MODULE 1: INVESTMENT IN ASSOCIATE

OVERVIEW
When someone is holding money in his hands, he thinks where he could put his money. It is either through
spending or investing. Investment has many forms, one of which is the acquisition of shares of one entity.
Accounting in this kind of investment depends on its purpose. Purposes of acquiring shares of other entity
are simply to accrue income through dividend and investment appreciation, to exert significant influence
over other entity and to obtain control over other entity. This module will discuss the accounting for
investment which the investor has significant influence over the investee.
OBJECTIVES
1. To identify different form of share investments
2. To define and assess significant influence
3. To know the accounting for investment in associate
Required reading: Financial Accounting Volume I First Part Conrado Valix, Jose Peralta and Christian
Aris Valix (Source or Reference Book)

DISCUSSION
DIFFERENT FORM OF SHARE INVESTMENTS

ACCOUNT TITLE PERCENTAGE SHARE PURPOSE

Investment in Equity Securities Below 20% To accrue income through
dividend and investment
appreciation
Investment in Associate 20% to 50% To exert significant influence
over the entity
Investment in Subsidiary more than 50% To obtain control over the entity

ASSESSMENT OF SIGNIFICANT INFLUENCE

This is a matter of judgment. PAS 28 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 investor and investee
D. Interchange of managerial personnel
E. Provision of essential technical information
Furthermore, PAS 28 provides practical guidance to assist management in making assessment. 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 it is
not the case.
For practical assessment, the percentage of ownership is usually used but factors provided above should be
first considered. It means that there may be instances that investor holds less than 20% but has significant
influence or although he is holding 20% or more of the voting power, he has no significant influence. Again,
this is a matter of judgment.
An investor who has significant influence over the investee, investee is said to be “Associate”. Hence, the
investment should be presented in financial statement as Investment in Associate. Note that this kind of
investment pertains to ordinary share since preference share is a non-voting equity.
POTENTIAL VOTING RIGHTS
The existence of potential voting rights is considered in assessing whether an entity has significant
influence. Such rights should be currently exercisable. But in computing the share of investor in profit or
loss of the investee, the present ownership interest is used as basis and shares or equity interest from the
potential exercise of rights is not included or considered.
EQUITY METHOD
This method is applicable when an investor has a significant influence over investee. Investment associate
accounted for using equity method shall be classified as noncurrent asset.

CARRYING AMOUNT of INVESTMENT IN

ASSOCIATE
Initial Measurement Cost
Increase/Decrease Share in Investee’s Profit/(Loss)*
Decrease Dividend received**
*Share in Investee’s Profit or Loss is recognized in the investor’s profit or loss and accounted in
Investment Income or Loss account
**No dividend income is recognized under this method because dividends are deduction to Investment in
Associate account. Share dividend received is recorded through memorandum entry and does not affect the
carrying amount of investment in associate. Share dividends do not affect the equity interest of an
investor since all other investors are also given when share dividend is distributed.
EQUITY METHOD NOT APPLICABLE
PAS 28 provides that an investment in associate shall not be accounted for using 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 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
EXCESS OF COST OVER CARRYING AMOUNT
Cost – the amount paid to purchase shares
Carrying amount – Carrying amount of net assets of an investee x Percentage % share acquired
Excess of Cost Over Carrying Amount – the investor pays more than the carrying amount of his share

The excess may be attributed to the following:

a. Undervaluation of investee’s assets
b. Goodwill
If undervaluation pertains to depreciable and intangible assets, excess is amortized over the remaining
life of the asset. Undervaluation of assets means understatement of depreciation expense and overstatement
of profit or understatement of loss of investee.
If the profit of investee is overstated, amount recorded in investment income and in investment in associate
is overstated. So, the entry to amortize the excess is: Debit Investment Income Credit Investment in
Associate
If the loss is understated, amount recorded in investment loss is understated and in investment in associate
is overstated. So, the entry to amortize the excess is: Debit Loss in Investment Credit Investment in
Associate.
If undervaluation pertains to non-depreciable assets, excess is not amortized.
If undervaluation pertains to Inventory, excess is expensed when the inventory is sold.
If the excess is attributable to Goodwill, it is included in the carrying amount of the investment and is
not amortized.

EXCESS OF FAIR VALUE OVER COST

This means that investor pays less than the fair value of the equity or the amount can be purchased in the
market.

PAS 28 provides that excess of the investor’s share of the net fair value of the associate’s identifiable assets
and liabilities over the cost is included in the determination of the investor’s share of the associate’s
profit or loss in the period in which the investment is acquired.

