gary leung garyleung.hk

ACCA Paper P2 (HKG) Corporate Reporting- HKAS 28(Investments in Associates and Joint

Ventures) ,HKFRS 11 (Joint Arrangements) and HKFRS 12 (Disclosure of Interests in

Other Entities) 14 Sept. 2012

Gary Leung

www.garyleung.hk

1ACCA P2 -Dec 2012

HKAS 28 Investments in Associates and Joint Ventures

• Introduction

• Definition

• Separate financial statement

• Equity method

• Transactions between parent and associate

• Share of losses of the associates

• Impairments losses

• Dissimilar accounting policies

• Different reporting dates

• Main defects of equity accounting2ACCA P2 -Dec 2012

Introduction• In June 2011, HKICPA issued HKAS 28 (2011) Investments in Associates

and Joint Ventures supersedes HKAS 28 (2003) Investments in Associates.

• Where one company has a controlling investment in another company, a parent subsidiary relationship is formed and accounted for as a group. Companies may also have substantial investments in other entities without actually having control. Thus, a parent-subsidiary relationship does not exist between the two.

• If the investing company can exert significant influence over the financial and operating policies of the investee company, it will have an active interest in its net assets and results.

• Including the investment at cost in the company's accounts would not fairly present the investing interest.

• So that the investing entity (which may be a single company or a group) fairly reflects the nature of the interest in its accounts, the entity’s interest in the net assets and results of the company, the associate, needs to be reflected in the entity’s accounts. This is achieved through the use of equity accounting

3ACCA P2 -Dec 2012

Introduction• A third relationship exists where an entity shares

control with one or more other entities. This shared or joint control, does not give any dominant or significant influence and all parties that share control must agree on how the shared entity is to be run.

• Prior to 2011 joint ventures an entity could choose to use either equity accounting or proportional consolidation.

• The use of proportional consolidation never had the support of the accounting profession and in 2011 the HKICPA withdrew HKAS 31, which allowed its use, and replaced it with HKFRS 11 Joint Arrangements. This standard only allows joint ventures to be accounted for using equity accounting.

4ACCA P2 -Dec 2012

Definitions of Key Terms • Associate– An entity over which the investor has significant influence

• Significant influence– The power to participate in the financial and operating

policy decisions of the investee but is not control or joint control of those policies

• Joint arrangement– An arrangement of which two or more parties have joint

control• Joint control– The contractually agreed sharing of control of an

arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control

5ACCA P2 -Dec 2012

Definitions of Key Terms • Joint venture– A joint arrangement whereby the parties that have joint

control of the arrangement have rights to the net assets of the arrangement

• Joint venturer– A party to a joint venture that has joint control of that joint

venture• Equity method– A method of accounting whereby the 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. The investor's profit or loss includes its share of the investee's profit or loss and the investor's other comprehensive income includes its share of the investee's other comprehensive income

6ACCA P2 -Dec 2012

Significant Influence • If an investor holds, directly or indirectly (eg through

subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case.

• If the investor holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated.

7ACCA P2 -Dec 2012

Significant Influence• The existence of significant influence by an investor is

usually evidenced in one or more of the following ways:– (a) representation on the board of directors or equivalent governing

body of the investee;– (b) participation in policy-making processes, including participation

in decisions about dividends or other distributions;– (c) material transactions between the investor and the investee;– (d) interchange of managerial personnel; or– (e) provision of essential technical information.

• When significant influence is lost any remaining investment will be measured at fair value. Any difference between the carrying amount of the investment in associate and the remeasured amount will be included within profit or loss. From that point on the investment will be accounted for in accordance with HKFRS 9.

8ACCA P2 -Dec 2012

Potential voting rights

• The existence and effect of potential voting rights that are currently exercisable or convertible, including potential voting rights held by other entities, are considered when assessing whether an entity has significant influence.

• Potential voting rights are not currently exercisable or convertible when, for example, they cannot be exercised or converted until a future date or until the occurrence of a future event.

9ACCA P2 -Dec 2012

Illustration 1

• X Owns 60% of the voting rights of Y,Z owns 19% of the voting rights of Y, and the remainder are dispersed among the public. Z also is the sole supplier of raw materials to Y and has a contract to supply certain expertise regarding the maintenance of Y’s equipment.

• Required:• What is the relationship between Z and Y ?

10ACCA P2 -Dec 2012

Illustration 1

• Z may be able significant influence over Y, and therefore it may have to be treated as an associate. Although Z owns only 19% of the voting rights, it is the sole supplier of raw materials to Y and provides expertise in the form of maintenance of Y’s equipment.

11ACCA P2 -Dec 2012

Separate financial statements of the investor

• In the separate financial statements an investment in an associate or a joint venture are to be accounted for in accordance with HKAS 27 Separate Financial Statements.

• In the separate financial statements, the investment is accounted for:– Under HKFRS 5 if classified as held for sale;– At cost or in accordance with HKFRS 9.

• The emphasis in the separate financial statements will be on the performance of the assets as investments.

