BSA 3202 Topic 1 - Investment in Associates

BSA 3202 Accounting for Business Combination Investment in Associates
Module 1 – Investment in Associates
Intercorporate share investment
An intercorporate share investment is the purchase of the equity shares of one entity by another entity. In other
words, it is a case of one entity investing in another entity through the acquisition of share capital.
An entity may purchase enough shares of another entity in order to exert significant influence over the financial
and operating policies of the investee entity.
Significant influence
The assessment of significant influence is a matter of judgment. Significance influence is the power to
participate in the financial and operating policy decisions of the investee but not control or joint control over
those policies.
If the investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee,
it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not
the case.
Conversely, if the investor holds directly or indirectly through subsidiaries, less than 20%, the voting power of
the investee, it is presumed that the investor does not have significant influence, unless such influence can be
clearly demonstrated.
A substantial or majority ownership by another investor does not necessarily preclude an investor from having
significant influence. Beyond the mere 20% threshold of ownership, PAS 28, paragraph 6, provides that the
existence of significant influence is usually evidenced by the following factors:
a. Representation in the board of directors
b. Participation in policy making process
c. Material transactions between the investors and the investee
d. Interchange of managerial personnel
e. Provision of essential technical information
Potential voting rights
An entity may own share warrants, debt or equity instruments that are convertible into ordinary shares have the
potential, if exercised or converted, to give the entity additional voting power over the financial and operating
policies of another entity.
PAS 28, paragraph 7, provides that the existence of such potential voting rights is considered in assessing
whether an entity has significant influence.
The potential voting rights should be currently exercisable or convertible. Potential voting rights are not
currently exercisable or convertible when the rights cannot be exercised or converted until future date or until
the occurrence of a future event.
However, when potential voting rights exist, the investor's share of profit or loss of the investee and of changes
in the investee's equity is determined on the basis of "present ownership interest" and does not reflect the
possible exercise or conversion of potential voting rights.
Loss of significant influence
An entity loses significant influence over an investee when it loses the power to participate in the financial and
operating policy decisions of the investee. The loss of significant influence can occur, with or without change in
the absolute or relative ownership interest.
For example, the loss of significant influence could occur when an associate becomes subject to control of a
government, court, administrator or regulator. The loss of significant influence could also occur as a result of a
contractual agreement.
Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Equity method
The equity method is based on the economic relationship between the investor and the investee. The investor
and the investee are viewed as a single economic unit. The equity method is applicable when the investor has
a significance influence over the investee.
Accounting procedures
a. The investment is initially recognized at cost.

b. The carrying amount is increased by the investor's share of the profit of the investee and decreased by
the investor's share of the loss of the investee. The investor's share of the profit or loss of the investee
is recognized as investment income.
c. Distributions or dividends received from an equity investee reduce the carrying amount of the
investment.
d. Note that the investment must be in ordinary shares. If the investment is in preference shares, the
equity method is not appropriate regardless of the percentage because the preference share is a
nonvoting equity. The investment in preference shares may be accounted for as at fair value through
profit or loss or at fair value through other comprehensive income or at cost.
e. Technically, if the investor has significant influence over the investee, the investee is said to be an
associate. Accordingly, under the equity method, the investment in ordinary shares should be
appropriately described as investment in associate.
f. The investment in associate accounted for using the equity method shall be classified as noncurrent
asset.
Illustration – equity method

1. On January 1, 2020, an investor purchased 20,000 shares of the 100,000 outstanding ordinary shares of
another entity at P200 per share. The investment represents 20% equity interest and the investor has a
significant influence over the investee. The acquisition cost is equal to the carrying amount of the net assets
acquired.
Investment in associate 4,000,000
Cash 4,000,000
2. The investee reported net income of P5,000,000 for 2020. The investor recognized a share of the net
income of the investee equal to 20% of P5,000,000 or P1,000,000.
Investment income 1,000,000
3. Received a 25% share dividend from the investee on December 31, 2020.
Memo — Received 5,000 ordinary shares as 25% share dividend on 20,000 original shares. Shares now
held, 25,000 shares.
Note that the 20% equity interest is not affected by the share dividend. The equity interest is the same before
and after the share dividend.
4. The investee reported a net loss of P 1,000,000 for 2021. The investor recognized a share in the net loss of
the investee equal to 20% of P1,000,000 or P200,000.
Loss on investment 200,000
Investment in associate 200,000
5. The investee declared and paid a cash dividend of P2,500,000 on ordinary shares on December 31, 2021.
The investor recognized a share in the cash dividend paid by the investee equal to 20% of P2,500,000 or
P500,000.
Cash 500,000
Under the equity method, cash dividend is not an income but a return or reduction of investment.

