ReSA - THE REVIEW SCHOOL OF ACCOUNTANCY

CPA Review Batch 43  May 2022 CPA Licensure Examination  Week No. 5

FINANCIAL ACCOUNTING & REPORTING C. UBERITA  J. BINALUYO  G. MACARIOLA

FAR-4308: INVESTMENT IN ASSOCIATES

Associate – is an entity, including an un-incorporated entity such as a partnership, over which the investor
has significant influence and that is neither a subsidiary nor an interest in a joint venture.

Significant influence - is the power to participate in the financial and operating policy decisions of the investee
but is not control or joint control over those policies. Below are the features of the definition:

A. It requires the investor to have the power, or the capacity, to affect the investee but does not require the
investor to actually exercise that power. Instead, the focus is on the existence of the power or capacity.

B. The specific power is that of being able to participate in the financial and operating decisions of the investee
but has no power or capacity to dominate the financial and operating decisions.

C. In the definitions of an associate and significant influence, there is no requirement for the investor to hold
any shares, or have a beneficial interest, in the associate. However, the application of the equity method of
accounting is based on the investor owning shares in the associate. In other words, if significant influence is
exercised by one entity over another by virtue of an association or contract other than from the holding of
shares, then the equity method cannot be applied in relation to the associate.

D. The level of influence is significant when the investor holds 20% up to 50% interest in the voting power of
the investee it is presumed that the investor has significant influence over the investee. This is a rebuttable
presumption because if the investor can demonstrate that such influence does not exist, then the investee is
not classified as an associate. Further, where the investor owns less than 20% of another entity, there is
presumption that the investee is not an associate.

Accounting Method Use:

A) Full Application of the Standards (PAS 28) - Equity Method
Measurement at point of acquisition – measured at historical cost. The cost represents the fair market
value of the shares acquired or fair value of the consideration given up whichever is clearly determinable
and any transaction costs incurred.

Measurement subsequent to acquisition – the cost of the equity securities is increased or decreased to
recognize the investor’s share of the profit or loss of the investee after the date of acquisition. The investor’s
share of the profit or loss of the investee is recognized in the investor’s profit or loss. Distributions received
from an investee reduce the carrying amount of the investment. Adjustment to the carrying amount may
also be necessary for changes in the investor’s proportionate interest in the investee arising from changes in
the investee’s equity that have not been recognized in the investee’s profit or loss. Such changes include
those arising from the revaluation of property, plant and equipment and from foreign exchange translation
differences. The investor’s share of those changes is recognized directly in equity of the investor

The carrying value of the investment is also affected by the recognition of the excess of the acquirer’s interest
in the net fair value of acquiree’s identifiable assets, liabilities and contingent liabilities over cost after
reassessing the identification and measurement of the acquiree’s identifiable assets, liabilities and contingent
liabilities. The amount of excess is actually the negative goodwill.

However, if there is an indication that the investment in associate is impaired such that the carrying amount
of the investment is higher than its recoverable amount, the amount of impairment loss should be recognized,
the investment in associate account should be reported in the statement of financial position at its
recoverable amount.

Exceptions:
The equity method of accounting is not applied to investments in associates classified as held for sale in
accordance with PFRS 5 “Non-current assets held for sale and discontinued operations”. An investor measures
an associate that is classified as held for sale at the lower of its carrying amount at the date of classification
as held for sale and fair value less cost to sell. Therefore, equity method ceases once an associate is classified
as held for sale.

B) IFRS for SME

In an entity’s consolidated and individual financial statements, and entity must choose one of the following
methods:

➢ Cost Method 2. Fair value method 3. Equity method

The cost method option is not applicable to investments in associates for which there is published price
quotation available. When published price quotations are available, the fair value of IFRS for SME must be
applied.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4308
Week 5: INVESTMENT IN ASSOCIATE

Under the cost method (model), investments in associates are measured at cost less any accumulated
impairment loss. Dividends or other distributions received from the investment are recognized as income.
No special treatment is required for pre-acquisition profits of the associate and therefore the entity does not
need to differentiate between dividends received out of post-or-pre-acquisition profits.

Under the fair value method (model), the investment in an associate is initially measured at the transaction
price, excluding transaction costs. At subsequent reporting dates, the investment in associate is measured
at fair value with changes in fair value recognized in profit or loss.

Under the equity method (model), the investment in associate is initially recorded at the transaction price
(including transaction costs), is subsequently adjusted to reflect the investor’s share of the profit or loss and
other comprehensive income of the associate. On initial recognition, goodwill or negative goodwill must be
determined, and goodwill carried as a separate asset.

Under the equity method, an investor measures its interest in associates by using the procedures established
under the equity method of accounting. Other items of other comprehensive income affecting the equity of
the associate should also be considered as they may require adjustments to the investment in associate.

