ias 28 investments in associates and joint...

IAS 28 —Investments in associates and joint ventures

October 2020

PwC

1. Introduction 3

2. Recognition 13

3. Measurement 17

4. Disclosure & Summary 44

Agenda

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October 2020IAS 28 — Investments in Associates

Introduction

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Associate and Significant Influence

An associate is an entity in which the investor has significant influence (neither a subsidiary nor ajoint venture).

Significant influence is the power to participate in the financial and operating policy decisions of theinvestee but is not control over those policies.

IAS 28 — Investments in Associates and Joint VenturesIntroduction

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Joint Venture (IFRS 11)

A joint arrangement is an arrangement of which two or more parties have joint control. It can be in the form of joint operation and joint venture.

A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement.

A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.


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Decision tree – Joint operation OR Joint venture


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IAS 28 — Investments in Associates and Joint VenturesIntroduction – Joint arrangement

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Joint operation Joint venture

Characteristics The parties have rights to the assets and obligations for the liabilities relating to the arrangement

The parties have rights to the net assets relating to the arrangement.

Rights to assets The parties share all interests in the assets in specified proportion

The assets belong to the arrangement. The parties to the arrangement do not have direct rights, title or ownership of the assets.

Obligations for liabilities

The parties share all liabilities and are liable for claims on the arrangement

The joint arrangement is liable for the debts or obligations of the arrangement. The parties are liable to the arrangement only to the extent of their respective investments. Creditors do not have the rights of recourse against the parties in respect of the liabilities of the arrangement.

Revenue and expenses

The arrangement establishes an allocation of revenue and expenses based on relative performance if each party.

The arrangement establishes each party’s share in the profit or loss of the arrangement.

Financial reporting

In line with appropriate standards Equity method

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Short Quiz 1 – TEST YOUR KNOWLEDGE!

• An investment property is equally held by three parties.

• The agreement outlines that the parties are required to unanimously agree on certain decisions relating to the investment property, such as appointment/removal of property manager, capital expenditure, etc.

• The agreement outlines that the property expenses are shared based on their ownership interest.

• The parties are also jointly and severally liable for claims upon the investment property.

• Rental income is also distributed to the owners based on their relative ownership interest.

Question: What is the classification of the joint arrangement?


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Short Quiz 2 – TEST YOUR KNOWLEDGE!

• A large telecommunication company (Telco) is seeking to establish operations in an undeveloped market.

• The company (Telco) establishes a separate company with a local investor to enter this market.

• The legal form of the separate company confers the rights to the assets and liabilities to Telco.

• The contractual agreement states the following,- The assets of the arrangement are owned by the new company, instead of Telco or the local investor;- The liabilities of Telco and the local investor are limited to any unpaid capital, and- Profits of the new company will be distributed based on the parties’ interest in the arrangement.

Question: What is the classification of the joint arrangement?


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Indicators Joint operation Joint venture

Characteristics The parties have rights to the assets and obligations for the liabilities relating to the arrangement

The parties have rights to the net assets relating to the arrangement.

Rights to assets The parties share all interests in the assets in specified proportion

The assets belong to the arrangement. The parties to the arrangement do not have direct rights, title or ownership of the assets.

Obligations for liabilities

The parties share all liabilities and are liable for claims on the arrangement

The joint arrangement is liable for the debts or obligations of the arrangement. The parties are liable to the arrangement only to the extent of their respective investments. Creditors do not have the rights of recourse against the parties in respect of the liabilities of the arrangement.

Revenue and expenses

The arrangement establishes an allocation of revenue and expenses based on relative performance if each party.

The arrangement establishes each party’s share in the profit or loss of the arrangement.

Financial reporting

In line with appropriate standards Equity method (IAS 28)

Recognition

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Significant influence

IAS 28 — Investments in Associates and Joint VenturesRecognition

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Hold 20% + voting power of the investee

(directly or indirectly through subsidiaries)

Hold < 20% voting power of the investee

Substantial/majority ownership by another, does not preclude an investor from having significant influence.

Significant influence could be demonstrated by one or more of the following ways:

Representation on the board of directors or equivalent governing body of the investee;

Participation in policy making processes;

Material transactions between the investor and the investee;

Provision of essential technical information

Inter-change of managerial personnel

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IAS 28 — Investments in Associates and Joint VenturesRecognition

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The principle of Significant Influencestill applies, even when the investordoes not exercise their influence.