Excess of cost over carrying amount
An accounting problem arises if the investor pays more or less for an investment than the carrying amount of
underlying net assets.
For example, if the earning potential of the investee is abnormally high, the current value of the investee's net
assets is frequently higher than their carrying amount. If the investor pays more than the carrying amount of
the net assets acquired, the difference is commonly known as "excess of cost over carrying amount" and may
be attributed to the following:
a. Undervaluation of the investee's assets, such as building, land and inventory.
b. Goodwill
In practice, it is often difficult to determine which specific identifiable assets are undervalued.
If the assets of the investee are fairly valued, accountants frequently attribute the excess of cost over carrying
amount of the underlying net assets to goodwill.
If the excess is attributable to undervaluation of depreciable asset, it is amortized over the remaining life of the
depreciable asset.
If the excess is attributable to undervaluation of land, it is not amortized because the land is nondepreciable.
The amount is expensed when the land is sold.
If the excess is attributable to inventory, the amount is expensed when the inventory is already sold.
If the excess is attributable to goodwill, it is included in the carrying amount of the investment and not
amortized.
However, the entire investment in associate including the goodwill is tested for impairment at the end of each
reporting period.
Illustration
At the beginning of the current year, an investor purchased 20% of the outstanding ordinary shares of an
investee for P5,000,000. The net assets of the investee on the date of acquisition are fairly valued except for a
depreciable asset for which the fair value is P2,000,000 greater than its carrying amount. Any remaining
excess is attributable to goodwill.
The carrying amount of the investee's net assets was P20,000,000. The investor therefore paid P1,000,000 in
excess of the carrying amount of net assets, computed as follows:
Acquisition cost 5,000,000
Carrying amount of net assets acquired
(20% x P20,000,000) 4,000,000
Excess of cost over carrying amount 1,000,000
The excess is attributable to the following:

Undervaluation of depreciable asset of
investee with remaining life 5 years
(20% x P2,000,000) 400,000
Goodwill – remainder 600,000
The journal entry to amortize the "excess of cost" attributable to the undervaluation of depreciable asset is as
follows:
Investment income 80,000
(400,000/5 years)
When depreciable and intangible assets of the investee are undervalued, depreciation and amortization are
naturally understated resulting to overstatement of the investee's net income. Thus, the investor should
decrease investment income.
The "excess of cost" attributable to goodwill is not amortized. The goodwill is included in the carrying amount of
the investment in associate.

Excess of net fair value over cost

PAS 28, paragraph 32, provides that any excess of the investor's share of the net fair value of the associate's
identifiable assets and liabilities over the cost of the investment is included as income in the determination of
the investor's share of the associate's profit or loss in the period in which the investment is acquired.
Appropriate adjustments to the investor's share of the associate's profit or loss after acquisition are also made
to account, for example, for depreciation of depreciable assets based on their fair value on the acquisition date.
Illustration
At the beginning of the current year, an investor purchased 40% of the ordinary shares outstanding of an
investee for P15,000,000 when the net assets of the investee amounted to P30,000,000. At acquisition date,
the carrying amounts of the identifiable assets and liabilities of the investee were equal to their fair value,
except for the following:
a. Equipment whose fair value was P7,000,000 greater than carrying amount.
b. Inventory whose fair value was P2,500,000 greater than carrying amount.
The equipment has a remaining life of 4 years and the inventory was all sold during the current year. The
investee reported net income of P20,000,000 for the current year and paid P5,000,000 cash dividend at year-
end.
Computation
Carrying amount of net assets 12,000,000
Excess attributable to equipment
(40% x P7,000,000) (2,800,000)
Excess attributable to inventory
(40%x P2,500,000) (1,000,000)
Excess net fair value over cost (800,000)
Journal entries
1. To record the investment:
Cash 15,000,000
2. To record the share in net income:

(40% x P 20,000,000)
3. To record the share in cash dividend:

Cash (40% x P5,000,00) 2,000,000
4. To record the amortization of the excess attributable to the equipment:

(2,800,000 / 4 years)
5. To record the amortization of the excess attributable to inventory:

The excess is fully "expensed" because all the inventory was already sold during the year.
6. To record the "excess net fair value" as investment income:

