Investment in Associates Definition
Investment in Associate refers to the investment in an entity in which the investor has significant influence but does not have full control like a parent and a subsidiary relationship. Usually, the investor has significant influence when it has 20% to 50% of shares of another entity.
Accounting for Investment in Associates
Accounting for investment in associates is done using the equity method. In the equity method, there is not a 100% consolidation used. Instead, the proportion of shares owned by the investor will be shown as an investment in accounting.
When an investor takes some shares in associate than in the balance sheet of the investor, it is recorded as an “increase in Associates,” and cash gets reduced by the same amount. The dividend from the associate is shown as an increase in cash for the investor. To record the proportion of the net income of associate, the investment revenue of investor gets credit and investment in associate account get debited.
Example of Investment in Associates
Below are some of the basic to advanced examples of Investment in Associates.
Basic Example
Let’s say Corp ABC has purchased 30% shares of XYZ company. That means ABC has significant influence over XYZ, and XYZ can be treated as an associate of ABC. Value of 30% shares is $500,000. So, while making a purchase, below will be an accounting transactionAccounting TransactionAccounting Transactions are business activities which have a direct monetary effect on the finances of a Company. For example, Apple representing nearly $200 billion in cash & cash equivalents in its balance sheet is an accounting transaction. read more for ABC.
After 6 months, XYZ declares $10,000 dividends to its shareholders. That means ABC will receive 30% of dividends or $3,000. Below will be accounting entriesAccounting EntriesAccounting Entry is a summary of all the business transactions in the accounting books, including the debit & credit entry. It has 3 major types, i.e., Transaction Entry, Adjusting Entry, & Closing Entry. read more for the same:
XYZ also declares a net income of $50,000. ABC will debit 30% of $50,000 in its “Investment in Associates” account while crediting the same amount as “Investment Revenue” in its Income Statement.
The ending balance of ABC’s “Investments in Associates” account increased to $512,000.
Practical Example – Nestle’s Investment in Associates
Nestle is a Swiss multinational company headquartered in Switzerland. Nestle is the largest food company globally, with revenue of around CHF 91.43 billion in 2018. Below is the income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more of Nestle as per the 2018 annual report.
Source: www.nestle.com
We can see that Income from associates has increased from CHF 824 million to CHF 916 million.
Source:www.nestle.com
Also, as per balance, their “Investment in Associates” account has gone down from CHF 11.6 billion to CHF 10.8 billion.
Below is the more elaborate information on associates for Nestle:
Source: www.nestle.com
In L’Oreal, Nestle is having 23% shares after the elimination of its treasury shares. Nestle holds another number of associates also, but that is not material. Major factors in “Investment in Associates” are Share of results with CHF 919 million.
Practical Example – Siemens AG
Siemens AG is a German multinational company which is headquartered in Berlin and Munich. Siemens AG is mainly operating in Industry, Energy, Healthcare, and Infrastructure. Their revenue is around Euro 83 bn as per the 2018 Annual report. Below is the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more snippet for Siemens AG, which is showing its investment in Associates, which is shown under “Investment Accounted for using the equity method.”
Source: siemens.com
As we can see that their investment in Associates has changed from Euro 3 billion to Euro 2.7 billion.
We can see below their definition of Associates also.
Source: siemens.com
As we have mentioned above, they are treating the investment as associates in which they have 20% to 50% shares, and they are using the equity method to accountEquity Method To AccountEquity Accounting is a method used by firms to maintain & record the income & profit details about their investment in another entity. It is applied while the investor holds a certain degree of influence over the investee. read more that investment is recognized at cost.
Advantages
- With these investments, investor shows the accurate and more reliable balance of income. It shows the percentage of earnings from its investment.
- Since investor shows the only percentage of income or investment in associate, it is easy to reconcile the accounts.
Disadvantages
- It is a bit complex to make the accounting for this method. A lot of time is required to gather and analyze, evaluate the figures, and get the correct information.
- The investor cannot show dividends from associates as revenue. It can only be treated as a “reduction to investment” amount and not as a dividend income.
Important Points to Note about Change in Investment in Associates
- A company is treated as an associate when share in investee is between 20% and 50%.
- The equity method is used to do the accounting.
- Investment is treated as an asset, and only the percentage of shares bought is treated as an investment.
- Dividends are treated as a change in investment, not the dividend revenue.
Conclusion
Investment in Associates is a common practice for companies to use their investment where they want to take a lesser stake in another company. The equity method is useful for the accounting process for these investments. Though companies can show the net income of the associate company as part of their revenue, however, dividend income won’t be part of it, and it would be a reduction in “investment in associate” asset.
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