HAND-OUT NO.

10: INVESTMENT IN ASSOCIATE

Brian Christian S. Villaluz, CPA
FINANCIAL ACCOUNTING AND REPORTING
HAND-OUT NO. 10: Investment in Associate

INTRODUCTION
An associate is an entity over which the investor has significant influence.

TYPES OF INVESTMENT Nature of relationship Applicable Standard

with investee
Investment measured at fair value Regular investor IFRS 9
Investment in associate Significant influence IAS 28
Investment in subsidiary Control IFRS 3 and IFRS 10
Investment in joint venture Joint control IFRS 11 and IAS 28

Significant influence is the power to participate in the financial and operating policy decisions of the investee but not to
control those policies. It is presumed to exist if the investor holds, directly or indirectly (e.g., through subsidiaries), 20%
or more of the voting power of the investee. An investor may have significant influence even if it has less than 20% of the
voting power if these can be clearly demonstrated.

Percentage of ownership interest Types of investment

Less than 20% Financial assets at fair value
20%-50% Investment in associate
51%-100% Investment in subsidiary

Other evidences of significant influence

Any of the following may provide evidence of the existence of significant influence even if the percentage of ownership
interest is less than 20%:
a. Representation on the board of directors or equivalent governing body of the investee;
b. Participation in policy-making processes, including participation in decisions about dividends or other
distributions;
c. Material transactions between the entity and its investee;
d. Interchange of managerial personnel; or
e. Provision of essential technical information.

Voting Rights
The investment should provide the investor voting rights for significant influence to exist. Therefore, investment in
preference shares, regardless of percentage of ownership, is not accounted for under IAS 28 because preference shares
do not give the investor voting rights.

Equity method
Investment in associates are accounted for using the equity method. Under the equity method, the investment is initially
recognized at cost and subsequently adjusted for the investor‘s share in the investee’s change in equity (e.g., profit or
loss, dividends, and other comprehensive income).

Application of Equity method

An investor starts using the equity method as from the date when it obtains significant influence over the investee.

Problem 1: (Acquisition cost is equal to the carrying amount of the net assets acquired)
At the beginning of 2018, RR Company purchased 20% of SS Company’s ordinary shares outstanding for P6,000,000.
Transaction cost incurred is 10% of the purchase price of the shares. At the date of acquisition, the carrying amount of the
identifiable net assets were equal to their fair values. During the current year, the investee reported net income of
P7,000,000 and paid cash dividend of P4,000,000.

In 2019, SS reported loss of P1,000,000 and issued 10% stock dividends, and recognized revaluation surplus of P300,000
and loss on exchange differences on translation of foreign operations of P100,000 in other comprehensive income.

1. Prepare the journal entries to record the foregoing.

2. What is the investment income in 2018?

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Brian Christian S. Villaluz, CPA
3. What is the carrying amount of the investment in associate at December 31, 2018?
4. What is the investment income in 2019?
5. What is the carrying amount of the investment in associate at December 31, 2019?

Problem 2: (Existence of significant influence even if ownership percentage is less than 20%) [ANSWER: B]
At the beginning of current year, Harrison Company purchased 10% of Wells Company’s ordinary shares for P4,000,000.
Harrison Company is the largest single shareholder in Wells Company and Harrison’s officers are a majority of Wells’ board
of directors. The investee reported net income of P5,000,000 for the current year and paid cash dividend of P1,500,000.

What amount should be reported as investment in Wells Company at year-end?

A. 4,500,000 B. 4,350,000
C. 4,000,000 D. 3,850,000

Problem 3: (Net income is earned unevenly during the year)

On July 1, 2018, BP Company paid P1,000,000 for 100,000 outstanding shares which represent 40% of CA Company. At
that date, the net assets of CA Company totaled P2,500,000 and the fair values of all of CA Company’s identifiable assets
and liabilities were equal to their carrying amount. CA Company reported net income of P500,000 for 2018, of which
P200,000 was for the six months ended June 30, 2018. CA Company paid cash dividend of P250,000 on September 30,
2018.