12ACCA P2 -Dec 2012

Consolidated accounts

• The objective of IAS 28 is to prescribe the accounting for associates and to describe the use of the equity method for both associates and joint ventures.

ACCA P2 -Dec 2012 13

Equity accounting• The investment in an associate or a joint venture

is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition.

• Distributions received from the investee reduce the carrying amount of the investment.

• Adjustments to the carrying amount may also be necessary for changes in the investor's proportionate interest in the investee arising from changes in the investee's other comprehensive income (e.g. to account for changes arising from revaluations of property, plant and equipment and foreign currency translations.)

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Equity accounting• Such changes include those arising from the

revaluation of property, plant and equipment and from foreign exchange translation differences.

• The investor’s share of the current year’s profit or loss of the associate is recognised in the investor’s profit or loss.

• The associate is not consolidated line-by-line. Instead, the group share of the associate’s net assets is included in the consolidated statement of financial position in one line, and share of profits (after tax) in the consolidated profit or loss and other comprehensive income in one line.

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Treatment in a consolidated statement of financial position

• In group investments, replace the investment as shown in the individual company statement of financial position with:– Either: share of equity at the balance sheet date

(plus fair value adjustments at acquisition) , PLUS any unimpaired goodwill remaining at the balance sheet date,

– Or: cost PLUS share of post-acquisition reserves at the balance sheet date LESS goodwill impaired and written off since acquisition.

16ACCA P2 -Dec 2012

Treatment in a consolidated statement of financial position

• In group reserves, include the parent’s share of the associate’s (or JV) post-acquisition reserves (the same as for subsidiary).

• Cancel the investment in associate in the individual company’s books against the share of the associate’s (or JV) net assets acquired at fair value. The difference is goodwill.

• The fair values of the associate’s (or JV) assets and liabilities must be used in calculating goodwill. Any change in reserves, depreciation charges etc due to fair value revaluations must be taken into account (as they are when dealing with subsidiaries).

• Where the share of the associate’s net assets acquired at fair value are in excess of the cost of investment, the difference is included as income in determining the investor’s share of the associate’s (JV) profits or losses. 17ACCA P2 -Dec 2012

Illustration 2 • P owns 80% of S and 40% of A. A statement of financial position of the

three companies at 31December 2011 are:• P S A• $ $ $• Investment: shares in S 800 – –• Investment: shares in A 600 – –• Other non-current assets 1,600 800 1,400• Current assets 2,200 3,300 3,250• ——— ——— ———• 5,200 4,100 4,650• ——— ——— ———• • Issued capital – $1 O.S. 1,000 400 800• Retained earnings 4,000 3,400 3,600• Liabilities 200 300 250• ——— ——— ———• 5,200 4,100 4,650• ——— ——— ———

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Illustration 2 • P acquired its shares in S seven years ago when S’s retained

earnings were $520 and P acquired its shares in A on the 1 January 2011 when A’s retained earnings were $400.

• The goodwill in S was fully written off after five years.• There were no indications during the year that the

investments in A wase impaired.• Non-controlling interest is valued at the proportionate

share of the subsidiary’s identifiable net assets, it is not credited with its share of goodwill (i.e. partial goodwill method).

• Required:• Prepare the consolidated statement of financial position at

31 December 2011.

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Illustration 2• P Consolidated statement of financial position as at 31 December 2011• $• Investment in associate 1,880• Non-current assets (1,600 + 800) 2,400• Current assets (2,200 + 3,300) 5,500• ———• 9,780• ———• Issued capital 1,000• Retained earnings (W5) 7,520• ———• 8,520• NCI (W4) 760• Liabilities 500• ———• 9,780• ———

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Illustration 2• WORKINGS• • (1) Group structure• • P•

80% 40%• S A

•

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Illustration 2• (2) Net assets working• • Balance Acquisition sheet date• $ $• Issued capital 400 400• Retained earnings 3,400 520• ——— ——• 3,800 920• ——— ——• A Balance Acquisition• sheet date• Issued capital 800 800• Retained earnings 3,600 400• ——— ———• 4,400 1,200• ——— ———• (3) Goodwill• S $ Cost of investment 800• Net assets acquired (80% X 920 (W2)) (736)• ——• 64• ——• A $• • Cost of investment 600• Net assets acquired (40% × 1,200 (W2))(480)• ——• 120• ——•

22ACCA P2 -Dec 2012

Illustration 2• (4) NCI• $• S only – (20% X 3,800) 760• ——• • • (5) Retained earnings• $• P – from question 4,000• Share of S [80% X (3,400 – 520) (W2)] 2,304• Share of A [40%X (3,600 – 400) (W2)] 1,280• Less Goodwill impaired (W3) (64)• ———• 7,520• ———

23ACCA P2 -Dec 2012

Illustration 2• (6) Investment in associate• • $ Share of net assets (40% × 4,400) 1,760• Goodwill 120• ———• 1,880• ———• • OR• Cost 600• Share of post acquisition profits 1,280• ———• 1,880• ———•

24ACCA P2 -Dec 2012

Illustration 3 Dividend paid by an Associate

• On 1 Jan 2010 entity A acquire 35% interest in entity B. Entity A paid $475,000 for its interest in B. At that date the book value of B’s net assets was $900,000, and their fair value $1,100,000, the difference of $200,000 relates entirely to an item of PPE with a remaining useful life of 10 years. During the year B made a profit of $80,000 and paid a dividend of $120,000 on 31 Dec 2010.