The (total) net investment income can also be computed for the year as:
Share in net income 8,000,000
Amortization of excess attributable to equipment (700,000)
Amortization of excess attributable to inventory (1,000,000)
Excess net fair value 800,000
Net investment income 7,100,000
Investee with heavy losses

PAS 28, paragraph 38, provides that if an investor's share of losses of an associate equals or exceeds the
carrying amount of an investment, the investor discontinues recognizing its share of further losses. The
investment is reported at nil or zero value.
The carrying amount of the investment in associate is not just the balance of the account "investment in
associate". The carrying amount of the investment in associate also includes other long-term interests in an
associate, such as long-term receivables, loans and advances, and investment in preference shares.
However, trade receivables and any long-term receivables for which adequate collateral exists, such as
secured loans, are excluded from the carrying amount of an investment in associate.
Additional losses are provided for or a liability is recognized, to the extent that the investor has incurred legal or
constructive obligations or made payments on behalf of the associate.
If the associate subsequently reports income, the investor resumes including its share of such income after its
share of the income equals the share of losses not recognized.
Illustration
On January 1, 2020, an investor acquired 25% of the ordinary shares of an associate for P5,000,000. On this
date, the identifiable assets and liabilities of the associate were measured at fair value and there is no goodwill
arising from the acquisition.
The profits and losses made by the associate over the first 5 years of operations were:
Profit (loss) Investor’s share
2020 (1,000,000) (250,000)
2021 (10,000,000) (2,500,000)
2022 (12,000,000) (3,000,000)
2023 2,000,000 500,000
2024 2,500,000 625,000
Journal entries
2020 Investment in associate 5,000,000
Cash 5,000,000
Loss on investment 250,000

2021 Loss on investment 2,500,000

2022 Loss on investment 2,250,000


Loss on investment:
2020 (250,000)
2021 (2,500,000)
Carrying amount – January 1, 2022 2,250,000
The investor's share in the loss of the associate for 2022 is P3,000,000. However, the loss to be recognized
cannot exceed the carrying amount of the investment of P2,250,000. The investment is reduced to zero.
2023 No entry
Share in the loss for 2022 (3,000,000)

Loss recognized in 2022 (2,250,000)
Unrecognized loss in 2022 (750,000)
Share in profit for 2023 500,000
Remaining unrecognized loss (250,000)
If the associate subsequently reports profit, the investor resumes recognizing its share of profit only after the
share of profit equals the share of losses not previously recognized.
2024 Investment in associate 375,000

Share in profit for 2024 625,000

Remaining unrecognized loss (250,000)
Share in profit to be recognized in 2024 375,000
Impairment loss
If there is an indication that an investment in associate may be impaired, PAS 28, paragraph 40, requires that
an impairment loss shall be recognized whenever the carrying amount of the investment in associate exceeds
recoverable amount.
The recoverable amount is measured as the higher between fair value less cost of disposal and value in use.
Fair value is the price that would be received to sell an asset in an orderly transaction between market
participants at the measurement date.
Value in use is the present value of the estimated future cash flows expected to arise from the continuing use
of an asset and from its ultimate disposal. The value in use of an investment in associate is the investor’s
share in either of the following:
a. Present value of estimated future cash flows expected to be generated by the investee, including cash
flows from operations of the investee and the proceeds on the ultimate disposal of the investment.
b. Present value of the estimated future cash flows expected to arise from dividends to be received from
the investment and from its ultimate disposal.
Under appropriate assumptions, both methods give the same result. PAS 28, paragraph 42, states that since
goodwill is not separately recognized from the investment amount, the impairment loss recognized is applied to
the investment as a whole.
The recoverable amount of an investment in associate is assessed for each individual associate.
An exception is when an individual associate does not generate cash inflows from continuing use that are
largely independent of those from other assets of the reporting entity.
Investee with preference shares
When an associate has outstanding cumulative preference shares, the investor shall compute its share of
earnings or losses after deducting the preference dividends, whether or not such dividends are declared.
When an associate has outstanding noncumulative preference shares, the investor shall compute its share of
earnings after deducting the preference dividends only when declared.
For example, an investee reported the following capital accounts at the beginning of current year:
Preference share capital, 12% cumulative,
P100 par, 50,000 shares issued 5,000,000
Ordinary share capital, P50 par, 500,000 shares
authorized and 200,000 shares issued 10,000,000
Retained earnings 5,000,000
On same date, an investor acquired 40,000 ordinary shares of the investee representing a 20% interest for
P3,000,000. The net assets of the investee are fairly valued.
The investee reported net income of P2,000,000 for the current year and paid cash dividends of P500,000 to
ordinary shareholders and the preference dividends at the preference rate.
Journal entries for current year

