Accounting Standards

FRS 101
First-time Adoption of Financial Reporting Standards

Implementation Guidance

Accounting for Investments in Associates

The standards, which have been set in bold italic type, should be read in the context of the background material and implementation guidance in this Standard, and in the context of the Preface to Financial Reporting Standard. Financial Reporting Standards are not intended to apply to immaterial items.

Scope

1. This Standard should be applied in accounting by an investor for investments in associates.

Definitions

2. The following terms are used in this Standard with the meanings specified:

An associate is an enterprise in which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control over those policies.

Control (for the purpose of this Standard) is the power to govern the financial and operating policies of an enterprise so as to obtain benefits from its activities.

A subsidiary is an enterprise that is controlled by another enterprise (known as the parent).

The equity method is a method of accounting whereby the investment is initially recorded at cost and adjusted thereafter for the post acquisition change in the investor's share of net assets of the investee. The income statement reflects the investor's share of the results of operations of the investee.

The cost method is a method of accounting whereby the investment is recorded at cost. The income statement reflects income from the investment only to the extent that the investor receives distributions from accumulated net profits of the investee arising subsequent to the date of acquisition.

Significant Influence

3. If an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee, it is presumed that the investor does have significant influence, unless it can be clearly demonstrated that this is not the case.¹ Conversely, if the investor holds, directly or indirectly through subsidiaries, less than 20% of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

¹See also INT FRS-33: Consolidation and Equity Method - Potential Voting Rights and Allocation of Ownership Interests

4. The existence of significant influence by an investor is usually evidenced in one or more of the following ways:

1. representation on the board of directors or equivalent governing body of the investee;
   
   
2. participation in policy making processes;
   
   
3. material transactions between the investor and the investee;
   
   
4. interchange of managerial personnel; or
   
   
5. provision of essential technical information.

Equity Method

5. Under the equity method, the investment is initially recorded at cost and the carrying amount is increased or decreased to recognise the investor's share of the profits or losses of the investee after the date of acquisition. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for alterations in the investor's proportionate interest in the investee arising from changes in the investee's equity that have not been included in the income statement. Such changes include those arising from the revaluation of property, plant, equipment and investments, from foreign exchange translation differences and from the adjustment of differences arising on business combinations.²

²See also INT FRS-33: Consolidation and Equity Method - Potential Voting Rights and Allocation of Ownership Interests

Cost Method

6. Under the cost method, an investor records its investment in the investee at cost. The investor recognises income only to the extent that it receives distributions from the accumulated net profits of the investee arising subsequent to the date of acquisition by the investor. Distributions received in excess of such profits are considered a recovery of investment and are recorded as a reduction of the cost of the investment.

Consolidated Financial Statements

7. An investment in an associate should be accounted for in consolidated financial statements under the equity method except when :

1. the investment is acquired and held exclusively with a view to its subsequent disposal in the near future ; or
   
   
2. it operates under severe long-term restrictions that significantly impair its ability to transfer funds to investor.

Such investments should be accounted for in accordance with FRS 39, Financial Instruments: Recognition and Measurement .

8. The recognition of income on the basis of distributions received may not be an adequate measure of the income earned by an investor on an investment in an associate because the distributions received may bear little relationship to the performance of the associate. As the investor has significant influence over the associate, the investor has a measure of responsibility for the associate's performance and, as a result, the return on its investment. The investor accounts for this stewardship by extending the scope of its consolidated financial statements to include its share of results of such an associate and so provides an analysis of earnings and investment from which more useful ratios can be calculated. As a result, the application of the equity method provides more informative reporting of the net assets and net income of the investor.

9. An investor should discontinue the use of the equity method from the date that:

1. it ceases to have significant influence in an associate but retains, either in whole or in part, its investment; or
   
   
2. the use of the equity method is no longer appropriate because the associate operates under severe long-term restrictions that significantly impair its ability to transfer funds to the investor.

The carrying amount of the investment at that date should be regarded as cost thereafter.

Separate Financial Statements of the Investor

10. An investment in an associate that is included in the separate financial statements of an investor that issues consolidated financial statements and that is not held exclusively with a view to its disposal in the near future should be either:

1. carried at cost;



2. accounted for using the equity method as described in this standard; or



3. accounted for as an available-for-sale financial asset as described in FRS 39, Financial Instruments: Recognition and Measurement.

11. The preparation of consolidated financial statements does not, in itself, obviate the need for separate financial statements for an investor.

12. An investment in an associate that is included in the financial statements of an investor that does not issue consolidated financial statements should be either:

1. carried at cost;
   
   
2. accounted for using the equity method as described in this standard if the equity method would be appropriate for the associate if the investor issued consolidated financial statements; or
   
   
3. accounted for under FRS 39, Financial Instruments: Recognition and Measurement, as an available -for -sale financial asset or a financial asset held for trading based on definitions in FRS 39,

13. An investor that has investments in associates may not issue consolidated financial statements because it does not have subsidiaries. It is appropriate that such an investor provides the same information about its investments in associates as those enterprises that issue consolidated financial statements.

