Investment in PAS 28

Associates
 Purchase cost not equal to FV of interest acquired

If the purchase cost of the investment exceeds the FV of the

interest acquired, the excess is GOODWILL. Such goodwill
is included in the carrying amount of the investment and is
not accounted for separately, meaning it is neither amortized
nor tested for impairment separately.
If the purchase cost of the investment is less than the FV of the
interest acquired, the deficiency is GAIN FROM A BARGAIN
PURCHASE (Negative Goodwill). Such negative goodwill is
recognized in profit or loss in the period the investment is acquired.
 Fair value of the interest acquired

The FV of the interest acquired is determined by multiplying the investor's ownership

percentage on the net fair value of the associate's identifiable assets and liabilities. Identifiable
assets exclude any goodwill recognized by the associate as asset.
Carrying Amounts different from fair values
If the carrying amount of the associate's asset is less than its Fair Value so that in
effect is undervalued, the investor's share on the undervaluation is recognized on a
rational basis as deduction to both investment income and investment account over the
remaining life of the asset. The opposite treatment applies if the asset is over valued.
If the carrying amount of an associate's liability is less than its fair value so that an
effect it is undervalued, the investor's share on the undervaluation is recognized on a
rational basis as addition to both investment income and investment account over the
remaining term of the liablity. The opposite treatment applies if the liability is over
valued.
 SHARE IN UNDERVALUATION OF ASSET

DEDUCTION to both
Share in the profit of associate (investment income)
Investment in associate account
Example: PURCHASE COST EXCEEDS FAIR VALUE OF INTEREST ACQUIRED
On January 1, 2018, ABC Co. Purchased 25% interest in the ordinary shares of XYZ,
Inc. For P2,000,000. XYZ 's assets and liabilities approximate their fair values except
for inventories with carrying amount of P500,000 and fair value of P100,000 and
depreciable asset with carrying amount of P3,000,000 and fair value of P5,000,000.
The remaining useful life of the depreciable asset is 10 years. XYZ's net assets has a
book value of P5,000,000.
Prepare the corresponding entries of the above transactions.
1. The entry on Jan 1, 2018 to record the purchase is as follows:
Jan. 1. 2018 Investment in associate 2,000,000
Cash in bank 2,000,000
The goodwill/ (negative goodwill) from the acquisition is computed as follows:
Purchase cost 2,000,000
Less: Fair value of the net assets acquired (1, 650,000)*
350,000
* The Fair Value of the net assets acquired is computed as follows:
Book Value of net assets 5,000,000
Overvaluation of inventory (500K-100K) (400,000)
Undervaluation of depreciable asset (5M-3M) 2,000,000
6,600,000
Multiply by 25%
1, 650,000
Alternate solution: The excess of purchase cost over book
value of interest acquired is allocated as follows:
Purchase cost 2,000,000
Book value of interest acquired (5Mx 25%) (1,250,000)
Excess of cost over book value 750,000
Share in overvaluation of inventory
(500K-100K) x 25% 100,000
Share in undervaluation of depreciable asset
(5M-3M) x 25% (500,000)*
Goodwill 350,000
*Undervaluation of asset is a deduction
Goodwill arising from investment in associate is included in the carrying amount of the
investment and not accounted for separately.
On December 31, 2018, XYZ reported P1,200,000 profit and declared and paid dividends
of P500,000. The entries are as follows:
Dec 31, 2018 Investment in associate 300,000
Share in profit of associate 300,000
(1.2M x 25%)
To record share in profit
Dec 31, 2018 Cash on hand (500,000 x 25%) 125,000
Investment in associate 125,000
To record share in dividends
The entry to adjust investment income for the overvaluation of inventory as follows:
Dec 31, 2018 Investment in associate (400K x 25%) 100,000
Share in profit of associate 100,000

The share in the overvaluation of inventory is recognized in full because the inventory is assumed
to have been sold entirely during 2018.