• • Required: How A accounts for its investment in B

under the entity method.


Illustration 3- Dividend paid by an Associate

• EITHER • 1) • Cost 475,000• Post acq. Profits35% X $80,0000 28,000• Adjustment of Fair value (35% X $200,000) /10 (7,000)• Dividend paid (35% X 120,000) (42,000)• Closing balance of A’s investment in B 454,000• OR• 2) • Share of FV NAV at 31 Dec 2010• ($1,100,000 + 80,000 – 120,000) X 35% – 7,000 364,000• Unimpaired Goodwill (475,000 – 315,000-70,000) 90,000• 454,000


Treatment in a consolidated profit or loss and other comprehensive income

• Treatment is consistent with consolidated statement of financial position :– Include group share of the associate’s (or JV) profits after tax in the

consolidated statement of comprehensive income. This replaces dividend income shown in the investing company’s own statement of comprehensive income.• Parent’s % the associate ’s (or JV) profit for the year X• Less: any impairment loss in the current year (X)• Less: the parent’s % of additional depreciation on fair value adjust. (X)• X

– Do not add in the associate’s (or JV) revenue and expenses line-by-line as this is not a consolidation and the associate is not a subsidiary.

– Time-apportion the associate’s results if acquired mid-year.• Note that the associate statement of financial position is NOT time

apportioned as the statement of financial position reflects the net assets at the period end to be equity accounted.

27ACCA P2 -Dec 2012

Illustration 3•

• P has owned 80% of S and 40% of A for several years. consolidated profit or loss and other comprehensive income for the year ended 31 December 2011 are:

• P S A• $ $ $• Revenue 14,000 12,000 10,000• Cost of sales (9,000) (4,000) (3,000)• ——— ——— ———• Gross profit 5,000 8,000 7,000• Administrative expenses (2,000) (6,000) (3,000)• ——— ——— ———• 3,000 2,000 4,000• Dividend from associate 400 – –• ——— ——— ———• Profit from ordinary activities before taxation 3,400 2,000 4,000• Income taxes (1,000) (1,200) (2,000)• ——— ——— ———• Profit from ordinary activities after taxation 2,400 800 2,000• ——— ——— ———• Dividends (paid) (1,000) – (1,000)• Retained earnings for the period 1,400 800 1,000• Goodwill was fully written off three years ago.• Required:• Prepare the consolidated profit or loss and other comprehensive income for the year ended

31 December 2011.•

28ACCA P2 -Dec 2012

Illustration 3• P Consolidated profit and loss account for the year ending 31 December 2011• $ • Turnover 26,000• Cost of sales (13,000)• ———• Gross profit 13,000• Administrative expenses (8,000)• ———• Operating profit 5,000• Income from associate 800• ———• Profit before taxation 5,800• Income taxes (2,200)• ———• Profit after taxation 3,600• ———• Profit attributable to:- • Owner of the parent 3,440• NCI (W3) 160• 3,600• Dividends (paid) (1,000)

29ACCA P2 -Dec 2012

Illustration 3• 1) Consolidation schedule • P S 40% A

Consolidation• • Revenue 14,000 12,000 26,000• Cost of sales (9,000) (4,000) (13,000)• Administration expenses (2,000) (6,000) (8,000)• Income from associate 40% × 2,000 800 800• Tax – group (1,000) (1,200) (2,200)• • (2) NCI• • S only 20% × 800 $160•

30ACCA P2 -Dec 2012

Impairments losses• After application of the equity method, including recognising the

associate’s losses, the investor applies the requirements of HKAS 36 to determine whether it is necessary to recognise any additional impairment loss.

• Because goodwill included in the carrying amount of an investment in an associate is not separately recognised, it is not tested for impairment separately.

• Instead, the entire carrying amount of the investment is tested for impairment, by comparing its recoverable amount with its carrying amount. Accordingly, any reversal of that impairment loss is recognised in accordance with HKAS 36 to the extent that the recoverable amount of the investment subsequently increases

31ACCA P2 -Dec 2012

Impairments losses• In determining the value in use of the investment, an entity

estimates:– its share of the present value of the estimated future cash flows

expected to be generated by the associate, including the cash flows from the operations of the associate and the proceeds on the ultimate disposal of the investment; or

– the present value of the estimated future cash flows expected to arise from dividends to be received from the investment and from its ultimate disposal.

