Associates

Definition

In accounting, associates refer to entities over which an investor has significant influence but not control, typically defined as owning 20% to 50% of the voting shares. This relationship allows the investor to use the equity method of accounting, where they recognize their share of the associate's profits or losses in their financial statements.

5 Must Know Facts For Your Next Test

1. Associates are accounted for using the equity method, which requires that the investor recognizes their proportionate share of the associate's profits or losses.
2. If an associate experiences a decline in value, it may require an impairment assessment to determine if the carrying amount exceeds its recoverable amount.
3. Investors must monitor their investment in associates for indicators of impairment, such as significant losses or adverse changes in market conditions.
4. Dividends received from an associate are not recognized as income under the equity method; instead, they reduce the carrying amount of the investment.
5. The equity method ensures that an investor's financial statements reflect not only their own performance but also their share of the performance of the associates.

Review Questions

• How does the equity method apply to investments in associates and what implications does this have for financial reporting?
  • The equity method is used for investments in associates where significant influence exists. Under this method, the investor records their share of the associate's net income or losses directly on their income statement, impacting reported earnings. This approach provides a more accurate representation of the investor's financial performance and ensures that they recognize their stake in the operational results of the associate.
• Discuss the criteria used to determine whether an investment qualifies as an associate and how this affects accounting treatment.
  • An investment qualifies as an associate if the investor holds between 20% and 50% of the voting shares and has significant influence over its policies. This relationship leads to applying the equity method, where earnings from the associate are incorporated into the investor's financial statements. If these criteria are not met, different accounting methods, like cost or fair value, must be used, significantly altering how investments are reported.
• Evaluate the importance of assessing impairment for investments in associates and how it influences overall financial analysis.
  • Assessing impairment for investments in associates is crucial because it ensures that investors do not overstate their assets on balance sheets. If an associate experiences significant losses or market downturns, an impairment review may indicate that the carrying amount should be reduced. This process influences overall financial analysis by providing a clearer picture of potential risks associated with such investments, ensuring stakeholders have accurate information about asset valuations and company performance.

Related terms

Equity Method: An accounting technique used to record investments in associates, where the investor recognizes their share of the associate's net income or loss on their income statement.

Significant Influence: The power to participate in the financial and operating policy decisions of an entity without having control over those policies.

Impairment: A reduction in the carrying amount of an asset when its fair value falls below its book value, indicating that it may not be recoverable.