Associates help needed

Hi,

When you are tackling questions like this it is important to break it all down into stages and to deal with each stage in its entirety, thus building up your answer. Here you have a investor that has acquired an associate. Therefore IAS 28 provisions kick in. IAS 28 also deals with the definition of the equity method of accounting. Under equity accounting you know that you recognise the investment at cost which is then adjusted for the investor's share of the associate's profit/loss. So tackle it in this order:

1st - Deal with the cost of the investment
The scenario tells you the A acquired a 35% interest in B for $475,000. Now what I can do is to actually break this down for you because A has acquired 35% of B's net assets and 35% of the fair value adjustment, hence:

Share in book value of B's net assets (35% x $900,000).......................................$315,000
Share in fair valuation of B's net assets (35% x ($1,100,000 - $900,000)..............$ 70,000
Goodwill is therefore ($475,000 - $315,000 - $70,000)..........................................$ 90,000
As per the question - cost of the investment in B by A......................................................................$475,000

(it's no coincidence that my reconciliation there balances back to the $475k investment
- all I have done is simply work backwards).

2nd - Deal with the associate's profit made in the year
Share of B's reported profit for the period (35% x $80,000).....................................$28,000
Adjustment needed to reflect the effect of fair values *
(35% x ($1,100,000 - $900,000) / 10 yrs.................................................................($ 7,000)
..........................................................................................................................................................$21,000

*the scenario tells you that difference of $200k relates to
PPE which has a useful life left of 10 yrs, hence this FV adj needs depreciating.

3rd - Deal with the revaluation of the available-for-sale assets
Share in revaluation of available-for-sale asset (this will be recognised in
other comprehensive income) (35% x $20,000)...................................................................................$7,000

4th - Deal with the dividend received by A in the year
Dividends reduce the value of the investment because they are essentially a
return on the investment, hence:

Dividend received by A during t he year (35% x $120,000)..............................................................(42,000)

Closing balance of A's investment in B per A statement of financial position..................................461,000

I will be able to then reconcile my closing balance of $461,000 (which might also make it easier for you to understand where my figures all plug into the equation) as follows:

Share in book value of B's net assets
$315,000 + 35% ($80,000 profit in year - $120,000 divi + $20,000 increase in AVS investment).....$308,000

Share in fair valuation of B's net assets
$70,000 minus $7,000 depreciation of fair value adjustment............................................................$ 63,000

Goodwill on investment in B
$475k proceeds, less ($900k x 35%) $315k, less ($200k x 35%) $70k............................................$ 90,000
Closing balance of A's investment in B.........................................................................................$461,000

I hope that helps you. Rather than tackle the question all in one go, try to break it down into bits and build up your answer like I did here - it makes it simpler to approach and keeps things 'on track'.

Best wishes
Steve

*Jo wrote: »

I forgot to deduct the dividend paid from the share of the net assets which is 35% of of 120,000 £42,000 the difference between my answer of £503,000 and Steve's of £461,000....Is that right?

Hi Jo,

Yes, the difference between your answer and mine is the dividend paid to the shareholders of B. It's a really easy mistake to make - especially when you've got all that other information to deal with. Just remember that the investor will only receive their share of the dividend. Put simply all you're doing is:

Cost of investment + Share of profit + Revaluation - Dividend = Carrying value.

Also, try to keep in mind that goodwill in an associate is not shown separately in the statement of financial position - it is always combined in with the cost of the investment!

All the best and good luck with the studies.

Steve

Hi Jo

No you wouldn't recognise the dividend in the income statement because under equity accounting the parent's share of the associate's profit after tax (profit before dividends) is included under equity accounting as 'income from associate' in the income statement. The dividend will reduce the cost of the investment because this is a return on the investment (see the $42k reduction in my reconciliation of cost to carrying value in my earlier thread).

Keep in mind the following where associates are concerned:

Carrying value = share of net assets at acquisition + goodwill + share of post-acquisition profit or loss less dividends from the associate.

Hope that helps.

Steve

Just one last 'tip' where associates are concerned! Don't show the goodwill in the associate separately on the face of the consolidated statement of financial position because it is included in the cost of the investment! Only show goodwill separately on the face of the consolidated statement of financial position for a subsidiary consolidated under the provisions in IAS 27.

All the best
Steve