What amount of income should be reported from the investment in CA Company?

A. 200,000 B. 100,000
C. 120,000 D. 80,000

Problem 4: (Net income is earned evenly during the year)

On July 1, 2018, DT Company purchased 30,000 shares of EE Company’s 100,000 outstanding ordinary shares for P200
per share. On December 15, 2018, the investee paid P400,000 in cash dividend to the ordinary shareholders.

The investee’s net income for the year ended December 31, 2018 was P1,200,000, earned evenly throughout the year.

What amount of income from the investment should be reported in 2018?

A. 360,000 B. 180,000
C. 120,000 D. 60,000

Problem 5: (Cost of Investment is not equal to the fair value of investee’s identifiable net assets)
At the beginning of current year, US Company bought 40% of SE Company’s outstanding ordinary shares for P3,500,000.
The company also paid P500,000 to a business broker who helped find a suitable business and negotiated the purchase.

The carrying amount of SE’s net assets at the purchase date totaled P9,000,000.

The difference was attributed to plant which had a carrying amount of P1,100,000 and a fair value of P2,000,000 and to
inventory which had a carrying amount of P250,000 and a fair value of P350,000. The plant has an 18-year life. All inventory
was sold during the current year.

During the current year, the investee reported net income of P1,200,000 and paid a P200,000 cash dividend.

1. What amount should be reported as investment income for the current year?
A. 480,000 B. 420,000
C. 360,000 D. 320,000

2. What is the carrying amount of the investment in associate at year-end?

A. 4,400,000 B. 4,420,000
C. 4,340,000 D. 4,220,000

Problem 6: (Cost of Investment is not equal to the fair value of investee’s identifiable net assets)
At the beginning of current year, MA Company purchased 40% of the outstanding ordinary shares of BR Company for
P3,500,000 when the net assets of BR amounted to P7,000,000.

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Brian Christian S. Villaluz, CPA
At acquisition date, the carrying amounts of the identifiable assets and liabilities of BR were equal to their fair value, except
for equipment for which the fair value was P1,500,000 greater than carrying amount and inventory whose fair value was
P500,000 greater than cost.

The equipment has a remaining life of 4 years and the inventory was all sold during the current year.

MA Company reported net income of P4,000,000 and paid P1,000,000 cash dividends during the current year.

1. What is the maximum amount of the “equity in earnings of the investee”?

A. 1,350,000 B. 1,250,000
C. 1,600,000 D. 1,700,000

2. What is the carrying amount of the investment in associate at year-end?

A. 4,450,000 B. 4,350,000
C. 4,700,000 D. 4,850,000

Problem 7: (Investment in Ordinary and Preference Shares)

Hyper Company owned 20% of ER Company’s preference share capital and 50% of the ordinary share capital on December
31, 2018. The investee reported net income P600,000 for the year ended December 31, 2018.

10% cumulative preference share capital P 1,000,000

Ordinary share capital 7,000,000

What is the equity in earnings of the investee for 2018?

A. 270,000 B. 300,000
C. 350,000 D. 250,000

Problem 8: (Share in investee’s net loss) [Answer: B]

At the beginning of the current year, LL Company acquired 40% of the outstanding ordinary shares of an investee for
P6,500,000. The carrying amount of the net assets of the investee equaled P12,500,000. Any excess of cost over carrying
amount is attributable to goodwill.

The investee reported net loss of P4,000,000 and paid cash dividend of P2,500,000.

What is the carrying amount of the investment at year-end?

A. 6,500,000 B. 3,900,000
C. 4,900,000 D. 5,500,000

Problem 9: (Step Acquisition)

On January 1, 2018, Mega World Company acquired 10% of the outstanding ordinary shares of Hela Company for
P4,000,000. The investment was appropriately accounted for under cost method.

