An investment in an associate is defined under IAS 28 and the IFRS. A much broader view of investment in associates is covered under the IAS 28. It states the identification of an associate as an investing activity and holds between 20% or more voting power in a company. Investment in associates is a part of the inter-corporate investment.
Key points to remember while classifying an investment in associates:
- Rightly define an associate.
An associate is defined as an entity with voting power, and the investor overpowers in influencing the associates but has no control or joint control over the associate.
- Rights of an associate
While classifying as an associate, it should be known that the associate has the right to participate in policy-making such as the financial and the operating policy but cannot solely control them or make decisions about them.
- Voting Powers
Only when the voting power of an associate is 20% or more it is considered an influential significance by the investor. It also means the below is true about the associate.
- Between the investor and the associate, there are significant transactions taking place.
- The associate has a representation on the board of directors or other governing body of the investor, which results in the policy-making process.
- Has a provision of essential technical information.
- Interchange in the managerial position.
Accounting policy for investment in associates
The investment in associates is accounted for using the equity method of accounting once the associate has been identified and classed as an influential associate. The profits earned by one firm through its investment activity in another company are recorded using the equity method of accounting. The revenue booked by the invested company is reported on the investor's income statement. The threshold for the significant influence by the associate is between 20% or more.
Steps in Accounting in Equity method
- The original investment is recorded in the balance sheet at its fair value of historical cost.
- Earnings by the associate or investee are added to the investor's balance sheet.
- The investment is recorded according to the fair value of IAS 39, and any changes in the fair value must be shown in the profit and loss statement.
- In case of any dividend payout, the amount recorded in the balance sheet is proportionally lower.
- If the dividend payout has been towards the investee company, it has to be recorded in the investee Income Statement.
- According to IFRS 3, any difference between the cost of acquisition and the investor's potential of fair values of the net recognizable assets of the associate is accounting as goodwill.
- Furthermore, any depreciation or amortization is recorded for the associate's assets based on their fair values over the carrying amounts at the time of investment.
- Under the impairment component, the investment in the associate gets calculated by the reference to IAS 36. The carrying amount is tested or impaired for each individual asset for the recoverable amount invested in the associate as a single asset.
- Also, under the equity method, the unrealized profits and losses are to be eliminated up to the investor's interest in the associate for both up and downstream transactions.
- Under IAS 28.22, eliminating the unrealized losses must be recorded until the transactions show an impairment towards the asset transfer from the associate's side.
- If the investor loses influence over the associate, it must be treated as partial disposal of the associate. It must derecognize the associate and book the profit and loss with the difference between the sum of proceeds received from the associate and the value of retained interests and the carrying amount of the association until the date of significant loss of influence.
Since the accounting standards differ for the reporting entities, the associates' accounting standards must be adjusted to the investors. The auditor should consider the date of the financial reports of the associates as the exact date of that of the investor. There should not be more than three months under the same accounting period of variance in the reporting impracticable reporting variances.
Accounting firms in Dubai
The equity method is used to determine the investment in associates. The investor must consider the investment in associates as a non-current asset. Suppose due to any reason, the investor discontinues records profits and losses from the associates. In that case, it should be disclosed separately in the statement of equity changes under IAS standards of presentation of Financial Statements. Hence the disclosure of the same is an important part of the audit.