Accounting for Investment in Associates

AS 23 describes the principles and procedures for recognizing investments in associates (in which the investor has significant influence, but not a subsidiary or joint venture of investor) in the consolidated financial statements of the investor. An investor which presents consolidated financial statements should account for investments in associates as per equity method in accordance with this standard but in its separate financial statements, AS 13 will be applicable.

Objective

The objective of this Statement is to lay down principles and procedures for recognizing the investments in associates and its effect on the financial operations of the group in the consolidated financial statement. Reference to AS 23 is compulsory for the companies following AS 21 and preparing consolidated financial statement for their group. For disclosing investment in associates in the separate financial statement of the investor itself, one should follow AS 13.

Terms used in the AS-23

• A subsidiary is an enterprise that is controlled by another enterprise (known as the parent). A parent is an enterprise that has one or more subsidiaries.
• A group is a parent and all its subsidiaries.
• Equity is the residual interest in the assets of an enterprise after deducting all its liabilities.
• Consolidated financial statements are the financial statements of a group presented as those of a single enterprise.
• An associate is an enterprise in which the investor has significant influence and which is neither a subsidiary nor a joint venture of the investor.

Significant influence is the power to participate in the financial and/or operating policy decisions of the investee but not control over those policies. This definition excludes the subsidiaries or joint venture from the scope of an associate but apart from these any other enterprises, which are significantly influenced by the investor is an associate for the purpose of this standard. Any enterprise having 20% or more control over voting power or any interest directly or indirectly in any other enterprise will be assumed to have significantly influencing the other enterprise unless proved otherwise. Similarly any enterprise that does not have 20% or more control then it is assumed not having significant influence on the enterprise unless proved otherwise.

An enterprise can influence the significant economic decision making by many ways like:

• Having some voting power.
• Representation on the board of directors or governing body of the investee.
• Participation in policy-making processes.
• Interchange of managerial personnel.
• Provision of essential technical information.
• Influencing intercompany transactions i.e. sale of goods and services, sharing technical knowledge etc.

As a general rule, significant influence is presumed to exist when an investor holds, directly or indirectly through subsidiaries, 20% or more of the voting power of the investee.

As with the classification of any investment, the substance of the arrangement in each case should be considered. If it can be clearly demonstrated that an investor holding 20% or more of the voting power of the investee does not have significant influence, the investment will not be accounted for as an associate.

A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

If the investor holds, directly or indirectly through subsidiaries, less then 20% 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. The presence of one or more of the indicators as above may indicate that an investor has significant influence over a less than 20% owned corporate investee.

Control exists when parent company has either:

• The ownership, directly or indirectly through subsidiary(ies), of more than one-half of the voting power of an enterprise.
• Or control of the composition of the board of directors in the case of a company or of the composition of the corresponding governing body in case of any other enterprise so as to obtain economic benefits from subsidiary company’s activities.

If any company is controlling the composition of governing body of gratuity trust, provident fund trust etc., since the objective is not the economic benefit and therefore it will not be included in consolidated financial statement.

An enterprise is considered to control the composition of the board of directors or governing body of a company, if it has the power, without the consent or concurrence of any other person, to appoint or remove all or a majority of directors of that company or members of the body. An enterprise is deemed to have the power to appoint a director/member, if any of the following conditions is satisfied:

• A person cannot be appointed as director/member without the exercise in his favour by that enterprise of such a power as aforesaid; or
• A person’s appointment as director/member follows necessarily from his appointment to a position held by him in that enterprise; or
• The director/member is nominated by that enterprise or a subsidiary thereof.

To understand the above definitions let us take few examples:

Example1: A Ltd. has 70% holding in C Ltd. and B Ltd. also has 28% holding in the same company. So, A Ltd. with the majority holding i.e. more than 50% is the parent company and C Ltd. with more than 20% share though minor but a business associate.

Example 2: A Ltd. holding 90% share in B Ltd. and 10% in C Ltd., and also B Ltd. holding 11% shares in C Ltd. In this case, A Ltd. is parent of B Ltd. but due to total of direct and indirect holding of (10 + 11) 21% in C Ltd., C Ltd. is an associate of A Ltd. Though for consolidated financial statement purpose, these holding will be 19.9% (10% + 90% of 11%), as rest 1.1% belongs to minority interest.