ACCT 6010 Advanced Financial Reporting
Class 9 Equity Accounting
The University of 1
Learning objectives
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Learning objectives
After completing this topic students should be able to
1. Explain the purpose of equity accounting
2. Explain for which entities the equity method is applied
3. Explain and apply the definition of significant influence
4. Prepare equity accounting adjusting journal entries & relevant disclosures
9.3 – 9.10
5. Evaluate arguments for and against equity accounting
9.2 & Nobes (2005) & Bradbury (2018)
The University of 2
LS CLASS 9 1
Arthur et al. Chapter 9
Accounting Standards
– AASB 128 Investment in Associates and Joint Ventures
– AASB 127 Separate Financial Statements
– AASB 136 Impairment of Assets
– AASB 112 Income Taxes
– AASB 124 Related Party Disclosures (Para. 9(b), 18 & 19)
– AASB 12 Disclosure of Interests in Other Entities (Para. 20-23, B12 & B16)
“Rules-Based Standards and the Lack of Principles in Accounting”, Nobes (2005)
”Commentary on the Adjustments Required for Intercompany Transactions when Equity Accounting Under IAS 28”, Bradbury (2018)
“In the headlines”, KPMG May 2011, Issue 2011/15
The University of 3
1. Overview of equity accounting – Types of investment
Fair Value through OCI
The University of
significant influence
Joint Venture
Joint Operation
joint control
Subsidiary
Fair Value AASB 9 (ACCT6001)
Equity accounting AASB 128 (week 11)
Consolidation AASB 10 (week 1-10)
LS CLASS 9 2
1. Overview of equity accounting
– Accounting method for investments in associates and joint ventures. – Joint ventures are covered in class 10.
– Associates are entities over which an investor has “significant influence” over investee
– Investment carrying amount reflects cost plus investor’s OI% of adjusted post-acquisition movements in equity.
– Regulated by AASB 128
– Refer to Bluescope IS, SCI & BS
The University of 5
The University of 6
LS CLASS 9 3
The University of 7
LS CLASS 9
The University of 8
2. Significant influence
– Significant influence is the power to participate in the financial & operating policy decisions but is not control or joint control over those policies [AASB 128.3]
– AASB 128 suggests ≥ 20% of direct & indirect voting shares (subs) results in significant influence [AASB 128.5]
– Need to also consider debt or equity instruments currently convertible into ordinary shares* [AASB 128.7]
– US GAAP / IFRS point of difference
The University of 9
2. Significant influence (cont.)
Indicators of significant influence [AASB 128.6]
– Material transactions between investor & investee – Board representation;
– Provision of essential technical information;
– Participation in policy making process; and
– Interchange of management personal
The University of 10
Ø Complete Arthur et al. E9.1 (CP)
LS CLASS 9 5
3. Accounting for associates
Where to apply equity accounting
a) Account for investment using the equity method in the single
entity financial statements of the investor [AASB128.16]
– Applies to both investors that do not prepare CFS (i.e. have no subsidiaries) and investors that prepare CFS (i.e. a parent entity that opts to use equity accounting in its separate financial statements)
a) Measure investment at COST or FV according to AASB 9 in separate financial statements of investor [AASB 127.10] and apply equity accounting in consolidated financial statements
– Only applies to investors that prepare CFS
The University of 11
3. Accounting for associates (cont.)
Objectives of Equity Accounting
– To provide useful information about performance of an investment in another entity
– Provide a more relevant measure than cost in the absence of control or a clear market value
– Cost method is inappropriate due to: • Revenue recognition
• Asset valuation
– Consolidation is used only when control exists. [AASB 128.11]
The University of 12
LS CLASS 9 6
4. Application
How does equity accounting work?
– Post-acquisition changes in net assets (movements in OE) relate to: • Profit or loss;
• Dividends;
– Investor’s profit or loss includes its share of the investee’s profit or
loss and the investor’s OCI includes its share of the investee’s OCI
– Adjustment through equity accounting adjusting journal entries.
The University of 13
Investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. [AASB 128.3]
4. Application: Illustrative Example
Background information
– On1July20X6,InvestorLtd(Investor)acquired20%ofvotingsharesin Associate Ltd (Associate) for a consideration of $300,000.
– Atacquisitiondate,shareholders’equityinAssociateconsistsofissued capital ($1,000,000) and retained earnings ($100,000).
