Welcome to the World of Associates!
In your journey through Group Accounts, you’ve already learned about Subsidiaries—those companies where the Parent is the "boss" and has full control. But what happens when a company has some power, but not total control? That’s where Associates come in!
Think of a Subsidiary like a child (you make all the decisions for them) and an Associate like a business partner or a close friend (you have a say in what they do, but you don't rule them). In this chapter, we will learn how to reflect these "business friendships" in our consolidated financial statements.
1. What Exactly is an Associate?
An Associate is an entity over which an investor has Significant Influence. It is neither a subsidiary nor a joint venture.
The "Significant Influence" Rule
How do we know if we have "significant influence"? Usually, it comes down to the percentage of shares you own:
• If you own less than 20%: You are just an investor (like buying a few shares on the stock market).
• If you own between 20% and 50%: You are presumed to have Significant Influence. This is an Associate!
• If you own more than 50%: You have Control. This is a Subsidiary.
Did you know? Even if you own only 15%, you might still have significant influence if you have a seat on the Board of Directors or participate in making the company's big policy decisions. However, for your FA exam, look for that 20%–50% range!
Key Takeaway: Significant influence = The power to participate in financial and operating policy decisions, but not the power to control them.
2. How to Account for Associates: The Equity Method
When dealing with subsidiaries, we use "Line-by-Line" consolidation (adding all the Assets and Liabilities together). For Associates, we use a much simpler method called the Equity Method.
Analogy: Imagine your friend starts a lemonade stand. If you owned the stand (Subsidiary), you’d record every lemon and every dollar in your own books. Since you are just a "partner" (Associate), you don't record their lemons; you just record your share of the stand's total value and profit.
In the Consolidated Financial Statements, we do not add the Associate's assets or liabilities line-by-line. Instead, we show everything as a "one-line entry."
3. The Consolidated Statement of Financial Position (CSOFP)
In the CSOFP, the Associate appears as a single line item under Non-Current Assets called "Investment in Associate."
How to Calculate "Investment in Associate":
Don't worry if this seems tricky; just follow this standard "recipe":
1. Cost of the Investment: What the parent originally paid to buy the shares.
2. Plus: Share of Post-Acquisition Retained Earnings: (Parent's % share) × (Associate’s Retained Earnings today – Associate’s Retained Earnings at the date we bought them).
3. Less: Impairment losses: If the value of the associate has dropped permanently, we subtract the loss.
The Formula:
\( \text{Investment in Associate} = \text{Cost} + [\% \times (\text{Closing Retained Earnings} - \text{Acquisition Retained Earnings})] - \text{Impairment} \)
Quick Memory Aid: SPAR
Think of SPAR to remember what to add to the cost:
Share of Post-Acquisition Retained earnings.
Key Takeaway: We only care about the profit the Associate made after we joined them. Anything they earned before we arrived is not ours!
4. The Consolidated Statement of Profit or Loss (CSPL)
Just like the Balance Sheet, we do not add the Associate’s Sales or Expenses to the Parent’s. Instead, we include one single line in the CSPL.
Where does it go?
It usually appears just before "Profit Before Tax" and is labeled: "Share of Profit of Associate."
How to calculate it:
\( \text{Associate's Profit After Tax} \times \text{Parent's \% Share} \)
(Note: If there was an impairment during the year, subtract it from this figure.)
Example:
If an Associate earns \$10,000 profit for the year and the Parent owns 30%, the Parent records \( \$10,000 \times 30\% = \$3,000 \) as "Share of Profit of Associate."
5. Common Mistakes to Avoid
Even the best students can get tripped up! Watch out for these "traps":
1. Line-by-line consolidation: Never, ever add an Associate's Assets or Revenue to the Parent's figures. It’s a "one-line" relationship only!
2. Pre-acquisition profits: Only include the Associate's profit earned after the date of purchase.
3. Dividends: In the consolidated accounts, we ignore dividends received from the Associate. Why? Because the "Share of Profit" already includes that value. We don't want to count it twice!
Summary Checklist
• Ownership: Is it 20% to 50%? (If yes, it's an Associate).
• CSOFP: Did I use the "Cost + Share of Post-Acq Profit - Impairment" formula?
• CSPL: Did I include the "Share of Profit" as a single line?
• Method: Did I remember NOT to add assets and liabilities line-by-line?
Keep practicing! Associates are actually much faster to calculate than subsidiaries once you get the hang of the "one-line" rule. You've got this!