Connolly – International Financial Accounting and Reporting – 4 th Edition CHAPTER 29 ASSOCIATES

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.1 INTRODUCTION IAS 28 Investments in Associates and Joint Ventures How should associates be accounted for in the financial statements of a company that does, and does not, publish consolidated financial statements? (See Section 29.2) The application of the equity method of accounting, together with the disclosure requirements (See Section 29.3) (Example 29.1 and Example 29.2)

Connolly – International Financial Accounting and Reporting – 4 th Edition Definition of an associate An entity in which an investor has significant influence (traditionally 20%-50% of equity voting rights) and is in a position to exercise significant influence and that is neither a subsidiary nor an interest in a joint venture

Connolly – International Financial Accounting and Reporting – 4 th Edition Significant influence Power to participate in financial and operating policy decisions of investee but not control those decisions Presumed to exist if investor, directly or indirectly, owns 20% or more of the voting power (unless it can be clearly demonstrated that such ownership does not constitute significant influence)

Connolly – International Financial Accounting and Reporting – 4 th Edition Significant influence Usually evidenced by one or more of the following: Representation on board of directors or other governing body Participation in policy making process Material transactions between investor and investee Interchange of managerial personnel, or Provision of essential technical communication

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.2 ACCOUNTING FOR AN ASSOCIATE Category 1 An investment in an associate, for an entity not publishing consolidated financial statements, should be either: (a)carried at cost (or in accordance with IFRS 5 – See Chapter 20); or (b)accounted for under IFRS 9 Financial Instruments (See Chapter 25).

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.2 ACCOUNTING FOR AN ASSOCIATE Category 2 An investment in an associate, for an entity publishing consolidated financial statements, should be accounted for as follows: In the Separate Financial Statements of the Investor (a)carried at cost (or in accordance with IFRS 5 – See Chapter 20); or (b)accounted for under IFRS 9 Financial Instruments (See Chapter 25).

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.2 ACCOUNTING FOR AN ASSOCIATE In the Consolidated Financial Statements of the Investor Use the equity method of accounting for associates unless exempt through meeting one of the following conditions: Entity is a parent that is exempt under IFRS 10 (See Chapter 26); Investment is held by, or is held indirectly through, an entity that is a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds (may elect to measure the investment at FVTPL in accordance with IFRS 9 Financial Instruments (See Chapter 25); The investment, or portion of, meets the criteria to be classified as held for sale in accordance with IFRS 5. Any remaining portion is accounted for using the equity method until the time of disposal, at which time the retained investment is accounted under IFRS 9, unless the retained interest continues to be an associate or joint venture.

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.3 APPLYING THE EQUITY METHOD Statement of Financial Position Investment is initially recorded at cost and adjusted thereafter for the post acquisition change in the investor's share of net assets of the associate (See Figure 29.1) IAS 28 does not require separate disclosure of goodwill within the ‘investment in associates’ heading However, goodwill (and the investment in the associate) should be tested annually for impairment

Connolly – International Financial Accounting and Reporting – 4 th Edition Figure 29.1: Carrying amount of an associate Method 1 €’000 Cost of investmentX Plus Share of post-acquisition retained profits and reserves of Associate (to reporting date)X Less Any premium written off (because of impairment)(X) Carrying amount of investmentX Method 2 Group’s share of net asset of Associate (at reporting date)X Plus Premium on acquisition not written off since acquisition dateX Carrying amount of investmentX

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.3 APPLYING THE EQUITY METHOD SPLOCI IAS 28 only requires one line in the SPLOCI – P/L (‘share of associate’s net profit/loss’) This is the investor's share of the profit or loss of the associate This single figure (%PAT) is shown in immediately before PBT

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.3 APPLYING THE EQUITY METHOD In determining investor’s share of post acquisition profits/losses, adjustments include:  Elimination of unrealised profits and losses arising from “upstream” and “downstream” transactions between investor (or its consolidated subsidiaries) and associate, but only to extent of investor’s interest in associate  Those needed to reflect depreciation based on fair values at date of acquisition If associate’s financial statements drawn up to different reporting date, adjust for effects of significant transactions/events occurring between date of associate’s and date of investor’s financial statements before applying equity method If associate uses different accounting policies to investor for like transactions/events, make appropriate adjustments to associate’s financial statements before applying equity method  If not practicable, disclose that fact

Connolly – International Financial Accounting and Reporting – 4 th Edition 29.3 APPLYING THE EQUITY METHOD If investor’s share of associate’s losses exceeds carrying amount of investment, investment reported at nil and equity method discontinued Additional losses only provided for if investor has incurred obligation on behalf of associate If associate subsequently reports profits, resume equity method only after share of profits equals share of losses not recognised

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 1 – Equity method P Limited purchased 40% of the ordinary shares of A Limited on 1 January 2013 for €550,000. As at 1 January 2013 the retained earnings were €1,120,000. The following balances were extracted from the SFP of A Limited as at 31 December 2013: Ordinary Share Capital€200,000 Retained Earnings €1,340,000 Requirement a)What is the figure to be included in the SPLOCI in relation to associates? b)What is the figure to be included in the SFP in relation to associates?