– Associate’sassetsarestatedatfairvalueexceptforabuilding,which had a fair value of $1,200,000 (cost $2,000,000 and accumulated depreciation $1,000,000) with a remaining useful life of 10 years.
– InvestorhassignificantinfluenceoverAssociate.
– Investorisaparententity.
– Thetaxrateis30%.
The University of 14
LS CLASS 9 7
4. Application: Initial investment in investee
– Investment in investee initially recognised at cost [AASB128.10]
On 1 July 20X6, Investor Ltd acquired 20% of voting shares in Associate Ltd for a consideration of $300,000.
1-0) Record investor’s initial investment*:
Carrying amount of Investment in Associate: ___________
* This journal entry is recorded in the single entity accounts of the investor (permanent). It is not an equity accounting adjustment.
Investment in Associate
The University of 15
4. Application: Initial investment in investee (cont.)
– Fair value adjustments (FVA) and goodwill (GW) are not separately recognised, but included in the cost of the investment [AASB 128.32a]:
Recognised pre-acquisition equity x OI %
($1,100,000 x 20%)
Fair value adjustment x OI%
($200,000 x 0.7 x 20%)
Goodwill (C – FVINA x OI%)
($300,000 – 220 – 28)
Contrast: Gain on bargain purchase included in P&L in period of acquisition [AASB 128.32b]. If C < FVINA x OI%, record:
Dr Investment in Associate Cr Cash
Cr Share of Profit of Associate
The University of 17
LS CLASS 9 8
4. Application: Share of investee’s current period profit (loss)
– Investor recognises a share of the investee’s profit when it is realised by the investee rather than distributed (as dividend) [AASB128.10] :
For the year ended 30 June 20X7, Associate Ltd recorded a net profit after tax of $500,000.
1-1) Equity accounting – Recognise share of profit of associate:
Workings: $500,000 x 20%
Carrying amount of Investment in Associate: ___________
Investment in Associate
Cr Share of Profit of Associate
The University of 18
4. Application: Share of investee’s current period profit (cont.)
– Carrying amount of the investment is increased (decreased) to recognise the investor’s share of the investee’s post acquisition profit (loss) after tax [AASB 128.10]
– Adjustment = OI% x Investee’s reported profit
– If the investee makes a loss, the investment account is credited.
– Limit: until the carrying amount of the investment is zero
– A liability for the losses of an investee cannot be recognised unless the investor has an obligation on behalf of the associate
– Cannot apply equity accounting again until all losses are recovered [AASB 128.39]
The University of 20
Contrast: Share of loss of investee
Dr Share of Loss of Associate Cr Investment in Associate
LS CLASS 9 9
4. Application: Current period dividends
– Dividends paid by the investee reduces their net assets, hence the carrying amount of the investment decreases and Investment in Associate is credited.
– The adjustment avoids double counting profits & dividends received by the investor [AASB 128.10]
– Recall: Under equity accounting a share of the investee’s profit is recognised by the investor when it is earned by the investee (see Adjustment 1)
– However, in the investor’s single entity records, revenue is recorded when the dividend is received
– Hence, the overall effect of the adjustment is an increase in the investor’s cash and decrease in the carrying amount of the investee
The University of 21
4. Application: Current period dividends (cont.)
During the year ended 30 June 20X0, Associate Ltd paid dividends of $250,000.
1-2) Equity accounting: Adjust for dividend received by investor:
Workings: $250,000 x 20%
Carrying amount of Investment in Associate: ___________
Recall: Dividends received was recorded in Investor’s single entity accounts as:
Dividend Revenue
Cr Investment in Associate
Cr Dividend Revenue
The University of 22
LS CLASS 9 10
4. Application: Adjustments to share of profit of investee
Investee’s profit (or loss) may require adjustments when the investor recognises their share under equity accounting
– depreciation differences related to FVA
– unrealised profit or losses from inter-entity transactions
The University of 24
4. Application: FVA and related depreciation differences
– If fair value of investee’s net assets at investment date ≠ cost recorded in investee’s single entity accounts, assets are “marked to fair value” by investor on initial recognition under equity accounting in accordance with AASB 3 [AASB 128.32]
– No FVA adjustment required since it is included in the cost of the investment under equity accounting
– However, changes in fair value of depreciable assets will cause depreciation differences to occur
– Adjustment = Depreciation difference x OI%
– Depreciation differences are adjusted against "Share of Profit of
Associate" account. [AASB 128.32]
The University of 25
LS CLASS 9 11
4. Application: FVA and related depreciation differences (cont.)
At investment, Associate’s assets are stated at fair value except for building, which had a fair value of $1,200,000 (cost $2,000,000 and acc. depreciation $1,000,000) with a remaining useful life of 10 years.