1. To record the investment:
Cash 3,000,000
2. To record the share in net income:


Net income 2,000,000

Preference dividend (12% x 5,000,000) (600,000)
Net income to ordinary share 1,400,000
Share in net income (20% x 1,400,000) 280,000
3. To record the share in cash dividend:

Cash (20% x 500,000) 100,000
Other changes in equity
Adjustments to the carrying amount of the investment in associate may be necessary for changes in the
investor's proportionate interest in the investee arising from changes in the investee's equity that have not
been recognized in the investee's profit or loss.
Such changes include those arising from revaluation of property, plant and equipment and from foreign
exchange translation differences.
The investor's share of those changes is recognized directly in equity of the investor.
Illustration
The investment in associate is 20% as a consequence of which the investor has significant influence over the
investee. The investee reported the following for the current year:
Net income 6,000,000
Dividend paid 2,000,000
Revaluation surplus 3,000,000
Journal entries for current year

1. Share in net income:
(20% x 6,000,000)
2. Share in dividend paid:

Cash (20% x 2,000,000) 400,000
3. Share in revaluation surplus:

Revaluation surplus – investee 600,000
(20% x 3,000,000)
Adjustment of investee's operations
a. The most recent available financial statements of the associate are used by the investor in applying the
equity method. When the reporting dates of the investor and the investee are different, the associate
shall prepare for the use of the investor financial statements as of the same date as the financial
statements of the investor unless it is impracticable to do so. In any case, the difference between the
reporting date of the associate and that of the investor shall be no more than three months.
b. If an associate uses accounting policies other than those of the investor, adjustments shall be made to
conform the associate's accounting policies to those of the investor.
c. Profits and losses resulting from upstream and downstream transactions between an investor and an
associate are recognized in the investor's financial statements only to the extent of the unrelated
investors' interests in the associate. The investor's share in the associate's profits and losses resulting
from these transactions is eliminated.

Upstream transactions
Upstream transactions are sales of assets from an associate to the investor. For example, the associate sells
inventory or noncurrent asset to the investor. The unrealized profit from these transactions must be eliminated
in determining the investor's share in the profit or loss of the associate.
Sale of inventory from associate to investor

On January 1, 2020, an investor acquired 20% interest in an investee, enabling the investor to exercise
significant influence over the investee. On this date, the identifiable assets and liabilities of the investee is
recorded at fair value.
During the year, the investee reported net income of P2,000,000 and paid no dividend. Also, during the year,
the investee sold inventory costing P200,000 for P300,000 to the investor. The inventory is unsold by the
investor on December 31, 2020.
Ignoring income tax, the investor's share in the profit of the associate for 2020 is determined as:
Net income for 2020 2,000,000
Unrealized profit on ending inventory
on 12/31/2020 (100,000)
Adjusted net income 1,900,000
Investor's share (20% x 1,900,000) 380,000
Or another approach can be used:

Share in net income (20% x 2,000,000) 400,000
Share in unrealized profit(20% x 100,000*) (20,000)
Investor's share 380,000
Sale price 300,000

Cost of inventory 200,000
*Unrealized profit on ending inventory 100,000
The journal entry to recognize the investor's share in the profit of the associate for 2020 is:
Continuing the illustration, the investee reported net income of P2,500,000 for 2021.
The inventory sold by the associate to the investor in 2020 is subsequently sold by the investor in 2021.
The investor's share in the profit of the associate for 2021 is determined as:
Realized profit on beginning inventory 100,000
The journal entry to recognize the investor's share in the profit of the associate for 2021 is:
Downstream transactions
Downstream transactions are sales of assets from the investor to an associate. Unquestionably, the unrealized
profit from these transactions must be also eliminated as prescribed by Paragraph 28 of PAS 28.
The accounting issue is how to eliminate the unrealized profit from downstream transactions. Unfortunately,
PAS 28 does not offer a crystal clear guidance on the accounting issue. Up to this writing, this issue is still the
subject of a discussion paper for an IFRIC interpretation.
It is believed that computation of the investor's share in the profit of the associate and the journal entries are
exactly the same whether upstream or downstream. The point is that the unrealized profit must be eliminated
in determining the investor's share in the profit or loss of the associate.
There is no good argument for this approach apart from simplicity and the economic relationship of the investor
and the associate viewed as a "single economic entity".