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 1 – Equity method Solution At acquisition date: €€ Cost550,000 At acquisition date OSC Retained Earnings x Group Share Premium on Acquisition 200,000 1,120,000 1,320,000 x 40%(528,000) 22,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 1 – Equity method SPLOCI: (€1,340,000 – €1,120,000) x 40%€88,000 SFP: € € Cost of Investment 550,000 Retained Earnings Now 1,340,000 Acquisition Date (1,120,000) 220,000 x Group Share x 40% 88, ,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 1 – Equity method Alternative method to calculate SFP Figure: € OSC 200,000 Retained Earnings 1,340,000 1,540,000 x Group Share x 40% 616,000 Premium on acquisition 22, ,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 2 – Equity method P Limited purchased 25% of the ordinary shares of A Limited on 1 January 2013 for €600,000. As at 1 January 2013 the retained earnings were €2,100,000. The following balances were extracted from the SFP of A Limited as at 31 December 2013: Ordinary Share Capital €100,000 Retained Earnings €2,420,000 The investment in A Limited has been impaired by €10,000. Requirement a)What is the figure to be included in the SPLOCI in relation to associates? b)What is the figure to be included in the SFP in relation to associates?

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 2 – Equity method Solution Step 1: Calculate the goodwill / premium on acquisition €€ Cost600,000 At acquisition date OSC Retained Earnings x Group Share Premium 100,000 2,100,000 2,200,000 x 25%(550,000) 50,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 2 – Equity method SPLOCI: € (€2,420,000 – €2,100,000) x 25% 80,000 Less impairment (10,000) 70,000 SFP: € € Cost of Investment 600,000 Retained Earnings Now 2,420,000 Acquisition Date (2,100,000) 320,000 x Group Share x 25% 80,000 Less impairment (10,000) SFP 670,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 2 – Equity method Alternative method to calculate SFP Figure: € OSC 100,000 Retained Earnings 2,420,000 2,520,000 x Group Share x 25% 630,000 Premium on acquisition 40,000 (€50,000 – €10,000) 670,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 3 – Equity method P Limited purchased 30% of the ordinary shares of A Limited on 1 January 2013 for €420,000. As at 1 January 2013 the retained earnings were €1,500,000. The following balances were extracted from the SFP of A Limited as at 31 December 2013: Ordinary Share Capital €100,000 Retained Earnings €1,750,000 Requirement a)What is the figure to be included in the SPLOCI in relation to associates? b)What is the figure to be included in the SFP in relation to associates?

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 3 – Equity method Solution Step 1: Calculate the goodwill / premium on acquisition Journal to recognise FV adjustment: Dr Associate €60,000 Cr Retained Earnings (SPLOCI – P/L) €60,000 €€ Cost420,000 At acquisition date OSC Retained Earnings x Group Share 100,000 1,500,000 1,600,000 x 30%(480,000) (60,000)

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 3 – Equity method SPLOCI: € (€1,750,000 – €1,500,000) x 30% 75,000 Gain on bargain purchase 60,000 SFP:€ € Cost of Investment 420,000 Retained Earnings Now 1,750,000 Acquisition Date (1,500,000) 250,000 x Group Share x 30% 75,000 FV adjustment 60, ,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Example 3 – Equity method Alternative method to calculate SFP Figure: € OSC 100,000 Retained Earnings 1,750,000 1,850,000 x Group Share x 30% 555,000

Connolly – International Financial Accounting and Reporting – 4 th Edition Disclosure The disclosure requirements for associates have been placed in IFRS 12 Disclosure of Interests in Other Entities In order for users of financial statements to better understand the relationship between an investor and its associates, the information disclosed should enable users of its financial statements to evaluate:  the nature, extent and financial effects of interests in associates, including the nature and effects of contractual relationships;  the nature of, and changes in, the risks associated with interests in associates.

See Chapter 29, Example 29.1