On January 1, 2019, Mega World gained the ability to exercise significant influence over financial and operating control of
Hela by acquiring an additional 20% of Hela’s outstanding ordinary shares for P10,000,000.

The fair value of Hela’s net assets equaled their carrying amount. The fair value of the 10% interest on January 1, 2018 was
P6,000,000.

For the years ended December 31, 2018 and 2019, the investee reported the following:

2018 2019
Dividends paid 2,000,000 3,000,000
Net income 6,000,000 6,500,000

The recoverable value of the net assets of Hela Company is P50,000,000.

1. What is the investment income in 2018?

A. 200,000 B. 400,000
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C. 600,000 D. 300,000

2. What is the investment income in 2019?

A. 1,300,000 B. 1,950,000
C. 1,000,000 D. 1,900,000

3. What is the carrying amount of the investment in associate on December 31, 2019?
A. 16,000,000 B. 17,050,000
C. 15,000,000 D. 16,700,000

Problem 10:
Chicken Company acquired 30% of Tikka Company’s voting share capital for P2,000,000 on January 1, 2018. Chicken’s
30% interest in Tikka gave Chicken the ability to exercise significant influence.

During 2018, Tikka earned P800,000 and paid dividend of P500,000.

Tikka reported earnings of P1,000,000 for the 6 months ended June 30, 2019 and P2,000,000 for the year ended December
31, 2019.

On July 1, 2019, Chicken sold half of the investment in Tikka for P1,500,000 cash. The retained investment is to be held as
financial asset at fair value through profit or loss. The fair value of the retained investment is P1,600,000 on July 1, 2019.

Tikka paid dividend of P1,000,000 on October 1, 2019. The fair value of the investments is P2,000,000 on December 31,
2019.

1. On December 31, 2018, what is the carrying amount of the investment in associate?
A. 2,000,000 B. 2,090,000
C. 2,240,000 D. 2,300,000

2. What is the carrying amount of the investment in associate before disposal on June 30, 2019?
A. 1,790,000 B. 2,390,000
C. 1,195,000 D. 2,240,000

3. What total amount of income should be reported in 2019?

A. 1,560,000 B. 1,410,000
C. 1,160,000 D. 1,260,000

RECLASSIFICATION OF CUMULATIVE OTHER COMPREHENSIVE INCOME

When the equity method is discontinued, all amounts previously recognized in other comprehensive income in relation to
the investment are either reclassified to profit or loss as a reclassification adjustment or transferred directly to retained
earnings using the provisions of other IFRSs.

If ownership interest is reduced but significant influence or joint control is not lost, only a proportionate amount of the OCI
relating to the reduction of interest is reclassified to profit or loss or transferred directly to retained earnings, as
appropriate.

Problem 11: (Reclassification adjustment for OCI)

Morisette Co. owns 30% of Amor Co.’s ordinary shares. On July 1, 2018, Morisette sold half of its investment for P400,000.
The adjusted balances of the related accounts immediately before the sale are as follows:

Investment in associate 1,200,000

Cumulative share in associate’s exchange differences
on translation of a foreign operation 500,000 Cr.

1. How much is the gain or loss on sale of investments?

2. Assuming the remaining ownership does not give Morisette significant influence over Amor, how much of the OCI
shall be reclassified to profit or loss, if any?

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Brian Christian S. Villaluz, CPA
3. Assuming the remaining ownership does not give Morisette significant influence over Amor, how much of the OCI
shall be reclassified to retained earnings, if any?
4. Assuming the remaining ownership still gives Morisette significant influence over Amor, how much of the OCI shall
be reclassified to profit or loss, if any?
5. Assuming the remaining ownership still gives Morisette significant influence over Amor, how much of the OCI shall
be reclassified to retained earnings, if any?

