Introduction – Chapter 2

Ppt
Level of Control/Influence
Determining the Accounting Method to Use
If your business invests in another business there are
three accounting methods, cost (Fair Value), equity
and consolidation. The one you use depends on how
big a stake you have in the other business. (level of
influence/control you have over that business)
 Investment Associate Subsidiary Joint
(Acquiree) Arrangement

Criteria Insignificant Significant Control Joint Control

Influence (Passive Influence
interest)
Share <20% 20% - 50% >50% Equal
Accounting IFRS9 IAS28 IFRS 10 Depends on
Cost or Market Equity method Acquisition type - IFRS 11
Value (Fair Value) method (full joint control
method. consolidation) IAS28 joint
ventures

Equity investments accounted for by using the cost method are classified as either trading securities or available ‐for ‐
sale securities, and the value of the investment is adjusted to market value at reporting date – results in unrealized
gain or loss – FVTPL, FVTOCI
Differences Valuation Unrealized holding Other Income Effects
Gains or Losses *

Holding less than Fair Value Recognized in Net Dividends

20% Income (FVTPL or declared/received, and
FVTOCI) gains and losses from
sale of investment

Holding between Equity Not recognized Proportionate share of

20% and 50% investee’s net income

Holding more than Consolidation Not recognized Not applicable

50%

*An unrealized gain is an increase in the value of an asset or investment that an

investor holds but has not yet sold for cash; unrealized loss is a decrease in the value
An investment in: Will be classified as: And carried at: If management intends to:
Ordinary shares of another A financial asset at fair Fair value, with value Hold the financial asset for
entity value through profit or loss changes recognised in trading (short term profit
profit or loss taking)
Available for sale Fair value, with value Hold the financial asset for
changes recognised in the longer term
other comprehensive
income
Debt instruments (such as A financial asset at fair Fair value, with fair value Hold the financial asset for
bonds) of another entity value through profit or loss changes recognised in trading (short term profit
profit or loss taking)
Held to maturity Amortised cost (which Hold the financial asset to
results in value changes maturity and the entity
being recognised in profit has the ability to do so
or loss)
Available for sale Fair value, with value Hold the financial asset for
changes recognised in the longer term, but not
other comprehensive until maturity
income

Default: FVTPL
If the instrument is: It may be measured at: If:
A non-equity instrument e.g. Amortized cost [Link] meets both:The ‘contractual
debt instrument cash flow characteristics’ test,
and
[Link] ‘hold to collect’ business
model test
Fair value through other [Link] meets both:The ‘contractual
comprehensive income cash flow characteristics’ test,
and
[Link] ‘hold to collect and sell’
business model test
Significant Influence –
Equity Accounting
SIGNIFICANT INFLUENCE
• A power to participate in the financial and operating policy decisions of
the investee (associate) but it is not control nor joint control of these
policies

INDICATORS OF SIGNIFICANT INFLUENCE

• Investor holds directly or indirectly 20%+ of the voting power of the
investee. But there are other factors:
• The investor has representation on the board of directors
• The investor participates in the policy-making process, including decisions
about dividend distributions
• There are material transactions between the investor and the investee
• There is interchange of personnel between the investor and the investee,
and
• The investor provides essential technical information to the investee
IAS 28 requires that an entity with significant influence in
an investee shall account for its investment in an
associate or a joint venture using Equity method.
Some exemptions however
• Entity is a subsidiary of another entity
• Entity’s instruments not traded
• Entity is not in the process of issuing publicly traded
securities
• The ultimate parent produces consolidated financial
statements
Cont.
• An Associate is an entity over which the investor has a
significant influence and that is neither a subsidiary nor
an interest that represents joint control over an entity

