Arthur et al. Q9.6 Views on the nature of equity accounting (Section 9.3.1)
This question is open-ended and is designed to encourage some discussion to help students rationalise the use of the equity method. At the same time, the discussion should highlight some of the conceptual difficulties with the particular version of the equity method that is prescribed by AASB 128.
(a) Extension of the accrual process for recognising revenue from investments
The equity method can be considered an application of accrual accounting to investment income. The idea here is that revenue from the associate is recorded as the investee¡¯s profits are earned rather than upon receipt of cash dividends appropriated from these profits.
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Under the AASB Framework for the Preparation and Presentation of Financial Statements, the asset and liability definitions determine all other elements of the financial statements, including revenue. So the view that the equity method is nothing more than an accrual of revenue is not a sufficient explanation because it does not encompass the measurement of assets or liabilities.
(b) Measurement method for the statement of financial position value of certain investments
This is the view AASB 128 seems to favour. AASB 128 states that ¡°the equity method provides more informative reporting of the net assets of the investor¡±.
Through a series of adjusting equity accounting entries, the investor will eventually have a carrying amount in their financial statements that will be closer to the fair value of the associate¡¯s net assets. This is particularly useful if the associate does not have a quoted market share price.
(c) Extension of consolidation techniques for a particular class of investment.
The view that equity accounting is a consolidation technique suggests that associated entities form part of the group for which consolidated financial statements are prepared but this is at odds with paragraph 6 of SAC 1, which states ¡°an economic entity means a group of entities comprising a controlling entity and one or more controlled entities operating together to achieve objectives consistent with those of the controlling entity¡±.
The view that the equity method is a consolidation technique is contradicted by the requirement to recognise the share of profit of associate as a one-line item on the face of the statement of comprehensive income (refer to AASB 101.82(c)). If a consolidation technique, then this would imply that the share of profit of associate should be added to the equivalent balance for the economic entity.
A further contradiction is the treatment of unrealised profits from intragroup transactions (e.g. sales by the associate to the investor). If a consolidation technique, then the inventory balances of the associate should be adjusted for 100% of the unrealised profit because the inventory balance is where the unrealised profit is included. By contrast, AASB 128 requires that the investment account and share of profit of associate be adjusted for the investor¡¯s interest in the unrealised profits arising from the inventory transfers.
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