INVESTMENT IN ASSOCIATE

An associate is an entity over which the investor has significant influence.

Significant influence is the power to participate in the financial and operating policy decisions of the
investee but is not control or joint control of those policies.
The existence of significant influence by an investor is usually evidenced in one or more of the following
ways:
a. representation on the board of directors or equivalent governing body of the investee
b. participation in policy-making processes, including participation in decisions about dividends or
other distributions
c. material transactions between the investor and the investee
d. interchange of managerial personnel
e. provision of essential technical information

The Standard does not require the equity method to be applied when an associate is acquired and held
with a view to its disposal within twelve months of acquisition.

Associate Having Outstanding Preference Shares

If an associate has outstanding cumulative preference shares that are held by parties other than the
investor and classified as equity, the investor computes its share of profits or losses after adjusting for
the dividends on such shares, whether or not the dividends have been declared.

Computation of Share in Net Income

Net income of the associate XX
Less: Preference share dividend ( XX )
Net income to ordinary share XX
Multiply by: Percentage of ownership - Ordinary shares %
Share in net income of the associate XX

The preference dividend to be deducted from the net income is:

Cumulative preference Fixed rate x total par value of outstanding preference shares for only one
share year, declared or not.
Noncumulative Actual dividends declared.
preference share

Redeemable Preference Shares

Redeemable preference shares are treated as financial liability. Thus, any dividends declared shall be
treated as finance cost in the Profit and Loss Statement.

Therefore, the preference dividends shall no longer be deducted from the net income of the associate
because such were already deducted as an expense (i.e., finance cost) in computing for the net income
during the period.

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ADJUSTMENT OF INVESTEE’S OPERATIONS
Upstream Transactions
Profits and losses resulting from ‘upstream’ and ‘downstream’ transactions between an investor
(including its consolidated subsidiaries) and an associate are recognized in the investor’s financial
statements only to the extent of unrelated investors’ interests in the associate. ‘Upstream’ transactions
are, for example, sales of assets from an associate to the investor.

Downstream Transactions
‘Downstream’ transactions are, for example, sales of assets from the investor to an associate. The
investor’s share in the associate’s profits and losses resulting from these transactions is eliminated.

When downstream transactions provide evidence of a reduction in the net realizable value of the assets
to be sold or contributed, or of an impairment loss of those assets, those losses shall be recognized in
full by the investor. When upstream transactions provide evidence of a reduction in the net realizable
value of the assets to be purchased or of an impairment loss of those assets, the investor shall recognize
its share in those losses.

The share in the profit or loss of an associate is recognized only to the extent of unrelated investor’s
interest in the associate. If the transaction is:
 Downstream Sale – eliminate the entire unrealized profit. (e.g., 100%)
 Upstream Sale – eliminate the investor’s share in unrealized profit. (percentage of ownership)

Basic Formula:
Net income x percentage of ownership XX
Less: Unrealized profit on upstream sale x percentage of ownership (XX)
Add: Realized profit on upstream sale x percentage of ownership XX
Less: Unrealized profit on downstream sale (XX)
Add: Realized profit on downstream sale XX
Share in the net income XX

LECTURE DRILLS
Problem 1
At the beginning of the current year, an entity purchased 40% of the outstanding ordinary shares of
another entity for ₱9,500,000 when the net assets of the investee amounted to ₱15,000,000. At
acquisition date, the carrying amounts of the identifiable assets and liabilities of the investee were equal
to their fair value, except for equipment whose fair value was ₱3,000,000 greater than carrying amount,
land whose fair value was ₱2,500,000 greater than cost and inventory whose fair value was ₱2,000,000
greater than cost. The equipment had a remaining life of 4 years. The land was sold, and the inventory
was one-half sold during the current year. The investee reported net income of ₱10,000,000, paid
₱4,000,000 cash dividend and issued 10% share dividend during the current year.