32ACCA P2 -Dec 2012

Illustration 4• A acquired 30% of the issued capital of B for $1

million on 31 Dec 2010. The accumulated profit and the share capital at that date were $2 million and $ 1 million (share capital @ $1) respectively.

• Financial information of B Ltd at 31 Dec 2008 is • Share capital $1 million• Retained profit $3 million• Recoverable amount is $ 6 million• Required:• What amount should be shown in A’s

consolidated balance sheet at 31 Dec 2011, for the investment in B ?

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Illustration 4• Goodwill = 1 million – (30% X 3 million)=0.1 million.• Interest in associate at 31 Dec 2008• Cost 1 • Add: profit acq. Profits. ( 3-2)X 30% 0.3• 1.3• RA ( 6 X 30%) 1.8• An impairment test would prove that the carrying

amount of the investment is not impaired.

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Illustration 5 • The following are the summarised accounts of India, New and Delhi for the year

ended 30 June 2011.• Statements of financial position • India New Delhi• Tangible assets 90,000 80,000 60,000• Investment in New 92,000• Investment in Delhi 30,000• Current assets 88,000 50,000 10,000• 300,000 130,000 70,000• Share capital ($1 share) 175,000 75,000 40,000• Accumulated profits 114,000 51,000 29,000• Equity 289,000 126,000 69,000• Liabilities 11,000 4,000 1,000• 300,000 130,000 70,000

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Illustration 5• Profit or loss and other comprehensive income• India New Delhi• Revenue 500,000 200,000 100,000• Operating costs (400,000) (140,000) (60,000)• Profit before tax 100,000 60,000 40,000• Tax (25,000) (20,000) (14,000)• Profit for the year 75,000 40,000 26,000• Additional information

i) New – 1. India acquired 60,000 shares in New three years ago when the accumulated profits were $15,000.– 2. At the date of acquisition the fair value of New’s non current assets, which at that time had a

remaining useful life of ten years, exceeded their book value by $5,000.– 3. The group policy is to calculate the goodwill arising on the consolidation of a subsidiary gross with the

NCI at fair value. At acquisition the fair value of the NCI of New was $24,000.– 4. Impairment reviews reveals that no impairment losses have arisen.

• ii) Delhi– 5. India acquired 12,000 shares in Delhi three years ago when the accumulated profits were $5,000.– 6. At the date of acquisition the fair value of Delhi’s non-current assets, which at that time had a

remaining useful life of four years, exceeded the book value by $20,000.– 7. The impairment review reveals the recoverable amount of Delhi at their year-end to be $103,333.

• Required:• Prepare the consolidated profit or loss and other comprehensive income and the

consolidated statement of financial position for the India Group 2011.

36ACCA P2 -Dec 2012

Illustration 5

• W1) Group • India• 80% 30%

• New Delhi

37ACCA P2 -Dec 2012

Illustration 5• W2 Net Assets • New Delhi• DOA 2009 DOA 2009• Share Cap. 75,000 75,000 40,000 40,000• Acc. Profits 15,000 51,000 5,000 29,000• Fair value • adjustment 5,000 5,000 20,000 20,000• Less: add.• dep. (1,500) # (15,000)

* 95,000 129,500 65,00074,000

• % of Post acq. profits of New 80% (129,500 – 95,000) = $27,600• % of Post acq. Profits of Delhi 30% ( 74,000 – 65,000) = $2,700• # $5,000 X 1/10 X 3 years = $1,500• * $20,000 X ¼ X 3 years = $15,000 38ACCA P2 -Dec 2012

Illustration 5• W3) Investment in associate • Cost of investment 30,000• Plus Post acq. Profits (30% X 9,000) 2,700• Less: impairment loss (1,700)• 31,000• W4) Impairment review• Carrying value before impairment 32,700• Recoverable amount (30% X 103,333) (31,000)• Impairment loss 1,700

39ACCA P2 -Dec 2012

Illustration 5• W 5) Goodwill • Cost of the New investment 92,000• Fair value of the NCI 24,000• Net assets (95,000)• Gross goodwill at acquisition 21,000• • W6) NCI• Fair value of the NCI at DOA 24,000• Plus NCI % of the post acq. Profits • ( 20% X 34,500) 6,900• 30,900• OR • NCI % of the net assets at 2009 25,900• ( 20% X 129,500)• Plus goodwill ( 24,000 – (20% X 95,000)) 5,000• 30,900 40ACCA P2 -Dec 2012

Illustration 5• W7) Accumulated profits• Parent 114,000• New - Post acq. Profits (80% X 34,500) 27,600• Delhi-Post acq. Profits ( 30% X 9,000) 2,700• Impairment loss on the associate –Delhi (1,700) • 142,600• W8) Income from associate• Parent’s % of the associate’s profit for the year (30% X 26,000) 7,800• Less: additional deprecation ( 30% X 5,000) (1,500)• Less: the impairment loss arising in the year (1,700)• 4,600• W9) NCI in the subsidiary’s profits for the year• NCI % of the subsidiary’s profits ( 20% X 40,000) 8,000• Less: the NCI % of the deprecation of FVA ( 20% X 500) (100)• 7,900

