IAS 28 - Investments in Associates and Joint Ventures (detailed review)

Objective

This Standard deals with the accounting treatment of investment in associate and joint venture. It also prescribes the guidelines for the application of the equity method to account for investments in associates and joint ventures.

Scope

The requirements of this standard are applicable in the financial statements of entities which have investment in associate or joint venture to account for such investments.

Definitions

Associate
The entity which is subject to significant influence by another entity is called associate.

Significant Influence
It is the ability to participate in the operating, financial and accounting policy decisions of the investee but other than control or joint control over the investee.

Joint Arrangement
It is when two or more parties have joint control of another entity.

Joint Control
It is the contractually agreed sharing of control of an arrangement which requires mutual consent of the parties sharing control regarding the relevant activities of such arrangement.

Joint Venture
It is when a separate legal entity is subject to joint control of two or more parties and the parties that have joint control of the arrangement have rights to the net assets of such arrangement.

Joint Venturer
The party to a joint venture that has joint control of the arrangement is called joint venturer.

Establishment of Significant Influence

• The entity is deemed to have significant influence over the investee if the entity owns, directly or indirectly (e.g. through subsidiary), 20 percent or more of the voting rights of the investee, unless it is clear that this is not the case.
• On the other side, if the entity owns, directly or indirectly (e.g. through subsidiary), less than 20 per cent of the voting rights of the investee, it is assumed that the entity does not have significant influence over the investee. However, there are some certain circumstances when entity owns less than 20% voting rights of the investee but entity can exercise significant influence over the investee such circumstances may include:

(a) The entity has representation on the board of directors or equivalent governing body of the investee;
(b) The entity has the right to participate in policy-making processes regarding relevant activities of the investee
(c) Occurrence of substantial transactions between the entity and its investee;
(d) Inter-change of management personnel between the entity and its investee
(e) Provision of essential technical information and services by the entity to investee.

• The entity may own share warrants, share call options, debt or other equity instruments that are convertible into ordinary shares and have the potential, if exercised or converted, to give the entity additional voting rights in the investee. Therefore, in determination of significant influence, the entity should consider not only the existing voting rights but also such potential voting rights, if these are currently exercisable or can be converted any time, when assessing whether an entity has significant influence.

• The entity should consider all the pertinent facts and circumstances including the contractual terms relating to the potential voting rights when these are considered in the assessment of significant influence.

• The entity loses the significant influence over the investee when entity loses its ability to participate in the operating, financial and accounting policy decisions of the investee.

Equity Method and Application

• When an entity has significant influence over, or a joint control of, an investee. It will account for such investment in an associate or a joint venture as per the Equity Method under this standard

• Equity method requires the investment in associate or joint venture to be measured at:

(a) Cost of investment which is adjusted for

(b) Investor’s share of profit or loss in the investee’s post acquisition profit or loss and

(c) Investor’s share of other comprehensive income, in the investee’s post acquisition other comprehensive income

(d) Any dividend received will be deducted from the carrying amount of investment

• If potential voting rights exist and have been considered in determination of an entity’s interest in an associate or a joint venture, the entity’s share of investee’s net assets will be determined on the basis of existing ownership interests only.

• If the investee has in issuance irredeemable preference share, the investee’s profit should be adjusted for the dividend relating to such preference shares whether or not the dividend has been declared, before determining the entity’s share of profit or loss in investee’s profit or loss.

• The application of equity method will start right from the date when the entity obtains significant influence over, or a joint control of, an investee.

• On the date of acquisition of the investment in associate or joint venture, the difference between the original cost of acquiring the investment and the entity’s share in the fair value of the identifiable net assets of investee will be accounted for as follows:

(a) Any excess of original cost of acquiring the investment over the entity’s share in the fair value of the identifiable net assets of the investee will be goodwill, which is not recognized separately as it is included in the carrying amount of the investment.

(b)  Any excess of entity’s share in the fair value of the identifiable net assets of investee over the original cost of acquiring the investment will be treated as income in the entity’s financial statements in the period in which the investment is acquired.

