IAS 28 – Investments in Associates and Joint Ventures

Objective

The primary objective of IAS 28 Investments in Associates and Joint Ventures is to provide guidance on the correct accounting treatment for investments in associates and joint ventures and to lay down the requirements and the basis of application of the method known as equity accounting which is utilized by businesses in accounting for investments in joint ventures and associates.

Furthermore, it also defines and explains in detail the concept of “Significant Influence” and how this can have an effect when determining control and doing accounting for investment in joint venture and associates.

Effective Date

The Accounting standard IAS 28 Investments in Associates and Joint Ventures came into being on  January 1, 1990 and ever since it has been amended and revised to accommodate various changes as published by the IASB. The latest and most updated version of the standard IAS 28 Investments in Associates and Joint Ventures is the 2011 amendment.

The IAS 28 is applicable for entities with annual periods commencing on or after January 1, 2013. Earlier application is permitted however with the following additional requirements. In case of an early adoption of the IAS 28 Standard, the entity needs to disclose that fact in the financial statements and also simultaneously apply related accounting standards such as IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of Interests in Other Entities and IAS 27 Separate Financial Statements.

Scope

The scope of this standard extends to cover all entities that are investors having significant influence over or joint control of an investee. IAS 28 aims to cover all transactions amongst inventors and investees (joint venture or significant influence) that are not covered under the scope of IFRS 9 Financial Instruments.

Key Terms and Definitions

Before moving on to the application and use of this standard, let us first take a look at the key terms and definitions relevant to our understanding and analysis of this accounting standard.

Associate: It can be defined as any entity over which another entity has significant power or influence.

Consolidated Financials: The financials of a group in which equity, liabilities, assets, expenses and income of the parent entity as well as its subsidiaries are presented as that it is a single entity.

Joint Arrangement: A business arrangement in which parties to the arrangement have joint control.

Joint Control: The sharing of control that has been contractually agreed in any arrangement and that exists only where decisions pertaining to relevant business activities or operations require the consent of all the parties having share in control.

Joint Venture: It is an arrangement in which the parties having joint control also have rights and access to the arrangement’s net assets.

Joint Venturer: It can be defined as any entity that is part to a joint venture arrangement and also has joint control over the operations of the venture.

Significant Influence: The power to participate in the investee’s decision making process regarding its operating and financial policies.

Equity Method: It is an accounting method in which the businesses initially recognize their investments at cost and then subsequently adjust them to reflect the change in their share of the net assets of the investee after acquisition. The profit or loss of the investor consists of its share or part of the profit or loss of the entity in which it has invested and similarly the other comprehensive income of the investor consists of its share or part of the other comprehensive income of the entity in which it has invested.

Exercise 1:

Company Y and Company P hold an equal number of shares in company Z. Company Z has no other investors besides the two. Company Q is the ultimate parent of Company Z.

The management of Company Z is keen to enter the European market and for this purpose, they have decided to work together with Company E which is based in Europe. This European investment is financed by a special loan obtained for this particular purpose.

1. What is the parent of Company P?
2. What is the relationship between Company Z and Company E?
3. Is Company E a subsidiary of Company Q?
4. Does Company Q has significant influence over Company Y?
5. Is Company P a direct party of the European project?

Answers to Exercise 1:

1. Company Z. If Company P and Y are the immediate parent of Company Z and Company Q is its ultimate parent, then Company Q is the parent of company P.
2. Company Z and E are joint ventures to the European Project.
3. No, Company E is an external company with no direct or indirect link of ownership or control to Company Q, its subsidiaries or associates.
4. Holding significant influence means Q is able to influence Company Y but does not have control or ownership over Company Y. This is not correct. Company Q is implied to be the only shareholder of Company Y thus it can control Company Y hence there is no element of significant influence involved.
5. No, the joint venture parties are Company Z and Company E as they are the ones involved in the European project. Company P is not a direct party to the European project.

Significant Influence

If an entity has 20 or more percentage when it comes to the voting rights in an investee, either directly or indirectly via subsidiaries, then it is deemed that the entity having voting power in excess of 20 per cent has significant power or influence over its investee unless it can be illustrated that this is not the case. In general terms, if an entity has voting power between 20 per cent to 50 per cent in an investee then it is presumed that the entity has significant influence. Voting power that exceeds 50 per cent is deemed to be a situation of exerting control over the investee.

Similarly, if an entity’s holding in its investee is not more than 20 per cent then in such a scenario, it will be deemed that the business entity does not have significant power or influence unless the power or influence can be illustrated.

A majority or substantial stake in the investee by another investing entity does not mean that the entity cannot have significant influence over that investee.

