Chapter 33

Accounting for equity investments

33.1

Superannuation plans, life insurers, and general insurers are required to value investments
(including those held as current assets) on the basis of the investments market value. Equity
investments held by other entities can be classified as either financial assets at fair value
through profit and loss, or available for sale financial assets. For those equity investments
measured at fair value through the profit and loss, they are to be measured at fair value with
any changes therein being taken to profit or loss. This is the case regardless of whether the
investments are held as current or non-current assets.
Those investments that are designated as available for sale financial assets are also to be
measured at market value, but changes in the market value are recognised directly in equity.
When the financial asset is subsequently sold the balance in equity is taken to profit and loss.
While there is a general requirement in AASB 139 that equity investments be measured at fair
value, where equity investments do not have a quoted market price in an active market and
the fair value cannot be reliably measured then pursuant to AASB 139 such investments shall
be measured at cost (or at recoverable amount if this is less than cost).

33.2

Under the cost method of accounting:

the investment is initially recorded at its cost of acquisition;

income from the investment is recognised by the investor when the investee makes a
dividend declaration from post-acquisition profits;

dividends declared from pre-acquisition profits are not considered to be income but
are considered to represent a recovery of part of the cost of the investment and,
therefore, are to be treated as a reduction in the carrying amount of the investment;

if the net-realisable value of the investment falls below its cost then the carrying
amount of the investment is written down;

the net-realisable value can be determined on a share-by-share basis or on a portfolio

basis;

the holding gain or loss is recognised on disposal of the securities, and not
continuously throughout the holding of the assets (as would be the case if the fair
value approach to accounting was applied).

Under the fair value method of accounting:

the investment is initially recorded at its cost of acquisition;

dividends, whether out of pre-acquisition or post-acquisition reserves of the investee,

are recognised as income by the investor when received or when declared by the
investee;

subsequent changes in the fair value of the investment are recognised as gains or
losses when they arise; and

net-realisable value can be determined on a share-by-share basis, or on a portfolio

basis.

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33.3

33.4

(a)

Under the cost method of accounting, dividends received out of pre-acquisition

earnings of an investee are deemed to represent a recovery of part of the cost of the
investment and, therefore, are to be treated as a reduction in the carrying amount of
the investment.

(b)

Under the fair value method of accounting, dividends, whether out of pre-acquisition
or post-acquisition reserves of the investee, are recognised as income by the investor
when received or when declared by the investee.

The answer to this question really depends upon the views that an individual holds with
respect to the main aims of financial accounting. Some may argue that using the cost method
is more appropriate as it allows financial statement readers to know how much was actually
spent on obtaining the asset (assuming cost is greater than net-realisable value). The cost
method would also be favoured by individuals who support the doctrine of conservatism
that is, that gains should not be recognised until such time that the gains have actually been
realised. As the cost method does not rely on market valuations (except where the
recoverable amount is below cost) some people may also argue that figures generated by the
cost method of accounting are more reliable. Figures based on the cost method also show
less volatility as they are not generally impacted by short-term fluctuations in market or fair
values.
In recent times there have been moves towards valuing equity investments and other assets
on the basis of fair values. This movement towards fair values shows that the accounting
regulators appear to consider that values based on the fair value approach are more relevant
to financial statement users than values generated by the cost method. As we would
appreciate, in many cases, the fair values of assets can become far removed from their
historical cost amounts. Arguably, using fair values enables financial statement readers to
better assess the investment performance of a reporting entity than would be possible if
historical costs were reported.

33.5

AASB 128 stipulates that an investor that is required to prepare a consolidated financial
report must recognise an investment in an associate by applying the equity method of
accounting in its consolidated financial report and by applying the cost method of accounting
in its own financial report.
An investor that is not required to prepare a consolidated financial report must recognise an
investment is an associate by applying the equity method in its own financial report.
An associate is defined as an entity, including an unincorporated 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 defined as the power to participate in the financial and operating
policy decisions of the investee but is not control or joint control over those policies.