41ACCA P2 -Dec 2012

Illustration 5• India group • Revenue ( 500,000 + 200,000) 700,000• Operating costs (540,500)• (400,000 + 140,000 + 500 dep. (5,000 X 1/10))

• Operating profit 159,500• Income from associate (W8) 4,600• Tax ( 25,000 + 20,000) (45,000)• Profit for the year 119,100• Attributable:• Owner 111,200• NCI (W9) 7,900• 119,100

42ACCA P2 -Dec 2012

Illustration 5 • India consolidated profit or loss and other comprehensive income • $• Goodwill 21,000• Tangible ( 90,000 + 80,000 + 5,000- 1,500) 173,500• Investment in associate (w3) 31,000• Current assets 138,000• 363,500

• Ordinary shares ($1) 175,000• Accumulated profits (w7) 142,600• NCI (w6) 30,900• Equity 348,000• Liabilities 15,000• 363,500

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Inter- company items with associate and Joint Venture

• Inter-company trading• Dividends• Unrealised profit

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Inter-company trading• Members of the group can sell to or make purchases

from the associate. This trading will result in the recognition of receivables and payables in the individual company accounts.

• Do not cancel inter-company balances on the statement of financial position and do not adjust sales and cost of sales for trading with associate.

• In consolidated statement of financial position, show balances with associate separately from other receivables and payables.

• The associate is not part of the group. It is therefore appropriate to show amounts owed to the group by the associate as assets and amounts owed to the associate by the group as liabilities.

45ACCA P2 -Dec 2012

Dividends• Consolidated statement of financial position:– Ensure dividends payable/receivable are fully accounted

for in individual companies’ books.– Include receivable in the consolidated statement of

financial position for dividends due to group from associates.

– Do not cancel inter-company balance for dividends.• Consolidated profit or loss and other comprehensive

income:– Do not include dividends from the associate in the

consolidated statement of P&L and OCI. Parent’s share of the associate’s profit after tax (hence before dividends) is included under equity accounting in the income from associate.

46ACCA P2 -Dec 2012

Unrealised profit• If parent sells goods to associate and associate still has these goods in

stock at the year end, their carrying value will include the profit made by parent and recorded in its books. Hence, profit is included in inventory value in associate’s net assets (profit is unrealised); and parent’s revenue.

• If associate sells to parent, a similar situation arises, with the profit being included in associate’s revenue and parent’s inventory.

• To avoid double counting when equity accounting for associate, this unrealised profit needs to be eliminated.

• Unrealised profits should be eliminated to the extent of the investor’s interest in the associate.

• To eliminate unrealised profit, deduct the profit from associate’s profit before tax and retained earnings in the net assets working before equity accounting for associate, irrespective of whether sale is from associate to parent or vice versa.

• Unrealised losses should not be eliminated if the transaction provides evidence of an impairment in value of the asset that has been transferred.

47ACCA P2 -Dec 2012

Unrealised profit • Unrealised inter-company profits and losses resulting from

‘upstream’ and ‘downstream’ transactions are to be eliminated, but on partial rather than full elimination basis, i.e. only the investor’s proportionate interest in the inter-company profit and losses is adjusted for.

• ‘Upstream’ transactions are, for example, sales of goods from an associate to the investor.

• Dr. Retained earning • Cr. Inventory• ‘Downstream’ transactions are, for example, sales of goods

from the investor to an associate.• Dr. Retained earning • Cr. Investment in associate

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Illustration 6 • Company A sells inventory to its 30% owned

associate, B. The inventory had cost A $200,000 and was sold for $300,000 to B.

• B also has sold inventory to A. The Cost of this inventory to B was $100,000, and it was sold for $120,000.

• Required:• How would the inter company profit on these

transactions be dealt with in the financial statements if none of the inventory had been sold at year-end ?

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Illustration 6

• Solution• Company A to Company B $000• The inter group profit is $(300 -200) 100• Unrealised Profits would be 100X 30/100 30• The unrealised profit would be deferred until the sale

of the inventory • Consolidated Journal :• Dr. Retained profits 30• Cr. Interest in Associate 30

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Illustration 6• Company B to Company A $000• The inter group profit is $(120 -100) 20• Unrealised Profit would be (20X 30/100) 6• The unrealised profit would be deferred until the

sale of the inventory .• Consolidated Journal :• Dr. Retained profits 6• Cr. Inventory (B/S) 6•

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Shares of losses of the associates• If an investor’s share of losses of an associate (or JV) equals or exceeds its interest in

the associate, the investor discontinues recognising its share of further losses.• The interest in the associate is its value under the equity method plus any long-term

interest that forms part of the investor’s net investment.• Such interests may include preference shares and long-term receivables or loans but do

not include trade receivables, trade payables or any long-term receivables for which adequate collateral exists, such as secured loans.

• After the investor’s interest is reduced to zero, additional losses are provided for, and a liability is recognised, only to the extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate.