Significant influence

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IAS 28 — Investments in Associates and Joint Ventures

Exercise

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Scenario Is this an Associate?

Company P holds 20% of the voting shares in Company A. YES. This is a simple demonstration of Significant Influence.

Company P holds 10% of the voting shares in company A but has representation on the board of directors (3 of the 8 Directors are from Company P).

YES. This is a simple demonstration of Significant Influence.

Company P holds 15% of the voting shares in Company A and has 2 members on the Board of Directors (total Directors = 6). The company A Directors never vote in the meetings although they have the right to do so.

YES. Even though the right to vote is not utilised, Significant Influence still exists.

Recognition

Quiz 4 – TEST YOUR KNOWLEDGE!

Measurement

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Associates in consolidated accounts

IAS 28 — Investments in Associates and Joint VenturesMeasurement

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Use equity method in

consolidated accounts

except when…

Investment is held exclusively with a view to

disposal in the near future

Associate operates under severe long term

restrictions

Apply IFRS 9 Financial

Instruments

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When to use equity account in consolidated accounts


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Equity Accounting Commences

Equity Accounting Ceases

At the date Significant Influence is gained

At the date Significant Influence ceases

OR

The investment becomes a subsidiary

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Deemed disposal

Deemed disposal of an associate or a joint venture is simply reduction in interest or share in an associate or a joint venture other than by actual disposal by the transfer of shares or liquidation.

How the deemed disposal may happen? Very common ones are:

• You (investor) ignore the rights issue by the associate or joint venture (or you do not acquire the new shares fully).

• An associate issues warrants or options to own shares and someone else exercise them (thus new capital is issued).

• An associate issues new shares to someone else (just as in my short story above).

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How to account for deemed disposal

Does the investor lose significant influence?

Yes No

1. Gain/Loss from partial disposal2. Stop equity method3. Apply IFRS 9 for the remaining

investments

1. Gain/Loss from partial disposal2. Continue equity method3. Apply IAS 28 for the remaining

investments

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Example 1 – Entity’s stake in Associate is diluted

Entity A has an Associate, entity B, that has 100 shares in issue, of which entity A owns 30. At thetime when the investment was made, the fair value of entity B’s net assets was C233 and the initialcarrying value of the investment was C100, including C30 of goodwill.

Since the investment was made, entity B has generated profits and the carrying value of theinvestment is now C127. Entity B now has a fair value of C600.

Entity B issues 50 shares at C300 (fair value) to investors other than entity A. Entity A’s holding isnow diluted to 20% (30/150 shares).

Question: What is the gain or loss on the dilution and what will happen on the carrying value of theinvestment in associate?


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Example 1 – Entity’s stake in Associate is diluted (continued)

The dilution means that entity A has ‘disposed’ of one-third of its interest in entity B, because theinterest is diluted from a 30% to a 20% shareholding. The dilution gain or loss is calculated bycomparing the carrying value of the disposed interest (C127 × 1/3 = C42) to entity A’s share of theproceeds received for the new shares issued (C300 × 20% = C60), represented by an increase in theAssociate’s net assets. The gain on dilution is, therefore, C18.

A portion (C42) of the carrying value of the Associate is de-recognised, including de-recognition ofC10 of goodwill, being one-third of the original goodwill of C30. The share of proceeds (C60) is addedto the carrying value of the investment in the Associate. The gain (C18) increases the carrying value ofthe Associate and is recorded in profit or loss.


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Associates in individual investor accounts

Investment in Associate included in individual investor accounts should be:

- Carried at cost,

- Accounted for using equity method, or

- Accounted for as financial instruments as described in IFRS 9.


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Initial recording in the Balance Sheet

• Investment in Associates – initially record at cost


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COST = Investors % x (fair value of Net Assets) +/- Goodwill

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Subsequent recording in the Balance Sheet


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The carrying value of an associate investment increases/ decreases by the

share of profits in the investment;

Distributions received reduce carrying amount of investment;

Goodwill relating to an associate is included in the carrying amount of

the investment;

The Investor

An Associate

20%

Equity Method

Value of investment 200% investment 20%Profit made by Associate 500Share of profit 100Carrying value 300

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Example 2

Poltergeist Ltd, a company with subsidiaries, acquired 25,000 of the 100,000 ordinary shares ofAlchemists Co on 1 January 2022.

In the year to 31 December 2022, Alchemists earns profits after tax of 40,000, from which it declaresa dividend of 8,000.

