributed earnings and losses from the date of acquisition. (a) What is another name for most companies which are 20% to 50% owned? (b) What is meant by the word ‘equity’ in the above statement? (c) What are the entries in the statement of comprehensive income under the equity method of accounting? (d) What are the differences between the equity method and consolidation?

Review questions (Continued) Why are associated companies accounted for under the equity method rather than consolidated? How does the treatment of inter­company unrealised profit differ between subsidiaries and associated companies? IAS 28, para. 17, states: The recognition of income on the basis of distributions received may not be an adequate measure of the income earned by an investor on an investment in an associate. Explain why this may be so.

Review questions (Continued) Where an associate has made losses, IAS 28, para. 30, states: After the investor’s interest is reduced to zero, additional losses are provided for, and a liability is recognised, only to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate. If the associate subsequently reports profits, the investor resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised. Explain why profits are recognised only after its share of the profits equals the share of losses not recognised.