Introduction Statement of cash flows

Chapter 34 – Associates Page 445 Under the equity method of accounting, the investment in the associate is initially recognised at cost and is subsequently adjusted in each period for changes in the investor’s share of net assets of the associate. The investor’s reported profit or loss for the period will include its share of the associate’s reported profit or loss for the period, presented as a single line item. [IAS 28.2] Where the parent and a number of its subsidiaries have an interest in a single entity, the group’s share in the investment is determined by adding together all the interests held by group entities. An investor’s interest in an associate should be presented in the statement of financial position as a single line under non-current assets. [IAS 28.38] Illustration 1 Pecs has a number of wholly owned subsidiaries and a 40 interest in the share capital of Abs. These shares were acquired three years ago when the balance on Abs’ retained earnings was CU100. Pecs Abs Group CU CU Investment in Abs 120 - Other assets 1,080 650 1,200 650 Liabilities 200 150 1,000 500 Share capital 300 100 Retained earnings 700 400 1,000 500 The consolidated statement of financial position of Pecs should incorporate Abs using the equity method of accounting. The carrying amount of the investment is calculated as: Cost of investment CU120 Share of post acquisition retained earnings 40 x 400 – 100 CU120 CU240 Consolidated statement of financial position Pecs Group CU Investment in Abs 240 Other assets 1,080 1,320 Liabilities 200 1,120 Share capital 300 Pecs 700 plus share of Abs’ Retained earnings 820 post acquisition profit 120 1,120 Chapter 34 – Associates Page 446 Illustration 2 The consolidated statement of comprehensive income of Pecs and its subsidiaries and the statement of comprehensive income of Abs for the current year are shown below. Pecs Abs Group CU CU Revenue 1,100 600 Cost of sales 200 150 Gross profit 900 450 Expenses 130 150 Profit from operations 770 300 Finance income 90 - Finance costs 40 10 Profit before tax 820 290 Tax 270 70 Net profit for the year 550 220 The consolidated statement of comprehensive income of Pecs will only include its share of the profit after tax of Abs. Pecs Group CU Revenue 1,100 Cost of sales 200 Gross profit 900 Expenses 130 Profit from operations 770 Finance income 90 Finance costs 40 Share of profits of associates 40 × 220 88 Profit before tax 908 Tax 270 Net profit for the year 638

4.1 Procedures to be used

The procedures used in the preparation of the consolidated financial statements in accordance with IAS 27 are used in the application of equity accounting. Where transactions take place between an investor and its associates, adjustment should be made to eliminate any internally generated profit or loss that arises. The amount eliminated is only the element that relates to the investor’s share, since this is the amount that is essentially internally generated by the group. Chapter 34 – Associates Page 447 Illustration 3 If an investor holds a 30 share in an associate and made a profit of CU100 from a sale to the associate of goods still held in the associate’s inventory, then only CU30 i.e. the investor’s share would be eliminated from the investor’s reported profit. As equity accounting does not involve the aggregating of the individual asset and liability balances with those of the parent and subsidiaries, the receivables and payables balances due from and to associates are not eliminated. At the acquisition date the investment in the associate should be recognised at its cost. This represents the share of the fair value of the net assets acquired and the future economic benefits attributable to assets which cannot be separately identified and recognised i.e. goodwill. Fair value is generally market value, although where no market exists for the transfer of such items, fair value may need to be assessed using a different basis. The calculation of fair values is consistent with the application of IFRS 3. If the goodwill is a positive figure it should be included as part of the carrying amount of the investment. If the cost was less than the fair value of the net assets acquired, then a discount was achieved on the purchase which is unlikely to occur in practice. The discount should be included as part of the investor’s share of the associate’s profit or loss for the period in which the investment was made. The associate’s most recent set of financial statements should be used for equity accounting purposes. If the end of the reporting period of the associate is different from that of the investor, then financial statements should be prepared to the end of the investor’s reporting period, unless it is impracticable to do so. The additional financial statements should be based on the associate’s financial statements prepared to the end of its last reporting period and adjusted for significant events that have occurred during the period between the two dates. The end of the reporting periods of the associate and its investor should not be more than three months different to each other. [IAS 28.24, 28.25] The associate’s accounting policies should be consistent with those of its investor. Where any of the main accounting policies are different, adjustments should be made to the associate’s financial statements for equity accounting purposes. [IAS 28.26] If an associate makes losses, then the investor should equity account for these in the same way as it recognises profits, by reducing the carrying amount of the share of the associate’s net assets. If, however, losses continue, the carrying amount of the associate should only be reduced as far as nil. Any excess loss should only be recognised by the investor as a liability where it has an obligation to make payments on behalf of the associate. If the associate makes profits in future periods, the investor should resume equity accounting for its share.

4.2 Impairment losses

The requirements of IAS 39 should be applied to determine whether an impairment loss should be recognised in respect of the investment. An impairment arises where the recoverable amount of the asset has fallen below its current carrying amount. Where IAS 39 indicates that an impairment has arisen, IAS 36 Impairment of assets should be applied to assess its size. The recoverable amount of the investor’s share in an associate is determined by considering the net realisable value i.e. net selling price of the investment and its value in use. The value in use is determined either by estimating the present value i.e. taking into account the time value of money of the future cash flows that are expected to be generated by the associate or by estimating the present value of the expected future dividend stream.