• Appropriate adjustment will be made in respect of additional depreciation based on the fair value of investee’s depreciable assets at the date of acquisition in determination of entity’s share of the associate or joint venture.

• If the reporting date of associate or joint venture is different from the reporting date of the entity. The entity will account for such situation as follows:

(a) If the difference between the reporting date of the associate or joint venture and the reporting date of the entity is no more than three months, then adjustments will be made for the effects of material transactions or events that has taken place between that date and the reporting date of the entity’s financial statements

(b) If the difference between the reporting date of the associate or joint venture and the reporting date of the entity is more than three months, then the associate or joint venture is required to prepare additional financial statements to the same reporting date as the financial statements of the entity for the application of equity method.

• If the accounting policies of the associate or joint venture are different from the accounting policies of the entity for like transactions or events, adjustment will be made to bring in line the accounting policies of the associate or joint venture as to the entity’s accounting policies before the application of equity method.

• If the associate or a joint venture has reported net loss for the period, the entity will recognize its share of loss in associate or joint venture only up to extent of its interest in the associate or joint venture, any excess loss will not be recognized. The interest in an associate or a joint venture is the carrying amount of the investment in the associate or joint venture calculated using the equity method.

• However, if the entity’s interest is reduced to zero because of entity’s share of post acquisition loss in associate or joint venture, additional losses and related liability can only be recognized up to the extent that the entity has a legal or constructive obligation to compensate such excess losses. And if the associate or joint venture reports profit in the subsequent periods, the entity will recognize its share of profit after its share of losses not recognized.
• Intra-group receivable and payable balances with associate and joint venture are not cancelled out.

• Similarly, intra-group sales with associate or joint venture are not cancelled out. However, the profit or loss on such transactions will be eliminated as follows:

(a) For downstream transaction (i.e. when entity is seller of stock to the associate or joint venture) and upstream transaction (i.e. when associate or joint venture is seller of stock to the entity), any resulting gain will be recognized only up to the extent of other investor’s interest and such gain up to the extent of entity’s own interest will be eliminated.

(b) In case of downstream transactions, if there is loss on the assets to be sold or contributed, or impairment loss on such assets, these losses will be recognized in full in the financial statements of Investor

(c) In case of upstream transactions, if there is loss on the assets to be sold or contributed, or impairment loss on such assets, the investor will recognize its share of loss in its own financial statements.

(d) If an entity receives equity interest in an associate or joint venture in exchange for the contribution of a non-monetary asset to an associate or a joint venture, any resulting gain or loss on this transaction will be accounted for as above in (a) to (c) above.

Impairment Loss on Investment in Associate or joint Venture

If there is an indication of impairment in respect of entity’s investment in associate or joint venture, the whole carrying value of the investment will be tested for impairment as a single asset under IAS 36 by comparing the recoverable amount with its carrying value using equity method, and any resulting impairment loss will be charged against the carrying value of investment in associate or joint venture.

Discontinuing the Use of the Equity Method

The entity will discontinue the use of the equity method right from the date when it loses significant influence over, or joint control of, an associate or a joint venture. And it will be accounted for as follows:

(a) If this investment becomes a subsidiary, then it will be accounted for as per IFRS 3 Business Combination& IFRS 10 Consolidated financial statements.

(b) If this investment becomes ordinary investment, the retained investment will be accounted for under IFRS 9, any gain or loss will be recognize in statement of profit or loss which is the difference between:

(i) Proceeds from disposal of part interest plus fair value of retained investment and

(II) Carrying value of the investment on this date.

(c) When the entity ceases the use of the equity method, the entity is required to reclassify any gain or loss that had previously been recognized in other comprehensive income to the statement of profit or loss.

(d) If the investment in associate becomes an investment in joint venture or vice versa, the entity will continue to recognize the use of equity method.