Sale of depreciable asset

On January 1, 2020, an investor acquired 20% interest in an associate. During the year, the investee sold an
equipment with carrying amount of P4,500,000 to the investor for P7,000,000.
The equipment has a remaining useful life of 5 years. The investee reported net income of P6,000,000 for
2020. Ignoring income tax, the investor's share in the profit of the associate in 2020 is determined as:
Unrealized profit on sale of equipment (2,500,000)
Realized profit on sale of equipment
(2,500,000 / 5 years) 500,000
Sale price of equipment 7,000,000

Carrying amount (4,500,000)
Unrealized profit on sale of equipment 2,500,000
Note that the profit on the sale of the equipment is unrealized because the equipment is not sold to an
unrelated party.
The profit on the sale of the equipment is realized as the asset is used or over the remaining life of the asset.
Thus, as the equipment is depreciated on a straight-line basis over a 5-year period, one-fifth of the profit is also
realized each year. After a 5-year period, the whole of the profit is realized.
Continuing the illustration, if the investee reported net income of P8,000,000 for 2021, the investor's share in
the profit of the associate in 2021 is determined as:
Realized profit on sale of equipment 500,000
Investor's share (20% x 8,500,000) 1,700,000
Discontinuance of equity method – change from equity
PAS 28, paragraph 22, provides that an investor shall discontinue the use of the equity method from the date
that it ceases to have significant influence over an associate. Consequently, the investor shall account for the
investment as follows:
a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
PAS 28, Basis for Conclusion 18, requires an investor that continues to have significant influence over an
associate to apply the equity method even if the associate is operating under severe long-term restrictions that
significantly impair the ability to transfer funds to the investor. Significant influence must be lost before the
equity method ceases to be applicable.
Measurement after loss of significant influence

PAS 28, paragraph 22, provides that on the date the significant influence is lost, the investor shall measure any
retained investment in associate at fair value.
The difference between the carrying amount of the retained investment at the date the significant influence is
lost and the fair value of the retained investment shall be included in profit or loss.
Of course, the difference between the net proceeds from disposal of part of the investment and the carrying
amount of the investment sold is also included in profit or loss.
Paragraph 22 further provides that the fair value of the investment at the date it ceases to be an associate shall
be regarded as the fair value on initial recognition as a financial asset.
Illustration
An entity purchased 30,000 ordinary shares of the 100,000 outstanding shares of another entity representing
30% interest several years ago. At year-end, the investment in associate has a carrying amount of P6,000,000.
On the same date, the investor sold 20,000 shares for net proceeds of P5,000,000 resulting to a loss of
significant influence. The quoted market price for such investment is P260 per share on the date of sale.

Journal entries
1. To record the sale of 20,000 shares or 20% interest (20,000 / 100,000):
Cash 5,000,000
Gain on sale of investment 1,000,000
Sale price 5,000,000

Carrying amount of 20,000 shares sold
(20,000 / 30,000 x P6,000,000) 4,000,000
Gain on sale 1,000,000
2. To remeasure the retained investment of 10,000 shares or 10% interest (10,000 / 100,000):
Gain from remeasurement to fair value 600,000
Fair value of shares retained (10,000 x 260) 2,600,000

Carrying amount of retained investment
(6,000,000-4,000,000) 2,000,000
Gain from remeasurement 600,000
The gain from remeasurement to fair value is included in profit or loss.
3. To reclassify the retained investment as financial asset at fair value through profit or loss.
Financial asset – FVPL 2,600,000
Equity method not applicable
PAS 28, paragraph 17, provides that an investment in associate shall not be accounted for using the equity
method if the investor is a parent that is exempt from preparing consolidated financial statements or if all of the
following apply:
a. The investor is a wholly-owned subsidiary, or a partially owned subsidiary of another entity and the
other owners do not object to the investor not applying the equity method.
b. The investor's debt and equity instruments are not traded in a public market or "over the counter"
market.
c. The investor did not file or it is not in the process of filing financial statements with the SEC for the
purpose of issuing any class of instruments in a public market.
d. The ultimate or any intermediate parent of the investor produces consolidated financial statements
available for public use that comply with Philippine Financial Reporting Standards.
In these circumstances, the investment is accounted for as follows:

a. Financial asset at fair value through profit or loss.
b. Financial asset at fair value through other comprehensive income.
c. Nonmarketable investment at cost or investment in unquoted equity instrument.
Associate held for sale
PAS 28, paragraph 20, provides that if the investment in associate is classified as held for sale, it is accounted
for in accordance with PFRS 5. The investment in associate classified as held for sale shall be measured at
the lower of carrying amount and fair value less cost of disposal.
Investment of less than 20%
If the investor holds, directly or indirectly, through subsidiaries 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.
Accounting for investment of less than 20%

a. Fair value method
This is applicable to financial asset measured at fair value through profit or loss and financial asset
measured at fair value through other comprehensive income.
b. Cost method
The cost method is usually applied with respect to investment in unquoted equity instrument or
nonmarketable equity investment.

