Accounting for investment in associates (Part 2)
IAS 28 defines the equity method as a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of net assets of the investee.
The equity method
An entity with significant influence over, or joint control of, an investee should account for its investment in an associate or a joint venture using the equity method except when the investment qualifies for exemption.
IAS 28 defines the equity method as a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor's share of net assets of the investee. The profit or loss of the investor includes the investor's share of the profit or loss of the investee, and the investor's other comprehensive income includes its share of the investee's other comprehensive income.
IAS 28 justifies the use of the equity method by noting that the recognition of income on the basis of distributions received may not be an adequate measure of the income earned by an investor on an investment in an associate or a joint venture because the distributions received may bear little relation to the performance of the associate or joint venture. Because the investor has joint control of, or significant influence over, the investee, the investor has an interest in the associate's or joint venture's performance and, as a result, the return on its investment. It is therefore appropriate for the investor to account for this interest by extending the scope of its financial statements to include its share of the profit or loss of such an investee. As a result, application of the equity method provides more informative reporting of the investor's net assets and profit or loss.
The equity method is used whether or not the investor, because it also has subsidiaries, prepares consolidated financial statements. However, the investor does not apply the equity method when presenting separate financial statements.
Application of the equity method
Under the equity method, an investment is initially recognised at cost, and the carrying amount is adjusted thereafter for:
- The investor's share of the post-acquisition profits or losses of the investee, which are recognised in the investor's profit or loss; and
- Distributions received from the investee, which reduce the carrying amount of the investment.
Adjustments to the carrying amount may also be necessary for changes in the investor's proportionate interest in the investee arising from changes in the investee's other comprehensive income (such as the impact of property revaluations and some exchange differences). The investor's share of those changes is recognised in other comprehensive income of the investor.
The investor's share of the investee's profits or losses after acquisition is also adjusted to take account of items such as additional depreciation of depreciable assets based on their fair values at the acquisition date.
Similarly, appropriate adjustments to the investor's share of the associate's or joint venture's profit or loss after acquisition are made for impairment losses such as for goodwill or property, plant and equipment.
IAS 28(2011):10 specifies that the investment in an associate or joint venture accounted for using the equity method is initially recognised at cost. Generally, cost includes the purchase price and other costs directly attributable to the acquisition or issuance of the asset such as professional fees for legal services, transfer taxes and other transaction costs. Therefore, the cost of an investment in an associate or joint venture at initial recognition comprises the investment's purchase price and any directly attributable expenditure necessary to acquire it.