What is the amount shown in Poltergeist’s consolidated income statement and balance sheet for theyear ended 31 December 2022 with respect to its investment in Alchemists?


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Measurement

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Answer

Income Statement – share of profit 10,000 (25% out of 100% share holding)

Note – the full 10,000 is recognised in the Income Statement as the payment of the dividend onlyreduces the carrying value in the consolidated Balance Sheet.

Balance Sheet


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Carrying value of investment

Original cost 100,000

P’s share of profit 10,000

Less% of dividend (2,000)

108,000

Measurement

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Income Statement

Investor’s share of Associate’s profit before tax is disclosed on one line

Investor’s share of Associate’s tax and extraordinary items are added to the corresponding lines

Investor takes account of its share of the earnings of Associate, whether or not Associate distributes the earnings as dividends


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Mechanics of Equity


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Accounting Policies

Accounting Dates

Investor must adjust Associate’s results for differences in accounting policies.

Use most recently available financial statements of Associate (usually same year end as Investor);

Be consistent from period to period;

Where year-ends are different, make adjustments for significant events/transactions.

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Elimination of unrealised profits/losses


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Investor (or consolidated

subsidiary)

Associate (accountedfor using equity

method)

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m

Do

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Unrealised profits / losses – eliminated toextent of investor’s interest in Associate

NOT to extent transaction gives evidence of impairment of asset transferred

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Example 3 – Elimination is made against the carrying amount of the Associate

An entity has a 20% interest in an Associate.

Year 201X: The Associate sells inventory costing C300 to the entity for cash of C500. The inventoryhas not been sold to third parties at the balance sheet date in year 201X. The profit attributable to theentity is required to be eliminated from the consolidated financial statements. The Associate recordeda profit of C200 on this transaction. The entity’s share of this profit is C40 (C200 × 20%).

The entity eliminates its share of the profit against the carrying amount of the Associate.


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Consolidation adjusting entry

Dr. Share of profit of the associate Cr. Investment in the associate

C40 C40

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Example 3 – Elimination is made against the carrying amount of the Associate (continued)

Year 201X+1: Assuming that the entity sells the inventory to a third party in the following year201X+1 for C500, it is necessary to reverse the profit elimination entry made on consolidation in theprior year, because the unrealised profit has now been crystallised by an onward sale.


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Dr. Investment in the associateCr. Share of profit of the associate

C40 C40

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Example 4 – Elimination is made against the asset transferred

Year 201X: The facts are the same as in example 3, except that the entity’s share of the profit (C40)is eliminated against the asset transferred. In this case, the entity’s interest in its Associate isincreased by the profits that it generates from selling upstream before the transaction is crystallisedby an onward sale. This is consistent with the requirements of paragraph 3 of IAS 28, because theAssociate is carried at an amount equal to cost plus a share of the change in net assets.

IAS 28 — Investments in AssociatesMeasurement

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Dr. Share of profit of the associate Cr. Inventory

C40 C40

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Quick quiz

Assume that Poltergeist Ltd owns 40% of Apple Book Co (ABC).

ABC sold books (inventory) to Poltergeist in 2022 for 10,000 above its cost to ABC. 20% of thisinventory remains unsold by Poltergeist at the end of 2002.

ABC’s net income for the year, including the profit on the inventory sold to Poltergeist, is 100,000.Assume that ABC’s tax rate is 35%. How much of ABC’s profit should be recognised in Poltergeist’sincome statement for the year?

(a) 40,000 (b) 39,200 (c) 39,480


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Measurement

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Answer

Poltergeist records 40,000 as its 40% share of ABC’s results (100,000 x 40%) for the year 2022. Itthen has to take into account the unrealised profit on inventory purchased from ABC.

(a) 40,000. It is not correct as the adjustment for unrealised profit has been omitted.

(b) 39,200. 40,000 – 800 = 39,200 is not correct. The unrealised profit has been taken into account;however, this profit has not been reduced by the tax (35%).

(c) 39,480. (100,000 – 1,300) x 40% is the correct answer. The after tax unrealised profit has beenreduced from the results of ABC, which has further been multiplied by the shareholding to derive39,480.