Classification as Held for Sale

• If an entity classifies an investment or a portion of an investment in an associate or a joint venture as held for sale, such investment or portion of investment will be covered under IFRS 5.
• The entity will account for any remaining portion of investment in associate or joint venture using the equity method, till the disposal of the portion which is classified as held for sale.
• However, after the disposal of the portion which is classified as held for sale, the entity will account for any remaining interest in the associate or joint venture as per IFRS 9 unless the remaining interest continues to be an associate or joint venture, in such a case the entity will use the equity method.

Exemptions from Equity Method Application

• The entity is not required to account for its investment in associate or joint venture as per the equity method if it meets all of the following:

(a) The entity is a wholly or a partially-owned subsidiary of another entity and its owners do not have any objection for not applying the equity method.
(b) The debt or equity instruments of the entity are not traded in the public, local and regional markets.
(c) The entity is not in the process of issuing any class of instruments for trading in a public market.
(d) The entity’s ultimate or any intermediate parent prepares consolidated financial statements for use by the public.

• If an investment in an associate or a joint venture is held by, or is held indirectly through an entity that is a venture capital organization, or a mutual fund, the entity may chose to measure such investments in those associates and joint ventures at fair value through profit or loss as per IFRS 9.

Separate Financial Statements

When an entity prepares Separate Financial Statements, it will account for its Investment in associate and any other ordinary investment either:

• At Cost or
• As per the IFRS 9

 

Worked Example

On 1 January 2013, AB Ltd. acquired 30% of the ordinary share capital of Grange a private limited company, which gives it the significant influence over the investee. The purchase consideration was $5 million, and on this date the fair value of the net assets of Handy was $18 million.
On the date of acquisition, the retained earnings and other reserve of Grange Ltd were $8 million and $6 million respectively. The summarized statement of financial position of Grange Ltd at 31 December 2013 is as follows:

 

	$m
Share capital of $1	4
Other reserves	6
Retained earnings	10
Total Net Assets	20

 

There had been no new issues of shares by Grange Ltd, since acquisition by AB Ltd and the estimated recoverable amount of the net assets of Grange Ltd at 31 December 2013 was $22 million.

Required
Discuss how the investment in Grange Ltd. will be accounted for in the financial statements of AB Ltd for the year ended 31 December 2013 and calculate the impairment loss in respect of investment in associate(if any) at 31 December 2013.

Solution:

• If an entity owns 20% or more of the voting rights in another entity, it is deemed that the entity have significant influence over the investee. When an entity has significant influence over an investee the entity will account for such investment in an associate as per the Equity Method under IAS 28.

• Equity method requires the investment in associate or joint venture to be measured at:

(a) Cost of investment, which is adjusted for

(b) Investor’s share of profit or loss, in the investee’s post acquisition profit or loss and

(c) Investor’s share of other comprehensive income, in the investee’s post acquisition other comprehensive income

(d) Any dividend received will be deducted from the carrying amount of investment.

• On the date of acquisition of associate, any excess of entity’s share in the fair value of the investee’s identifiable net assets over the cost of investment will be treated as income in the entity’s financial statements in the period in which the investment is acquired. Therefore, the excess or negative goodwill of $0.4 million [$5 million – ($18×30%)] will be treated as income in the statement of profit or loss (Dr. Cost $0.2million, Cr. P/L $0.2million).

 

Note:

 The $0.4 million is not part of post acquisition retained earnings. It is adjustment to the original cost to adjust the negative goodwill.

• This is investment in associate therefore, the equity method will be applied as follows:

	$’m
Cost of investment	5
Plus adjustment of negative goodwill [$5 million – ($18×30%)]	0.4
Adjusted Cost	5.4
Plus Share of Post Acquisition Profit ($10 - $8) × 30%	0.6
Plus Share of Post Acquisition OCI	-
Carrying value of investment	6

For the purpose of impairment test, the recoverable amount will be compared with its carrying value using equity method as follows:

	$’m
Carrying value of investment (using equity method as above)	6
Impairment Loss	-
Recoverable value ($22 million × 30%)	6.6

As the recoverable value is higher than carrying value, therefore there is no impairment loss and investment will remain at $6 million in the statement of financial position of AB Ltd.