INVESTMENT

IN ASSOCIATE
Definition of associate and significant influence
Identification of associates
Equity Method
OCI that will be reclassified within equity or retained
earnings and OCI that will be reclassified to profit or loss
Comparison of cost method and equity method
Timing of recognition of amortization of excess
Associate having outstanding preference shares
Treatment for redeemable preference shares
Change from cost to equity method
Discontinuance of equity method
Accounting for deemed disposal of associate (Loss and No
Loss of Significant Influence)
Remeasurement gain or loss related to change in
ownership
Associate having heavy losses
Impairment losses
Intercompany transactions
Financial statement presentation
1. Under PAS 28, an investment in associate is accounted for
using the equity method.
2. The equity method of accounting requires recognizing the
investor's share of the associate's net assets and income on
the investor's balance sheet and income statement.
3. If an investor holds control over an investee, the equity
method is used to account for the investment.
4. Under the equity method, the investor records dividends
received from the associate in its profit or loss.
5. If an investor's share of losses in an associate exceeds the
carrying amount of the investment, the investor does not
recognize additional losses unless the investor has
obligations to fund those losses.
6. The investor's share of the associate's other comprehensive
income is recognized in the investor's statement of
comprehensive income.
7. PAS 28 requires an investor to adjust its share of an
associate's profits or losses to account for any depreciation or
amortization of the associate's identifiable assets.
8. If an associate's financial year-end differs from the investor's,
the investor must adjust for any significant transactions or
events between the investor's year-end and the associate's
year-end.
9. Under the equity method, unrealized gains or losses on
transactions between the investor and the associate are
recognized in the investor's financial statements.
10. If an investor gains significant influence over an associate
after the initial acquisition, the investor retroactively applies the
equity method from the date of initial acquisition.
On January 1, 2023, Drenz Co. acquired 30,000 ordinary shares
out of the 100,000 ordinary shares of Josiah Inc. for P5,000,000.
Josiah's assets and liabilities approximate their fair values,
except for inventories with carrying amount of P800,000 and
fair value of P900,000 and machinery with carrying amount of
P2,500,000 and fair value of P2,200,000. The remaining useful
life of the machinery is 5 years. Josiah's net assets have a book
value of P10,000,000.

On December 31, 2023, Josiah reported net income of

P2,000,000 and declared and paid dividends of P800,000. On
December 31, 2024, Josiah reported net income of P4,500,000
and declared and paid dividends of P1,600,000.
Requirements:

1. How much is the implied goodwill from acquisition?

2. How much is the net share in the profit or loss of the
associate (investment income) in 2023?
3. How much is the carrying amount of the investment as of
December 31, 2023?
4. How much is the net share in the profit or loss of the
associate (investment income) in 2024?
5. How much is the carrying amount of the investment as of
December 31, 2024?
6. Prepare the journal entries for 2023 and 2024.
INVESTMENT IN ASSOCIATE
An associate is an entity over which the investor
has significant influence.