The IFRS for SMEs provides specific principles regarding the application of the equity method. The principles
for the equity method of accounting in the IFRS for SMEs are different to that of full IFRS. The full IFRS
method should not be confused with the IFRS for SMEs’ equity method, and may not be used as a substitute
for equity accounting in terms of the IFRS for SMEs.

Income (Loss) From Investment (Equity Method)

a. During the holding period or when held – share in the investee’s reported net profit or loss adjusted by
the amount of any understatement or overstatement of expenses on the related assets and liabilities of the
investee, impairment of goodwill or any amount of negative goodwill. The “Income from Investment or
Equity in Earnings of Associate” may be used to reflect the share on the earnings or loss and the related
adjustments.

When an associate has outstanding cumulative preference shares that are held by parties other than the
investor and classified as equity, the investor computes its share of earnings or losses after deducting the
dividends on such shares, whether or not such dividends have been declared. For preference shares that are
non-cumulative, the dividends are deducted only when there is declaration.

The above discussion relates only to dividends that are classified as equity because, for those preference
shares classified as debt, the payments to the holders are treated as interest and deducted before calculating
profit or loss for the period. For preference shares treated as equity, the payments to holders are classified
as dividends and appropriated subsequent to the calculation of profit or loss.

b. Upon derecognition or disposal – the difference of the net disposal proceeds over the carrying value of
the investment at the time of disposal is the measure of gain or loss on disposal of investment. Any other
comprehensive income recognized by the investor in relation to the investment in associate must be recycled
and included in the gain or loss on disposal measurement.

Deemed Disposal:
An investor’s interest in an associate may be reduced other than by an actual disposal. Such a reduction in
interest, which is commonly referred to as a ‘deemed disposal’ gives rise to a ‘dilution’ gain or loss. Deemed
disposal may arise for a number of reasons, including:
(a) the investor does not take up its full allocation in a rights issue by the associate
(b) the associate declares scrip dividends which are not taken up by the investor so that its proportional interest
is diminished
(c) another party exercises its options or warrants issued by the associate; or
(d) the associate issues share to third parties

Although IASB did not explicitly consider accounting for deemed disposals of associates in drafting IAS 28,
paragraph 20 of the standard refers to the concepts underlying the procedures used in accounting for the
acquisition of a subsidiary in accounting for acquisitions of interests in associates. Therefore, rather than relying
on a literal reading of the definition of the equity method, it is more appropriate to account for deemed disposals
of associates in the same way as deemed disposals of subsidiaries. IAS 27 has been amended as part of phase
II of the business combination project so as to require that partial disposals of subsidiaries, were control is
retained, are accounted for as equity transactions. Under equity accounting an investor only accounts for its own
interest. Given that the other investors’ ownership in the associate is not reflected in the accounts of an investor
there is no basis for concluding that deemed disposals can only be treated as equity transaction.

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4308
Week 5: INVESTMENT IN ASSOCIATE

1. On January 2, 2021, Marco Company purchased 25,000 shares (30%) of Polo Company’s ordinary shares for
P220 per share. Marco also paid transaction cost of P100,000. The fair value of the net assets acquired is
P5,000,000. During 2021, Polo reported the following in its Statement of Comprehensive Income a
P4,500,000 net income and a P500,000 revaluation surplus at the end of the year. Marco Company received
cash dividends of P1,250,000 on December 31, 2021. What is the carrying value of the Investment on
December 31, 2021?
a. P5,450,000 c. P4,970,000
b. P5,180,000 d. P4,800,000

2. On January 1, 2020, Girls Generation Company acquired 10% of the outstanding voting shares of Twice
Incorporated for P900,000. These shares were designated as equity investments at fair value through other
comprehensive income.

On July 1, 2021, Girls Generation gained the ability to exercise significant influence over financial and
operating policies of Twice Incorporated by acquiring additional 20% of the outstanding shares for
P2,600,000. The two purchases were made at prices proportionate to the value assigned to Twice’s net assets
is equal to their carrying amounts. For the years ended December 31, 2020 and 2021, Twice reported the
following:
Year 2020 2021
Dividends paid P2,000,000 P3,000,000
Profit for the year 6,000,000 6,500,000

The fair values of the investments at December 31, 2020 and 2021 were P1,380,000 and P5,100,000,
respectively. All dividends and net income were evenly incurred and paid during the period.

