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IAS 28 — Investments in Associates Objective of IAS 28: The objective of IAS 28 is to prescribe the accounting for investments in associates and to set out the requirements for the application of the equity method when accounting for investments in associates and joint ventures.

Scope of IAS 28: IAS 28 applies to all entities that are investors with joint control of, or significant influence over, an investee (associate or joint venture).

Key definitions An entity over which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor. Significant influence The power to participate in the financial and operating policy decisions of the investee but is not control or joint control of those policies. Joint arrangement An arrangement of which two or more parties have joint control. Joint control 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 venture A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. Joint venturer A party to a joint venture that has joint control of that joint venture. Equity method A method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of the investee's net assets. The investor's profit or loss includes its share of the investee's profit or loss and the investor's other comprehensive income includes its share of the investee's other comprehensive income.

Associates

Significant influence: Where an entity holds between 20% and 50% of the voting power (directly or through subsidiaries) on an investee, it will be presumed the investor has significant influence unless it can be clearly demonstrated that this is not the case. If the holding is less than 20%, the entity will be presumed not to have significant influence unless such influence can be clearly demonstrated (e.g. representation on the board). A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence. The existence of significant influence by an entity is usually evidenced in one or more of the following ways: • Representation on the board of directors or equivalent governing body of the investee; • Participation in the policy-making process, including participation in decisions about dividends or other distributions; • Material transactions between the entity and the investee;

• Interchange of managerial personnel; or • Provision of essential technical information The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities, are considered when assessing whether an entity has significant influence. In assessing whether potential voting rights contribute to significant influence, the entity examines all facts and circumstances that affect potential right. An entity loses significant influence over an investee when it loses the power to participate in the financial and operating policy decisions of that investee. The loss of significant influence can occur with or without a change in absolute or relative ownership levels. This might occur, for example, if the investee becomes subject to the control of a government, a court or a regulator. Alternatively, influence might be lost if an entity holds 25% of the equity in another company but the other 75% of the equity is acquired by a single purchaser who therefore gains control. When significant influence is lost, any remaining investment will be measured at fair value. Any difference between the carrying amount of the investment in associate and the remeasured amount will be included within profit or loss. From that point on, the investment will be accounted for in accordance with IFRS 9. Example: AB, CD, EF and GH each hold a 25% stake in another entity, XYZ. Any decisions relating to XYZ need to be approved by 75% of the voting members. XYZ is not jointly controlled by the four parties; any combination of three of the four parties is required to vote through any decisions relating to XYZ. The relationship is that of "collective control" as defined in IFRS 11. Each of the four parties will recognise their share of XYZ as an associated undertaking as each has significant influence over XYZ. Therefore, each party will apply equity accounting measurement principles to its investment in XYZ.

The equity method of accounting Basic principle: The equity method is defined as a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income. Distributions and other adjustments to carrying amount. The investor's share of the investee's profit or loss is recognised in the investor's profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor's proportionate interest in the investee arising from changes in the investee's other comprehensive income (e.g. to account for changes arising from revaluations of property, plant and equipment and foreign currency translations.)

Potential voting rights. An entity's interest in an associate or a joint venture is determined solely on the basis of existing ownership interests and, generally, does not reflect the possible exercise or conversion of potential voting rights and other derivative instruments. Interaction with IFRS 9. IFRS 9 Financial Instruments does not apply to interests in associates and joint ventures that are accounted for using the equity method. An entity applies IFRS 9, including its impairment requirements, to long-term interests in an associate or joint venture that form part of the net investment in the associate or joint venture but to which the equity method is not applied. Instruments containing potential voting rights in an associate or a joint venture are accounted for in accordance with IFRS 9, unless they currently give access to the returns associated with an ownership interest in an associate or a joint venture. Classification as non-current asset. An investment in an associate or a joint venture is generally classified as non-current asset, unless it is classified as held for sale in accordance with IFRS 5 Noncurrent Assets Held for Sale and Discontinued Operations.

The reasons for the use of the equity method: The equity method is used to represent the nature of the relationship between an investor and an associate (or JV). The equity method reflects the investor’s significant influence. This is less than control, but more than just the right to receive dividends that a simple investment would give. Consolidated financial statements include 100% of a subsidiary’s assets and liabilities, because these are controlled by the parent, even if the parent owns less than 100% of the equity shares. Consolidation would not be an appropriate way of accounting for an associate (or JV). Under the equity method: • The investor’s share of the associate (or JV)’s assets, liabilities, profits and losses is included in the investor’s financial statements; this represents significant influence • The investor’s share of the associate (or JV) is shown on one line in profit or loss, one line in other comprehensive income and one line in the statement of financial position, making it clear that the associate (or JV) is separate from the main group (a single economic entity).