Significant influence is the power to participate in

the financial and operating policy decisions of the
investee, but is not control or joint control of those
policies.
IDENTIFICATION OF ASSOCIATES
If an investor holds, directly or indirectly (e.g., through
subsidiaries), 20 percent or more of the voting power of the
investee, it is presumed that the investor has significant influence,
unless it can be clearly demonstrated that this is not the case.
Conversely, if the investor holds, directly or indirectly (e.g.,
through subsidiaries) less than 20 percent of the voting power of
the investee, it is presumed that the investor does not have
significant influence, unless such influence can be clearly
demonstrated.
A substantial or majority ownership by another investor does not
necessarily preclude an investor from having significant
influence.
EXISTENCE OF SIGNIFICANT INFLUENCE
The existence of significant influence by an investor is usually
evidenced in one or more of the following ways:
Representation on the Board of Directors or equivalent governing
body of the investee;
Participation in policy-making processes, including participation
in decisions about dividends or other distributions;
Material transactions between the investor and the investee;
Interchange of managerial personnel; or
Provision of essential technical information.
EQUITY METHOD
Under the equity method, the investment in an associate or joint
venture is:
Initially recognized at cost
Increased or decreased to recognize the investor's share of the profit
or loss of the investee after the date of acquisition
Decreased for distributions received (e.g., cash or property
dividends)
Increased or decreased to recognize the investor’s share for
changes in the investor’s proportionate interest in the investee
arising from changes in the investee’s equity that have not been
recognized in the investee’s profit or loss (i.e., other comprehensive
income)
Decreased for impairment loss.
Changes in the investor’s proportionate interest in the
investee arising from changes in the investee’s equity that
have NOT been recognized in the investee’s PROFIT OR LOSS:
(1) Other comprehensive income that will NOT be
reclassified to profit or loss (i.e., reclassified within equity
or retained earnings)
(2) Other comprehensive income that will be reclassified to
profit or loss (i.e., reclassification adjustments)
Other comprehensive income that will not be reclassified to profit or loss (i.e.,
reclassified within equity or retained earnings)
Changes in revaluation surplus;
Remeasurements of defined benefit plans;
Gains and losses from investments in equity instruments designated as at
fair value through other comprehensive income;
Change in fair value of financial liabilities designated as at fair value
through profit or loss attributable to credit risk;
Gains and losses on hedging instruments that hedge investments in equity
instruments measured at fair value through other comprehensive income;
Changes in the value of the forward elements of forward contracts when
separating the forward element and spot element of a forward contract
and designating as the hedging instrument only the changes in the spot
element, and changes in the value of the foreign currency basis spread of a
financial instrument when excluding it from the designation of that financial
instrument as the hedging instrument.
Other comprehensive income that will be reclassified to profit or loss (i.e.,
reclassification adjustments)
Gains and losses arising from translating the financial statements of a
foreign operation;
Gains and losses on financial assets measured at fair value through other
comprehensive income (debt);
The effective portion of gains and losses on hedging instruments in a cash
flow hedge and the gains and losses on hedging instruments that hedge
investments in equity instruments; and
Changes in the value of the time value of options when separating the
intrinsic value and time value of an option contract and designating as the
hedging instrument only the changes in the intrinsic value.
Under PAS 28 Investment in Associate and Joint
Venture, an investment in associate and joint
venture should be accounted for under equity
method. PFRS 11 Joint Arrangement should be used in
identifying whether a joint arrangement is classified
as joint venture.
COMPARISON OF COST METHOD AND
EQUITY METHOD
 Formula:
Acquisition cost (or purchase
price) XX
Less: Book value of the net
assets acquired (XX)
Excess of cost over book
value XX
Less: Undervaluation of assets (XX)
Add: Overvaluation of assets XX
Goodwill (or gain on bargain
purchase) XX

Adjustments for Amortization:

Inventory - Upon disposal or sale
Land - Upon disposal or sale
Depreciable asset - Every year through depreciation
Goodwill - When there is impairment
1. IIA - 71M
2. NII - 9M
1. NII - 275,000
2. IIA - 2,175,000
3. NII - 250,000
4. IIA - 2,300,000
ASSETS HAVING OUTSTANDING PREFERENCE SHARES
If an associate has outstanding cumulative
preference shares that are held by parties other than
the investor and classified as equity, the investor
computes its share of profits or losses after adjusting
for the dividends on such shares, whether or not the
dividends have been declared.
REDEEMABLE PREFERENCE SHARES
Redeemable preference shares are treated as
financial liability. Thus, any dividends declared shall
be treated as finance cost in the Profit and Loss
Statement.

Therefore, the preference dividends share shall no

longer be deducted from the net income of the
associate because such were already deducted as
an expense (i.e., finance cost) in computing for the
net income during the period.
Case No. 1:
1.150,000
2.4,150,000
Case No. 2:
1.140,000
2.4,140,000
Case No. 3:
1.200,000
2.4,200,000
POSSIBLE SCENARIOS OF CHANGES IN OWNERSHIP INTEREST
1.From cost to equity method –accounted for under PAS 28
2.Discontinuance of equity method –accounted for under
either PFRS 9 or PFRS 3 and PFRS 10
CHANGE FROM COST TO EQUITY METHOD
In accounting for change in ownership of an investment at cost or
fair value to equity method (i.e., step acquisition), the rules in step
acquisition or business combination achieved in stages under PFRS
3 should be applied.