1. What is the investment income for the current year?

a. 2,800,000
b. 2,300,000
c. 1,600,000
d. 4,400,000

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2. What is the carrying amount of the investment in associate at year-end?
a. 12,300,000
b. 10,200,000
c. 10,700,000
d. 13,900,000

Problem 2
At the beginning of the current year, an entity acquired a 30% interest in an investee at a cost of
₱3,500,000. The equity of the investee on the date of acquisition was ₱6,000,000, consisting of
₱4,000,000 share capital and ₱2,000,000 retained earnings. All the identifiable assets and liabilities of
the investee were recorded at fair value on the date of acquisition. During the current year, the investee
reported net income of ₱4,000,000 and paid dividend of ₱1,500,000. The equity of the investee at year-
end showed the following:
Share Capital 4,000,000
Retained Earnings 3,500,000
Retained Earnings appropriated 1,000,000
Revaluation surplus 2,000,000
The revaluation surplus arose from a revaluation of land made at the end of current year. The retained
earnings appropriated arose from a transfer of unappropriated retained earnings to retained earnings
appropriated for contingencies.

1. What is the investment income for the current year?

a. 1,200,000
b. 1,650,000
c. 3,200,000
d. 2,000,000

2. What is the carrying amount of the investment in associate at year-end?

a. 3,500,000
b. 4,700,000
c. 4,250,000
d. 4,850,000

Problem 3
At the beginning of the current year, an entity acquired 40% of the ordinary shares of an associate. On
such date, assets and liabilities of the investee were recorded at fair value and acquisition showed that
goodwill of ₱1,000,000 was acquired. The investee reported net income of ₱8,000,000 for the current
year. In December, the investee sold inventory costing ₱3,000,000 to the investor for ₱5,000,000. One-
half of the inventory remained unsold by the investor at year-end. At the beginning of current year, the
investee sold an equipment to the investor with carrying amount of ₱6,000,000 for ₱8,500,000. The
remaining life of the equipment is 5 years. What amount of investment income should be reported for
the current year?
a. 1,800,000
b. 2,000,000
c. 1,600,000
d. 2,400,000

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Problem 4
On January 1, 2020, an entity acquired a 40% interest in an associate for ₱7,000,000. On this date, the
carrying amounts of the net assets of the associate were equal to fair value. The cumulative net loss of
the entity totaled ₱20,000,000 from 2020 through 2022. On January 1, 2021, the entity made cash
advances of ₱2,000,000 to the associate. On December 31, 2022, it is not expected that the entity will
provide further financial support for the associate. The entity reported ₱4,000,000 net loss for 2023 and
₱3,500,000 net income for 2024.

1. What amount should be reported as loss from investment in 2023?

a. 1,600,000
b. 1,000,000
c. 4,000,000
d. 0

2. What amount should be reported as income from investment in 2024?

a. 1,400,000
b. 1,000,000
c. 600,000
d. 800,000

Problem 5
An entity owned 60% of another entity’s preference shares and 20% of ordinary shares. The investee’s
share capital outstanding at year-end included ₱5,000,000 of 10% cumulative preference shares and
₱10,000,000 of ordinary shares. The investee reported net income of ₱8,000,000 for the current year.
No dividend was declared for both preference and ordinary shares during the current year. What
amount should be reported as investment income for the current year?
a. 1,600,000
b. 1,500,000
c. 1,800,000
d. 1,700,000

Problem 6
On January 1, 2022, an entity acquired a 10% interest in an investee for ₱3,000,000. The investment was
accounted for under the cost method. During 2022, the investee reported net income of ₱4,000,000
and paid dividend of ₱1,000,000. On January 1, 2023, the entity acquired a further 15% interest in the
investee for ₱8,500,000. On such date, the carrying amount of the net assets of the investee was
₱36,000,000 and the fair value of the 10% existing interest was ₱3,500,000. The fair value of the net
assets of the investee is equal to carrying amount. The investee reported net income of ₱8,000,000 for
2023 and paid dividend of ₱6,000,000 on December 31, 2023.

1. What amount of income should be recognized by the investor in 2022?

a. 400,000
b. 100,000
c. 300,000
d. 200,000

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2. What is the implied goodwill in 2023?
a. 3,000,000
b. 2,500,000
c. 1,500,000
d. 0

3. What total amount of income should be recognized by the investor in 2023?

a. 2,000,000
b. 2,500,000
c. 1,500,000
d. 5,500,000

4. What is the carrying amount of the investment in associate on December 31, 2023?
a. 10,500,000
b. 12,500,000
c. 13,000,000
d. 10,000,000

END

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