CHAPTER 4

ASSOCIATES
IAS 28 defines an associate as an entity over which the investor has significant influence. 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 those policies.

Significant influence is assumed with a shareholding of 20% to 50%. An associate is accounted for base
on the principle of equity accounting.

Principles of equity accounting and reasoning behind it

Equity accounting is a method of accounting whereby the investment is initially recorded at cost and
adjusted thereafter for the post-acquisition change in the investor’s share of net assets of the
associate.

The effect of this is on the consolidated statement of financial position includes:

➢ 100% of the assets and liabilities of the parent and subsidiary company on a line by line basis
➢ An ‘investments in associates’ line within noncurrent assets which includes the cost of the
investment plus the group share of post-acquisition reserves.

The effect of this on the consolidated statement of profit or loss includes:

➢ 100% of the income and expenses of the parent and subsidiary company on a line by line basis
➢ One line ‘share of profit of associates’ which includes the group share of any associate’s profit
after tax.

Note: in order to equity account, the parent company must already be producing consolidated
financial statements (i.e. it must already have at least one subsidiary).

Equity method exemption

Accounting for associates according to IAS 28
The equity method of accounting is normally used to account for associates in the consolidated
financial statements.

The equity method should not be used if:

➢ The investment is classified as held for sale in accordance with IFRS 5 or
➢ The parent is exempted from having to prepare consolidated accounts on the grounds that it
is itself a wholly, or partially, owned subsidiary of another company (IFRS 10).

Associates in the consolidated statement of financial position

Preparing the CSFP including an associate
The CSFP is prepared on a normal line by line basis following the acquisition method for the parent
and subsidiary. The associate is included as a noncurrent asset investment calculated as:

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The group share of the associate’s post- acquisition profits or losses and the impairment of associate
investment will also be included in the group retained earnings calculation.

Standard workings
The calculations for an associate (A) can be incorporated into standard CSFP workings as follows:

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Fair values and the associate
If the fair value of the associate’s net assets at acquisition are materially different from their book
value the net assets should be adjusted in the same way as for a subsidiary.

Balances with the associate

Generally the associate is considered to be outside the group. Therefore balances between group
companies and the associate will remain in the consolidated statement of financial position.

If a group company trades with the associate, the resulting payables and receivables will remain in the
consolidated statement of financial position.

Unrealised profit in inventory

Unrealised profits on trading between group and associate must be eliminated to the extent of the
investor's interest (i.e. % owned by parent).

Adjustment must be made for unrealised profit in inventory as follows.

(1) Determine the value of closing inventory which is the result of a sale to or from the associate.
(2) Use mark-up/margin to calculate the profit earned by the selling company.
(3) Make the required adjustments. These will depend upon who the seller is:
Parent company selling to associate – the profit element is included in the parent company’s
accounts and associate holds the inventory.
Dr Group retained earnings (W5)
Cr Investment in associate (W6)

Associate selling to parent company – the profit element is included in the associate
company’s accounts and the parent holds the inventory.
Dr Group retained earnings (W5)
Cr Group inventory

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Exercise 1
Below are the statements of financial position of three entities as at 30 September 20X8

Further information:

(i) P acquired 75% of the equity share capital of S several years ago, paying $5 million in cash. At
this time the balance on S's retained earnings was $3 million.

(ii) P acquired 30% of the equity share capital of A on 1 October 20X6, paying $750,000 in cash. At
1 October 20X6 the balance on A's retained earnings was $1.5 million.

(iii) During the year, P sold goods to A for $1 million at a mark-up of 25%. At the year-end, A still
held one quarter of these goods in inventory.

(iv) As a result of this trading, P was owed $250,000 by A at the reporting date. This agrees with the
amount included in A's trade payables.

(v) At 30 September 20X8, it was determined that the investment in the associate was impaired by
$35,000.

(vi) Non-controlling interests are valued using the fair value method. The fair value of the non-
controlling interest in S at the date of acquisition was $1.6 million.

Required: Prepare P’s consolidated statement of financial position as at 30 September 20X8.