• Note, even if you have say, 30% of the voting rights, you
might not have significance influence; someone else
might own 70%. You would therefore use the cost(fair
value) method
How are associates accounted for?
IAS 28 describes the accounting for associates in financial statements that are not separate financial statements.
Equity accounting is required for associates in the following circumstances:
• If the associate is part of a consolidated group, in the consolidated financial statements, or
• If the associate is not part of a consolidated group but the investor has an investment in associate, in the financial
statements of the investor.
Equity Accounting vs. Cost Method
If there is no significant influence over the investee, the investor
instead uses the cost (fair value) method to account for its investment
in an associated company. The cost method of accounting records the
cost of the investment as an asset at its historical cost. However, the
value of the asset doesn't change regardless of whether the investee
reported profits or losses.(but may need to recognize unrealized gains
or losses marked to market)
The investor might however receive distributions such as dividends.
On the other hand, the equity method makes periodic adjustments to
the value of the asset on the investor's balance sheet since they have
a 20%-50% controlling investment interest in the investee
Insignificant influence - Fair Value Method Significant influence - Equity Method
On January 10, 2021, Dragon acquired 50,000 shares (20% of Harry Company) at a cost of $10 per share
Dr Equity Investment $500,000 Dr Equity Investment $500,000
Cr Cash $500,000 Cr Cash $500,000
For the year ended 2021, Harry reported net income of $50,000; Dragon’s share is 20% of $50,000
No entry Dr Equity Investment $10,000
Cr Investment Income $ 10,000
At 31 December 2021, the 50,000 shares held in Harry Company have a fair value (market price) of $12.50 per share
Dr Fair Value Adjustment $125,000 No entry
Cr Unrealized holding gain or loss $125,000
On January 25, 2022 Harry announced and paid a cash dividend of $80,000; Dragon received 20%, or $16,000
Dr Cash $16,000 Dr Cash $16,000
Cr Dividends revenue $16,000 Cr Equity Investment $16,000
For the year 2022, Harry reported a net loss of $40,000; Dragons share is 20%, or $8,000
No entry Dr investment Income $8,000
Cr Equity Investment $ 8,000
At 31 December 2022, the 50,000 shares held in Harry Company have a fair value (market price) of $11 per share
Dr Unrealized holding gain No entry
Or loss $ 75,000
Cr Fair Value Adjustment $75,000
Now let’s just
introduce
Consolidations
Control exists under IFRS 10 when the investor has power,
exposure to variable returns and the ability to use that power to
affect its returns from the investee
What is the Consolidation Method?
The consolidation method is a type of investment
accounting used for incorporating and reporting the
financial results of majority-owned investments. This
method can only be used when the investor possesses
effective control of the investee or subsidiary, which often,
but not always, assumes the investor owns at least 50.1%
of the subsidiary shares or voting rights.
Full Consolidation versus Equity Method
Consolidation Equity Method
Aggregate 100% of all line items (net No aggregation of 100% of all line items
assets) and allocate % to NCI – i.e. cost – only include one line item investors
plus/minus 100% of since acquisition share of post-acquisition net assets
equity minus NCI % in equity
i.e. we recognize 100% of the net assets i.e. initial investment in associate +
of the subsidiary but then we “take out” share of profit or loss of associate minus
what does not belong to us (the NCI) share of dividends

In P&L – Share of profit of associate

• i.e. in Equity method, we are still doing a type of consolidation but via single line items
investment in associate (SFP), Share of profit of associate (SPL), and we call it group accounts.
• Investment in associate is not eliminated because we are not including share of assets and
liabilities of associate which we would do in full consolidation
IAS27 SEPARATE FINANCIAL STATEMENTS – Investor presents
separate financial statements and consolidated financial
statements
IFRS3 BUSINESS COMBINATIONS – Defines business combination
and how to recognize it, and also measurement and recognition
principles
Does not describe the consolidation procedures
IFRS9 – Financial Instruments

IFRS10 CONSOLIDATED FINANCIAL STATEMENTS – Defines control,

requires consolidated financial statements, and also contains
procedure for consolidation
What happens on acquisition – consolidation – Consolidated accounts

1. Assets and Liabilities of parent and subsidiary added together

2. Investment in subsidiary (which would have been in parent company’s balance sheet) is
eliminated because it has effectively been replaced by the individual assets and liabilities of
the subsidiary

3. The assets and liabilities from subsidiary including goodwill are brought in to the
consolidated balance sheet at their far values

4. Consolidated equity amounts are only those from the parent company

Post-acquisition

5. Revenues and expenses of parent and subsidiary are added together

6. Any premiums that have been identified to assets (e.g. land, plant and equip, inventory etc.)
might mean that depreciation, expenses, COGS need to be adjusted
7. Any intercompany transactions are eliminated
e.g. A Company Purchases B Co for $400k
• A shows $400k as Investment in B in L/T assets section of its balance sheet
• At acquisition, B’s equity totaled $300k (i.e. net assets)
• Difference of $100k
• Assume land in B’s balance sheet was shown as $75k but fair value is
actually $110k; FV difference of $35k
• The difference between $100k and $35k is $65k which is goodwill

Acquisition consolidated balance sheet. Note:

Land: A land $25k + B land $75k + FV adjustment $35k = $135k
Intangible assets will now include $65k goodwill
As mentioned, equity will only contain A’s share capital and retained earnings
(Because B’s net assets have been included in the consolidated position)
Also, investment in B has been eliminated in the consolidated balance sheet