. Associates & Joint Ventures
If a holding company owns 20% to 50% shares in another company, the other company is referred to as an “associate” of the holding company.
The accounting treatment for associates is different from that of a subsidiary. The income statement for a subsidiary involves consolidation of the overall income and expenses of the subsidiary; for associates, the holding company only recognises its share of the profit earned by the associate. This is known as “equity accounting” in accounting language.
Similar accounting treatment is used on Joint Ventures.
For example, if Company A owns 30% of Company B, and Company B reported a net profit after tax of RM10 million, Company A will recognise RM3 million (30% x RM10 million) in its income statement under Share of Profit of Associates.
Using back Axiata’s example in table 6 (please refer to Chapter 9 – Part 5 posting on 18 March 2019), there is a line item called “Associates – share of results (net of tax)” worth RM131.1 million. This means that Axiata recognised a total of RM131.1 million as its share of results of its associates.
At the balance sheet level, the accounting treatment for associates again is different. As explained earlier, in the case of subsidiaries, the holding company will consolidate the assets and liabilities of its subsidiary into its account. This is not the case for associates.
For associates, the holding company will not consolidate the assets and liabilities of the associate. What the holding company will recognise in its balance sheet is its initial investment cost when investing in the associate. This initial cost is subsequently adjusted for the following:
- When the associate makes a profit, the holding company’s share of profit will be added to the investment cost. Likewise, when the associate makes a loss, the holding company’s share of losses will be deducted from the investment cost.
- Any dividend received by the holding company from the associate will be deducted from the investment cost.
The logic for the above is simple. If the associate continues to be profitable, then the value of the investment in associate will increase. If the associate pays dividend, the initial cost of the holding company in investing in the associate will decrease.
For example, assume Company A invested RM100 million for a 20% associate stake in Company B. When Company B makes RM20 million profit, RM4 million (20% X RM20 million) belongs to Company A. However, since Company A did not withdraw the profit, Company A’s investment in associate Company B is now recorded as RM104 million (RM100 million initial cost plus RM4 million profit attributable to Company A).
If Company B declared RM30 million as dividend (it is possible for dividend declared to be higher than net profit if the company has retained earnings available), Company A will be entitled to RM6 million worth of dividend (20% X RM30 million). Now since RM6 million has been returned to Company A in the form of dividend, Company A’s investment cost in Company B is reduced to RM98 million (RM104 million less RM6 million in dividend).
One interesting case study for associate accounting would be for Batu Kawan Bhd (“Batu Kawan”). Batu Kawan owns a 46.57% stake in Kuala Lumpur Kepong Bhd (“KLK”) since 1973.
Until financial year 2013 (Batu Kawan’s financial year end falls on 30 September), Batu Kawan has been recognising KLK as an associate. In Batu Kawan’s 2013 annual report, in page 55 and 56, the group stated that:
“FRS 10 replaces part of FRS 127 Consolidated and Separate Financial Statements that deals with consolidated financial statements and IC Interpretation 112 Consolidation – Special Purpose Entities.
Under FRS 10, an investor controls an investee when
(a) the investor has power over an investee,
(b) the investor has exposure, or rights, to variable returns from its involvement with the investee, and
(c) the investor has ability to use its power over the investee to affect the amount of the investor’s returns.
Under FRS 127 Consolidated and Separate Financial Statements, control was defined as the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities.
The application of FRS 10 will affect the accounting for the Group’s equity interest in Kuala Lumpur Kepong Berhad, which is currently treated as an associate of the Group and accounted for using the equity method of accounting.
As at 1 October 2013, the Group is the majority shareholder of Kuala Lumpur Kepong Berhad (“KLK”) with a 47% equity interest. All other shareholders individually own less than 1% of the equity shares of KLK.
Historically, the other shareholders did not form a group to exercise their votes collectively. The directors have assessed that the Group has had control over KLK and therefore, in accordance with the requirements of FRS 10, KLK will be accounted for as a subsidiary of the Company.”
To see the impact of the change, we will compare the difference in the income statement and balance sheet for Batu Kawan in 2013, as well as the differences when KLK was recognised as an associate and as a subsidiary.
Table 8 shows the impact on income statement whereas Table 9 shows the impact on the balance sheet.
|Table 8: Extracted financial data from Batu Kawan’s Statement of Comprehensive Income for Financial Year Ended 30 Sep 2013 (in RM ‘000)|
|Cost of sales||(268,166)||(7,418,524)|
|Other operating income||46,549||154,026|
|Other operating expenses||(160)||(159,419)|
|Share of profits of equity accounted investees, net of tax||427,594||13,668|
|Profit before taxation||513,383||1,285,791|
|Profit for the financial year||492,823||1,032,434|
|Profit attributable to non-controlling interests||(9,114)||(548,725)|
|Profit attributable to equity holders of the Company||483,709||483,709|
|*Extracted from 2013 Annual Report;
#Extracted from 2014 Annual Report
Notice that the profit for both treatments, i.e. either KLK as an associate or a subsidiary, will result in the same net profit. What differs is that when KLK is treated as an associate, Batu Kawan recognises its share of KLK’s net profit in Batu Kawan’s profit and loss statement. When KLK is recognised as a subsidiary, Batu Kawan recognises KLK’s full income statement into Batu Kawan’s own income statement.
|Table 9: Extracted financial data from Batu Kawan’s Statement of Financial Position for Financial Year Ended 20 Sep 2013 (in RM ‘000)|
|Property, plant & equipment||270,464||3,999,069|
|Prepaid lease payments||–||196,585|
|Land use rights||3,356||–|
|Land held for property development||–||216,932|
|Goodwill on consolidation||–||326,511|
|Investment in associates||3,382,666||118,131|
|Deferred tax assets||174||103,479|
|Trade & other receivables||102,889||946,571|
|Other receivables, deposits and prepayments||–||371,090|
|Other current assets||3,742|
|Property development cost||–||40,812|
|Derivative financial assets||–||14,158|
|Assets held for sale||–||11,610|
|Short term trust funds||537,804||–|
|Cash & bank balances||109,561||2,463,740|
|Trade & other payables||54,065||371,115|
|Loans and borrowings||19,568||796,694|
|Provision for retirement benefits||4,587||263,809|
|Deferred tax liabilities||22,004||272,067|
|Loans and borrowings||521,000||2,079,227|
|Equity Attributable to Owners of the Company|
|Less: Cost of treasury shares||–||(223,387)|
|TOTAL EQUITY AND LIABILITIES||4,685,972||13,069,472|
|*Extracted from 2013 Annual Report;
#Extracted from 2014 Annual Report
On the balance sheet, when KLK is recognised as an associate, Batu Kawan’s only factor in its investment in KLK on its balance sheet is “Investment in associates”. When KLK is recognised as a subsidiary, Batu Kawan consolidates all KLK’s assets and liabilities on Batu Kawan’s own balance sheet.
From Batu Kawan’s example, investors can clearly see the financial impact of recognising another company as either an associate or a subsidiary. In this case the change was mere realisation of existing influence, not change in the percentage stake. Thus, the profits to shareholders remain the same. The impact would be on the calculation of financial ratios, which we will discuss further in subsequent chapters.
This marks the end of Chapter 9. Next week, we will move into Chapter 10: Cash Flow – The Life Line of Business.