Welcome to Group Accounts: Associates and Joint Ventures!
In your previous studies, you likely learned about subsidiaries, where a parent company has "control" (usually over 50% of the shares). But what happens when a company has a lot of influence over another business, but doesn't quite run the show?
That is where Associates and Joint Ventures come in. Think of it like this: if a subsidiary is a child you "parent" (control), an associate is like a business partner you "advise" (influence). In this chapter, we will learn how to show these relationships in the group accounts using a method called Equity Accounting.
1. What is an Associate?
An associate is an entity over which an investor has significant influence. This is the "middle ground" of investing. You aren't just a passive shareholder, but you aren't the boss either.
How do we identify "Significant Influence"?
According to IAS 28, we usually assume significant influence exists if the investor holds between 20% and 50% of the voting power.
However, it isn't just about the percentage! Don't worry if the numbers aren't exactly in that range; significant influence can also be proven by:
- Representation on the board of directors (having a seat at the table).
- Participation in policy-making processes (helping decide on dividends or strategies).
- Material transactions between the two companies (buying/selling a lot of goods to each other).
- Interchange of managerial personnel (swapping bosses).
- Provision of essential technical information.
Quick Review:
- 0% to 20%: Simple Investment (Financial Asset).
- 20% to 50%: Associate (Significant Influence).
- 50% to 100%: Subsidiary (Control).
2. The Equity Method (The "One-Line" Method)
When dealing with subsidiaries, we use "Full Consolidation" (adding lines together). But for associates, we use the Equity Method.
Crucial Rule: We do NOT add the associate's assets and liabilities line-by-line to the group accounts. Instead, we show our investment as a single line in the Statement of Financial Position and a single line in the Statement of Profit or Loss.
In the Consolidated Statement of Financial Position (CSOFP)
We calculate the value of our investment using this standard "Pro-forma":
\( \text{Cost of the investment} \)
\( + \text{Group share (%) of post-acquisition retained earnings} \)
\( - \text{Group share (%) of any impairment losses} \)
\( - \text{Group share (%) of Unrealized Profit (URP)} \)
= Carrying Amount in the CSOFP
In the Consolidated Statement of Profit or Loss (CSPL)
We simply include one line: "Share of profit of associate."
This is calculated as: \( (\text{Associate's Profit After Tax}) \times (\text{Our % share}) \).
Remember to subtract any impairment of the associate that occurred during the current year!
Example: P Ltd buys 30% of S Ltd for \$100. Since then, S Ltd has made \$50 in profit. P’s share is \$15 (30% of \$50). The value in P’s group accounts is \$115.
3. Joint Arrangements (IFRS 11)
A joint arrangement is where two or more parties have joint control. This means no single party can make decisions alone—everyone must agree (unanimous consent).
There are two types you need to know:
- Joint Operation: The parties have rights to the assets and obligations for the liabilities. (Think of it as two companies sharing a specific factory machine). You account for your share of assets/liabilities directly.
- Joint Venture: The parties have rights to the net assets of the arrangement. This is usually a separate legal company.
Key Point for F2: Under IFRS 11, Joint Ventures are accounted for using the exact same Equity Method we use for Associates! So, if you learn the associate calculation, you’ve already learned the joint venture calculation.
4. Dealing with Unrealized Profit (URP)
This is a common "trick" in exams. If the Parent sells goods to the Associate (or vice versa) and those goods are still in stock at the year-end, we must remove the "fake" profit.
The Calculation:
1. Calculate the total profit on the sale.
2. Find the portion still in stock.
3. Multiply by the Group's % share in the associate.
The Adjustment:
- DR Group Retained Earnings (reducing profit).
- CR Investment in Associate (reducing the asset value).
Analogy: Imagine you sell a toy to your business partner for a profit, but you still own 30% of that partner's business. In a way, you've "sold" 30% of that toy to yourself. You can't make a profit by selling to yourself, so we have to cancel that 30% out!
5. Important Nuances and "Watch Outs"
Dividends
When an associate pays a dividend, it doesn't affect the profit in the CSPL (we already took our share of their total profit). Instead, the dividend reduces the carrying amount of the investment in the CSOFP because the associate is "sending away" some of its value in cash.
Impairment
Unlike subsidiaries, where we might split impairment between the Parent and Non-Controlling Interest (NCI), Associate impairment is always charged fully against the group’s share. There is no NCI in an associate!
Common Mistake to Avoid
Do not include the Associate's assets in the Group Cash Flow Statement. Only include dividends received from the associate as a cash inflow.
6. Summary Key Takeaways
1. Significant Influence: 20-50% shareholding = Associate.
2. Joint Control: Unanimous agreement = Joint Venture.
3. Equity Method: Cost + % Post-acq Profit - Impairment - URP.
4. One Line: Associates/JVs appear as a single line in both the CSOFP (Investment in Associate) and CSPL (Share of Profit).
5. No NCI: We never calculate Non-Controlling Interest for an associate.
Don't worry if this seems tricky at first! The most important thing to remember is that an Associate is a "partner," not a "child." You don't add their house to yours; you just record the value of your friendship on one line of your balance sheet!