Disadvantages of the equity method: The equity method has some important disadvantages for users of the financial statements. Because only the investor’s share of the net assets is shown, information about individual assets and liabilities can be hidden. For example, if an associate (or JV) has significant borrowings or other liabilities, this is not obvious to a user of the investor’s financial statements. In the same way, the equity method does not provide any information about the components that make up an associate (or JV)’s profit for the period.

Statement of financial position: IAS 28 requires that the carrying amount of the associate is determined as follows: $00 0 X X

Cost Add: P% of increase in reserves or Plus/(Minus): Parent’s share of profits (losses) of the associate (or JV) since acquisition Plus/(Minus): Parent’s share of OCI of the associate (or JV) since acquisition Less: impairment losses (X) Less: P% of unrealised profits if P is the seller (X) Less: P% of excess depreciation on fair value adjustments (X) Investment in associate X The investment in the associate is shown in the non-current assets section of the consolidated statement of financial position. There is no separately-recognised goodwill on acquisition of an investment in an associate. The accumulated profits of the reporting entity (or the consolidated accumulated reserves when consolidated accounts are prepared) should include the investor’s share of the post-acquisition retained profits of the associate (or JV), (minus any impairment in the value of the investment since acquisition). Similarly any other reserve of the reporting entity (or any other consolidated reserves when consolidated accounts are prepared) should include the investor’s share of the post-acquisition movement in the reserve of the associate (or JV).

Statement of profit or loss and other comprehensive income: In the statement of profit or loss and other comprehensive income, there should be separate lines for: • ‘Share of profits of associate (or JV)’ in the profit and loss section of the statement • ‘Share of other comprehensive income of associate (or JV)’ in the ‘other comprehensive income’ section of the statement. This is made up as follows: $00 0 P% of associate's profit after tax X Less: Current year impairment loss (X) Less: P% of unrealised profits if associate is the seller (X) Less: P% of excess depreciation on fair value adjustments (X) Share of profit of associate X Within consolidated other comprehensive income, the group should present its share of the associate's other comprehensive income (if applicable).

Example: Entity P acquired 30% of the equity shares in Entity A during Year 1 at a cost of $147,000 when the fair value of the net assets of Entity A was $350,000. Entity P is able to exercise significant influence over Entity A. At 31 December Year 5, the net assets of Entity A were $600,000. In the year to 31 December Year 5, the profits of Entity A after tax were $80,000. Required: What figures would be included for the associate in the financial statements of Entity P for the year to 31 December Year 5? Answer: In the statement of financial position, the investment in the associate is as follows: Investment at cost Investor’s share of post-acquisition profits of A W1 Investment in the associate The accumulated profits will include: Investor’s share of post-acquisition profits of A W1

$ 147,000 75,000 222,000

$ 75,000

$ W1 Retained post-acquisition profits of Entity A Net assets of the associate at 31 December Year 5 600,000 Net assets of Entity A at date of acquisition of shares (350,000) Retained post-acquisition profits of Entity A 250,000 The share ‘owned’ by Entity P is 30% × $250,000 = $75,000 In the statement of profit or loss, the share of the associate’s after-tax profit for the year is shown on a separate line as: “Share of profits of associate (30% × $80,000): $24,000. Adjustments: Dividends received from the associate must be removed from the consolidated statement of profit or loss. Transactions and balances between the associate and the parent company are not eliminated from the consolidated financial statements because the associate is not a part of the group.

Trading with an associate or joint venture: There might be trading between a parent and an associate (or JV). If in addition to the associate (or JV) the parent holds investments in subsidiaries there might also be trading between other members of the group and the associate (or JV). In such cases there might be: • Inter-company balances (amounts owed between the parent (or group) and the associate (or JV) in either direction); and • Unrealised profit on inter-company transactions. The accounting rules for dealing with these items for associate (or JV)s are different from the rules for subsidiaries.

The group share of any unrealised profit arising on transactions between the group and the associate must be eliminated.

Inter-company balances: Inter-company balances between the members of a group (parent and subsidiaries) are cancelled out on consolidation. Inter-company balances between the members of a group (parent and subsidiaries) and associates (or JVs) are not cancelled out on consolidation. An associate (or JV) is not a member of the group but is rather an investment made by the group. This means that it is entirely appropriate that consolidated financial statements show amounts owed by the external party as an asset and amount owed to the external party as a liability. This is also the case if a parent has an associate (or JV) and no subsidiaries. The parent must equity account for the investment. Once again, it is entirely appropriate that consolidated financial statements show amounts owed by the external party as an asset and amount owed to the external party as a liability.

