Auditing Investments in Associates

The quality financial analysis relies heavily on a solid understanding of accounting rules and treatments. Whether you are getting started in the financial sector or working in a company finance advisory team, understanding how to account for different investments is important in computing the value and prospects of a business. This guide examines investments in associates and how to record them in financial statements.

But what is an investment in associates?

It means investment in a firm where an investor holds a lot of power or influence but has less control compared to a subsidiary or parent relationship. Essentially, the investor has considerable influence when they have 20%- 50% of shares of a different entity.

Accounting for Investment in Associates

There are two methods for accounting for investment in associates, but the most popular approach is the equity method. Note, however, the equity method does not feature 100% consolidation. Rather, the percentage/number of shares an investor owns will be recorded as an investment in accounting.

If an investor takes shares in associate instead of the balance sheet, it is accounted as “increased in Associates,” and the money is deducted by the exact amount. The associate dividend is recorded as an increase in cash for the investor. To account for the net income of the association, the investor’s revenue is credited and the investment in the associated account debited.

Equity Method: Application

Basic Principle

As aforementioned, under this method, equity investment is first accounted at cost and then computed to reflect the share of the net profit/loss of the associate.

Distribution and Other Computations to Carrying amount

Distributions that the investee receives reduce the investment’s carrying amount. Adjustments made on the carrying amount may be requested based on the adjustments in the investee’s other income that are not recorded in the profit/loss statements, such as revaluations.

Potential Voting Rights

Potential voting rights are crucial when determining the existence of significant influence. But the investor’s share of profit/loss of investee and adjustments made on the equity of the investee is calculated based on the current ownership interests. It must not reflect the possible conversion or exercise of potential voting rights.

Implicit Goodwill and Fair Value Adjustments

Once the investment in associate has been acquired, any positive or negative difference between the investor’s share of fair values of net assets of the associate and the cost of acquisition is recorded as goodwill.

Changes are made accordingly, to the investor’s share of profits/losses after acquisition to record additional amortization or depreciation of the associate’s amortizable or depreciable assets contingent on the excess of fair values and carrying amounts during the acquisition of the investment.

Impairment Indicators

Based on IAS 39 Financial Instruments: Recognition and Measurement, if impairment indicators are identifiable, the amount is computed based upon the IAS 36 Impairment of Assets. The investment’s carrying amount is assessed for impairment as a single asset.  Note, goodwill is also tested at this juncture.

Terminating the Equity Method

The implementation of the equity method must stop the date the end of the significant influence. And the carrying amount of the investment at this date is considered a new cost basis.

Financial Statements of the Investor Should Br Separated

There need to be separate financial statements for equity accounting of the investor irrespective of whether or not consolidated accounts are required, for instance, since the investor lacks subsidiaries.

However, equity accounting is not needed where the investor is exempted from creating financial statements. In this case, the parent would record account for:

• At cost.
• Based on IAS 39.

Example of Investment in Associates

Let us look at an example of a calculation of investment in associates.

Let us assume an entity X purchased 35% shares of Y firm. This means company X has significant influence over company Y and entity Y can be considered as an associate of X.

Value of 35% shares is $600,000. So, during a purchase, the accounting transaction of X will be recorded as follows:

After 180 days, company Y declares $15,000 dividends to its shareholders. This means company X will receive 35% of dividends is $5250.

Here is the accounting entries:

Also, company X declares a net income of $100,000. Company Y will debit 35% of $100,000 in its “investment in Associates” account and credit the same figure as “Investment Revenue” in their income statement.

So, the final balance in company Y’s Investment in Associate account will be:

In Conclusion

Companies leverage investment in associates in situations where they want to acquire a lesser stake in another firm. As seen from the above, the equity method is the most ideal approach for these investments.

However, audit firms in Dubai can show the net income of the associate entity as part of their revenue, but dividend income will not be included, and would be considered a reduction in investment in associate assets.