33.6

Significant influence is defined at AASB 128 as the power to participate in the financial and
operating policy decisions of the investee but is not control or joint control over those
policies. Significant influence therefore clearly falls short of control. Further, there is only a
need to have the power to participate in the financial and operating policies of the investee.
This can be contrasted with the test for control provided in AASB 127, which requires the
power to govern the financial and operating policies of an entity so as to obtain benefits from
its activities.
If an entity has control over another entity, then to the extent that the entity with control is a
reporting entity, it must be prepare consolidated accounts. If the entity has significant
influence then it must account for the investee by way of the use of equity accounting. If the
investee has subsidiaries and therefore prepares consolidated reports then it must use equity

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accounting in its consolidated reports. If it does not produce consolidated reports (it has no
subsidiaries) then it will use equity accounting in its own separate accounts.
33.7

Significant influence is defined in AASB 128 as the power to participate in the financial and
operating policy decisions of the investee but is not control or joint control over those
policies. This can be contrasted with control which is defined in AASB 127 as the power to
govern the financial and operating policies of an entity so as to obtain benefits from its
activities.
The following is a list of some of the factors which, singly or in combination, may indicate
the existence of significant influence, even if the percentage of voting power held is less than
20 per cent (these factors are provided in AASB 128):

representation on the investees board of directors;

participation in decisions on the distribution or retention of the investees profits;

participation, in other ways, in policy-making decisions of the investee;

material inter-company transactions between investor and investee;

interchange of managerial personnel; and,

provision of essential technical information.

Where significant influence is exerted over an investee, equity information is required to be

disclosed in accordance with AASB 128.
33.8

In a sense, it could be seen that equity accounting breaches the doctrine of conservatism as
equity accounting requires that the book value of the investment be increased by the
proportional interest in the earnings of the investee, even though there is no certainty that the
earnings will ultimately be paid to the investor in the form of dividends. The proportional
share of the earnings is treated as earnings of the economic entity (or the investor, if
consolidated accounts are not required to be prepared).
Various arguments could be presented as to whether equity accounting is more or less
conservative than a net-market-valuation or fair value approach to accounting. Equity
accounting adjustments are based on movements in accounting-based figures which may or
may not lead to changes in market values. As such, there may be some argument that equity
accounting is less conservative than net-market/fair value accounting, which is based on
judgements about actual changes in market prices.

33.9

If a subsidiary has very high levels of debt then it may be preferred that the entity not be
consolidated as this would bring the debt of the subsidiary onto the consolidated financial
statements. When using the equity method of accounting we do not bring the debt of the
associate on to the investors balance sheet (nor do we bring individual assets on the balance
sheet).
Further, AASB 128 requires that where an associate incurs losses, the investment account
should be reduced by the investors share of those losses only until such time as the carrying
amount is zero. The carrying amount of the investment in the associate shall not be reduced
below zero. When the equity-accounted value of the investment in the associate falls to zero,
and losses continue, the use of the equity-accounting method should be suspended. If the
entity was consolidated, however (that is, if it were controlled), all losses would be reflected
in the consolidated accounts, thereby reducing the reported profits of the economic entity.

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Of course, whether management prefers to treat an investment as a subsidiary or as an

associate should be irrelevant. The classification of the investee should be objectively
undertaken based on the facts available.
33.10 (a)

Under the equity method of accounting, when an investment is made in an associate

the carrying amounts of the identifiable assets and liabilities of the associate are
notionally adjusted to their fair value. The fair value of the associates net assets is
multiplied by the investors ownership interest. The goodwill will be calculated as the
surplus of the cost of the acquisition over the investors share of the fair value of the
associates net assets. The investors proportional interest in the goodwill relating to
the acquisition of an associate is included in the carrying amount of the investment.

(b)

Simply stated, goodwill on acquisition is calculated because the accounting standard

requires it to be calculated. While goodwill must be calculated, it is not to be
separately disclosed and is therefore included in the carrying amount of the
investment. Amortisation of the goodwill is not permitted and is not included as an
adjustment in the determination of the investors share of the associate profits or
losses. While the calculation of goodwill will not lead to any adjustments, if in the
process of calculating the difference between the costs of the investment and the
investors share of the net fair value of the associates identifiable assets, liabilities and
contingent liabilities it becomes apparent that the associate has been acquired at a
discount, then that discount is to be included as income in the determination of the
investors share of the associates profit or loss in the period in which the investment
is acquired.

