Accoutning for associates

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8. Explain significant influence and contrast it with control

AASB 1016 defines significant influence as ¡¥the capacity of an entity to affect substantially (but not control) either, or both, of the financial and operating policies of another entity¡¦. Common indicators as suggested by the standard that indicate significant influence over another entity, are;

„Holding 0 percent or more of the voting power in the associate but not greater than 50 percent as this would be control

„Representation on the associates board of directors

„Extent of the materiality of inter-company transactions

„Economic or technological dependencies

„Restrictions on the investee¡¦s ability to make distribution to owners

„The investment must be held long-term for it to give rise to significant influence and establish investor-associate relationship

(The above points are just a suggestion by the standard and all may not apply to every case trying to determine investor-associate relationship).

From the above definition and indicators it is very clear that there is a fine line between significant influence and control, this is because there are no clear rules to distinct significant influences from control.

However the one main difference between significant influence and control is that;

„For a company to have control over another entity it must control both the financial and operating policies of the other entity.

But for significant influence the entity must have significant influence over either or both the financial and operating policies of the other entity.

8.4 What is an associated company? Why should an investment in such a company be treated differently from an investment in a subsidiary company or an investment in some other company?

An associated company, also known as investee refers to a company which an investor can exercise significant influence over (but not control).

AASB 1016 definition of associate is;

An investee not being

(a) a subsidiary of the investor; or

(b) a partnership of the investor; or

(c) an investment acquired and held exclusively with view to it¡¦s disposed in the near future¡K..

over which the investor has significant influence.

A basic example that would give rise to a investor-associate relationship is when company A acquires a small but significant portion of company B shares. Because the investment is small it suggests significant influence rather than control which gives rise to an investor- associate relationship rather than parent-subsidiary relationship (control).

The factor that differentiates associate investment from investments in subsidiary or other companies is that even despite the investor¡¦s significant influence, the associate company remains independent of its investor/s. With subsidiaries, the parent controls the subsidiary, therefore the subsidiary dependant on the parent where as with associate companies significant influences by investors can counter act each other.

8.8 Do you agree with the following proposition ¡¥when applying the equity accounting method, the distinction between pre-acquisition and post-acquisition profits of the investee is irrelevant¡¦.

The distinction between pre-acquisition and post-acquisition profit would only be irrelevant if we were to adhere to AASB 1016. 5. (b) which states that, ¡¥for equity accounting purposes, the investor must account for dividends from associates as a deduction to the investment account.¡¦

This means that regardless of whether its pre-acquisition or post-acquisition profits. They will both be credited against the investment¡¦s carrying value, and not revenue. This application of equity accounting does not clearly reflect profits from investments.

However with the method applied by Jubb

„Pre-acquisition profits remained treated as a reduction of the investments cost (same as all other investment accounting method)

„But, post-acquisition profits are treated as revenue, ¡¥revenue from associates¡¦

This method not only provides a distinction between pre-acquisition and post acquisition profits but it also highlights the profits from investment as opposed to if profits were directly credited to the carrying value of the investment.

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