Under the fair value and cost method, the investor does not share in the profit or loss of the investee because
of the legal relationship between the investor and the investee. The investor and the investee are independent
of the other.
Accordingly, dividends received by the investor from the investee are accounted for as dividend income.
Dividend from preacquisition retained earnings
There is no longer a distinction between preacquisition dividends and postacquisition dividends. In applying the
fair value and cost method, dividends received from an investee are recognized as dividend income,
regardless of whether the dividends originated from preacquisition retained earnings or postacquisition
retained earnings.
Illustration – cost method

1. On January 1, 2020, an investor purchased 10,000 shares of the 100,000 outstanding ordinary shares of
another entity at P200 per share. The investment is unquoted and represents a 10% equity interest.
Investment in shares 2,000,000
Cash 2,000,000
2. The investee reported net income of P1,000,000 for 2020.

No entry is required. The investor does not recognize a share in the net income of the investee.
3. The investor received a 20% share dividend on December 31, 2020.

Memo – Received 2,000 ordinary shares from investee as 20% share dividend on 10,000 original shares.
Shares now held, 12,000 shares.
4. The investee reported a net loss of for 2021.

No entry is required. The investor does not recognize a share in the net loss of the investee.
5. The investee declared and paid a cash dividend of P1,500,000 on December 31, 2021.
Cash (10% x P1,500,000) 150,000
Dividend income 150,000
6. The investor sold 3,000 ordinary shares at P250 per share on December 31, 2021.
Cash 750,000
Investment in shares 500,000
Gain on sale of investment 250,000
Sale price (3,000 x 250) 750,000

Less: Cost of shares sold
(3,000 / 12,000 x 2,000,000) 500,000
Gain on sale of investment 250,000
Investment in associate achieved in stages
An investor owned a 10% interest in an investee on January 1, 2020. The investor acquired additional 10%
interest in the same investee on January 1, 2021 enabling the investor to exercise significant influence over the
investee.
In 2020, the investment is accounted for under the cost or fair value method. However, in 2021, the investment
must be accounted for under the equity method because the investee is now an associate.
This scenario or phenomenon is known as "investment in associate achieved in stages."
The investment in associate achieved in stages is not covered by PAS 28. However, this is parallel to a
business combination achieved in stages. PFRS 3, paragraph 42, provides that in a business combination
achieved in stages, the acquirer shall remeasure the previously held equity interest at fair value and recognize
the resulting gain or loss in profit or loss.
By inference, this "fair value approach" should be followed when an associate is acquired in stages.

Fair value approach

a. The existing interest in the associate is remeasured at fair value with any change in fair value included in
profit or loss.
b. However, if the existing interest is accounted for at fair value through other comprehensive income, any
unrealized gain or loss at the date the investee becomes an associate is reclassified to retained earnings.
c. The fair value of the existing interest plus the cost of the additional interest acquired constitutes the total cost
of the investment for the initial application of the equity method.
d. The total cost of the investment for the initial application of the equity method minus the carrying amount of
the net assets acquired at the date significant influence is obtained equals excess of cost over carrying amount
or excess net fair value.
Illustration – Cost method to equity method

On January 1, 2020, an investor acquired a 10% interest in an investee for P2,000,000. The investment is
accounted for under the cost method because the investment is unquoted.
On January 1, 2022, the investor acquired a further 20% interest in the investee for P4,000,000. On such date,
the carrying amount of the net assets of the investee is P18,000,000.
Any excess of cost over carrying amount is attributable to an undervalued equipment with remaining useful life
of 5 years.
On January 1, 2022, the 10% existing investment has a fair value of P2,500,000.
The investee reported the following net income and dividends:

Net income Cash dividend
2020 2,000,000 800,000
2021 3,000,000 1,000,000
2022 4,000,000 2,000,000
Journal entries
2020
Cash 2,000,000
Cash (10% x 800,000) 80,000

2021
Cash (10% x 1,000,000) 100,000
2022
1. To record the new 20% interest:
Cash 4,000,000
2. To remeasure the 10% existing interest at fair value:

