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Financia l Report ing IAS28

Accounting for Associates has been around for over 40 years and the accounting treatment inIreland is very similar to that internationally so very few changes were required in switching tointernational financial reporting standards.

IAS 28 Accounting for Investments in Associates governs the accounting treatment. Essentially itrequires the adoption of the equity method of accounting to provide a true and fair view of theinvestment in associates.

Definition of an associate

An associate is defined as an entity in which the investor has significant influence and which is neithera subsidiary nor a joint venture of the investor. The key to deciding whether or not a company has an

associate is the definition of significant influence.Significant influence means that an entity has the power to participate in the financial and operating

policy decisions of the investee but has not control over those policies. There are a number of guidelinesto help investors decide whether that exists or not as shown below.

Significant Influence

If an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it ispresumed that it has significant influence, unless it can be clearly demonstrated that this is not the case.Conversely, if less than 20% the presumption is that the investor does not have significant influence. Amajority shareholder by another investor does not preclude an investor having significant influence.

Its existence is usually evidenced in one or more of the following ways:

(a) representation on the board of 

directors;

(b) participation in policy makingprocesses;

(c) material transactions between theinvestor and the investee;

(d) interchange of managerial personnel;or

(e) provision of essential technicalinformation.

It is possible that a holding of more than20% does not provide significant influence

and that is the case in Ryanair’s investment inAer Lingus. However, Ryanair must explainwhy that is the case in their notes as there isa presumption that a 20% or more holdingwould provide the investor with significantinfluence. Their note for year ended 31stMarch 2008 is provided in image 1. Similarlythere is a presumption that under 20% willnot provide significant influence but that canbe rebutted as well.

S i g n i f i c a n t I n f l u e n c e – T h e K e yt o A c c o u n t i n g f o r I n v e s t m en t si n A s s o c i a t e

Robert Kirk reviews IAS28 Accounting for Investments in Associates.

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Financia l Report ing IAS2

The equity method

Once the relationship is defined as an associate the only method of accounting permitted inaccounting for associates is the equity method. This is a method of accounting whereby theinvestment is initially recorded at cost and adjusted thereafter for the post acquisition changein the investor’s share of net assets of the investee. The income statement reflects theinvestor’s share of the results of operations of the investee but strangely, this is recorded aftertax, in the pre tax profits of the group.

Distributions received may bear little relationship to the performance of the associate. As theinvestor has significant influence over the associate, the investor has a measure of responsibilityfor the associate’s performance and it should account for this stewardship by extending thescope of consolidation to include the investor’s share of results of such an associate. As a result,the application of the equity method provides more informative reporting of both net assetsand net income of the investor.

A good example of the methodology is provided by CRH Plc:

CRH Plc Year ended 31st Dec 2008

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Financia l Report ing IAS28

Exceptions to the Equity Method

An investment in an associate should be accounted for inthe consolidated accounts under the equity method exceptwhen:

(a) the investment is acquired and held exclusively with aview to its subsequent disposal in the near future; or

(b) it operates under severe long-term restrictions.

In these latter cases, the investments should beaccounted for in accordance with IAS 39.

Cessation of Equity Method

An investor should discontinue the use of the equitymethod from the date that:

(a) it ceases to have significant influence but retainseither, in part or in whole, its investment; or

(b) the use of the equity method is no longer appropriateas the associates operates under severe long termrestrictions.

The carrying value should be regarded as cost thereafter.

Application of the Equity Method

Many of the procedures appropriate for applying equityaccounting are similar to consolidation under IAS 27. Forexample, on acquisition any difference between the cost of acquisition and the investor’s share of the fair values of thenet identifiable assets is accounted for under IFRS 3 asgoodwill/negative goodwill. Appropriate adjustments arethen made to the post acquisition share of profits for:

(a) depreciation based on fair values; and

(b) any possible impairment of goodwill.

The most recent available financial statements of theassociate are used by the investor in applying the equitymethod and they are usually drawn up to the same date asthe investor. However, if the dates differ, the associate oftenprepares statements specifically for the investor to the samedate but if this is impracticable then a different date may beused. However the length of the reporting periods should beconsistent from period to period.

When different dates have to be adopted, anyadjustments for significant events occurring between thedate of the associate’s statements and the date of theinvestor’s financial statements must be made.

Similar to consolidation, uniform accounting policies

should be adopted and appropriate adjustments are madeto the associate’s statements but if this is not practicable thatfact must be disclosed.

If an investor’s share of losses exceeds the carryingamount of the investment, the investor should normally stopincluding its share of losses and the investment thenreported at nil. Additional losses are only provided for tothe extent that the investor has incurred obligations which ithas guaranteed to the investee. However, if subsequentlythe associate reports profits, the investor only resumesinclusion of its share of the investee profits after its share of profits equals share of losses not recognised.

Annual impairment reviews are required similar tosubsidiaries and also if there is an indication of impairmentlosses between the annual review and the year end. Thereporting entity applies IAS 36 in such cases.

In determining value in use, an entity must estimate:

(a) its share of the present value of estimated future cashflows expected to be generated by the investee as a

whole, including the proceeds on ultimate disposal or(b) the present value of estimated future cash flowsexpected to arise from dividends and from ultimatedisposal.

Both methods give the same result, under appropriateassumptions. Any impairment loss is allocated as per IAS 36.It is therefore allocated first to goodwill.

Disclosure

The following disclosures are required by IAS 28:

(a) an appropriate listing and description of significantassociates, including the proportion of ownershipinterest and, if different, the proportion of voting

power held; and

(b) the methods used to account for such investments.

Investments in associates should be classified as long-term assets and disclosed separately in the Statement of Financial Position (balance sheet). The investor’s share of profits/losses should also be disclosed separately in theincome statement. Both of these requirements can be seenin CRH’s example above. However, the appropriate listing isprovided below:

Conclusion

As can be seen from the above discussion accounting forassociates internationally is very similar to that required inIreland under FRS 9 Associates and Joint Ventures and thosecompanies adopting the full IAS standard or the expectedIFRS for Non Publically Accountable Entities should havevery little problem in the conversion process.

Robert Kirk is Professor of Financial Reporting at theUniversity of Ulster.