Associates are the companies over which the other company has significant influence in such a way that it does not hold more than 50 percent shares. By significant influences we mean the power or right to participate in the operating and financial decisions but such influence does not allow the investor to exercise control over these activities. Usually, the holding of shares between 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} to 50 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} constitute the associate status.
Example
Alpha acquired 25{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} shares in the entity C. This entitles Alpha to attend the meetings of C to have a say but this holding of shares does not let him affect any decision singly as he lacks the ownership to exercise significant control over the operating and financial activities.
Accounting Treatment
In order to perform the accounting for associates, there is no need to consolidate its financial figures. The treatment required is to just make one line entry into the financial statements as follows:
Balance Sheets
Non-Current Assets
Investment in associates xxx
Income Statement
Profit or Loss
Share of associate xxx
Question
Alpha acquired 40{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} of the shares in C Plc on 1st June 2013 for $750,000. The accumulated profit figure of C at that time was $700,000. The accounts of both companies for the year ended 30th June 2015 are as follows:
| Income Statement | ||
| For the period ended 30th June 2015 | ||
| Alpha | C | |
| Sale revenue | 5,140 | 1,200 |
| Cost of goods sold | (2,000) | (420) |
| Gross profit | 3,140 | 780 |
| Operating expenses | (600) | (200) |
| Operating profit | 2,540 | 580 |
| Investment income | 20 | 20 |
| Profit before interest | 2,560 | 600 |
| Finance charges | (260) | (80) |
| Profit before tax | 2,300 | 520 |
| Tax | (300) | (120) |
| Profit after tax | 2,000 | 400 |
| Balance Sheet | ||
| Ast at 30th June 2015 | ||
| Assets | ||
| Non-current assets | ||
| Property,Plant & Equipment | 4,000 | 1,200 |
| Investment – Associate company | 750 | – |
| Current Assets | 200 | 600 |
| Total Assets | 4,950 | 1,800 |
| Equity | ||
| Share capital | 1,000 | 500 |
| Accumulated profit/ retained earnings | 3,750 | 1,100 |
| Current liabilities | 200 | 200 |
| Total equity and liabilities | 4,950 | 1,800 |
| C declared and paid a dividend of $100,000 in the year which is included in the operating expenses of Alpha. There is an impairment of goodwill by 20{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} in C. | ||
| Required: Prepare consolidated income statement for Alpha Group for the year ended 30th June 2015. | ||
Consolidated income statement
| Income Statement | ||||||
| For the period ended 30th June 2015 | ||||||
| Goodwill | Dividend | Earnings | Alpha | |||
| Alpha | C | Working 1 | Working 2 | Working 3 | Group | |
| Sale revenue | 5,140 | 1,200 | 5,140 | |||
| Cost of goods sold | (2,000) | (420) | (2,000) | |||
| Gross profit | 3,140 | 780 | 3,140 | |||
| Operating expenses | (600) | (200) | (54) | (40) | (694) | |
| Profit before interest | 2,540 | 580 | 2,446 | |||
| Investment income | 20 | 20 | 20 | |||
| Profit before tax | 2,560 | 600 | 2,466 | |||
| Finance charges | (260) | (80) | (260) | |||
| 2,206 | ||||||
| Share of associate | 160 | 160 | ||||
| Profit before tax | 2,300 | 520 | 2,366 | |||
| Tax | (300) | (120) | (300) | |||
| Profit after tax | 2,000 | 400 | 2,066 | |||
Workings
Impairment of goodwill:
Amount paid to acquire the interest in C $750
Net asset received: Share capital + Retained earning at the time of acquisition = 500 + 700 = 1200 x 40{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} share of group = 480
Goodwill on acquisition of A = 750 – 480 = 270
Impairment on goodwill = 20 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} x 270 = 54
Dividend recieved from associate company C = 100 x 40{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} = 40
Share of profit from associate = 400 x 40{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} = 160
Investment in C (Associate company)
Cost of investment 750 + 40{1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c} x (Change in retained earnings 400) – dividend received 40 – goodwill impairment value 54 = 816