PBEs: Accounting for investments in associates and joint ventures

In the March 2019 edition of Accounting Alert, we noted that financial reporting periods beginning on or after 1 January 2019 will bring a number of changes for Tier 1 and Tier 2 public benefit entities (“PBEs”). 

In the March 2019, May 2019, June 2019 and July 2019 editions of Accounting Alert we examined PBE IPSAS 37 Joint Arrangements (“PBE IPSAS 37”). 

In this edition we turn our attention to PBE IPSAS 36 Investments in Associates and Joint Ventures (“PBE IPSAS 36”).
 

PBE IPSAS 36 Investments in Associates and Joint Ventures

PBE IPSAS 36 supersedes PBE IPSAS 7 Investments in Associates.  PBE IPSAS 36 comes into effect for annual financial reporting periods beginning on or after 1 January 2019, which means that, depending on your balance date, it is already in effect, or soon will be:

Balance date

2018 year

2019 year

2020 year

31 December

Comparative period for adoption

Year of adoption

 

31 March

 

Comparative period for adoption

Year of adoption

30 June

 

Comparative period for adoption

Year of adoption

30 September

 

Comparative period for adoption

Year of adoption
 

 

Early adoption of PBE IPSAS 36 is permitted as long as that fact is disclosed and all of the following new PBE Standards are also applied at the same time:

 

  • PBE IPSAS 34 Separate Financial Statements
  • PBE IPSAS 35 Consolidated Financial Statements (“PBE IPSAS 35”)
  • PBE IPSAS 37
  • PBE IPSAS 38 Disclosure of Interests in Other Entities.

Identifying associates

PBE IPSAS 36 defines an associate as “an entity over which the investor has significant influence”. 

PBE IPSAS 36 states that significant influence is “the power to participate in the financial and operating policy decisions of another entity but is not control or joint control of those policies.” 
 

If an entity holds a quantifiable ownership interest in an investee and it holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the entity has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the entity holds, directly or indirectly, less than 20% of the voting power of the investee, it is presumed that the entity does not have significant influence, unless such influence can be clearly demonstrated.  When examining voting rights, an investor must consider the existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities.  A substantial or majority ownership by another investor does not necessarily preclude an entity from having significant influence. 

 

Determining whether there is significant influence requires the application of professional judgement and the assessment of all relevant circumstances.  The following factors often suggest the existence of significant influence:

  • 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 similar distributions
  • Material transactions between the entity and its investee
  • Interchange of managerial personnel
  • Provision of essential technical information.

Accounting for investments in associates and joint ventures

An entity with joint control of, or significant influence over, an investee, must account for its investment in the joint venture or associate by using the equity method (except in some very limited circumstances).

The equity method

Under the equity method, an investment in an associate or joint venture is initially recognised at cost.  Any difference between the cost of the investment and the entity’s share of the net fair value of the investee’s identifiable assets and liabilities:

  • Is accounted for as goodwill (where cost exceeds the investor’s share of the net assets)
  • Is included as revenue in the determination of the entity’s share of the associate or joint venture’s surplus or deficit in the period in which the investment is acquired (where the entity’s share of the net fair value of the investee’s identifiable assets and liabilities exceeds cost). 

Subsequent to initial recognition, the carrying amount of the investment is increased or decreased to recognise the investor’s share of the surplus or deficit of the investee after the date of acquisition.  The investor’s share of the investee’s surplus or deficit is recognised in the investor’s surplus or deficit. Distributions received from an investee reduce the carrying amount of the investor’s investment.  Gains and losses resulting from “upstream” and “downstream” transactions between an investor and its associate or joint venture are recognised in the investor’s financial statements only to the extent of unrelated investors’ interests in the associate or joint venture (the investor’s share in the associate’s or joint venture’s gains or losses resulting from these transactions is eliminated).  “Upstream” transactions are, for example, sales of assets from an associate or a joint venture to the investor. “Downstream” transactions are, for example, sales or contributions of assets from the investor to its associate or its joint venture.
 

If an investor’s share of the deficit of an associate or a joint venture equals or exceeds its interest in the associate or joint venture, the investor discontinues recognising its share of further deficits.  After the investor’s interest is reduced to zero, additional deficits are provided for, and a liability is recognised, only to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate or joint venture.  If the associate or joint venture subsequently reports surpluses, the investor resumes recognising its share of those surpluses only after its share of the surpluses equals the share of deficits not recognised. 

 

After application of the equity method, the investor must apply PBE IPSAS 29 Financial Instruments: Recognition and Measurement (“PBE IPSAS 29”) to determine whether it is necessary to recognise any additional impairment loss with respect to its net investment in the associate or joint venture.  Where the investment in an associate or a joint venture may be impaired, the investor must apply either PBE IPSAS 26 Impairment of Cash-Generating Assets or PBE IPSAS 21 Impairment of Non-Cash-Generating Assets, depending on whether the investment in the associate or joint venture is cash-generating or non-cash-generating. 

 

Adjustments to the carrying amount of the investor’s investment in the joint venture or associate may also be necessary as a result of changes in the investor’s proportionate interest in the investee arising from changes in the investee’s other comprehensive revenue and expense. Such changes include those arising from the revaluation of property, plant and equipment. The investor’s share of those changes is recognised in the investor’s other comprehensive revenue and expense.

 

An investor must discontinue the use of the equity method from the date when its investment ceases to be an associate or a joint venture.  If the investment becomes a controlled entity, the investor must account for its investment in accordance with PBE IFRS 3 Business Combinations and PBE IPSAS 35.  If the retained interest in the former associate or joint venture is a financial asset, the investor must measure the retained interest at fair value (and that fair value will be the investment’s fair value on initial recognition as a financial asset in accordance with PBE IPSAS 29).  When an investor discontinues the use of the equity method, the investor must account for all amounts previously recognised in other comprehensive revenue and expense 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.

The equity method – a simple example

On 1 April 2017, Company A purchases 25% of the shares in Company B for $44,000.  Company A has significant influence over Company B and therefore accounts for its investment in Company B using the equity method, by recognising the investment at cost: 

 

Dr Investment in Company B (associate) $44,000

Cr Cash $44,000.

 

At the end of the financial year (31 March 2018), Company B has made a surplus of $28,000.  Company A recognises its share of that surplus (25% x $28,000 = $7,000): 

 

Dr Investment in Company B (associate) $7,000

Cr Share of surplus of equity accounted investee (recognised in surplus or deficit) $7,000.

 

On 31 March 2018, Company B declares a dividend of $5,000.  Company A recognises its share of the dividend (25% x $5,000 = $1,250):

 

Dr Cash $1,250

Cr Investment in Company B (associate) $1,250.

 

At 31 March 2018, the carrying value of the investment in Company B is $49,750 ($44,000 + $7,000 - $1,250). 

 

At the end of the next financial year (31 March 2019), Company B has made a deficit of $20,000.  Company A recognises its share of that deficit (25% x $20,000 = $5,000):

 

Dr Share of loss of equity accounted investee (recognised in surplus or deficit) $5,000.

Cr Investment in Company B (associate) $5,000.

 

At 31 March 2019, the carrying value of the investment in Company B is $44,750 ($49,750 at 31 March 2018 - $5,000). 

For more on the above, please contact your local BDO representative.