Investment in shares 500,000
Gain on remeasurement to equity 500,000
(2,500,000 - 2,000,000)
3. To reclassify the 10% existing interest:

4. To record the share in 2022 net income:

(30% x 2,000,000)
5. To record the share in 2022 cash dividend:

Cash 600,000
6. To record the amortization of excess of cost:


Fair value of 10% existing interest 2,500,000

Cost of 20% new interest 4,000,000
Total cost of investment 6,500,000
(30% x 18,000,000) 5,400,000
Excess of cost attributable to equipment 1,100,000
Amortization (1,100,000 / 5) 220,000
Illustration – Fair value method to equity method

On January 1, 2020, an investor acquired a 10% interest in an investee for P3,000,000. The investment is
accounted for at fair value through other comprehensive income.
The fair value of the investment on December 31, 2020 is P4,000,000.
On January 1, 2021, the investor acquired a further 30% interest in the investee for P8,500,000. On such date,
the carrying amount of the net assets of the investee is P25,000,000. The fair value of net assets of the
investee is equal to carrying amount. Any excess of cost over carrying amount is attributable to goodwill.
The investee reported the following net income and cash dividend:
Net income Cash dividend
2020 5,000,000 3,500,000
2021 6,000,000 4,000,000
Journal entries
2020
Financial asset – FVOCI 3,000,000
Cash 3,000,000
Cash (10% x 3,500,000) 350,000


Unrealized gain – OCI 1,000,000
Fair value – December 31, 2020 4,000,000

Carrying amount 3,000,000
2021
1. To record new 30% interest:
Cash 8,500,000
2. To reclassify the unrealized gain to retained earnings:

Retained earnings 1,000,000
Application Guidance of PFRS 9, paragraph B5.7.1, provides that amount recognized in other comprehensive
income for financial asset measured at fair value through other comprehensive income is not subsequently
reclassified to profit or loss. The cumulative gain or loss is transferred directly to retained earnings.
3. To reclassify the 10% interest:

4. To record the share in 2021 net income:

(40% x 6,000,000)
5. To record the share in 2021 cash dividend:

Cash (40% x 4,000,000) 1,600,000

6. The excess of cost over carrying amount attributable to goodwill is not amortized.
Fair value of 10% existing interest 4,000,000
Cost of 30% new interest 8,500,000
Total cost of investment 12,500,000
(40% x 25,000,000) 10,000,000
Goodwill – not amortized 2,500,000
SAMPLE PROBLEMS
Problem 1
At the beginning of current year, Cynosure Company purchased 40% of the ordinary shares of another entity
for P3,500,000 when the net assets acquired amounted to P7,000,000.
At acquisition date, the carrying amounts of the identifiable assets and liabilities of the investee 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.
The investee reported net income of P4,000,000 and paid P1,000,000 dividends during the current year.
Required:
a. Prepare journal entries for the current year.
b. Compute the investment income for the current year.
Problem 2
Czar Company acquired a 40% interest in Film Company for P 1,700,000 on January 1, 2020.
The shareholders' equity of Film Company on January 1 and December 31, 2020 is as follows:
January 1 December 31
Share capital 3,000,000 3,000,000
Revaluation surplus 1,300,000
Retained earnings 1,000,000 1,500,000
On January 1, 2020, all the identifiable assets and liabilities of Film Company were recorded at fair value.
Film Company reported profit of P650,000, after income tax expense of P 350,000 and paid dividends of
P150,000 to
shareholders during the current year.
The revaluation surplus is the result of the revaluation of land recognized by Film Company on December 31,
2020.
Additionally, depreciation is provided by Film Company on the diminishing balance method whereas Czar
Company uses the straight-line.
Had Film Company used the straight line, the accumulated depreciation would be increased by P200,000. The
tax rate is
30%.
Required:
a. Prepare journal entries for the current year to recognize the transactions relating to the investment in
associate.
b. Determine the carrying amount of the investment in associate on December 31, 2020.