(c)

Any goodwill that is associated with the acquisition of the ownership interest in the
associate is not to be disclosed separately. The proportional interest in goodwill is
included in the account Investment in associate which will be shown in the financial
reports. Equity accounting does not involve the separate disclosure of the associates
various assets and liabilities.

33.11 As the textbook indicates, pursuant to AASB 128, the carrying amount of the investment in
the associate will be:
(a)

increased or decreased by the investors share of the post-acquisition profits or losses

of the associate, after adjusting the associates profit or loss for:
(i)

distributions to preference equity holders of the associate;

(ii)

revisions of depreciation of depreciable assets (the revised amount of

depreciation to be based on the fair values of the depreciable assets at the time
of the acquisition of the associate);

(iii)

dissimilar accounting policies; and

(iv)

certain inter-entity transactions.

(b)

decreased by the amount of dividends received, or receivable, from the associate;

(c)

increased or decreased by the amount of the investors share of post-acquisition

increments or decrements in the associates total reserves in relation to the financial
year, to the extent that the amounts of these movements have not been recognised
previously in the profit and loss account of the associate, or otherwise reflected in the
carrying amount of the investment.

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The above guidelines relate to the investment asset. In relation to the recognition of the
investors share of the associates profits and reserves:
(a)

the adjusted amount of the investors share of the post-acquisition profit or loss of the
associate (see (a)(i)(iv) above), must be recognised in the investors profit and loss
account;

(b)

the amount of the investors share of the post-acquisition increments and decrements
in the associates reserves in relation to the financial year, determined in accordance
with (c) above, must be recognised in the investors reserves.

33.12 Where a transaction is between two associates of the investor, the proportion of the
unrealised profits or losses to be eliminated in the equity accounting adjustments will be equal
to the product of the investors ownership interest in each of the associates multiplied by the
unrealised profit or loss. In this case the amount to be eliminated in the calculations to
determine the investors share of the associates profits, ignoring tax effects, will be:
0.2 0.2 $50 000 = $2 000.

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33.13 Cost method30 June 2010 entries

Dr
Cr

Cash
Dividend revenue

12 500
12 500

To recognise dividend income

Equity method30 June 2010 adjusting entries
In this question, the investors shares of the fair value of the net assets of the associate equals
the purchase costhence there are no goodwill-related adjustments.
Dr
Cr

Investment in Pa Ltd
Retained earnings1 July 2009

12 500
12 500

Equity account accumulated post-acquisition retained earnings of the associated company to

the beginning of the year. These are made up of the accumulated profits made since
acquisition, less dividends paid out of such profits: $12 500 = (80 000 30 000) 25%.
Dr
Cr

Investment in Pa Ltd
Share of associates profit

25 000
25 000

To increase the investment account for the investors share of the current period's profits:
$25 000 = $100 000 25%.
Dr
Cr

Dividend revenue
Investment in Pa Ltd

12 500
12 500

To reduce the investment account for dividends recognised by the investor during the current
year. This entry effectively eliminates the entry shown above under the cost method:
$50 000 25% = $12 500.
Dr
Cr

Investment in Pa Ltd
Revaluation reserve

17 500
17 500

To increase the investment account for the investors share of post-acquisition movement in
the associates asset revaluation reserves: $17 500 = $70 000 25%.
As at 30 June 2010, the value of the investment in the associated company as a result of
adopting equity accounting would be $417 500, reconciled as:

33.14

Original cost
Share of net post acquisition profits to 30 June 2009
Share of 2010 profit of the associated company
Dividends received from associated company
Share of post-acquisition increase in asset revaluation reserve

$375 000
12 500
25 000
(12 500)
17 500
$417 500

Purchase price of shares

Less: fair value of net assets acquired ($250 000 + $20 000) x (25%)
Goodwill

$120 000
67 500
$52 500

Extra depreciation expense = ($20 000 10 years) x (25%) =

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$500

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Note: only a proportion (ownership proportion in the investee) of the depreciation

adjustment is off-set against the share of the associated companys earnings.
Equity accounting entries for the year ended 30 June 2009
Dr
Cr

Investment in Cotter Ltd

Share of associated companys profit

7 500
7 500

To increase the investment account for the investors share of the current periods profits:
$7 500 = $30 000 25%.
Dr
Cr

Share of associated companys profit

Investment in Cotter Ltd

500
500

To record the extra depreciation for the current period.

