Investments in Associates and Joint Ventures are two types of investments that are in use by many larger groups of companies.
An associate is an entity over which the investor has significant influence. Many times associates are investments that an investor holds with a purpose, a strategic reason, such as new products, unique knowledge or production secrets. Investments in Associates and Joint Ventures
Significant influence is the power to participate in the financial and operating policy decisions of the investee without the power to control or jointly control those policies.
If an entity holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the entity has significant influence. When the investment is higher than 50% an investee many times changes to a subsidiary. Investments in Associates and Joint Ventures
A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement. A joint venture is also called a jointly controlled entity.The other type of joint arrangement is a joint operation. Joint ventures too are many times investments in an investee shared between two or more parties from a same type of industry to make use of new products, unique knowledge or production secrets and reach economies of scale otherwise more difficult to achieve.
IAS 28 requires an investor to account for its investment in associates using the equity method. IFRS 11 requires an investor to account for its investments in joint ventures also using the equity method (with some limited exceptions). Investments in Associates and Joint Ventures
Strategic investments in financial assets
Strategic investments generally include an investment in the shares of another company with the goal of a longer-term relationship with that company. The various classes of investments, as categorized by IFRS based on their nature, and the corresponding standards are shown below: Investments in Associates and Joint Ventures
The equity method
Investments in associates and joint ventures are accounted for using the equity method, which is applied in the same manner to both types of investments. This “one-line consolidation” method essentially collapses income earned from the investment into one line item in the statement of comprehensive income; it similarly reports the investor’s ownership interest in the individual assets and liabilities of the associate or joint venture in one line on the statement of financial position.
Investments in associates
Investments in associates are initially recognized at cost (the amount of cash or cash equivalents paid or the fair value of the other consideration given up to acquire an asset at the time of its acquisition). The difference between the price paid for an investment and the carrying (or book) value of the identifiable net assets acquired × the percentage ownership purchased is called the acquisition differential. Investments in Associates and Joint Ventures
Once the acquisition differential is calculated, it is allocated to the individual assets and liabilities of the associate that have an fair value that differs from the carrying value at the date of acquisition. Any amount in excess of the cost of the investment over the investor’s share of the net fair value of the investee’s identifiable net assets is goodwill but is not separated from the cost of an investee. (The opposite of goodwill is a bargain purchase, which occurs when the cost of the investment is less than the investor’s share of the net fair value of the investee’s identifiable net assets.) Investments in Associates and Joint Ventures
If a company paid $200,000 cash to acquire 30% of the ordinary shares of XYZ Co., with carrying values of net assets at the acquisition date of $400,000 and fair values of the identifiable net assets approximating their carrying values, the goodwill is $200,000 – ($400,000 × 30%) = $80,000. As the fair value and carrying value of the net assets are the same, the acquisition differential is equal to the amount of goodwill acquired in the transaction.
At year end, the company recognizes its proportionate share of the investee’s (associate’s) profit or loss for the year on the statement of comprehensive income (the share in the associate’s profit or loss in the investor’s profit or loss and the associate’s other comprehensive income in the investor’s other comprehensive income (per IAS 28 3). These shares are added to the investment in the associate as initially measured at cost (including goodwill/bargain). Investments in Associates and Joint Ventures
The investor reports its investment in the associate on the statement of financial position under the equity method as non-current assets unless they are held for sale. The investment account is increased by the investor’s proportionate share of the associate’s comprehensive income as reported in the associate’s statement of comprehensive income, and reduced by the amount of dividends received or receivable from the associate. Investments in Associates and Joint Ventures
Investments in Associates and Joint Ventures