Problem 3
On January 1, 2017, Angelic Company acquired as a long-term investment for P 7,000,000 a 40% interest in
an investee when the fair value of the net assets was P 17,500,000. The investee reported the following net
losses:
2017 5,000,000
2018 7,000,000
2019 8,000,000
2020 4,000,000
On January 1, 2019, Angelic Company made cash advances of P2,000,000 to the investee. On December 31,
2020, it is not expected that Angelic Company will provide further financial support for the investee.
Required: Prepare journal entries from 2017 to 2020 in relation to the investment in associate.
Problem 4
Glorious Company acquired 40% interest in an associate, Alta Company, for P5,000,000 on January 1, 2020.
At the acquisition date, there were no differences between fair value and carrying amount of identifiable assets
and liabilities.
Alta Company reported net income of P2,000,000 for 2020 and P3,000,000 for 2021.
On December 31, 2020 and 2021, Alta Company paid cash dividend of P800,000 and P 1,000,000,
respectively.
a. On January 1, 2020, Alta Company sold an equipment costing P 500,000 to Glorious Company for P
800,000. Glorious Company applies a 10% straight line depreciation.
b. On July 1, 2021, Alta Company sold an equipment for P900,000 to Glorious Company. The carrying
amount of the equipment is P500,000 at the time of sale. The remaining life of the equipment is 5 years
and Glorious Company uses the straight-line depreciation.
c. On December 1, 2021, Alta Company sold an inventory to Glorious Company for P 2,800,000. The
inventory had a cost of P 2,000,000 and was still on hand on December 31, 2021.
Required:
a. Determine the investor's share in the profit of the associate for 2020.
b. Determine the investor's share in the profit of the associate for 2021.
c. Prepare journal entries on the books of Glorious Company in relation to the investment in associate.
d. Determine the carrying amount of the investment in associate on December 31, 2021.
Problem 5
On January 1, 2020, Jam Company reported as long-term investments the following unquoted equity shares:
Dale Company, 5,000 ordinary shares (1% interest) 1,250,000
Ever Company, 10,000 ordinary shares (2% interest)1,600,000
Fox Company, 25,000 ordinary shares (10% interest)2,000,000
1. On May 1, 2020, Dale Company issued a 10% share dividend.

2. On November 1, 2020, Dale Company paid a cash dividend of P20 per share.
3. Oh January 1, 2020, Jam Company paid P5,000,000 for 50,000 additional ordinary shares of Fox
Company which represented a 20% investment in Fox Company. The fair value of all of Fox's identifiable
assets net of liabilities was equal to their carrying amount of P20,000,000. Jam Company's initial 10%
interest of 25,000 ordinary shares of Fox Company was acquired on January 1, 2019 for P2,000,000. The
10% interest was accounted for under cost method. On January 1, 2020, this 10% existing interest had a
fair value of P2,400,000.
4. Fox Company reported net income of P6,000,000 for 2020, and paid dividend of P20 per share on
December 31, 2020.
Required:
a. Compute the goodwill arising from acquisition on January 1, 2020.
b. Prepare journal entries for 2020.
c. Present the investments in equity securities on December 31, 2020.

BSA 3202 Topic 1 - Investment in Associates

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BSA 3202 Accounting for Business Combination Investment in Associates

Module 1 – Investment in Associates

Intercorporate share investment

Potential voting rights

Loss of significant influence

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

a. The investment is initially recognized at cost.

Illustration – equity method

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Excess of cost over carrying amount

The excess is attributable to the following:

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Excess of net fair value over cost

2. To record the share in net income:

3. To record the share in cash dividend:

4. To record the amortization of the excess attributable to the equipment:

5. To record the amortization of the excess attributable to inventory:

6. To record the "excess net fair value" as investment income:

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Loss on investment 250,000

2021 Loss on investment 2,500,000

2022 Loss on investment 2,250,000

Acquisition cost 5,000,000

Share in the loss for 2022 (3,000,000)

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Investment income 375,000

Share in profit for 2024 625,000

Investee with preference shares

Journal entries for current year

2. To record the share in net income:

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Investment in associate 280,000

Net income 2,000,000

3. To record the share in cash dividend:

Other changes in equity

Journal entries for current year

2. Share in dividend paid:

3. Share in revaluation surplus:

Adjustment of investee's operations

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Sale of inventory from associate to investor

Or another approach can be used:

Sale price 300,000

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Sale of depreciable asset

Sale price of equipment 7,000,000

Discontinuance of equity method – change from equity

Measurement after loss of significant influence

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.

Sale price 5,000,000

Fair value of shares retained (10,000 x 260) 2,600,000

The gain from remeasurement to fair value is included in profit or loss.

Equity method not applicable

In these circumstances, the investment is accounted for as follows:

Associate held for sale

Investment of less than 20%

Accounting for investment of less than 20%

Source: Valix, C. (2019). Intermediate accounting, Volume 1. Manila: GIC Enterprise.