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The correct answer is

% Inventory unsold 20%

Unrealised intra-co profit (20% x 10,000) 2,000

Unrealised intra-co profit net of taxes (2,000 x 0.65) 1,300

Measurement

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Example 5 – Downstream transactions: accounting for unrealised gains

Entity A owns 20% of the shares of its Associate, entity B. Entity A sells an asset to entity B for cash

of C400 in 201X. The carrying amount of the asset in entity A’s financial statements before the

transaction is C300.

The total gain to entity A from the transaction is C100. The gain should be reduced in entity A’s

consolidated financial statements by C20 (C100 × 20%) to reflect the entity’s interest.

The carrying amount of entity A’s investment in entity B in its consolidated financial statements is C5

just before the transaction. Entity A has no legal or constructive obligation on behalf of entity B, and it

has no long-term loans to entity B.

Entity B earns profits of C60 in 201X+1. The share of entity A in the profit of entity B is C12. At 31

December 201X+1, entity B still owns the asset that it acquired from entity A.

The asset is sold to a third party in 201X+2.


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Example 5 – Downstream transactions: accounting for unrealised gains (continued)

In 201X, the unrealised gain of C20 is eliminated, up to the point at which the carrying amount ofentity B in entity A’s consolidated financial statements is reduced to zero (that is, C5). No adjustmentis made for the remaining gain of C15 that entity A recognised in its consolidated financialstatements.

Because entity B earns profits, entity A will eliminate the remaining excess gain, up to the amount ofprofits available. A further C12 (20% of C60) of unrealised gain is eliminated in 201X+1. This meansthat no share of entity B’s profits is recognised in profit or loss.

The asset is sold to a third party in 201X+2. Thus, all of the previously deferred gain of C17 (C5 + C12)is recognised in 201X+2.


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Recognition of Losses of an associate

If Investor’s % of Associate losses = or > carrying value of the investment

STOP including share of further losses and Investment in Associate then recorded at nil value

Exception:

– where Investor incurred obligations/made payments on behalf of Associate that Investor hasguaranteed / otherwise committed


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Disposal of an Associate


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Partial Disposal where no longer retain significant influence:

carrying value of the investment is frozen

cease using equity method

continue to account as a financial asset under IFRS 9

Three entries required on disposal of Associate:

The tax effect should also be computed

The ProceedsThe reduction in the investment account

The gain or loss

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Example 6 – Partial disposal of an Associate retaining significant influence

Entity A has a 40% stake in entity B. Entity B is an Associate of entity A. During the period, entity Asells a quarter of its stake (10%) in entity B for consideration of C80 million. From the date of thepartial disposal, entity A will continue to recognise its remaining 30% interest in entity B as anAssociate. Entity B’s net asset carrying value at the date of the partial disposal is C300 million.Goodwill was calculated at C30 million at the date of acquiring the Associate and there has been noimpairment recognised.

At the date of the partial disposal, the Associate’s carrying values in entity A’s consolidated financialstatements are as follows:


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Investment in Associate (including goodwill) (40% x C300m + C30m) C150m

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Example 6 – Partial disposal of an Associate retaining significant influence (continued)

The accounting entry for the partial disposal is as follows:

The remaining investment in the Associate will continue to be accounted for using the equity methodfor the remaining 30% interest.


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Accounting entry Amount (in C)

Dr Cash 80m

Cr Investment in associate (25% x (40% x C300m + C30m)) 37.5m

Cr Gain on partial disposal 42.5m

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Impairment of investment in Associate

• Apply IAS 36 “Impairment of Assets”

• In determining Value in Use of investment, IAS 28 sets out specific items to consider

• Normally assess recoverable amount for each individual Associate


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Disclosure & Summary

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IAS 28 — Investments in Associates and Joint VenturesDisclosure

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Accounting Policies

List of significant Associate holdings

Balance Sheet presentation

Description of accounting policies used to accountfor Associates (as required by IAS 1)

Listing and description of significant Associates,including the proportion of ownership interest and,if different, the proportion of voting power held.

Investment in Associate (held as a long term asset)

Income Statement presentation

Share of Associates earnings - separate item aboveProfit before Tax

Contingencies In accordance with IAS 37 ‘Provisions, ContingentLiabilities and Contingent Assets’

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The key criteria is significant influence - ‘power to participate’, but not to ‘control’.

Significant influence presumed when the investor holds 20%+ of investee’s voting power.

Significant Influence may exist when < 20% is held if there is clear evidence to the contrary.

In the consolidated accounts, Associate’s should be accounted for using the equity method.

IAS 28 — Investments in Associates and Joint VenturesSummary

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