8.3 & 8.4

Question 1

How is an investment in associates accounted for?

Answer 1

Via the equity method

Question 2

Describe the initial accounting treatment of investment in associates

Answer 2

Initial investment is recorded at cost and reported on the balance sheet as a non-current asset

Question 3

What is the accounting treatment for investment in associates in subsequent periods, after the initial recognition?

Answer 3

1. The proportionate share of earnings increases the investment account on the balance sheet and is recognised in the income statement
2. Dividends received are treated as return of capital and reduce the investment account
3. Dividends are therefore not recognised in the income statement

Question 4

What happens if the investee reports a loss?

Answer 4

The proportionate share of the loss reduces the investment account and also reduces the investors income statement

Question 5

What happens if the investee losses reduce the investment account to zero?

Answer 5

1. The investor stops using the equity method and does not record any further losses
2. Equity method is resumed once the proportionate share of earnings exceeds the share of losses that were not recorded during the suspension

Question 6

What is the fair value method and when is it allowed?

Answer 6

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

Question 7

What is the accounting treatment of fair value for the equity method?

Answer 7

1. Any change in fair value is recorded in the income statement
2. Any dividend income is also recorded in the income statement

Question 8

Why would the purchase price ever exceed the book value of net assets?

Answer 8

Many of the investee’s assets and liabilities will reflect historical cost and not fair value

Question 9

What happens when the price paid is greater than the book value of net assets?

Answer 9

1. The difference is first allocated to specific assets or category of assets at fair value
2. Any excess that cannot be allocated to specific assets is recorded as goodwill

Question 10

What happens if the fair value of net identifiable assets is equal to the book value?

Answer 10

The entire excess of purchase price is considered as goodwill

Question 11

When would an investment become impaired?

Answer 11

If the fair value falls below its carrying value, and the decline is thought to be permanent

Question 12

What happens when an asset becomes impaired?

Answer 12

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

Question 13

What is the impairment process under IFRS?

Answer 13

1. There must be evidence of impairment from one or more loss events after the initial recognition of the investment
2. The loss event must impact the future cash flows, which can be reliably estimated

Question 14

How is an impairment loss recognised under IFRS?

Answer 14

1. The impairment loss is recognised on the income statement
2. On the balance sheet, the carrying amount is either reduced directly or via the use of an allowance account

Question 15

What is the impairment process under US GAAP?

Answer 15

1. Impairment loss is recognised if fair value declines below carrying value and the decline is thought to be permanent
2. Impairment loss recognised on IS and carrying value is reduced to fair value on BS

Question 16

Can an impairment loss be reversed?

Answer 16

No. Neither IFRS or US GAAP permit the reversal of impairment losses, even if fair value later increases

Question 17

In general, how is the profit from transactions with investees treated?

Answer 17

1. profits cannot be realised until confirmed through use or sale to third parties (profits are deferred until confirmed)
2. 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

Question 18

Why must the investor defer and eliminate its share of unrealised profit?

Answer 18

Because the investor can influence the terms and timing of transactions with associates

Question 19

What is the difference between upstream and downstream transactions?

Answer 19

Upstream is associate selling to investor
Downstream is investor selling to associate

Question 20

What is the accounting treatment of upstream transactions?

Answer 20

1. All of the profit on the intercompany transaction is recorded on the associates income statement
2. 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

Question 21

Wat is the accounting treatment for downstream transactions?

Answer 21

1. The profit is recorded on the investor’s income statement
2. Unrealised profit is eliminated from equity income until the profit is confirmed

Question 22

What is unearned profit and what is the accounting treatment?

Answer 22

1. Unearned profit is on goods that have not been used or sold by the investor
2. The investor must eliminate its share of the profit from the equity income account

Question 23

What is the treatment of dividends?

Answer 23

Dividends from investee companies are treated as return of capital and thus reduce the investment account

Question 24

What does the equity method do?

Answer 24

Applying the equity method recognises the investor’s full share of the associates income

Question 25

What happens in the consolidated balance sheet?

Answer 25

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