Chapter 5

INVESTMENT IN ASSOCIATELearning OutcomesTo explain the related requirements of statutes and standard on investment in associate To record journal entries using equity method of accountingTo account invenstment in associate in consolidation To prepare consolidated financial statements

Investment in associated companies represent another popular form of long term investments by Malaysian companies.Investors - no control - only allowed the investor to exercise significant influence over financial and operating policy decisions (BOD) IntroductionRequirements of Statutes and Accounting Standard1. Companies Act, 1965not mention specifically regarding an associate companythus, it should be treated as investments in shares or corporations or other investments, which must be separately disclosed in the investors Balance Sheet [2(1)(j) of the Ninth Schedule]the investment should be accounted using cost method in the separate financial statements (at cost)2. MFRS 101 - Presentation of FSinvestment as one of the line items that should be presented in the B/S (para 66)share of profits and losses as one of the line item that should be presented in IS (para 75)

3. MFRS 124 - Related Party Disclosuresby definition and scope is fall under MFRS 124

4. MFRS 128 - Investment in Associatesdeals specifically with accounting for associates in both consolidated FS and the separate FS of investorDefinition MFRS 128 Investment in Associates an enterprise which investor has significant influence and which is neither a subsidiary nor a joint venture of the investor. The criterion used to test for the existence of an associate is significant influence that is the power to participate in the financial and operating policy decisions of the investee but not control over those policiesPara 7 evidences of significant influence

The % ownership interest in an investee is not included in the definition but is applied for presumption purpose as follows:If an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee, it is presumed that the investor does have significant influence unless it can be clearly demonstrated that this is not the case; and

Conversely, if the investor holds directly or indirectly through subsidiaries, less than 20% of the voting power of the investee, its presumed that the investor does not have significant influence unless such influence can be clearly demonstrated.

Associates StructuresP P 30% Q Q R S PR

Q10%60%10%51%51%10%10%Methods of Accounting In separate Financial Statement:(if not classified as held for sale)At costrecord investment at costrecognises income on dividends distributed from net profits of the investee

In accordance with MFRS 139 Financial InstrumentClassified as available-for-sale investment & shall be measured at fair value with changes in fair value recognised in other comprehensive income & retained in a fair value reserve in equity.

Methods of Accounting In Consolidated Financial Statement:Equity methodMFRS 5 if investment is classified as held for sale (para13(a), MFRS 128)MFRS 139 if investor ceases to have significant influence (para18, MFRS 128)

Equity methodinvestment initially recorded at costcarrying amount is increased / decreased to recognise the investors share of the profits or losses of investeedividends received reduce the carrying amount of the investment.Carrying amount also adjusted for changes in the investors share of the componens of other comprehensive income of the associate after the acquisition dateEg: revaluation of PPE, foreign exchange translation difference & fair value changes in AFS investment

Equity method (cont)No fair value adjustment & no recognition of unrecorded intangible assets and contingent liability. Goodwill should be included in the carrying amount of the investment (para 23, MFRS 128).Thus, no separate account for goodwill relating to associate in the CFS.Equity method (cont)Transactions between Parent & Associate:Only unrealized intragroup profit and losses are eliminated. Intragroup account balances arising from intragroup transactions are not eliminated.For URP/L, partial rather than full elimination is used (to the extent of the investors interest in associate)MFRS 128Journal Entries1)Share of profit in the current year:Single-line item basis (recommends by MFRS 101):Dr Investment in assoc. xxxCr Share of profit in associate xxx

Two-line items basis:DRInv in assoc. xxxDR Share of tax in assoc xxxCR Share of profit b4 tax in assoc xxx

Equity method (cont)2) To eliminate dividend income at the group level Dr Dividend income (gross) xxxCr Taxation expense xxx Inv in assoc xxx(to convert from cost method to equity method for dividend from associate)

Example 1H Bhd acquired a 75% interest in S Bhd when the retained profits of S Bhd were RM1,000,000. On 1 January 2003, H acquired a 30% interest in the equity capital of A Bhd for a consideration of RM4,500,000.

The summarized accounts of the three companies for the year ended 31 December 2003 were as follows:

Solution:(i) CJE:(a) Share Capital of S7,500Retained Profit B/F 750Goodwill on con1,250Investment in S Bhd9,500(to eliminate COI against share of net assets and to establish goodwill on consolidation)

(b) Share Capital of S2,500Retained Profit B/F1,450Goodwill on con 417NCI in the SFP4,367(to credit NCI for their share of net assets)

NCI in the SCI1,050NCI in the SFP1,050(to credit NCI for their share of profit )Solution (cont)c) Investment in A840Share of tax in Associate360Share of profit before taxin associate1,200(to equity account for share in current year profit)

Dividend income342Tax expense102Investment in A240(to eliminate dividend income from A bhd)

H Bhd. RM000S Bhd.RM000Eliminations and AdjustmentsGroupRM000Sales20,00018,00038,000Less: operating expenses(13,000)(12,000)(25,000)Operating profitGross dividend incomeProfit before tax-GroupShare of profit of associate co.7,0003427,342-6,000-6,000-(d) 342(c) 1,20013,000-

1,200Less: TaxationShare of tax in associate(2202)-(1,800)-(c) 360(3,900)(360)Profit for the periodAttributable to:NCI (SCI)Equity holders of the Parent5,140-4,200-(b) 1,0509,940

(1,050)8,890Dividend paid(1,000)-(1,000)Retained profit for current year4,1404,2007,890Retained profit brought forward7,8605,800(a) 750(b) 1,45011,460Retained profit carried forward12,00010,00019,350Ordinary shares (RM1 each)20,00010,000(a) 7500(b) 250020,000NCI (SFP)(b) 5,4175,41732,00020,00044,767Investment in H Bhd9,500-(a) 9,500-Investment in S Bhd4,500-(c) 840(d) 2405,100Sundry net assets18,00020,00038,000Goodwill on consolidation(a) 1,250(b) 4171,66732,00020,00044,767(ii) Carrying amount of investment in associate:

Cost of shareRM4,500Add: Share of post-acq [30%x (5000-3000)]RM 600RM5,100

Alternative:c) Single-line item basis:Investment in A840Share of profit in associate840

Intercompany Sales of Inventories with AssociateDownstream Sales:To eliminate share of unrealised profit on sales to assocDr Sales xxxCr COGS xxx Inv in assoc xxxTo restate opening unrealised profit and to account for its realisation in the current year for FIFO basis Dr Retained profit b/f xxx COGS xxxCr Sales xxxIntercompany Sales of Inventories with AssociateUpstream Sales:To eliminate share of unrealised profit on sales to assocDr Share of profit in assoc xxx CrInventories (SFP) xxx

To restate opening unrealised profit and to account for its realisation in the current year for FIFO basisDr Share of assocs prof b/f xxxCrShare of profit in assoc xxx

Example 2Hansom Bhd, a parent company with subsidiaries, owns a 40% interest in the equity capital of Lawe Bhd, its associated company.During the year ended 31 Dec 2005, inter-company sales between Hansom Bhd and Lawe Bhd totaled RM10,000,000. At year end, stocks of RM2,000,000 attributable to these sales were held by the buyer. The gross profit margin to the seller was 30% on selling price.Ignore tax effect accounting.

REQUIRED:In respect of the above inter-company sales, show the equity accounting journal adjustments required if:the transaction were downstream salesthe transaction were upstream sales

End of the Chapter