Problem 12:
Morisette Co. owns 30% of Amor Co.’s ordinary shares. On July 1, 2018, Morisette sold half of its investment for P400,000.
The adjusted balances of the related accounts immediately before the sale are as follows:

Investment in associate 1,200,000

Cumulative share in associate’s revaluation increment
on property 500,000 Cr.

1. How much is the gain or loss on sale of investments?

2. Assuming the remaining ownership does not give Morisette significant influence over Amor, how much of the OCI
shall be reclassified to profit or loss, if any?
3. Assuming the remaining ownership does not give Morisette significant influence over Amor, how much of the OCI
shall be reclassified to retained earnings, if any?
4. Assuming the remaining ownership still gives Morisette significant influence over Amor, how much of the OCI shall
be reclassified to profit or loss, if any?
5. Assuming the remaining ownership still gives Morisette significant influence over Amor, how much of the OCI shall
be reclassified to retained earnings, if any?

FINANCIAL ACCOUNTING THEORIES

1. According to IAS 28 Investment in Associates and Joint Ventures, significant influence is
A. An entity over which the investor has significant influence. (associate)
B. The power to participate in the financial and operating policy decisions of the investee but is not control or joint
control over those policies.
C. Exposure or rights to variable returns from involvement with the investee and the ability to affect those returns
through power over the investee.
D. The contractually agreed sharing of control of an arrangement, which exists only when decisions about the
relevant activities require the unanimous consent of the parties sharing control. (joint control)

2. Which of the following statements is true concerning significant influence?

A. If an investor holds, directly or indirectly, less than 20% of the voting power of the investee, it is presumed that
the investor does not have significant influence, unless such influence can be clearly demonstrated.
B. If an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that
the investor does have a significant influence, unless it can be clearly demonstrated that this is not the case.
C. A substantial or majority ownership by another investor does not necessarily preclude an investor from having
significant influence.
D. All of these statements are true about significant influence.

3. Significant influence is presumed to exist when ownership interest is

A. Less than 20%
B. More than 20%
C. 20% or more
D. 25% or more

4. Investment in associates are initially recognized at

A. Cost
B. Cost adjusted for share in the associate’s changes in equity
C. Fair value
D. Fair value less transaction costs

5. Under the equity method, dividends received from an associate

A. Increases the investment income for the period.
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Brian Christian S. Villaluz, CPA
B. Decreases the investment income for the period.
C. Increases the investment account.
D. Decreases the investment account.

6. For an investment accounted for under the equity method, the investment income recognized in profit or loss for
the year may be computed as
A. Cash dividends received or receivable.
B. Share in the profit or loss of the associate minus amortization of undervaluation of assets.
C. Share in the profit or loss of the associate plus amortization of undervaluation of assets.
D. Share in the total comprehensive income of the associate minus amortization of undervaluation of assets.

7. When the associate has outstanding cumulative preference shares, the investor computes for its share in the
associate’s profit
A. After deducting one-year dividend on the cumulative preference shares, whether or not declared.
B. After deducting one-year dividend on the cumulative preference shares only when declared.
C. After deducting all dividends in arrears on the cumulative preference shares, whether or not declared.
D. Before deducting one-year dividend on the cumulative preference shares

8. Goodwill arising from an investment in associate is

A. Included in the carrying amount of the investment and amortized over the useful life.
B. Included in the carrying amount of the investment and not amortized.
C. Charged to retained earnings.
D. Charged to expense immediately.

9. The excess of the investor’s share of the net fair value of the associate’s net assets over the cost of investment is
A. Included in other comprehensive income.
B. Credited to retained earnings.
C. Recognized as income in the determination of the investor’s share of the associate’s profit or loss.
D. A deferred gain.

10. How is the impairment test carried out for an investment in associate?
A. The goodwill impairment is tested individually.
B. The entire carrying amount of the investment is tested for impairment by comparing the recoverable amount
with carrying amount.
C. The carrying amount of the investment shall be compared with fair value.
D. The recoverable amounts of all investments in associates shall be assessed together.

END OF HANDOUT

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