Application of the Equity Method

14. Many of the procedures appropriate for the application of the equity method are similar to the consolidation procedures set out in Financial Reporting Standard FRS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries. Furthermore, the broad concepts underlying the consolidation procedures used in the acquisition of a subsidiary are adopted on the acquisition of an investment in an associate. ³

³See also INT FRS-3, Elimination of Unrealised Profits and Losses on Transactions with Associates

15. An investment in an associate is accounted for under the equity method from the date on which it falls within the definition of an associate. On acquisition of the investment any difference (whether positive or negative) between the cost of acquisition and the investor's share of the fair values of the net identifiable assets of the associate is accounted for in accordance with Financial Reporting Standard FRS 22, Business Combinations. Appropriate adjustments to the investor's share of the profits or losses after acquisition are made to account for:

1. depreciation of the depreciable assets, based on their fair values; and
   
   
2. amortisation of the difference between the cost of the investment and the investor's share of the fair values of the net identifiable assets.

16. The most recent available financial statements of the associate are used by the investor in applying the equity method; they are usually drawn up to the same date as the financial statements of the investor. When the reporting dates of the investor and the associate are different, the associate often prepares, for the use of the investor, statements as at the same date as the financial statements of the investor. When it is impracticable to do this, financial statements drawn up to a different reporting date may be used. The consistency principle dictates that the length of the reporting periods, and any difference in the reporting dates, are consistent from period to period.

17. When financial statements with a different reporting date are used, adjustments are made for the effects of any significant events or transactions between the investor and the associate that occur between the date of the associate's financial statements and the date of the investor's financial statements.

18. The investor's financial statements are usually prepared using uniform accounting policies for like transactions and events in similar circumstances. In many cases, if an associate uses accounting policies other than those adopted by the investor for like transactions and events in similar circumstances, appropriate adjustments are made to the associate's financial statements when they are used by the investor in applying the equity method. If it is not practicable for such adjustments to be calculated, that fact is generally disclosed.

19. If an associate has outstanding cumulative preferred shares, held by outside interests, the investor computes its share of profits or losses after adjusting for the preferred dividends, whether or not the dividends have been declared.

20. If, under the equity method, an investor's share of losses of an associate equals or exceeds the carrying amount of an investment, the investor ordinarily discontinues including its share of further losses. The investment is reported at nil value. Additional losses are provided for to the extent that the investor has incurred obligations or made payments on behalf of the associate to satisfy obligations of the associate that the investor has guaranteed or otherwise committed. If the associate subsequently reports profits, the investor resumes including its share of those profits only after its share of the profits equals the share of net losses not recognised⁴.

⁴See also INT FRS-20, Equity Accounting Method - Recognition of Losses

Impairment Losses

21. If there is an indication that an investment in an associate may be impaired, an enterprise applies FRS 36, Impairment of Assets. In determining the value in use of the investment, an enterprise estimates:

1. its share of the present value of the estimated future cash flows expected to be generated by the investee as a whole, including the cash flows from the operations of the investee and the proceeds on the ultimate disposal of the investment; or
   
   
2. the present value of the estimated future cash flows expected to arise from dividends to be received from the investment and from its ultimate disposal.

Under appropriate assumptions, both methods give the same result. Any resulting impairment loss for the investment is allocated in accordance with FRS 36. Therefore, it is allocated first to any remaining goodwill (see paragraph 15).

22. The recoverable amount of an investment in an associate is assessed for each individual associate, unless an individual associate does not generate cash inflows from continuing use that are largely independent of those from other assets of the reporting enterprise.

Income Taxes

23. Income taxes arising from investments in associates are accounted for in accordance with Financial Reporting Standard FRS 12, Income Taxes.

Contingencies

24. In accordance with FRS 37, Provisions, Contingent Liabilities and Contingent Assets, the investor discloses:

1. its share of the contingent liabilities and capital commitments of an associate for which it is also contingently liable; and
   
   
2. those contingencies that arise because the investor is severally liable for all the liabilities of the associate.

Disclosure

25. The following disclosures should be made:

1. an appropriate listing and description of significant associates including the proportion of ownership interest and, if different, the proportion of voting power held; and
   
   
2. the methods used to account for such investments.

26. Investments in associates accounted for using the equity method should be classified as long-term assets and disclosed as a separate item in the balance sheet. The investor's share of the profits or losses of such investments should be disclosed as a separate item in the income statement. The investor's share of any extraordinary or prior period items should also be separately disclosed.

Effective Date

27. FRS 28, Accounting for Investments in Associates, is operative for financial statements covering periods beginning on or after 1st January 1991.

28. Paragraphs 21 and 22 of this Standard become operative when FRS 36 becomes operative - that is, for annual financial statements covering periods beginning on or after 1st October 2000, unless FRS 36 is applied for earlier periods.