Dr
Cr

Dividend revenue
Investment in Cotter Ltd

2 500
2 500

To reduce the investment account for dividends recognised by the investor during the current
year: $2 500 = $10 000 25%.
Equity accounting entries for the year ended 30 June 2010
Dr
Cr

Investment in Cotter Ltd

Retained earnings1 July 2009

5 000
5 000

Equity account accumulated post-acquisition retained earnings of the associated company to

the beginning of the year: $5 000 = (30 000 10 000) (25%)
Dr
Cr

Retained earnings1 July 2009

Investment in Cotter Ltd

500
500

To decrease the investment account for the previous periods extra depreciation expense.
Dr
Cr

Investment in Cotter Ltd

Share of associated companys profit

25 000
25 000

To increase the investment account for the investors share of the current periods profits:
$25 000 = $100 000 25%.
Dr
Cr

Share of associated companys profit

Investment in Cotter Ltd

500
500

To record the extra depreciation for the current period.

Dr
Cr

Dividend revenue
Investment in Cotter Ltd

12 500
12 500

To reduce the investment account for dividends recognised by the investor during the current
year:
$12 500 = $50 000 25%.

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33.15

Dr
Cr

Share of associated companys profit before tax

Inventory (in the investor accounts)

50 000
50 000

$50 000 = ($500 000 $300 000) 25%

Dr
Cr

Deferred tax asset

Share of associated companys tax expense

16 500
16 500

$16 500 = $50 000 33%.

33.16 We can firstly determine the goodwill acquired at acquisition date, as follows:
Identifiable net assets
Fair value adjustments:

375 000
125 000
30 000
530 000
25%
132 500
187 500
$55 000

Land
Depreciable assets
Fair value of identifiable net assets at 1 July 2008
Larry Ltds equity interest in Blair Ltd
Fair value of identifiable net assets acquired
Purchase consideration
Purchased goodwill therefore is:

The following entries would be recorded in the ledger accounts of Larry Ltd (using the cost
method):
1 July 2008
Dr
Cr

Investment in Blair Ltd

Cash

187 500

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187 500

33-8

Recognition of the initial investment in Blair Ltd using the cost method.
30 June 2009
Dr
Cr

Cash
Dividend revenue

11 250
11 250

Only dividends actually received are recognised by Larry Ltd.

$45 000 0.25 = $11 250
The following entries represent the equity accounting entries. These entries would be
recorded in the consolidation worksheet.
Calculation of Larry Ltds share of the current year profits of Blair Ltd
Associates profit for the year ended 30 June 2009
Less dividends paid by associate in 2009
Larry Ltds equity interest
Less: additional depreciation expense
Less: elimination of inter-entity transactions
Larry Ltds share of associates adjusted profit

$135 000
45 000
$90 000
25%
$22 500
750
572
$21 178

Explanations for the adjustments shown above:

1.

Depreciation adjustment
The depreciation adjustment is determined by dividing the investors share in the
difference between the book value and fair value of the depreciable assets by the
expected remaining useful life of the assets, which equals ($30 000 0.25) 10,
which equals $750.

2.

Adjustment for inter-entity transactions

Blair Ltd sold goods to Larry Ltd. The profit before tax in relation to the inventory
still on hand at reporting date is $3750. Therefore, assuming a tax rate of 39 per cent,
the after-tax profit on the unrealised component is calculated as $3750 (1 39 per
cent), which equals $2287.50. As the sale was made by the associate, the amount of
the profit to be eliminated will be based on the ownership interest in the associate.
Therefore, the adjustment to the associates profit will be $2287.50 0.25 =
$571.90
The accounting entry to recognise Larry Ltds share of the current years profits
would therefore be:

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June 2009 (in consolidation worksheet)

