Rajarata University of Sri Lanka

Faculty of Management Studies

B.Sc. (Accountancy & Finance) Special Degree
Year II Semester I
Advanced Financial Accounting

Accounting For Investment in Associate companies

Scope

SLAS 27 applies to all investments in which an investor has significant influence but not control or
joint control except for investments held by a venture capital organization, mutual fund, unit trust and
similar entity that are accounted for as held for trading under SLAS 22, those investments are
measured at fair value with fair value changes recognized in profit and loss.

Key Definitions

Associate: An enterprise in which an investor has significant influence but not control or joint control.

Significant influence: Power to participate in the financial and operating policy decisions but not
control them.

Equity method: A method of accounting by which an equity investment is initially recorded at cost and
subsequently adjusted to reflect the investor’s share of the net profit or loss of associate.

Identification of Associates

A holding of 20% or more of the voting power (directly or through subsidiaries) will indicate
significant influence unless it can be clearly demonstrated otherwise. If the holding is less than 20%,
the investor will presumed not to have significant influence unless such influence can be clearly
demonstrated.

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 the policy making process;
 Material transactions between the investor and investee;
 Interchange of managerial personnel; or
 Provision of essential technical information.
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Potential voting rights are a factor to be considered in deciding whether significant influence exists.

Determination of ‘Significant influence’ and the 20% test

It should be note that determination of significant influence is a subject matter. It is difficult to what to
look for, but it would normally be necessary for the investing group to influence the operating and
financial policies of investee under taking on a regular basis.

The 20% test is straightforward to apply in the case of an investment by the parent undertaking alone.

Example:

H plc owns 75% of the ordinary share capital of S Ltd and 10% of the ordinary share capital of A Ltd.
In additional, S Ltd owns 12% of the ordinary share capital of A Ltd.

The Equity Method of Accounting

In the equity method of accounting, the investment is initially recorded at cost and adjusted thereafter
for the post-acquisition change in the investor’s shares of net assets of the associate.

Example 01

On 1st January 2008 the non tangible assets of A Ltd amount to Rs.220,000 financed by 100,000 Rs 1
Ordinary shares and revenue reserves of Rs.120,000 H Ltd, a company with subsidiaries, acquires
30,000 of the shares in A Ltd for Rs. 75,000. During the year ended 31st December 2008, A Ltd’s
profit after tax is Rs.30,000 from which dividends of Rs.12,000 are paid

Required:
Show how H Ltd’s investments in A Ltd would appear in the consolidated balance sheet at 31
December 2008.

Example 02
P acquired 25% of the ordinary share capital of A Ltd for Rs.640,000 on 31 December 2006 when
accumulated profits of A stood at Rs. 720,000.P appointed two directors to the board of A and the

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investment is regarded as long term. Both companies prepare their Financial Statements to 31
December each year. The summarized balance sheet of A on 31 December 2008 as follows:
Rs.000

Sundry net assets 2,390

Capital and reserves

Share Capital 1,250
Accumulated profits 1,140
2,390

A has made no new issues of shares since P acquired its holding.

Show at what amount the investment will be shown in the consolidated balance sheet of P as on 31
December 2008.

Effect on Total Reserves

Total reserves in the published financial statement will be changed in two main ways due to the equity
accounting of the associate:

 Reserves will be increased by group share of post-acquisition reserves of the associate.

 Reserves will be decreased by any goodwill written off.

Transaction between the group and the associate

Trading transactions and/or loans may be between member companies of the group (i.e. parent and
subsidiaries) and the associate. As the associate is not consolidated, it follows that these transactions
are not cancelled out.

Trading between the group and the associate

An adjustment will only be required if there is unrealized profit at the balance sheet date, i.e.
inventories exists as a result of the trading .the elimination should be taken in the consolidated income
statement against either the group or the associate according to which of them recorded the profit on
the transaction.

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