Section 14 – Investment in Associates
Section 14 defines what an associate is, how it should be recognised, measured, derecognised and disclosed.
An associate is an entity over which the investor has significant influence and which is not a subsidiary or a joint venture (Section 14.2).
Significant influence is the power to participate in (but not to control or jointly control) the financial and operating policy decisions of the associate. A 20 per cent share (directly or indirectly) of the voting power is the presumed threshold for the existence of significant influence (Section 14.4).
What is new?
Under old GAAP (FRS 9), where a valuation was used under the alternative accounting rules, a director’s valuation was permitted, however, this is not permitted under Section 14.
Section 14.4 gives an entity which is not a parent the option to account for its investment in associates using either the cost model, fair value model through other comprehensive income (OCI) or at fair value through the profit and loss account. This compares with old GAAP (FRS 9) where the option to fair value through the profit and loss did not exist.
What is different?
The emphasis under old GAAP (FRS 9) was on the actual exercise of significant influence whilst FRS 102 requires that investors have the power to participate. It is, therefore, possible that more investments would qualify to be accounted for as associates. In reality there is unlikely to be significant differences from old GAAP.
Section 14.9 makes it clear that losses should be recognised until the carrying amount of the investment is reduced to nil and no further losses are recognised unless the entity has a legal or constructive obligation or has made payments on behalf of the associate. This contrasts with FRS 9 which required the continued recognition of losses even if they exceed the cost of the investment which were then shown as provisions.
In relation to the presentation of the equity accounted results of an associate, Section 14 requires the share of the income to be presented as one line, after the effects of interest and tax. This contrasts with FRS 9, where the share of operating profit of associates is presented after the group operating profit with interest and tax related to associates being presented alongside the interest and tax line items in the group profit and loss account. Old GAAP also required disclosure on the face of the balance sheet of the assets and liabilities of the associate to be shown, under FRS 102, the net figure need only be shown on the face of the balance sheet. In addition, old GAAP required the investment in associates and joint ventures to be shown separately on the face of the balance sheet. This is not required under FRS 102.
Where an interest is reduced such that it is no longer an associate; under FRS 102 it is then accounted for as a financial asset and comes within the scope of Section 11 and Section 12 of the standard. This would mean that it may need to be fair valued through the profit and loss account depending on whether it meets the requirements. This compares with GAAP where it would fall within FRS 5 which would not require it to be accounted at fair value through the profit and loss.
Other standards affecting Section 14 where differences arise:
Section 11 and Section 12 – Financial instruments – When an entity ceases to be an associate due to loss of control, it should be accounted for under Section 11 or Section 12 depending on applicability i.e. carried at FVTPL where there is an active market and if not at cost less impairments.
Section 35 – Transition to FRS 102 – For individual entity financial statements the investment can be measured at cost or fair value. Section 35.10 allows a first time adopter to deem the cost to be the carrying amount at the date of transition as determined under previous GAAP.
Section 29 – Income tax – Deferred tax may need to be recognised on investments measured at fair value as well as on unremitted profits.
What are the key points?
- In the individual entity financial statements associates are measured under either the cost model, fair value model through the OCI or at fair value through the profit and loss account;
- In the consolidated parent financial statements, the parent must use the equity accounting method (with the exception of investments in associates as part of an investment portfolio in which case they are measured at fair value through the profit and loss account). Goodwill is consumed within the initial investment and is not disclosed separately and amortised over its useful life;
- When profits or losses arise on transactions between an investor and its equity accounted associate, the investor eliminates unrealised profits and losses to the extent of its interest in the associate;
- Under the cost model the share of profits/losses of the associate is posted against the investment including any distributions received. Where losses occur the investment cannot be reduced below zero; and
- If the associates accounting policies differ then the results need to be aligned to ensure that they are consistent.
What do accountants need to do?
Be aware of the differences between Section 14 and old GAAP so that transition adjustments can be determined.
Review their client portfolio to identify clients who are affected by this section and advise those clients on the best of the three options to adopt based on the clients’ circumstances.
Where the fair value model is applied advise clients of the volatility this may cause on the results for the year as well as any current and deferred tax implications. Advise clients of the risk that fair valuing these investments may have with regard to pushing them above the small entity gross assets threshold.
What do companies need to do?
Assess whether this standard is applicable to the entity.
If applicable, be aware of the differences between Section 14 and old GAAP. Then determine which of the three options to measure the investment at and the possible impact this may have going forward.