• If the associate subsequently reports profits, the investor resumes recognising its share of those profits only after its share of the profits equals the share of losses not recognised.

• The investment in the associate can be reduced to nil but no further( i.e. the investment in associate will not be negative, even if there are post acquisition losses of the associate).

• However the investor should continue to recognise losses to the extent of any guarantees made to satisfy the obligation of the associate (or joint venture). This may require recognition of a provision in accordance with HKAS 37.

• Continuing losses of an associate (or a joint venture) is objective evidence that financial interests in the associate (or joint venture) other than those included in the carrying amount may be impaired.

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Illustration 7• A parent company has a 40% associate, which was acquired a

number of years ago for $1m. A long-term loan was also made to the associate of $250,000

• Since the acquisition the associate has made losses totalling $5m.

• The parent’s share of those losses would be $2m.• The parent would only be required to recognise the losses to

the extent of the investment of $1m plus $250,000, the remaining share of losses ($750,000) would not be recognised unless the parent had a present obligation to make good those losses.

• If the associate then became profitable, the parent would not be able to recognise those profits until its share of unrecognised losses had been eliminated.

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Dissimilar accounting policies

• Adjustments shall be made to conform the associate’s accounting policies to those of the investor when the associate’s financial statements are used by the investor in applying the equity method.

54ACCA P2 -Dec 2012

Different reporting dates

• If the reporting dates of the investor and the associate are different, the associate prepares – for the use of the investor – financial statements as of the same date as the financial statements of the investor unless it is impractical to do so. In any case, the difference between the reporting date of the associate and that of the investor should be no more than 3 months.

55ACCA P2 -Dec 2012

Main defects of equity accounting • Carrying value in the consolidated balance sheet is based on

share of NET assets• NET amounts may be immaterial while GROSS assets and

liabilities may be material• This could give rise to material items of the associate being “off”

the consolidated balance sheet• The same point applies to the reporting of the associate’s

results in the consolidated income statement• There is no reporting of the revenue of the associate and no

information as to its separate expenses in the consolidated income statement

• Ratios could be distorted• Specifically, gearing and ROCE with the former under-stated

and the latter over-stated

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HKFRS 11 Joint arrangements

• Introduction• Definition• Joint arrangement• Accounting Treatment • Transactions between a joint operator and joint

operation

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Introduction • HKFRS 11 Joint Arrangements provides for a more realistic reflection of

joint arrangements by focusing on the rights and obligations of the arrangement, rather than its legal form (as is currently the case). The standard addresses inconsistencies in the reporting of joint arrangements by requiring a single method to account for interests in jointly controlled entities.

• HKFRS 11 replaces HKAS 31 Interests in Joint Ventures and SIC-13 Jointly-controlled Entities — Non-monetary Contributions by Venturers. HKFRS 11 uses some of the same terms as HKAS 31, but with different meanings.

• Thus, there may be some confusion whether HKFRS 11 is a significant change from HKAS 31. For example, whereas HKAS 31 identified three forms of joint ventures where there is joint control (i.e., jointly controlled operations, jointly controlled assets and jointly controlled entities, or JCEs), HKFRS 11 addresses only two forms of joint arrangements (joint operations and joint ventures).

• One of the primary reasons for the issuance of HKFRS 11 was to increase comparability within HKFRS by removing the choice for JCEs to use proportionate consolidation. Instead, JCEs that meet the definition of a joint venture (as newly defined) must be accounted for using the equity method.


Definitions• Joint arrangement – An arrangement of which two or more

parties have joint control• Joint control–The contractually agreed sharing of

control of an arrangement, which exists only when decisions about the relevant activities require the unanimous consent of the parties sharing control


Definitions• Joint venturer–A party to a joint venture that has joint control

of that joint venture• Party to a joint arrangement–An entity that participates in a joint

arrangement, regardless of whether that entity has joint control of the arrangement

• Separate vehicle–A separately identifiable financial structure,

including separate legal entities or entities recognised by statute, regardless of whether those entities have a legal personality


Joint arrangement• A joint arrangement is an arrangement of which two or more

parties have joint control. • A joint arrangement has the following characteristics:

– the parties are bound by a contractual arrangement, and – the contractual arrangement gives two or more of those parties joint

control of the arrangement. • A joint arrangement is either a joint operation or a joint venture.• A joint arrangement that is structured through a separate entity

may be either a joint operation or a joint venture. In order to ascertain the classification, the parties to the arrangement should assess the terms of the contractual arrangement together with any other facts or circumstances to assess whether they have:– Rights to the assets, and obligations for the liabilities, in relation to the

arrangement (i.e. joint operation)– Rights to the net assets of the arrangement (i.e. joint venture)


Joint arrangement• Contractual arrangements generally specify the

following:– Purpose, activity and duration of the joint arrangement– Appointment of members of the board of directors (or

equivalent governing body)– Decision-making processes:– Matters requiring decisions from the parties– Voting rights of the parties– Required level of agreement for those matters– Capital or other contributions requirements

• Sharing of assets, liabilities, revenues, expenses or profit or loss relating to the joint arrangement


Types of joint arrangements• There are two types of joint arrangements. A joint

arrangement is either a joint operation or a joint venture. • 1) Joint venture

– A joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement

• 2) Joint operation– A joint arrangement whereby the parties that have joint control

of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement

• This classification depends on the rights and obligations of the parties to the arrangement.

