Welcome to the World of Associates!
In your journey through consolidated financial statements, you have already learned about subsidiaries—entities where a parent has control. But what happens when an investing entity has significant influence rather than total control? That is where associates come in!
Think of a subsidiary as an entity where you make all the governing decisions, while an associate is more like a significant business partner: you have an active voice and participate in policy decisions, but you do not control them. In this chapter, we explore how associates are identified and how the principles of equity accounting apply under IAS 28 Investments in Associates and Joint Ventures.
1. What Exactly is an Associate?
An associate is an entity over which the investor has significant influence. It is neither a subsidiary nor an interest in a joint venture.
Significant Influence and the Presumption Rule
Significant influence is defined as the power to participate in the financial and operating policy decisions of the investee, but is not control or joint control over those policies.
In practice and in exam questions, significant influence is generally assessed through voting rights and shareholdings:
• Less than 20% holding: Generally presumed not to have significant influence (treated as a simple investment unless significant influence can be clearly demonstrated).
• 20% to 50% holding: Rebuttable presumption that the investor has significant influence. This entity is an associate.
• More than 50% holding: The investor is presumed to have control, creating a parent-subsidiary relationship.
Key indicators of significant influence:
Even if share ownership is near or slightly below 20%, significant influence can be demonstrated by:
• Representation on the board of directors or equivalent governing body.
• Participation in policymaking processes, including participation in decisions about dividends or other distributions.
• Material transactions between the investor and the investee.
• Interchange of managerial personnel.
• Provision of essential technical information.
2. How to Account for Associates: The Equity Method Principle
When preparing consolidated financial statements for subsidiaries, we use line-by-line consolidation—combining 100% of the parent’s and subsidiary’s assets, liabilities, income, and expenses because the parent controls all of those resources.
Because an investor does not control an associate, line-by-line consolidation is prohibited. Instead, the entity is accounted for using the equity method.
Important syllabus note: In ACCA FA, you are required only to describe the principle of the equity method. You are not required to calculate or prepare complex equity-method consolidation figures.
3. The Equity Method in the Statement of Financial Position
In the consolidated statement of financial position, the associate is presented as a single line item under non-current assets, typically titled "Investment in associate".
Under the principle of the equity method:
• The investment is initially recognized at cost.
• The carrying amount is subsequently adjusted to recognize the investor's share of the post-acquisition profits or losses and other comprehensive income of the associate.
• Distributions received (such as dividends) from the associate reduce the carrying amount of the investment so that double counting is avoided.
No individual assets or liabilities of the associate are combined with those of the group.
4. The Equity Method in the Statement of Profit or Loss
Just as with the statement of financial position, the associate’s revenues and expenses are not combined line-by-line with group operations.
Instead, the group’s share of the associate’s performance is presented as a single line in the consolidated statement of profit or loss, usually titled "Share of profit of associate" (or share of profit of equity-accounted investees), positioned before profit before tax.
5. Key Distinctions to Remember
Watch out for common misconceptions tested in objective test questions:
• Control vs. Significant Influence: Control means directing the relevant activities (subsidiary; line-by-line consolidation). Significant influence means participating in financial and operating policy decisions without control (associate; equity method).
• Never consolidate line-by-line: Never add an associate's revenue, cost of sales, inventories, or cash to the parent's individual line items.
• Syllabus boundaries: Numerical preparation of equity-method working schedules is outside the FA syllabus. Focus on being able to identify an associate, define significant influence, and describe the one-line equity presentation principles in both primary statements.
Summary Checklist
• Definition: An associate is an entity over which the investor has significant influence (usually 20% to 50% voting power).
• Relationship: Power to participate in decisions, but not control them.
• Method: The equity method is used in consolidated financial statements.
• CSOFP Presentation: A single line under non-current assets ("Investment in associate").
• CSPL Presentation: A single line ("Share of profit of associate").