8.3 & 8.4 Flashcards
How is an investment in associates accounted for?
Via the equity method
Describe the initial accounting treatment of investment in associates
Initial investment is recorded at cost and reported on the balance sheet as a non-current asset
What is the accounting treatment for investment in associates in subsequent periods, after the initial recognition?
- The proportionate share of earnings increases the investment account on the balance sheet and is recognised in the income statement
- Dividends received are treated as return of capital and reduce the investment account
- Dividends are therefore not recognised in the income statement
What happens if the investee reports a loss?
The proportionate share of the loss reduces the investment account and also reduces the investors income statement
What happens if the investee losses reduce the investment account to zero?
- The investor stops using the equity method and does not record any further losses
- Equity method is resumed once the proportionate share of earnings exceeds the share of losses that were not recorded during the suspension
What is the fair value method and when is it allowed?
US GAAP allows equity method investments to be recorded at fair value
Under IFRS the fair value option is only available to venture capital firms, mutual funds and similar entities
The decision to use fair value is irrevocable
What is the accounting treatment of fair value for the equity method?
- Any change in fair value is recorded in the income statement
- Any dividend income is also recorded in the income statement
Why would the purchase price ever exceed the book value of net assets?
Many of the investee’s assets and liabilities will reflect historical cost and not fair value
What happens when the price paid is greater than the book value of net assets?
- The difference is first allocated to specific assets or category of assets at fair value
- Any excess that cannot be allocated to specific assets is recorded as goodwill
What happens if the fair value of net identifiable assets is equal to the book value?
The entire excess of purchase price is considered as goodwill
When would an investment become impaired?
If the fair value falls below its carrying value, and the decline is thought to be permanent
What happens when an asset becomes impaired?
It is written down to fair value on the balance sheet and a loss equal to the write down amount is recognised on the income statement
What is the impairment process under IFRS?
- There must be evidence of impairment from one or more loss events after the initial recognition of the investment
- The loss event must impact the future cash flows, which can be reliably estimated
How is an impairment loss recognised under IFRS?
- The impairment loss is recognised on the income statement
- On the balance sheet, the carrying amount is either reduced directly or via the use of an allowance account
What is the impairment process under US GAAP?
- Impairment loss is recognised if fair value declines below carrying value and the decline is thought to be permanent
- Impairment loss recognised on IS and carrying value is reduced to fair value on BS
Can an impairment loss be reversed?
No. Neither IFRS or US GAAP permit the reversal of impairment losses, even if fair value later increases
In general, how is the profit from transactions with investees treated?
- profits cannot be realised until confirmed through use or sale to third parties (profits are deferred until confirmed)
- The investor’s share of unrealised profit must be eliminated by reducing the equity income until the profit is realised, at which point the equity income can be recognised
Why must the investor defer and eliminate its share of unrealised profit?
Because the investor can influence the terms and timing of transactions with associates
What is the difference between upstream and downstream transactions?
Upstream is associate selling to investor
Downstream is investor selling to associate
What is the accounting treatment of upstream transactions?
- All of the profit on the intercompany transaction is recorded on the associates income statement
- The investors share of the unrealised profit is included in the equity income account of the investor’s income statement, but it is used to reduce equity income until the profit is confirmed
Wat is the accounting treatment for downstream transactions?
- The profit is recorded on the investor’s income statement
- Unrealised profit is eliminated from equity income until the profit is confirmed
What is unearned profit and what is the accounting treatment?
- Unearned profit is on goods that have not been used or sold by the investor
- The investor must eliminate its share of the profit from the equity income account
What is the treatment of dividends?
Dividends from investee companies are treated as return of capital and thus reduce the investment account
What does the equity method do?
Applying the equity method recognises the investor’s full share of the associates income
What happens in the consolidated balance sheet?
The book value of the the shareholdings in the investee is increased by the share of net income and reduce by the amortisation of surplus values and the amount of dividends received
