CHAPTER 17

Investment in Associates- Basic Principles

 INTERCORPORATE SHARE INVESTMENT
 Purchase of the equity shares of one entity by another entity
 An entity may purchase enough shares of another entity in order to exert
SIGNIFICANT INFLUENCE over financial & operating policies of the investee entity.
 SIGNIFICANT INFLUENCE
 Is the power to participate in the financial and operating policy decisions of
the investee but NOT control over those policies

NOTES:
 If the investor holds 20% or more of the voting power (ordinary shares) of the
investee, it is presumed that the investor has significant influence, unless it can be
clearly demonstrated that this is not the case.
 If the investor holds 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.
 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
 POTENTIAL VOTING RIGHTS
 Considered in assessing significant influence
 Should be currently exercisable/convertible
 The basis of investor’s share on P&L is based on present ownership interest and DOES
NOT reflect possible exercise/conversion of potential voting rights
LOSS OF SIGNIFICANT INFLUENCE
 Loses the power to participate in the financial and operating policy decisions of the
investee
 Can occur with or without change in absolute/relative ownership interest
 Became subject to control of a government/court/admin/regulator
 Contractual agreement
EQUITY METHOD
NOTES:

 The equity method is applicable when the investor has a significant influence
over the investee.
 Investment in associate accounted for using the equity method shall be classified
as NONCURRENT ASSETS
 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.
EQUITY METHOD
Exercise: Equity method
Problem: At the beginning of the current year, Marquez Company purchased 40% of
the ordinary shares of another company for P 3,500,000 when the net assets
acquired amounted to P 7,000,000.

At the acquisition date, the carrying amounts of the identifiable assets and
liabilities of the investee were equal to the fair value, except for equipment for
which the fair value was P 1,500,000 greater than the carrying amount and
inventory whose fair value was P 500,000 greater than the cost.

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

The investee reported a net income of P 4,000,000 and paid P 1,000,000 dividends
during the current year.
Exercise: Equity method
Solution:
Cost of the investment 3,500,000
Less: Carrying amount of net asset acquired ( P 7,000,000 x 40%) 2,800,000
Excess of cost over the carrying amount 700,000
Attributable to equipment (40% x 1,500,000) 600,000
Attributable to inventory (40% x 500,000) 200,000 800,000
Excess net fair value over cost (100,000)

Journal entries:
(1) To record the acquisition:
Investment in associate 3,500,000
Cash 3,500,000
(2) Share in investee’s income
Investment in associate (40% x P 4,000,000) 1,600,000
Investment income 1,600,000
(3) Dividend declared and paid by the investee
Cash ( 40% x 1,000,000 ) 400,000
Investment in associate 400,000
Exercise: Equity method
(4) Amortization of excess of cost attributable to equipment (with remaining
useful life of 4 years)
Investment income (600,000 / 4) 150,000
Investment in associate 150,000

(5) Amortization of excess of cost attributable to inventory ( already sold during

the current year)
Investment income 200,000
Investment in associate 200,000

(6) To record the excess net fair value over cost

Investment in associate 100,000
Investment income 100,000
 Investee with heavy losses
 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.
NOTES:

 The investment is reported at nil or zero value.

 Carrying amount of investment in associate includes the following:

(1) Long term receivables

(2) Loans
(3) Advances and investment in PS shares

 Carrying amount of investment in associate excludes the following:

(1) Trade receivable

(2) Long term receivable for which adequate collateral exists such as secured loans
Investee with heavy losses
NOTES:

 Losses recognized using the equity method as applied in the following order:

(1) Investment in associate

(2) Investment in Preference shares of associate
(3) Loans and advances to associate

 Subsequent recognition of the investor’s share in the net income of the associate
is recorded as reversal of the loss previously recognized respectively for the
following:

(1) Loans and advances to associate

(2) Investment in preference shares of associate
(3) Investment in associate
Exercise: Investee with heavy losses
Problem: On January 01, 2018, Nillas 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: 2018 – 5,000,000;
2019 – 7,000,000; 2020 – 8,000,000; 2021 – 4,000,000.

On January 01, 2020, Nillas Company made cash advances of P 2,000,000 to the
investee. On December 31, 2021, it is not expected that Nillas will provide further
financial support for the investee.
Exercise: Investee with heavy losses
Solution & Journal entries:
2018
Investment in associate 7,000,000
Cash 7,000,000
Loss from Investment ( 40% x P 5M ) 2,000,000
Investment in associate 2,000,000
2019
Loss from Investment ( 40% x P 7M ) 2,800,000
Investment in associate 2,800,000
2020
Advances to associate 2,000,000
Cash 2,000,000

Loss from Investment ( 40% x P 8M ) 3,200,000

Investment in associate 2,200,000*
Advances to associate 1,000,000

* 7,000,000 – 2,000,000 – 2,800,000 = 2,200,000 (remaining balance of investment in associate account.

Exercise: Investee with heavy losses
Solution & Journal entries:
2021
Loss form investment 1,000,000
Advances to associate 1,000,000

Acquisition cost 7,000,000

Cash Advances 2,000,000
Total investment 9,000,000
Share in net loss from 2018 – 2020 (5M + 7M + 8M) x 40% (8,000,000)
Carrying amount of investment – 12/31/2020 1,000,000

Share in net loss for 2021 ( 4M x 40%) 1,600,000

Loss from investment to be reported in 2021 should not exceed the carrying
amount of investment.
 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.
Exercise: Investee with preference
shares
Problem: Taopo Company reported the following capital accounts at the beginning of the
current year: Preference share capital, 10% cumulative, P 100 par, 40,000 shares issued –
P 4,000,000; Ordinary share capital, P 50 par, 500,000 shares authorized and 200,000
shares issued – P 10,000,000; Retained Earnings – P 5,000,000.

On the same date, Manrique acquired 40,000 ordinary shares of Taopo representing a
20% interest for P 3,000,000. The net assets of Taopo are fairly valued.

The investee reported net income of P 2,800,000 for the current year and paid cash
dividends of P 900,000 to ordinary shareholders and the preference dividends at the
preference rate.
Exercise: Investee with preference
shares
Solution & Journal entries:
(1) To record investment:
Investment in associate 3,000,000
Cash 3,000,000
(2) To record the share in net income
Investment in associate 480,000
Investment income 480,000

Net Income 2,800,000

Less: Preference dividend (10% x P 4,000,000) 400,000
Net income allocated to ordinary shares 2,400,000

(3) To record the share in cash dividend

Cash ( 20% x 900,000) 180,000
Investment in associate 180,000
Share in net income ( 20% x 2,400,000 = 480,000)