CHAPTER 18: PAS 28 - INVESTMENT IN ASSOCIATES

Associate

Associate is simply defined 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 associate but not
control or joint control over those policies.

The assessment of significant influence is a matter of judgement.

However, PAS 28, paragraph 5, provides a practical guidance to assist management in making such 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 this is not the case.

Conversely, 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.

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 investor and the investee
d) Interchange of managerial personnel
e) Provision of essential technical information

Measurement of investment in associate

The investment in associate is measured using the equity method of accounting.

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 investor and the investee are one and the same.

The equity method is applicable when the investor has a significant influence over the investee.

Accounting procedures – equity method

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) 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.
e) Technically, if the investor has significant influence over the investee, the investee is said to be an associate.
CHAPTER 18: PAS 28 - INVESTMENT IN ASSOCIATES

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 reported as noncurrent asset.

Illustration – equity method

1. On January 1, 2019, an investor purchased 20,000 shares of the 100,000 outstanding ordinary shares of another
entity at P200 per share.

The investment represents a 20% equity interest and the investor has a significant influence over the investee.

Investment in associate 4,000,000

Cash 4,000,000

2. The investee reported net income of P5,000,000 for 2019.

The investor recognizes a share of the net income of the investee equal to 20% of P5,000,000 or P1,000,000.

Investment in associate 1,000,000

Investment income 1,000,000

3. Received a 25% share dividend from the investee on December 31, 2019.

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 P1,000,000 for 2020.

The investor recognized a share in the net loss of the investee equal to 20% of P1,000,000 or P200,000.

Loss in 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, 2020.

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
Investment in associate 500,000

Under the equity method, cash dividend is not an income but a 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.
CHAPTER 18: PAS 28 - INVESTMENT IN ASSOCIATES

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

If the assets of the investee are fairly valued, the excess of the cost over carrying amount of the underlying net assets is
attributable 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 non-depreciable. 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. Any excess is attributable to goodwill.

The carrying amount of the investee’s net assets was P20,000,000 equal to fair value. The investor therefore paid
P1,000,000 in excess of the carrying amount of net assets.

Acquisition cost 5,000,000

Carrying amount of net assets acquired (20% x 20,000,000) 4,000,000
Excess of cost over carrying amount – goodwill 1,000,000

Excess of 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.

Illustration

At the beginning of the current year, an investor purchased 40% of the ordinary shares outstanding of an investee for
P10,000,000 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 fair value.

Acquisition cost 10,000,000

Fair value of net assets acquired (40% x 30,000,000) 12,000,000
Excess fair value 2,000,000

The excess fair value is included in investment income of the investor on the date of acquisition.
CHAPTER 18: PAS 28 - INVESTMENT IN ASSOCIATES

Investment in associate 2,000,000

Investment income 2,000,000

Impairment loss

If there is an indication that an investment in associate may be impaired, 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 the ultimate disposal.

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.

Investee which cumulative 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.

Investee with noncumulative preferences shares

When an associate has outstanding noncumulative preference shares, the investor shall compute its share of earnings
after deducting preference dividends only when declared.

Discontinuance of equity method

PAS 28, paragraph 22, provides that an investor shall discontinue the use of the equity method from the date that is
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.
CHAPTER 18: PAS 28 - INVESTMENT IN ASSOCIATES

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 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.

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 recognized as gain or loss on disposal of investment.

Equity method not applicable

PAS 28, paragraph 17, it 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 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.