INVESTMENT INCOME
Increase/Decrease Share in Investee’s Profit or loss
Decrease Amortization of excess attributable to
undervaluation of assets (Excess is the
difference of fair value over carrying
amount of investee’s assets multiply by
percentage share)
Increase Excess of Fair Value over cost
INVESTEE WITH HEAVY LOSSES
PAS 28 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.
Carrying amount of investment is not only composed of the balance in Investment in Associate account
but also includes other long term interests in associate such as long term receivables, loan and advances.
Trade receivables and any long term receivables with adequate collateral are excluded from the
carrying amount of investment.
Additional losses or liability is recognized if the investor has incurred legal or constructive obligations or
made payments in behalf of the associate.
When investee reports income after heavy losses, investor’s share is not reported until the unrecognized
losses are covered.
For example, Investment in Associate has carrying amount of P100,000 and Investor’s share in net loss is
P120,000. Loss in investment recognized is up to P100,000. Unrecognized loss is P20,000.
If after that loss, investee has profit and share of investor is P10,000. No investment income is recognized
since the P10,000 will be offset first in the unrecognized loss of P20,000. As of this year, unrecognized loss
is P10,000. Next year, investor’s share in profit is P50,000. The amount to be recorded as investment income
will be P40,000 (P50,000 less unrecognized losses of P10,000)

IMPAIRMENT LOSS
Impairment loss is recognized whenever the carrying amount of investment in associate exceeds the
recoverable amount.
Recoverable amount – Higher between Fair Value Less Cost of Disposal and Value in use.
Fair Value – price would be received if the asset is sold in orderly transaction between market
participants at the measurement date.
Value in Use – present value of the estimated future cash flows expected to arise from continuing
use of an asset and from ultimate disposal.
Recoverable amount is assessed for each individual associate unless an individual associate does not
generate cash inflows from continuing use that are largely dependent of those from other assets of the
reporting entity.

INVESTEE WITH PREFERENCE SHARES

Cumulative preference shares – whether declared or not
Investee’s Profit or Loss PXX
Preference share dividend (XX)
Income attributable to Ordinary share XX
Multiply percentage share of investor X%
Share in Investee’s Profit or Loss XX
Noncumulative preference shares – only when declared
Investee’s Profit or Loss PXX
Preference share dividend (XX)
Income attributable to Ordinary share XX
Multiply percentage share of investor X%
Share in Investee’s Profit or Loss XX

OTHER CHANGES IN EQUITY

Share in evaluation Surplus and translation difference from foreign exchange is recognized by the investor
and increases the investment in associate account.
ADJUSTMENT OF INVESTEE’S OPERATIONS
1. The most recent available financial statements of the associate 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 of the investor 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.
2. 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.
3. Profits or losses resulting from transactions between investor and investee should be eliminated
in computing share’s in profit or loss of the investor.

TRANSACTIONS BETWEEN INVESTOR AND INVESTEE

INVESTOR

DOWNSTREAM UPSTREAM

ASSOCIATE

Unrealized Profit or Loss occurs from transactions between related parties (investee and investor) and this
should be eliminated in computing share’s in profit or loss of the investor. This is only realized when
assets within the transactions are sold to unrelated or outside parties.
UPSTREAM TRANSACTIONS (SALE OF INVENTORY)

OUTSIDE PARTY
Unrealized Profit of P100,000 is
Sold inventory, bought from now realized and should be
added in profit or loss of investee
associate, to customers
in computing investor’s share
INVESTOR

Sold inventory to Investor Unrealized Profit of P100,000 is

costing P200,000 for eliminated in computing share
ASSOCIATE P300,000 of investor in profit or loss

UPSTREAM TRANSACTIONS (SALE OF DEPRECIABLE ASSETS)

Unrealized profit on sale of

INVESTOR P500,000 is eliminated in
computing share of investor
Sold building to Investor in profit or loss
with carrying amount of
P1,000,000 for P1,500,000 Realization of P500,000 is
ASSOCIATE through dividing it with
remaining useful life of the
asset

ACCOUNTING ISSUE
No clear guidance is issued yet how to eliminate the unrealized profit from downstream transactions.

INVESTMENT IN ASSOCIATE ACHIEVED IN STAGES

Fair Value Approach
a. The existing interest in the associate is re-measured at fair value with any change in fair value
included in profit or loss. If the existing interest is accounted for at fair value through other
comprehensive income
b. Total cost of investment for initial application of equity method = re-measured fair value of
existing interest + cost of additional interest acquired
c. Excess of cost over carrying amount = total cost of investment less carrying amount of net
assets acquired at the date the significant influence is obtained
If an investment in associate achieved in stages during the year, take note of the recognition of the
income.

Cost Method to Equity Method

Take note of this:
1. Under cost method, no share in investee’s profit or loss. Dividend received is recognized as
dividend income.
2. If significant influence is achieved during the year, income for the whole year consists of
dividend income under cost method and investment income under equity method. The share
in investee’s profit or loss should be proportionated properly from the time significant influence is
obtained to reporting period. Dividend received under equity method is not recognized as
dividend income.
Fair Value Method to Equity Method
1. Under fair value method, no share in investee’s profit or loss. Dividend received is recognized as
dividend income.
2. There are two methods under fair value: Fair Value through profit or loss and Fair Value through
Other Comprehensive Income. If profit or loss for the whole year is computed by adding
dividend income under fair value method, unrealized gain- FVPL and investment income under
equity method.

LOSS OF SIGNIFICANT INFLUENCE

An entity loses significant influence when it loses power to participate in the financial and operating policy
decisions of the investee. The loss can occur with or without change in the ownership interest.
PAS 28 requires an investor that continues to have significant influence to apply equity method even if
the associate is operating under severe long-term restrictions that significantly impair the ability to
transfer funds to the investor.
MEASUREMENT AFTER LOSS OF SIGNIFICANT INFLUENCE
The retained investment shall be measured at fair value. The difference between carrying amount and the
fair value of retained investment shall be included in profit or loss.