f u r t h e r f e at u r e s o f c o m p a n y a c c o u n t s
Accounting for associates
Accounting for associates is very simple, in principle. The investor com-
pany, rather than putting just the cost of the investment on its balance
sheet, instead recognises its share of the net assets of the associate. By
‘its share’ I mean the percentage of the associate’s share capital that the
investor company owns. This is known as the equity method.
So if, during a year, the associate makes a profit (thereby increasing its
net assets), the investor company would make the following double entry
on its balance sheets:
Increase Share of net assets of associate
Increase Retained profit
Since the investor company’s retained profit has gone up, its P&L must
naturally reflect this. This is done as follows. The investor company’s P&L
shows the share of the associate’s operating profit, exceptional item and
interest receivable/payable. In all items below that on the P&L, the share
of the associate is aggregated with the investor company’s figures but dis-
closed in the notes.
So not only is the performance of the associate reflected in the investor
company’s accounts, but you are actually given some details about that
performance. This information is not sufficient to enable you to analyse
the associate properly, however; for that you need a copy of the associ-
ate’s own annual report.
Up to now, we have been learning about accounting on the basis that the
net assets of a company (which are equal to the shareholders’ equity) rep-
resent the value of the shares to the shareholders. Thus, if an investor
company was going to buy 20 per cent of a company, we would expect it
to pay 20 per cent of the net asset value of the company.
For all sorts of reasons, investors (both companies and individuals) often
pay more than net asset value for shares in companies. We will go into