1-3) Equity adjustment – Adjust profit for depreciation difference:
Workings: ($1,200,000 – ($2,000,000-$1,000,000)) / 10yrs x 0.7 x 20% Carrying amount of Investment in Associate: ___________
Recall: Depreciation expense was recorded in Associate’s single entity accounts at $100,000 per year instead of $120,000 (before tax). Without adjustment, Investor’s share (20%) of Associate’s after tax profit would be overstated.
Share of Profit of Associate
Cr Investment in Associate
The University of 26
4. Application: Inter-entity transactions
– Equity accounting requires adjustments to share of investee’s profit for any unrealised profit (or losses)
– Adjustment = Unrealised profit (or loss) x OI%
– Applies to both upstream transactions (i.e. sale from investee to investor) and downstream transactions (i.e. sale from investor to investee) [AASB 128.28]
– Contrast: Lets think about that ... eliminating both upstream and downstream unrealised profit? Does that make sense? Discuss
– Where multiple inter-entity transactions have occurred a combined adjustment can be made
v Refer EFRAG reading paragraphs 59 & 42
The University of 28
LS CLASS 9 12
4. Application: Inter-entity transactions
During the year ended 30 June 20X7, Associate Ltd sold inventory for $220,000 (cost $120,000) to Investors Ltd, of which 80% remained unsold at year end.
1-4) Equity adjustment – Eliminate unrealised profit from inter- entity sales transaction (closing inventory):
Workings: ($220,000 - $120,000) x 0.8 x 0.7 x 20%
Carrying amount of Investment in Associate: ___________
Share of Profit of Associate
Cr Investment in Associate
The University of 29
4. Application - Post-acquisition movements in surplus/reserves
– If the investee recognises a revaluation increment in other comprehensive income (OCI), the investor also recognises % interest in OCI
– Required so balance of investment account reflects increase in net assets of the investee in the form of holding gains on non-current assets (OCI). [AASB 128.10]
– Similar adjustments for OCI in the form of cash flow hedge gains and fair value through OCI gains (credit equity). [AASB 128.10]
The University of 31
LS CLASS 9 13
4. Application: Post-acquisition movements in surplus/reserves
On 30 June 20X7, Associate Ltd recognised a net revaluation increment of $300,000 relating to land.
1-5) Equity adjustment – Adjust for revaluation gain:
Workings: $300,000 x 20%
Carrying amount of Investment in Associate: ___________
Investment in Associate
Cr Revaluation Surplus
The University of 32
4. Application: Post-acq. movements in surplus/reserves (cont.)
Carrying amount of investment in investee:
Investment in Associate (rounded in '000)
The University of 34
LS CLASS 9 14
4. Application: Tax effect (current period)
– As a result of the equity accounting adjustments the 'equity carrying amount' will differ from the tax base (cost) and so we must account for a taxable temporary difference if CA > TB [AASB 112.39]
Cost of investment in Associate (tax base): $300,000 Carryingamountafterequityaccountingadjustments: $396,000 Taxable temporary difference: $ 96,000
1-6) Equity adjustment – Adjust for tax effect:
Workings: $96,000 x 30%
Tax Expense
Cr Deferred Tax Liability
The University of 35
4. Application: Practice
The following information applies to the year ended 30 June 20X8:
– Associate recorded a net profit after tax of $600,000.
– Associate purchased inventory from Investor for $160,000 (cost
$80,000), of which 90% remained unsold at year end.
– Of the 80% inventory Associate sold to Investor and remained on hand at 30 June 20X7, none was sold during FY 20X8
– Associate paid a cash dividend of $200,000.
Required: Record the equity accounting adjustments for the current period movements in equity (excluding the final tax effect adjustment) and determine the carrying amount of Associate at 30 June 20X8.
The University of 36
LS CLASS 9 15
4. Application: Current period equity movement adjustments
Recognise share of profit
Recognise share of dividend
Adjust depreciation expense of building
Adjust profit for unrealised inter-entity profit
The University of 37
4. Application: Current period equity movement adjustments
Carrying amount of investment in associate (in investor’s SFS):
Investment in Associate (rounded in ‘000)
Opening balance
The University of 39
LS CLASS 9 16
4. Application: Current period tax adjustment
What is the tax effect for FY 20X8?