• Investors may or may not establish a joint arrangement as a separate vehicle.


Summary of classification


Structure of the joint arrangement

Not structured through a separate vehicle

Joint Venture Joint operation

An entity shall consider:1) The legal form of the separate vehicle2) The terms of the contractual arrangement; and3) Where relevant, other facts and circumstances

Structured through a separate vehicle

Illustration 1

• Three parties each have one third of the voting power in an entity and decisions are made by a simple majority. In the absence of a shareholder’s contract, it is clear that joint control does not exist.


Illustration 2 • A and B enter into a contractual arrangement to buy a

building that has 12 floors, which they will lease to other parties. A and B are responsible for leasing five floors each, and each can make all decisions related to their respective floors and keep all of the income with respect to their floors. The remaining two floors will be joined managed – all decision with respect to those two floors must be unanimously agreed between A and B, and they will share all profits equally.

• Therefore, there are three arrangements:– Five floors that A control – Accounted for under other HKFRSs.– Five floors that B control – Accounted for under other HKFRSs.– Two floors that A and B jointly control – a joint arrangement

(within the scope of HKFRS 11).


Joint control• Joint arrangement characteristics:

– Parities bound by contractual arrangement• Contractual arrangement gives two or more parties joint control • Join control exists only when:

– Contractual arrangement gives parties control of arrangement collectively

– Decisions about relevant activities require unanimous consent of parties that control arrangement collectively.

• Parties control arrangement collectively when they must act together to direct activities that significantly affect returns of arrangement (relevant activities)

• Decision-making process agreed upon in contractual arrangement implicitly leads to join control.

• Minimum required proportion achieved by more than one combination is not joint arrangement unless specifies which combination.


Unanimous consent • The requirement for unanimous consent means that

any party with joint control of the arrangement can prevent any of the other parties, or a group of the parties, from making unilateral decisions (about the relevant activities) without its consent.

• Decision about the relevant activities require the unanimous consent of all the parities, or a group of the parties, that collectively control the arrangement.

• Accordingly, it is not necessary for every party to the arrangement to agree to have unanimous consent.

• To have unanimous consent, only those parities that collectively control the arrangement must agree.


Illustration 3Minimum voting requirements

(Case One)75% vote to direct relevant activities

(Case Two) 75% vote to direct relevant activities

( (Case Three) Require the unanimous consent of A, B and C

Party A 50% 50% 50%

Party B 30% 25% 25%

Party C 20% 25% 25%

Conclusion Joint control – A and B collectively control the arrangement (since their votes, and only their votes, together meet the requirement). Because they are the only combination of parties that collectively control the arrangement, it is clear that A and B must unanimously agree.

No joint control – multiple combinations of parties could collectively control the arrangement (that is, A and B or A and C could vote together to meet the requirement). Since there are multiple combinations, and the contractual agreement does not specify which parties must agree, there is no unanimous consent.

A, B and C have joint control of the arrangement and each must account for its investment in according with HKFRS 11.


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Accounting Treatment • Joint operations– In both its consolidated and separate financial

statements, a joint operator recognize its assets, liabilities, revenues and expenses (including its shares) in accordance with HKFRSs

– Party participates but no joint control account for interest similarly if rights to assets, and obligations for liabilities. Otherwise, use HKFRs applicable.

• Joint ventures– Joint venturer account for investment using equity

method unless exempted.– Party participates but no joint control use HKFRS 9. If

significant influence, use HKAS 28(2011)

ACCA P2 -Dec 2012

Illustration 4

• Assume that the joint operator share and operate an asset together. Joint operator has a half-share of a jointly controlled gas pipeline that cost $100,000 to construct. Each joint operator will pass the following journal entry in its own book:

• Dr. Pipeline- Property, plant and equipment 50,000• Cr. Cash 50,000


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Illustration 5 • On 1 Jan. 2011, X and Y entered into a joint operation to purchase and

operate and oil pipeline. Both entities contributed equally to the purchase cost of $20 million and this was financed by a joint loan of $20 million.

• Contract terms– Y carries out all maintenance work on the pipeline but maintenance expense

are shared between X & Y in the ratio 40%: 60%– Both entities use the pipelines for their own operations and share any income

from third parties 50%: 50%. Sale to third parties are invoiced by Y.– The full interest on the loan is initially paid by X but the expense is to be

shared equally.• During the year ended 31 Dec. 2011

– Y carried out maintenance at a cost of $1.2m– Income from third parties was $900,000, all paid by Y.– Interest of $1.5m was paid for the year on 31 Dec. by X.