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Exercise 2
P acquired 80% of S on 1 December 20X4 paying $4.25 in cash per share. At this date the balance
on S’s retained earnings was $870,000. On 1 March 20X7 P acquired 30% of A’s ordinary shares. The
consideration was settled by a share exchange of 4 new shares in P for every 3 shares acquired in
A. The share price of P at the date of acquisition was $5. P has not yet recorded the acquisition of
A in its books.

The statements of financial position of the three companies as at 30 November 20X7 are as
follows:

The following information is relevant:

(i) As at 1 December 20X4, plant in the books of S was determined to have a fair value of $50,000
in excess of its carrying amount. The plant had a remaining life of 5 years at this date.

(ii) During the post-acquisition period, S sold goods to P for $400,000 at a mark-up of 25%. P had
a quarter of these goods still in inventory at the year-end.

(iii) In September 20X4 A sold goods to P for $150,000. These goods had cost A $100,000. P had
$90,000 (at cost to P) in inventory at the year-end.

(iv) As a result of the above inter-company sales, P’s books showed $50,000 and $20,000 as owing
to S and A respectively at the yearend. These balances agreed with the amounts recorded in
S’s and A’s books.

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 (v) Non-controlling interests are measured using the fair value method. The fair value of the non-
controlling interest in S at the date of acquisition was $368,000. Goodwill has impaired by
$150,000 at the reporting date. An impairment review found the investment in the associate
to be impaired by $15,000 at the year-end.

(vi) A’s profit after tax for the year is $600,000.

Required: Prepare P’s consolidated statement of financial position as at 30 November 20X7.

Associates in the consolidated statement of profit or loss

The equity method of accounting requires that the consolidated statement of profit or loss does not
include dividends from the associate but instead includes the parent’s share of the associate’s profit
after tax less any impairment of the associate in the year, presented below group profit from
operations.

Generally, the associate is considered to be outside the group. Therefore, any sales or purchases
between group companies and the associate are not normally eliminated and will remain part of the
consolidated figures in the statement of profit or loss.

It is normal practice to adjust for the unrealised profit in inventory. Only P's share of the unrealised
profit must be adjusted. Regardless of which company sells to the other, this amount should be
deducted from the share of the associate's profit.

Illustration 2 – Associates in consolidated SPL

Below are the statements of profit or loss for P, S and A for the year ended 30 September 20X8

Further information:
• P acquired 80% of S several years ago.
• P acquired 30% of the equity share capital of A on 1 October 20X6.
• During the current year, P sold goods to A for $1 million at a markup of 25%. At the year-end, A
still held one quarter of these goods in inventory.
• At 30 September 20X8, it was determined that the investment in the associate was impaired by
$35,000, of which $20,000 related to the current year.

Required:
Prepare P’s consolidated statement of profit or loss for the year ended 30 September 20X8.

Solution
Consolidated statement of profit or loss for the year ended 30 September 20X8

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(W1) PUP
Inter-company trading between the parent and associate are not eliminated as the associate is
outside the group. Therefore, no adjustment in respect of the sale for $1 million needs to be
made.

PUP = P's % × profit in inventory

Profit on sale (25/125 × $1,000,000) $200,000
Profit in inventory (1/4 × $200,000) $50,000
PUP (30% × $50,000) $15,000

In the CSPL, the PUP will be deducted from the parent's share of the associate's profit for the
year.

Exercise 3
Below are the statements of profit or loss of the Barbie group and its related companies as at 31
December 20X8.

You are also given the following information:

(i) Barbie acquired 45,000 ordinary shares in Ken a number of years ago. Ken has 50,000
$1 ordinary shares.

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 (ii) Barbie acquired 60,000 ordinary shares in Alice a number of years ago. Alice has
200,000 $1 ordinary shares.

(iii) During the current year Alice sold goods to Barbie for $28,000. Barbie still holds some
of these goods in inventory at the year end. The profit element included in these
remaining goods is $2,000.

(iv) Non-controlling interests are valued using the fair value method.

(v) Goodwill and the investment in the associate were impaired for the first time during
the year as follows:

Alice $2,000
Ken $3,000

Impairment of the subsidiary’s goodwill should be charged to operating expenses.

Prepare Barbie’s consolidated statement of profit or loss for the year ended 31 December 20X8.

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