ASSOCIATES AND JOINT VENTURES(IAS28, IAS31)

Associates and significant influenceIAS28 includes the following definitions:

• An associate is "an entity ... 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 these policies".

When an investor company owns (directly or indirectly) at least 20% of the voting power of an investee company, significant influence is presumed to exist unless it can be clearly demonstrated that this is not the case. Owning at least 20% of a company's voting power normally means owning at least 20% of that company's ordinary shares.

Evidence of significant influence

• representation on the board of directors which governs the investee company, or

• participation in policy-making processes of the investee, including participation in decisions about dividends or other distributions, or

• material transactions between the investor and the investee, or

• interchange of managerial personnel, or• provision of essential technical information.

The existence of significant influence may be evidenced by:

The equity methodIAS28 requires that an investment in an associate should normally be accounted for using the "equity method".

The equity method is defined as "a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of the net assets of the investee".

The profit or loss of the investor should include the investor's share of the investee's profit or loss.

Equity method

• IAS 28 requires all investments in associates and joint ventures to be accounted for using the equity method (unless held for sale)

• Exemptions:– If parent is exempt for preparing consolidated

financial statements– Or:

Exemptions to equity method

• (if all apply)– Investor is a wholly owned subsidiary or partially

owned subsidiary of another entity and the owners do not object to not using the equity method

– Securities are not publicly traded– Not in the process of issuing securities– The ultimate parent publishes financial

statements in accordance with IFRS

When to discontinue equity accounting

• When the investor ceases to have significant influence

• Then it is treated under IAS 39 Financial Instruments (e.g. fair value of retained interest must be treated as fair value on initial recognition as a financial asset

Application of the equity method

• The investor's share of the investee's profit or loss for the year is recognised in the investor's statement of comprehensive income and is either added to or subtracted from the carrying amount of the investment shown in the investor's statement of financial position.

• Any dividends received from the investee are subtracted from the carrying amount of the investment.

The investment made by the investing company is recorded initially at cost. In subsequent years:

Application of equity method: in summary

• SOFP: at cost, plus (or minus) share of post acquisition profits less impairment

• Profit or loss: group share of associate’s profit after tax

• OCI: group share of associate’s OCI after tax

Example

• Zyco acquired 35,000 of the 100,000 $1 shares of Beta Co for $70,000 on 1 January 20X7. In the year to 31 December 20X7, Beta Co generates profit for the year of $34,000. It then declares a dividend of $8,000.

• How should Zyco show its investments in its own accounts and in the consolidated accounts for year ended 31 December 20X7?

Individual accounts - Zyco

• Recorded at cost on acquisition (1/1/20X7)• Kept at this value in Zyco’s SOFP permanently• Record dividends in statement of profit or

loss and OCI (35% x $8,000 = $2,800)• DEBIT: Cash $2,800• CREDIT: Income from shares in associates $2,800

Consolidated accounts of Zyco Group

• Using equity accounting:• Group’s share of Beta’s profit after tax (35%

of $34,000 = $11,900)• As already distributed as dividend, it is

already included in Zyco’s company accounts and so will be included on consolidation. The portion not distributed will require an adjustment:

Consolidated accounts of Zyco Group (2)

• DEBIT: Investments in associates $9,100• CREDIT: Income from shares in associates $9,100

• This is then added to the ‘Investments in associates’ non current asset in the SOFP, e.g. $79100. This equates to cost plus group share of post acquisition profits.

Other issues

• Any impairment of investments in associates should be deducted from the asset value

• Financial statements should be to the same reporting date• Adjust for any material transactions/events in the

intervening period if not possible• Use common accounting policies• If there are third party held cumulative preference shares

held in the associate, adjust for the appropriate dividend first prior to calculating share of investor’s profits/losses

Upstream and downstream transactions

• These are transactions between an investor and an associate. IAS28 requires that unrealised profits resulting from such transactions should be eliminated to the extent of the investor's interest in the associate

Upstream and downstream transactions

• An example of an upstream transaction is the sale of goods by an associate to an investor

• A downstream transaction is the same transaction in reverse

Upstream and downstream transactions

• Upstream. In the investor's financial statements, the unrealised profit is subtracted from the investor's share of profit from associates. This automatically reduces the investment in associates figure shown in the investor's statement of financial position.

• Downstream. The unrealised profit is subtracted from the investor's gross profit (usually by increasing cost of sales) and is also subtracted from the investment in associates figure shown in the investor's statement of financial position.

Losses of an associate

• Should its share of an associate’s losses exceed the carrying amount of the associate in the investor’s financial statements:- the investor should cease to recognise its share of any further losses, unless it has a legal or constructive obligation

• See Example 5

IFRS11 JOINT ARRANGEMENTS

Joint arrangements

• Joint arrangements are either joint operations or joint ventures

• Depends on the rights and obligations of the parties

• Contributions can vary, e.g. finance, purchases, manufacture of goods, marketing skills, logistics

• IFRS 11 considers how the interest in the joint arrangement is accounted for by each party

Joint arrangements

• Joint operation: parties have joint control (the joint operators) have rights to the assets and obligations for the liabilities of the arrangement. A joint arrangement which is not a separate entity is always a joint operation

• Joint venture: parties (joint venturers) have joint control and have rights to the net assets of the arrangement

JA as separate entity

• Can be either joint operation or joint venture, depends on the contract

• If they have rights to assets and obligations for liabilities, then it is a joint operation

• If they have rights to the net assets it is a joint venture

Contractual arrangement

• Distinguishes a JA from an investment in an associate

• If there is no contractual arrangement, then a joint arrangement does not exist

• Evidence of a contractual arrangement could be a contract, minutes of discussions, incorporation of the joint venture

Joint venture considerations

• Contractual arrangement should cover in writing:

• Purpose, activity and duration• Appointment of board of directors and voting

rights of parties• Capital contributions of parties• How output, income, expenses or results will

be shared

Accounting for Joint Operations

• Line by line recognition in relation to its interest in a JO:– Assets, including share of jointly held assets– Liabilities, including share of joint incurred

liabilities– Revenue from sale of its share of output from JO– Share of revenue from sale of output by the JO– Expenses, including its share of expenses

incurred jointly

Accounting for Joint Ventures

• Only equity accounting permitted now• SOFP: interest in JV at cost plus share of post-

acquisition reserves less impairment• SOFP: include the group share of post

acquisition total comprehensive income in group reserves

Accounting for joint ventures (2)

• Consolidated statement of profit or loss and OCI:

• Include:– Group share of joint venture’s profit or loss– Group share of the joint venture’s other

comprehensive income

Transactions between JV’er and JV

• Upstream:• When JV sells to Jver, the Jver should not

recognise its share of profit made by JV on transaction until it resells the assets outside the group

• So the group share of the unrealised profit or loss in year end inventory should be eliminated

Transactions between JV and JV’er

• Downstream:• When Jver sells assets to JV, then the group share

of unrealised profit or loss in year end inventory or assets must be eliminated unless

• There is a loss AND• The transaction provides evidence of a reduction

in NRV of the asset or an impairment loss• Then the loss should be recognised in full by the

JVer

Associates and JA disclosure requirements

• Nature, extent and financial effects of any interests in associates or JA s including name, place of business, interest and method of accounting used including any restrictions on transfer of funds to the investor

• Risks associated with interests in associate of JV• Summarised financial information, more detail required

for JVs than associates

The main disclosures required by IFRS12 include: