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Accounting For Less Than a Controlling Interest - Associate Companies

What occurs when one company makes a substantial investment in other company but this does not give the investing company with a controlling interest?

Other words, the company whose shares have been attained do not become a subsidiary of the investing company. One technique would just include the investment of shares in the company at cost in the investing statement of financial position of company. Presuming that the shares are held on a long-term basis, they would be treated like a non-current asset. Any dividends that received from the investment would be treated like income in the investing income statement of company.

Though, the problem with this approach is that companies generally pay dividends of much less than the profits that earned for the period. The profits, which are not distributed, but are ploughed back to help to produce more profits for the future, yet belong to the shareholders. From the viewpoint of the investing company, the accounting treatment explained would not, so fully reflect the advantages from the investment made. In which the investment does not include the purchase of a substantial shareholding within the company, this difficulty is overlooked and thus the treatment of the Investment explained before (i.e., showing the investment, at cost, like a non-current asset and taking account just of any dividends received) is applied. In which though the investment includes the purchase of a important number of voting shares in the company, a dissimilar kind of accounting treatment seems more suitable.

To overcome with the problem that identified above, a specific type of relationship among the two companies has been defined. An associate company is one where an investing company or group contain a substantial, but not controlling, interest. To be more exact, it is a company over which another company can implement important affect regarding its operating and financial policies. If a company holds 20% or more of the voting shares of other company it is supposed to be able to exercise significant affect. This affect is generally demonstrated through the investing company being presented on the board of directors of the associate company or through participation in policy making. The appropriate international accounting standard (IAS 28 Investments in Associates) gives the detailed guidelines that concerning what constitutes an associate company.

Of an associate company the accounting treatment falls somewhere among consolidation, like with group financial statements, and the treatment of small share investments, as explained at the beginning of this section. Let us suppose that a company invests in other company that is why the latter becomes an associate of the former. The accounting treatment will be like this:

  • the investing company will be needed to generate consolidated financial statements which reflect not only its own performance and position, but also those of its associate company.
  • within the consolidated income statement, the investing company's share of the operating profit of the associate company will be depicted and will be added to the operating profit of the investing company. Like operating profit presents the profit before interest and taxation, the investing share of any interest payable of company and tax relating to the associate company will also be displayed. These will be subtracted in deriving the profit for the year for the investing company and its associate company.
  • In the financial position's consolidated statement, the investment that is made in the associate company will be displayed and the investing company's share of any post acquisition reserves will be added to the investment. In this approach profits of the associate which have not been paid to the investing company, will be accepted in the investing statement of financial position of company. This will have the influence of showing more fully the investment in the associate company.
  • Dividends received through the investing company from the associate company will not be involved in the consolidated income statement. This is since the investing company's share of the profit of associate company will already be fully reflected in the consolidated income statement.
  • If the investing company also contain subsidiaries, their financial statements will also contain to be incorporated.

So a company that has both subsidiary companies and associate companies will ready just one set of consolidated financial statements reflecting all of these, irrespective of how many subsidiaries and associates it may contain.

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