Question 1: How much is the amount recognized as unrealized gain (loss) in other comprehensive income
in 2020?
a. None c. P340,000
b. P250,000 d. P480,000

Question 2: What is the initial cost of the investment in associate upon reclassification on July 1, 2021?
a. P2,550,000 c. P3,900,000
b. P3,050,000 d. P3,940,000

Question 3: What is the carrying value of the investment in Associate as of December 31, 2021?
a. P3,875,000 c. P5,275,000
b. P4,425,000 d. P6,145,000

Question 4: How much is the total investment income recognized in its December 31, 2021 statement of
comprehensive income?
a. P1,205,000 c. P2,175,000
b. P1,125,000 d. P3,000,000

3. Table owns 50% and 20% of Chair Corporation’s ordinary and preference shares, respectively. Chair’s shares
outstanding at December 31, 2019 follow:

Ordinary share P4,000,000

10% cumulative preference share 900,000

Chair reported net income of P600,000 for the year ended December 31, 2019 and declared the current year
dividend on the preference shares.

What total amount of revenue should Table Company disclose in the statement of comprehensive income
related to its investment in Chair Company for the year ended December 31, 2019?
a. None c. P273,000
b. P255,000 d. P300,000

4. On January 1, 2020, Orange Corp. acquired 200,000 shares representing 40% interest of Kahel’s ordinary
shares for P4,500,000. Kahel reported during 2021 a total net income of P4,000,000 and foreign translation
loss of P500,000. Kahel also distributed total cash dividends at year end of P3,000,000. On January 1, 2021,
Kahel issued 300,000 shares at P 23 per share which Orange Corp. did not purchase any of these shares.

Q1: How much is the total net dilution gain/loss that should be recognized by Orange Corp.?
a. P112,500 gain b. P187,500 gain c. P187,500 loss d. P112,500 loss

Q2: What is the carrying value of Investment in Kahel after the recognition of dilution gain/loss?
a. P5,212,500 b. P4,987,500 c. P4,912,500 d. P5,287,500

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ReSA – THE REVIEW SCHOOL OF ACCOUNTANCY FAR-4308
Week 5: INVESTMENT IN ASSOCIATE

5. On January 1, 2020, Green Corp. acquired 30,000 shares representing 10% interest of Berde’s ordinary
shares for P4,000,000. Green does not have any significant influence nor control over the financial and
operating policy of Berde. Berde reported during 2020 a total net income of P4,000,000 and distributed
dividends of P400,000. On January 1, 2021, Green purchased additional 20% interest of Berde’s ordinary
shares for P7,500,000. The fair value of the 10% interest is P3,750,000. The net assets of Berde are fairly
valued. During 2021, Berde reported net income of P5,000,000 and distributed a total dividend of P300,000.

What is the carrying value of the Investment on December 31, 2021?

a. P12,190,000 b. P12,660,000 c. P10,310,000 d. P12,910,000

Gain or loss from deemed disposal

The gain or loss on deemed disposal is the difference between the carrying value of investment including any
goodwill that has been considered deemed disposed off and the share in the proceeds for any contribution or
issue of new shares by the investee adjusted by any amount reported in equity before the deemed disposal that
is to be recycled in profit or loss.

Cessation of an Associate
Accounting for Cessation – upon application of IAS 27 (as amended in 2008) and IFRS 3 as revised in
2008):
An investor shall discontinue the use of the equity method from the date when it ceases to have significant
influence over an associate and shall account for the investment in accordance with IFRS 9 from that date,
provided the associate does not become a subsidiary or a jointly controlled entity. On loss of significant influence,
the investor shall measure at fair value any investment the investor retains in the former associate. The investor
shall recognize in profit or loss any difference between:
1. the fair value of any retained investment and any proceeds from disposing of the part interest in the associate,
and
2. the carrying amount of the investment at the date when significant influence is lost.

Therefore, upon loss of significant influence there is a remeasurement to fair value of any remaining interest that
is taken to profit or loss regardless of the prospective accounting designation under IFRS 9.

6. Bloom Corporation acquired 30% of Gloom Company’s 100,000 voting stock on January 2, 2018 for
P2,000,000 when the net assets of Gloom Company was P6,000,000. Gloom earned P1,000,000 and
P1,500,000 in 2018 and 2019, respectively. Gloom Company paid dividends of P300,000 in 2018 and
P500,000 in 2019. Market value of Gloom’s ordinary shares is P80 on December 31, 2018 and P90 on
December 31, 2019. On January 2, 2019, Bloom Company sold 12,000 shares of its investment at the
prevailing market value of P80 of Gloom’s shares.

Question 1: How much is the gain or loss on sale taken to Profit or Loss on January 2, 2019?
a. none c. P114,000
b. P76,000 d. P190,000

Question 2: If after the sale Bloom Company reclassified its remaining investment to Investment at Fair
Value through Profit or Loss, how much is the total net amount of income that should be reported in
Profit or Loss for the year 2019?
a. P190,000 c. P370,000
b. P280,000 d. P460,000

Question 3: If after the sale Bloom Company reclassified its remaining investment to Investment at Fair
Value through Other Comprehensive Income, how much is the total net amount of income that should
be reported in Profit or Loss for the year 2019?
a. P190,000 c. P370,000
b. P114,000 d. P460,000

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