Dr
Cr

Investment in Blair Ltd

Share of associated companys profits

33 750

Dr
Cr

Dividend revenue
Investment in Blair Ltd

11 250

Dr
Cr

Share of associated companys profits

Investment in Blair Ltd

750

Dr
Cr

Share of associated companys profits

Investment in Blair Ltd

572

33 750

11 250

750

572

The carrying value of the investment in the accounts of Larry Ltd (using the cost
method) would be $187 500. The carrying amount of the investment in the associate
(adopting equity accounting) as shown in the consolidated financial statements would
be $208 678, which would be the original cost of the investment plus the share of the
associates revenue.
33.17 Calculations
Cost as per ABCs accounts
Add back dividend from pre-acquisition profits
Original cost of investment
Net assets acquired at 1/7/04
Share capital
Retained earnings
Total
@40%
Goodwill

$50 000
10 000 see workings
60 000
100 000
40 000
140 000
56 000
$4 000

Pre-acquisition dividend
A dividend of $80 000 was paid by DEF. All current-year earnings are paid first as dividends.
Current year earnings are $55 000. Thus, the balance of $25 000 must be pre-acquisition
which would have been off-set against the investment cost on the basis of the proportional
interest in the pre-acquisition dividend. The proportional interest in the pre-acquisition
dividend was $10 000 (25 000 40%). It is assumed that the cost of the investment was
reduced by the interest in the pre-acquisition dividend.
Equity accounting result
40% of current year profit of $55 000
Less dividend from current year profits, $55 000 40%
Share of equity accounted results
Add cost
Equity accounting value of investment

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$22 000
22 000
0
50 000
$50 000

33-10

The equity accounting entries would therefore be:

Dr
Cr

Investment in DEF Ltd

Share of associated companys profits

22 000

Dr
Cr

Dividend revenue
Investment in DEF Ltd

22 000

22 000
22 000

33.18 a)
Please note: In this question the question should say that Peet Ltd acquired its interest in
Keet Ltd for $3,250,000 and not $1,300,000.
Peet should classify its investment in Keet Ltd, as an Associate, because Peet has significant
influence over Keet. [AASB128.2].
Peet has significant influence over Keet because:
Peet has 40% of the voting power in Keet. The remaining voting power is held 40% by
Radio Ltd, and 20% by Birdman Unit Trust.
Peet has two representatives on Keets five member board of directors. The remaining
board members consist of two representatives of Radio Ltd, and one representative of
Birdman Unit Trust.
Therefore, for decisions to be made by Keets board of directors, or Keets
general meeting, at least two of the investors in Keet need to cooperate.
None of the investors in Keet have the capacity to unilaterally make financial or
operating decisions relating to Keet, (i.e. Keet is not controlled by any single
investor).
Each of the investors in Keet have the capacity to affect substantially, (but not
control), the financial and operating policies of Keet, (i.e. each investor has
significant influence over Keet). [AASB128.2].

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b) Accounting for Investment in Keet, in Peets accounts, assuming Peet is a Parent

Entity
Using the Cost Method if the investor is a parent entity then the investor must use the cost
method in its own accounts, and use the equity method to account for the associate in its
consolidated accounts.
Entries for the year ending 30 June 2008
1 July 2007
Investment in Keet:
Dr Investment in Keet
3,250,000
Cr
Cash
3,250,000
14 July 2007
Dividend paid out of 2006-2007 (Pre-Acquisition) Profits:
Dr Cash (200,000 x .40)
80,000
Cr
Investment in Keet
80,000
Because this dividend comes from pre-acquisition
earnings then it shall be treated as a reduction in the
cost of the investment rather than being treated as
dividend income
30 June 2008
Dividend paid out of 2007-2008 (Post-Acquisition) Profits:
Dr Cash (325,000 x .40)
130,000
Cr
Dividend Revenue
130,000
Entries for the year ended 30 June 2009
30 June 2009
Dividend declared out of 2008-2009 (Post-Acquisition) Profits:
DR Dividend Receivable
160,000
CR Dividend Revenue
160,000
(160,000 x .40)
c)

Accounting for Investment in Keet, in Peets accounts, assuming Peet is not a Parent
Entity
Using the Equity Method if the investor is not a parent entity, and therefore does not produce
consolidated accounts, then the equity method of accounting must be used in its own accounts.
Entries for the year ended 30 June 2008
1 July 2007
Investment in Keet:
Dr Investment in Keet
3,250,000
Cr
Cash