In a business combination achieved in stages, the acquirer shall

remeasure its previously held equity interest in the acquiree at its
acquisition-date fair value and recognize the resulting gain or loss,
if any, in profit or loss or other comprehensive income, as
appropriate.
CHANGE FROM COST TO EQUITY METHOD
In prior reporting periods, the acquirer may have recognized
changes in the value of its equity interest in the acquiree in other
comprehensive income. If so, the amount that was recognized in
other comprehensive income shall be recognized on the same
basis as would be required if the acquirer had disposed directly of
the previously held equity interest.
A. Determine the following:
1. Unrealized gain or loss to be included in other comprehensive
income as of December 31, 2021.
2. Income from investment in Jean Company to be recognized in
2022 profit or loss.
3. Adjustment to retained earnings as of January 2, 2018 as a result
of the acquisition of the additional 20% interest in Jean
Company.
4. Income from investment in Jean Company to be recognized in
2023 profit or loss.
5. Carrying amount of the investment in Jean Company as of
December 31, 2023.
B. Prepare all appropriate journal entries related to the investment
from 2021 to 2023.
Answers:
A.
1. Unrealized gain – OCI – P200,000
2. Dividend income – P250,000
3. Zero. No retroactive adjustment to retained earnings.
4. Net investment income – P4,387,500
5. Carrying amount, 12/31/2023 - P11,887,500
DISCONTINUANCE OF EQUITY METHOD – CHANGE FROM EQUITY
According to PAS 28, par. 22, an entity shall discontinue the use of
the equity method from the date when its investment ceases to be
an associate or a joint venture as follows:
(a)If the investment becomes a subsidiary, the entity shall account
for its investment in accordance with PFRS 3 Business Combinations
and PFRS 10 Consolidated Financial Statements.
DISCONTINUANCE OF EQUITY METHOD – CHANGE FROM EQUITY
According to PAS 28, par. 22, an entity shall discontinue the use of
the equity method from the date when its investment ceases to be
an associate or a joint venture as follows:
(b)If the retained interest in the former associate or joint venture is
a financial asset, the entity shall measure the retained interest at
fair value. The fair value of the retained interest shall be regarded as
its fair value on initial recognition as a financial asset in accordance
with PFRS 9. The entity shall recognize in profit or loss any difference
between:
(i)the fair value of any retained interest and any proceeds from
disposing of a part interest in the associate or joint venture; and
(ii)the carrying amount of the investment at the date the equity
method was discontinued.
Breakdown of the total gain or loss (P/L)
When an entity discontinues the use of the equity method, the entity
shall account for all amounts previously recognized in other
comprehensive income in relation to that investment on the same
basis as would have been required if the investee had directly
disposed of the related assets or liabilities.
ANSWERS:
A.
1.Investment balance, 12/31/2022 – P57,800,000
2.Loss on sale – (P900,000)
3.Total loss (P/L) – (P1,300,000)
4.Unrealized gain – OCI (SFP) – P500,000
ACCOUNTING FOR DEEMED DISPOSAL OF ASSOCIATE (DILUTION)
If the investee company issued additional shares of stock but the
investor did not acquire any of the new shares issued, the share of the
investor will decrease or will be diluted and has "deemed disposed
certain percentage of its ownership of that associate."

Accounting for deemed disposal of associate depends on whether the

investor loses significant influence or not.
ACCOUNTING FOR DEEMED DISPOSAL OF ASSOCIATE (DILUTION)
1.If the investor loses significant influence
1. Recognize gain or loss from partial disposal to be recognized in the
profit or loss;
2. Discontinue the equity method;
3. Reclassify the total share in OCI of associate in P/L or closed to
retained earnings;
4. Apply the requirements of PFS 9.
ACCOUNTING FOR DEEMED DISPOSAL OF ASSOCIATE (DILUTION)
2.If the investor does not lose significant influence
1. Recognize gain or loss from partial disposal to be recognized in the
profit or loss;
2. Continue the equity method;
3. Reclassify the share in OCI of associate in P/L or closed to retained
earnings in proportion to the decrease in ownership;
4. Apply the requirements of PAS 28.
ASSOCIATE HAVING HEAVY LOSSES
If an investor’s share of losses of an associate equals or exceeds its interest in the
associate, the investor discontinues recognizing its share of further losses. The
interest in an associate is the carrying amount of the investment in the associate
under the equity method, together with any long-term interests that, in substance,
form part of the investor’s net investment in the associate.

Total interest includes the following:

1. Carrying amount of investment in associate;
2. Investment in preference shares; and
3. Unsecured long-term receivables or loans.

