FINAL PAPER 1 Financial Reporting Chapter 5 Unit 3
CA. Ajay Lunawat
Learning Objectives
Meaning of Associates
Accounting Method for Associates
Non- Application of Equity Method
Treatment of change in equity of associate not arising out
of profit and loss account
Meaning of Associates
An associate
is an enterprise in which
an investor has significant influence and
which is neither a subsidiary
nor a joint venture of the investor.
Significant Influence
'Significant influence’ means the power
to participate in the financial,
and operating policy decisions of the investee
but the investor does not have control over those
policies.
Indicators of significant influence
Gained by
virtue of
Ownership
Statute
Agreement
Indicators of Significant influence
Representation on the board of directors or corresponding
governing body of the investee;
Participation in policy making processes;
Material transactions between the investor and the investee;
Interchange of managerial personnel; or
Provision of essential technical information.
Significant Influence
Holding 20% or more of voting power
Holds 20 % or more
voting power
Yes
No
Significant
influence
presumed to exist
Significant
influence not
presumed to exist
Significant Influence
Holding 20% or more of voting power
Significant influence presumed to exist
If it can be clearly demonstrated that the investor
does not have significant influence,
The investment
will not be accounted for as an associate.
Significant Influence
Holding less than 20% of voting power
Significant influence presumed not to exist
If it can be clearly demonstrated that the
investor have significant influence,
The investment
will be accounted for as an associate.
Accounting for Associates
Equity Method
• General Rule is that investments in associate is
accounted using Equity Method
Non applicability of Equity Method
• when an investment is acquired for the
purpose of disposal in the near future
• there is severe long term restriction on fund
transfer by the associate to the investor.
Equity Method of Accounting
Investment is initially recorded at cost
Carrying amount is increased/decreased on the basis of
share in the profit/loss
Distributions received from the investee reduce the carrying
amount of the investment
Initial recording of Investment
Value of Investment
Proportionate value of net assets
of the investee
Purchase Price > Value
of Investments
Purchase Price <
Value of Investments
Goodwill
Capital Reserve
Treatment of Goodwill / Capital Reserve
Goodwill / Capital Reserve
Included in the carrying amount of the
investments with a separate disclosure
Steps of Equity Method
Step 1 : Date of Investment
Step 2 : Extent of Investment
Step 3 : Analyse Profits
Step 4 : Share of Pre and Post acquisition profits
Step 5 : Ascertain Cost of Control
Step 6 : Inter Company Transactions
Step 7 : Reserves for consolidated balance sheet
Step 8 : Ascertain Carrying amount of investment
Steps of Equity Method
Step 1 :
Date of
Investment
• Ascertain date of investment of
investing entity in associate
• Investments may be made on more
than one date.
Step 2 :
Extent of
investment
• Ascertain extent of investing entity’s
interest in associate
Steps of Equity Method
• Analyse profits of associate as pre
Step 3 : Analyse acquisition and post acquisition
with reference to date of
profits
investment (Step 1)
Step 4 : Share
of pre and post • Ascertain investing entity’s share
of pre acquisition and post
acquisition
acquisition profits
profits
Steps of Equity Method
Step 5 : Ascertain Cost of Control
A)
B)
C)
Cost of Investment
(i) Amount invested
XXX
(ii) Less : Pre-acquisition Dividend
(XXX)
XXX
Share of net assets on the date of investment
represented by investing entity’s share of
(i) Share Capital
XXX
(ii) Pre acquisition Profits
XXX
Goodwill / Capital Reserve (A-B)
XXX
XXX
Steps of Equity Method
Step 6 : Inter
Company
Transactions
• Ascertain unrealised profits to the
extent of investing entity’s interest
• Inter company owings –No
adjustment is required
Steps of Equity Method
Step 7 : Reserves for consolidated balance sheet
A.
Aggregate reserves of parent and subsidiaries as per AS 21
XXX
B.
Add : Investing entity’s share of post acquisition profit of
associate (Step 4)
XXX
C.
Less : Unrealised profit – investing entity’s share (Step 6A)
(XXX)
D.
Net for Consolidated Balance Sheet
XXX
Steps of Equity Method
Step 8 : Carrying amount of investment
A.
Investing entity’s share of net assets of associate as
at date of investment (5B)
XXX
B.
Adjust for Goodwill / Capital Reserve (5C)
XXX
C.
Add / Less : Investing entity’s share of post
acquisition profit of associate (Step 4)
XXX
D.
Less : Dividends received from associate
(XXX)
E.
Less : Investors share of unrealised profit (6A)
(XXX)
F.
Net for Consolidated Balance Sheet
XXX
XXX
Important Points
Unrealised profit or loss resulting from transactions between the
investor (and its consolidated subsidiary) and the associate
should be eliminated to the extent of interest of the investor in
the associate.
In case an associate has made a provision for proposed dividend
in its financial statements, the investor’s share of the results of
operations of the associate should be computed without taking
into consideration the proposed dividend [ASI-16].
Non- Application of Equity Method
If any of the two conditions under-mentioned are fulfilled, the investment
is not accounted for using the equity method
a) when an investment is acquired for the purpose of disposal in the near
future, i.e., as short term investments; and
b) there is severe long term restriction on fund transfer by the associate to
the investor.
Accounted for in accordance with AS 13 ‘Accounting for Investments’ with
disclosure of the reasons for not applying the equity method in
accounting for investments;
Treatment of change in equity of associate not
arising out of profit and loss account
For example, the associate may revalue its fixed assets
and create revaluation reserve.
• increase/decrease in the value of investments should be
directly added to/subtracted from the carrying amount
of investments
• with corresponding credit/debit to the balance of the
consolidated profit and loss account in the balance
sheet
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