Unrealised inter-group profit: Unrealised inter-company (intra-group) profit between a parent and a member of a group must be eliminated in full on consolidation. For unrealised profit arising on trade between a parent and associate (or JV) only the parent’s share of the unrealised profit is eliminated. Parent sells to associate (or JV): • The unrealised profit is held in inventory of the associate (or JV). The investment in the associate (or JV) should be reduced by the parent’s share of the unrealised profit. • The other side of the entry increases cost of sales • If the associate is the purchaser: – Dr Cost of sales (P/L)/Retained earnings (SFP) – Cr Investment in the associate (SFP) Associate (or JV) sells to parent: • The unrealised profit is held in inventory of the parent and this should be reduced in value by the parent’s share of the unrealised profit. • The other side of the entry reduces the parent’s share of the profit of the associate (or JV). • If the associate is the seller: – Dr Share of the associate's profit (P/L)/Retained earnings (SFP) – Cr Inventories (SFP)

In both cases, there should also be a reduction in the post-acquisition profits of the associate (or JV), and the investor entity’s share of those profits (as reported in profit or loss). This will reduce the accumulated profits in the statement of financial position. Example: Entity P acquired 40% of the equity shares of Entity A several years ago. The cost of the investment was $205,000. Entity P’s share of the post-acquisition retained profits of Entity A was $90,000 as at 31 December Year 5. In the year to 31 December Year 6, the reported profits after tax of Entity A were $50,000. In the year to 31 December Year 6, Entity P sold $200,000 of goods to Entity A, and the mark-up was 100% on cost. Of these goods, $30,000 were still held as inventory by Entity A at the year-end. Required: What is the necessary adjustment for unrealised profit? Answer: The unrealised profit on this inventory is $30,000 × (100/200) = $15,000. Entity P’s share of this unrealised profit is (40%) $6,000. The double entry is: Dr Cost of sales: 6,000 Cr Investment in associate: 6,000 The investment in the associate (or JV) at 31 December Year 6 is as follows: Cost of the investment Entity P’s share of post-acquisition profits of Entity A [$90,000 + (40% × $50,000)] Minus: Entity P’s share of unrealised profit in inventory

$ 205,00 0 110,00 0 (6,000) 309,00 0

Application of the equity method of accounting Basic principle. In its consolidated financial statements, an investor uses the equity method of accounting for investments in associates and joint ventures. Many of the procedures that are appropriate for the application of the equity method are similar to the consolidation procedures described in IFRS 10. Furthermore, the concepts underlying the procedures used in accounting for the acquisition of a subsidiary are also adopted in accounting for the acquisition of an investment in an associate or a joint venture. Exemptions from applying the equity method. An entity is exempt from applying the equity method if the investment meets one of the following conditions:

• The entity is a parent that is exempt from preparing consolidated financial statements under IFRS 10 Consolidated Financial Statements or if all of the following four conditions are met (in which case the entity need not apply the equity method):  the entity is a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the investor not applying the equity method  the investor or joint venturer's debt or equity instruments are not traded in a public market  the entity did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market, and  the ultimate or any intermediate parent of the parent produces financial statements available for public use that comply with IFRSs, in which subsidiaries are consolidated or are measured at fair value through profit or loss in accordance with IFRS 10. • When an investment in an associate or a joint venture is held by, or is held indirectly through, an entity that is a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds, the entity may elect to measure investments in those associates and joint ventures at fair value through profit or loss in accordance with IFRS 9. The election is made separately for each associate or joint venture on initial recognition. When an entity has an investment in an associate, a portion of which is held indirectly through a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds, the entity may elect to measure that portion of the investment in the associate at fair value through profit or loss in accordance with IFRS 9 regardless of whether the venture capital organisation, or the mutual fund, unit trust and similar entities including investment-linked insurance funds, has significant influence over that portion of the investment. If the entity makes that election, the entity shall apply the equity method to any remaining portion of its investment in an associate that is not held through a venture capital organisation, or a mutual fund, unit trust and similar entities including investment-linked insurance funds.

Classification as held for sale. When the investment, or portion of an investment, meets the criteria to be classified as held for sale, the portion so classified is accounted for in accordance with IFRS 5. Any remaining portion is accounted for using the equity method until the time of disposal, at which time the retained investment is accounted under IFRS 9, unless the retained interest continues to be an associate or joint venture.

Discontinuing the equity method. Use of the equity method should cease from the date that significant influence or joint control ceases: • If the investment becomes a subsidiary, the entity accounts for its investment in accordance with IFRS 3 Business Combinations and IFRS 10 • If the retained interest i...