Total interest does NOT include the following:

1. Trade receivables;
2. Trade payables;
3. Any long-term receivables for which adequate collateral exists, such as secured
loans.
Losses recognized under the equity method in excess of the investor’s
investment in ordinary shares are applied to the other components of
the investor’s interest in an associate in the reverse order of their
seniority (i.e., reverse order of priority in liquidation).

The order of priority for liquidation is as follows:

1.External creditors
2.Internal creditors
3.Preferred stockholders
4.Common stockholders

So, the reverse order of seniority would be as follows:

1.Common stockholders
2.Preferred stockholders
3.Internal creditors
4.External creditors.
Therefore, the share in the loss of the associate shall be recorded as
follows:
1. First, charge to balance of investment in associate;
2. Next, charge to balance of investment in preference shares; and
3. Lastly, charge to unsecured long-term receivables and loans.

After the investor’s interest is reduced to zero, additional losses are

provided for, and a liability is recognized, only to the extent that the
investor has incurred legal or constructive obligations or made
payments on behalf of the associate. If the associate subsequently
reports profits, the investor resumes recognizing its share of those
profits only after its share of the profits equals the share of losses not
recognized.
IMPAIRMENT LOSSES
After application of the equity method, including recognizing the associate’s or joint
venture’s losses, the entity needs to determine whether there is any objective
evidence that its net investment in the associate or joint venture is impaired.

The entity applies the impairment requirements in PFRS 9 to its other interests in the
associate or joint venture that are in the scope of PFRS 9 and that do not constitute
part of the net investment.

Because goodwill included in the carrying amount of an investment in an associate

is not separately recognized, it is not tested for impairment separately by applying
the requirements for impairment testing goodwill in PAS 36 Impairment of Assets.
Instead, the entire carrying amount of the investment in PAS 28 is tested under PAS
36 for impairment, by comparing its recoverable amount (higher of value in use
and fair value less cost to sell) with its carrying amount, whenever application of the
requirements in PFRS 9 indicates that the investment may be impaired.
In determining the value in use of the investment, the entity estimates:
a. Its share of the present value of the estimated future cash flows expected
to be generated by the associate, including the cash flows from the
operations of the associate and the proceeds on the ultimate disposal of the
investment; or
b. The present value of the estimated future cash flows expected to arise
from dividends to be received from the investment and from its ultimate
disposal.

Under appropriate assumptions, methods give the same result. The

recoverable amount of an investment in an associate is assessed for each
associate, unless the associate does not generate cash inflows from
continuing use that are largely independent of those from other assets of the
entity.
ADJUSTMENT OF INVESTEE’S OPERATIONS
Intercompany Transactions
Profits and losses resulting from ‘upstream’ and ‘downstream’
transactions between an investor (including its consolidated
subsidiaries) and an associate is recognized in the investor’s
financial statements only to the extent of unrelated investor’s
interests in the associate.
Illustration:
On January 1, 2023, Ruben Company bought 30% outstanding ordinary
shares of Racquel Company for P3 million. Their book value was P9
million and the difference was attributable to the fair value of Racquel’s
buildings exceeding book value. The buildings have a remaining life of 20
years.

Racquel Company reported the following net income and dividends for
2023 and 2024:
2023 2024
Net income P3,000,000 P4,000,000
Dividends paid 1,000,000 1,500,000
The following transactions occurred between Ruben Company and Racquel
Company:
• January 1, 2023 - Racquel Company sold a land costing P600,000 to Ruben
Company for P500,000 to be used as its future plant site. The land was being
used by Racquel as one of its property, plant, and equipment.
• January 2, 2023 - Racquel Company sold a machinery costing P900,000 to
Ruben Company for P600,000. The machinery has a remaining life of six
years.
• April 1, 2024 - Ruben Company sold an equipment to Racquel Company for
P1,000,000. The equipment had a cost of P800,000. The remaining useful life of
the equipment is five years.
• November 21, 2024 - Racquel Company sold inventories to Ruben Company
for P1,200,000. The inventories had a cost of P1,000,000 and 60% are still on
hand on December 31, 2024.
FINANCIAL STATEMENT PRESENTATION
An investment in an associate or a joint venture is
generally classified as non-current asset, unless it is
classified as held for sale in accordance with PFRS 5
Non-current Assets Held for Sale and Discontinued
Operations.