If one or more of the following conditions exist, then it indicates a situation of significant influence over an investee:

• Participation in the decision-making process, including decisions pertaining to dividends or other distributions
• Representation on the investee’s board
• Transactions of material nature taking place between the investee and the investor
• Provision of critical technical information
• Interchange of managerial personnel

An entity can lose significant influence over one of its investee if it loses the right to take part in the decision making process pertaining to operating and financial policies of that investee. This type of loss can happen without a change in relative or absolute ownership levels as well.

For example, there could be a loss of significant influence when an associate entity comes under the control of a regulator, administrator, court or any government institution. This could also happen due to a contractual agreement or arrangement.

Equity Accounting for Investments in Associates and Joint Ventures

As per the method of equity accounting, the investor accounts for their share of the interest in a joint venture or an associate by extending the scope of financial statements to include its share of profit or loss from the investee. Hence, the equity method provides more informative reporting of the investor’s net asset and profitability position.

Initial Recognition

As per equity accounting, initially the investment in a joint venture or an associate is recognized at cost, and subsequently the carrying value is decreased or increased to recognize the investor’s share/ part of the profit or loss in the entity in which investment has been made after the acquisition date. The investing entity’s share or portion of the investee’s profit or loss is recognized in the investing entity’s statement of profit or loss.

Any distribution(s) received from the investee may reduce the investment’s carrying value.

The carrying value may be adjusted to reflect the changes in the investing entity’s proportionate interest in the investee resulting from changes in the other comprehensive income. Such instances where adjustments may be required are:

• Changes resulting from revaluation of operating fixed assets (Property, plant & equipment)
• Differences arising due to translation of foreign currency.

Equity Method for Potential Voting Rights

An entity’s interest in a joint venture or an associate is solely determined based on the existing structure of the ownership. It does not consider the existence of potential voting rights or other derivatives containing possible conversion or exercise of voting rights.

Application of Equity Method

A group’s share in a joint venture or an associate is the combined total of the holdings in that joint venture or associate by the parent and its subsidiaries. The holdings of the group’s other joint ventures or associates are ignored for this purpose.

When a joint venture or an associate has subsidiaries, joint ventures, and associates, then the net assets and profit or loss as well as other comprehensive income that are taken into consideration when applying the equity method are those recognized in the joint venture’s or associate’s financial statements after making necessary adjustments to ensure uniformity in accounting policies.

An investment is treated in an entity’s books as per the equity method of accounting from the time it either becomes a joint venture or an associate. On acquisition of interest in an entity, any type of difference among the entity’s share of the net fair value of the investee’s identifiable obligations and resources (liabilities and assets respectively) is treated in the following manner:

• Goodwill – Goodwill relating to a joint venture or an associate is included in the investment’s carrying value. Amortization arising on goodwill due to acquisition of interest in an investee is not permitted.
• Any excess of the entity’s portion of the net fair value of the investee’s identifiable liabilities and assets over the investment’s cost – It is to be treated as income when determining the entity’s share of the joint venture or associate’s profit or loss in the financial period in which the investment was made.

Adjustments for Depreciation and Impairment Losses

On the date of acquisition, adjustments need to be made to the depreciation component. For example, depreciation of the assets that are of depreciable nature is based on the fair values as at the date of acquisition. Similarly, appropriate adjustments to the entity’s share of profit or loss from the acquisition should account for impairment on goodwill and property, plant and equipment.

Differences in Accounting Policies

In a situation where the accounting policies used by associates or joint ventures differ from that of the acquiring entity, the investees need to align their accounting policies with that of the investor entity in order to maintain a uniform accounting policy among all parties.

Different Reporting Dates

The most recent financials of the joint venture or associate are utilized by the entity when applying the equity accounting. When the entity’s reporting period end is different from that of the joint venture or associate then the joint venture or associate prepares, specifically for the use of the entity, financials as of the same date as the financials of the entity unless it is not practical to do so.

Exemptions from Applying the Equity Method

An entity is not required to apply the equity method of accounting to its investment in a joint venture or an associate if the entity is a parent that has exemption from preparing consolidated financials only if all of the following apply:

• The entity is either entirely or partially owned by another entity and its other investors or owners, including those who do not have to right to vote, have been informed and they also have no objection regarding the entity not using the equity method; and
• The entity is not in the process of filing its financials with a securities commission or any other regulatory body for the sole purpose of issuing any kind of instruments in a public market; and
• The intermediate or ultimate parent of the entity prepares financials available for public use that comply with all the applicable IFRSs, in which all the subsidiaries are either consolidated when preparing the consolidated financials or are measured at fair value through profit or loss; and
• The entity’s equity or debt instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets)

Presentation and Disclosure Requirements

This standard doesn’t require any disclosures to be made by an entity with regards to its investments. However, IFRS 12 Disclosure of Interests in Other Entities specifies the disclosures to be made in the notes to the financial statements by entities having significant power or influence over or joint control of an investee.