Cost of investment in Associate (tax base): Carryingamountafterequityaccountingadjustments: Taxable temporary difference:
Cl. bal. Deferred Tax Liability @ 30%: Op. bal. Deferred Tax Liability: Adjustment to Deferred Tax Liability
1-6) Equity adjustment – Adjust for tax effect:
$300,000 $463,120 $163,120
$ 48,936 $ 28,800 $ 20,136
Tax Expense
Cr Deferred Tax Liability
The University of 41
4. Application: Equity carrying amount of Investment
500000 450000 400000 350000 300000 250000 200000 150000 100000
1/7/ 20X6 Cost
30/6/20X7 Shareof20X7 adjustedequity movement
30/6/20X8 Shareof20X8 adjustedequity movement
Carrying amount of Associate in Investor’s CFS
The University of 42
LS CLASS 9 17
4. Application: Past period equity movement adjustments
– Adjustments 2-1 to 2-4 only sufficient if equity accounting is applied in separate financial statements
– Equity accounting adjustments form part of the permanent records and are carried forward
– If Investor Ltd applies equity accounting on consolidation
– Associate recorded at cost in Investor’s SFS (permanent) – grey
– Share of post-acquisition movements in equity is allocated through (temporary) consolidation adjustments & worksheet
– Equity accounting adjustments required for both current period (red) and past period (orange) share of post-acquisition movement in equity
=> The following adjustments are required in addition to 2-1 to 2- 4 during FY20X8
The University of 43
4. Application: Post-investment movement in retained earnings
– Opening Retained Earnings (ORE) captures profit or loss and dividends paid in past periods up until the current period
– Adjustment = (ORE – pre-investment RE) x OI%
Share of RE @ 01/06/20X6 Share of profit during year Dividend revenue in year Share of RE @ 01/07/20X7
$ 20,000 $100,000 ($50,000) $ 70,000
2-5) Equity adjustment – Adjust for post-acq. movement in RE:
Workings: $7,000 – $20,000
Investment in Associate
Cr Opening Retained Earnings
The University of 44
LS CLASS 9 18
4. Application: Post-investment movement in retained earnings
– Past period profit included in Opening Retained Earnings (ORE) must be adjusted to only include realised movements in equity
2-6) Equity adjustment – Past period FVA depreciation:
Recall: 20X7 FVA depreciation adjustment was originally recorded in 1-3) as
Also: 20X7 and 20X8 adjustments can be combined in a single adjustment entry
Opening Retained Earnings
Cr Investment in Associate
Share of Profit of Associate
Cr Investment in Associate
The University of 45
4. Application: Post-investment movement in retained earnings
– Unrealisedprofitofpastperiodinter-entitysaleisremovedfromORE
2-7) Equity adjustment – Past period intra-entity sale (Op. Inv.):
Recall: 20X7 intra-entity sale adjustment was originally recorded in 1-4) as
Also: If inventory from FY20X7 intra-entity sale were sold in FY20X8, adjust share of current period profit:
Dr Investment in Associate
Cr Share of Profit of Associate
Opening Retained Earnings
Cr Investment in Associate
Share of Profit of Associate
Cr Investment in Associate
The University of 46
LS CLASS 9 19
4. Application: Post-investment movement in other equity accounts
– All movements in other equity accounts since initial investment must be recognised.
2-8) Equity adjustment – Movement in Revaluation Surplus:
Recall: Same equity adjustment as in 1-5)
Investment in Associate
Cr Revaluation Surplus
The University of 47
4. Application: Past-investment movement in retained earnings
Carrying amount of investment in associate (in investor’s CFS):
2-1 Dr 2-2 Dr 2-3 Dr 2-4 Dr 2-5 Dr 2-6 Dr 2-7 Dr 2-8 Dr
Investment in Associate (rounded in ‘000)
Share of Profit of Associate Dividend Revenue
Share of Profit of Associate Share of Profit of Associate Opening Retained Earnings Opening Retained Earnings Opening Retained Earnings Revaluation Surplus
The University of 48
LS CLASS 9 20
4. Application: Tax effect (current & past period)
– Current period tax effects (Tax Expense) and past period tax (Adjustment to Opening Retained Earnings) effects are recognised as a Deferred Tax Liability if CA > TB (and vice versa)
2-9) Equity adjustment – Current and past period tax effect:
Tax effect on current period increase in equity: $67,120 x0.3 Tax effect on past period increase in equity: $96,000 x 0.3
*Recall: Adapt
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