• Required:Show the relevant figures that would be recongised in the financial statements of

X and Y for the year ended 31 Dec. 2011.

ACCA P2 -Dec 2012

Illustration 5 Total amount

In X Financial statement

In YFinancial statement

Statement of financial statements

JCA – PPE, at cost $20 m $10 m $10 m

Share of loan $20 m $0 m $10 m

Current accounts with Y (owned by Y) –see working

$720,000

Current accounts with X (owned to X) –see working

$720,000

Statement of P&L and OCI

Income from third parties (50:50)

$900,000 $450,000 $450,000

Maintenance cost (40:60) $1.2 m $480,000 $720,000

Interest on loan (50:50) $1.5 m $750,000 $750,000


Illustration 5 • Workings Total X Y• Income from third parties (50:50) $900,000 $450,000 $450,000• Maintenance cost (40:60) $1.2 m $480,000 $720,000• Interest on loan (50:50) $1.5 m $750,000 $750,000• Net loss ($1.8 m) ($780,000) ($1,020,000)

• Cash expenses ($1.5 m) ($1.2 m) • Cash collected $900,000• Net cash expenses ($1.5 m) ($300,000)• Net cash due to X from Y $720,000 ($720,000)


Illustration 6• D and E establish a joint arrangement (F) using a separate vehicle, but the

legal form of the separate vehicle does not confer separation between the parties and the separate vehicle itself. That is, D and E have rights to the assets and obligations for the liabilities of F (F is a joint operation). Neither the contractual terms, nor the other facts and circumstances indicate otherwise. Accordingly, D and E account for their rights to assets and their obligations for liabilities relating to F in accordance with the relevant HKFRS.

• D and E each own 50% of the equity (e.g., shares) in F. However, the contractual terms of the joint arrangement state that D has the rights to all of Building No. 1 and the obligation to pay all the third party debt in F. D and E have rights to all other assets in F, and obligations for all other liabilities in F in proportion to their equity interests (i.e., 50%).


Illustration 6• F’s balance sheet is as follows: • Assets $ Liabilities and equity $• Cash 20 Debt 120• Building No. 1 120 Employee benefit plan obligation 50• Building No. 2 100 Equity 70• Total assets 240 Total liabilities and equity 240• Under HKFRS 11, D would record the following in its financial statements, to account for its rights to the

assets in F and its obligations for the liabilities in F. • Assets Liabilities and equity• Cash 10 Debt(2) 120• Building No. 1(1) 120 Employee benefit plan obligation 25• Building No. 2 50 Equity 35• Total assets 180 Total liabilities and equity 180• (1) Since D has the rights to all attached to Building No. 1, it records that amount in its entirety.• (2) D’s obligations are for the third-party debt in its entirety.


Transactions between a joint operator and joint operation

• Sales or contributions of assets to joint operation– If a joint operator sells goods to the joint operation

at a profit or loss then the joint operator will only recognise the profit or loss to the extent of the other parties’ interests in the joint operation.

• Purchases of assets from a joint operation– If a joint operator purchases goods from a joint

operation, to which it is a party to, it shall not recognise its share of any gains or losses until it resells the assets to an external party.

77ACCA P2 -Dec 2012

Illustration 6

• Entities A, B, C and D each hold a 25% stake in the joint operation of Z. Entity A sells goods to Z making a profit of $1,000. Entity A will only recognises $750 (75%) of profit in its financial statements.


HKFRS 12- Disclosure of interests in other entities

• Application• Disclosure


Application

• HKFRS 12 shall be applied by an entity if it has an interest in a subsidiary, an associate or a joint operation.

• The standard is not applicable to the following:– post-employment benefit plans (HKAS 19);– separate financial statements (HKAS 27);– an interest whereby an entity participates in, but

does not have joint control over a joint arrangement;– an interest that is accounted for under HKFRS 9.


Disclosure• An entity will disclose information that allows users to

evaluate:– the nature, extent and financial effects of any interest in an

associate or joint arrangement;– the nature and effects of any contractual relationship with other

investors who have joint control or significant influence over the associate or joint arrangement;

– the nature of, and changes in, the risks associated with its joint ventures and associates.

– The disclosures will include:• name of the joint arrangement or associate;• nature of the relationship;• proportion of ownership;• any significant restrictions on the ability of associate or joint venture

to transfer funds to the entity;• commitments it has relating to its joint ventures;• unrecognised share of losses of a joint venture or associate.


Interaction between HKFRS 9, 10, 11 , 12 and IAS 28 (2011)


Control alone ?

NoYes

Account for assets, liabilities, revenues and

expenses

Accounting for an investment in accordance

with HKAS 28HKFRS 9

Significant influence ?Define type of joint arrangement in accordance with HKFRS 11

Joint control ?Consolidation in accordance with HKFRS 10Disclosures in accordance with HKFRS

12 No

Yes

Disclosures in accordance with HKFRS 12

No

Disclosures in accordance with HKFRS 12

Joint VentureJoint operation

Yes

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