The entry to adjust investment income for the undervaluation of asset is as follows:
Dec 31, 2018 Share in profit of associate 50,000
Investment in associate 50,000
(2M x 25%) divided by 10 years
Notice that the effect of the undervaluation of asset is deduction to both the "share in associate's
profit" (investment income) and investment in associate"
 The Net Change in the investment in associate account is equal to
share in profit of associate (net of amortization of
over/undervaluation) minus share in the cash dividends

Investment, end 2,225,000 Share in profit, net 350,000

Investment, beg (2,000,000) Share in dividends (125,000)
Net Change 225,000 225,000

Cash dividends affect only the investment in associate account. Cash dividends do not affect share in
profit of associate of investment income
 Potential voting rights
In assessing whether significant influence exists, any Potential Voting Rights held by the investor that are
currently exercisable or convertible are assumed to have been exercised or converted even if management does
not intend to actually exercise or convert them.
If ownership percentage increases to 20% or more due to the assumed exercise or conversion of potential voting
rights, significant influence is assumed to exist. Therefore, PAS 28 will apply.
However, when recognizing the investor's share in the associate's profit or loss, the present ownership interest is
used (excluding the effect of the assumed exercise or conversion of potential voting rights) Potential voting
rights are considered only when assessing the existence of significant influence.
Potential voting rights include (a) share (b) share call options © debt or equity instruments that are convertible
into ordinary shares which if exercised or converted, give the entity additional voting power or reduce another
party's voting power over the financial and operating policies of another entity.
Potential voting rights that are not currently exercisable or convertible are ignored in assessing the existence of
significant influence. Potential voting rights are not currently exercisable or convertible if they cannot be
exercised or converted until a future date or until the occurrence of a future event.
Illustration: Potential voting rights
ABC Co. Owns 15,000 shares out of the 100,000 outstanding shares of XYZ, Inc.
As of year end, ABC holds 20,000 stock rights which enable ABC to acquire additional shares
from XYZ on a "2 rights for 1 share" basis. The stock rights are exercisable immediately. However,
management does not intend to exercise the stock rights. XYZ does not have any other stock rights
outstanding aside from those held by ABC.

XYZ reports year-end profit of P1,000,000 and declares cash dividends of P100,000. The
investment has a carrying amount of P300,000 before any year-end adjustment
Requirements:
a. How much is ABC's share in profit of associate for the year?
b. How much is the carrying amount of the investment as of year end?
 Solution
Shares presently held 15,000
Potential voting rights assumed exercised (20,000 divided 2 rights) 10,000
Total shares 25,000
Less Outstanding shares after exercise of rights (100,000 +10,000) 110,000
Assumed ownership interest 22.73%

The investment will be accounted for under equity method because significant influence is assessed
to exist. ( ie.22.73% is 20% or more)
The year end entries are as follows:
Dec 31, 2018 Investment in associate 150,000
Share in profit of associate (1M x 15%) 150,000
Dec. 31, 2018 Dividend receivable (100K x 15%) 15,000
Investment in associate 15,000
Note that the present ownership interest (ie 15%) is used in computing for the share in associate's
profit and dividends. Potential voting rights are considered only in assessing the existence of
significant influence.
Answers to requirements:
a. P150,000 (refer to journal entry)
b. Investment in associate
Beg 300,000
Share in profit 150,000 15,000 Dividends received
435,000 end
Cumulative Preference Share
If an associate has outstanding cumulative preference shares that are held by parties other than the investor
and classified as equity, the investor computes its share of profits or losses after deducting one-year dividend
on such shares, whether the dividends have been declared or not.
If the associate has outstanding noncumulative preference shares that are held by parties other than the
investor and classified as equity, the investor computes its shares of profits or losses after deducting dividends
on such shares only when declared.
If the preference shares are classified as liability by the associate, such as when they are mandatorily
redeemable, no adjustment is made for dividends when computing investor's share of associate's profits or
losses because the associate recognizes dividends on these shares in profit or loss (as interest expense). The
investor's share is based on the associate's profit or loss which necessarily had already been adjusted for any
dividends declared (interest expense) on the redeemable preference shares.
Illustration: Cumulative preference shares
ABC Co. Owns 20% of XYZ Inc's ordinary shares. XYZ also has an outstanding cumulative 6%
preference shares of P2,000,000. None of those preference shares is held by ABC. Cumulative
preference share dividends are in arrears for 3 years. XYZ reported year-end profits of P1,000,000
and declared no dividends.