3,250,000

14 July 2007
Dividend paid out of 2006-2007 (Pre-Acquisition) Profits:
Dr Cash (200,000 x .40)
80,000
Cr
Investment in Keet
80,000
30 June 2008
Recognising Share of Keets 2007-2008 Profit:
Dr Investment in Keet
290,000
Cr
Share of Associates Profit

290,000

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(725,000 x .40)
Goodwill Calculation
Cost of Acquisition
Less Fair Value of Equity acquired
Share Capital
4,500,000
Retained Profits 1/7/07
750,000
Revaluation Reserve
1,875,000
Undervaluation of Land (3,375,000 2,750,000)625,000
less Tax Effect Land (625,000 x .40)
(250,000)
Fair Value of Equity
7,500,000
Fair Value of Equity acquired by Keet
(7,500,000 x .40)
Goodwill
30 June 2008
Recognising Goodwill Impairment at 30 June 2008:
Dr Share of Associates Profit
25,000
Cr
Investment in Keet
(250,000 225,000)

3,250,000

3,000,000
300,000

25,000

30 June 2008
Dividend paid out of 2007-2008 (Post-Acquisition) Profits:
Dr Cash (325,000 x .40)
130,000
Cr
Investment in Keet
130,000
Entries for year ended 30 June 2009
30 June 2009
Recognising Share of Keets 2008-2009 Profit:
Dr Investment in Keet
340,000
Cr
Share of Associates Profit
(850,000 x .40)

340,000

30 June 2009
Dividend declared out of 2008-2009 (Post-Acquisition) Profits:
Dr Dividend Receivable
160,000
Cr
Investment in Keet
160,000
(400,000 x .40)
30 June 2009
Recognising Share of Keets 30/6/2009 Asset Revaluation:
Calculation of Revaluation Increment
Revaluation of Land (3,625,000 3,375,000)
250,000
less Tax Effect Land (250,000 x .40)
(100,000)
Revaluation Increment (net of tax)
150,000
Dr
Cr

Investment in Keet
Revaluation Reserve
(150,000 x .40)

60,000
60,000

d) Accounting for Investment in Keet, in the Consolidated Accounts, assuming Peet is a

Parent Entity
Converting from the Cost Method to the Equity Method where the investor is a parent entity,
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and therefore must prepare consolidated financial statements, then it must use the cost method
in its own separate accounts, and use the equity method in the consolidated accounts.
Entries for year ended 30 June 2008
30 June 2008
Recognising Share of Keets 2007-2008 Profit:
Dr Investment in Keet
290,000
Cr
Share of Associates Profit
(725,000 x .40)
30 June 2008
Recognising Goodwill Impairment at 30 June 2008:
Dr Share of Associates Profit
25,000
Cr
Investment in Keet
(2500,000 225,000)

290,000

25,000

30 June 2008
Dividend paid out of 2007-2008 (Post-Acquisition) Profits:
Dr Dividend Revenue
130,000
Cr
Investment in Keet
130,000
(325,000 x .40)
Entries for the year ended 30 June 2009
Because the equity accounting entries are undertaken in the consolidation worksheet they do
not carry forward in the ledger accounts of the investor. Therefore we must start the year with
an adjusting entry to recognise prior period profits of the investee.
Share of associates 2008 profit
Goodwill impairment recognised in 2008
Dividend paid/declared by associate in 2008
Adjustment to retained earnings
39 June 2009
Recognition of prior period adjustments:
Dr Investment in Keet
135,000
Cr
Retained earnings 1/7/2008
30 June 2009
Recognising Share of Keets 2008-2009 Profit:
Dr Investment in Keet
340,000
Cr
Share of Associates Profit
(850,000 x .40)

290,000
(25,000)
(130,000)
135,000

135,000

340,000

30 June 2009
Dividend declared out of 2008-2009 (Post-Acquisition) Profits:
Dr Dividend Revenue
160,000
Cr
Investment in Keet
160,000
(400,000 x .40)
30 June 2009
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Recognising Share of Keets 30/6/2009 Asset Revaluation:

Dr Investment in Keet
60,000
Cr
Revaluation Reserve
60,000
(150,000 x .40)

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