What Is an Associate Company in Accounting and How Does It Work?

Companies often invest in other businesses without fully acquiring them. When a company holds a significant but non-controlling stake in another entity, that business is referred to as an associate company. This arrangement allows the investing company to benefit from the associate’s financial performance while maintaining some level of influence over its operations.

Ownership Percentage Criteria

An investment is classified as an associate company when ownership falls between 20% and 50% of the voting shares. This range indicates a meaningful stake without outright control, which typically requires a majority holding.

A stake below 20% is generally considered a passive investment with minimal influence over business decisions. Exceeding 50% results in the entity being classified as a subsidiary, requiring full financial consolidation. The 20%-50% range represents a middle ground where the investor has influence but not control.

Regulatory frameworks such as International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) reinforce these thresholds. Under IFRS 28 and ASC 323, an entity within this ownership range is presumed to be an associate unless evidence suggests otherwise. This presumption may be challenged if the investor lacks board representation, voting power, or other forms of influence, but such cases are exceptions.

Equity Method Accounting

When an entity holds a significant but non-controlling stake in another business, financial reporting follows the equity method. This ensures the investor’s financial statements reflect its proportional share of the associate company’s earnings and losses, rather than just recording dividends received.

The initial investment is recorded at cost on the balance sheet. Over time, the carrying amount is adjusted to reflect the investor’s share of the associate’s net income or loss. If the associate reports a profit, the investor increases the value of its investment by its proportional share. If the associate incurs a loss, the investor reduces the investment’s value accordingly. These adjustments appear in the investor’s income statement.

Dividends from the associate do not count as income under this method but instead reduce the carrying value of the investment. This prevents double-counting of earnings, as profits are recognized when earned, not when distributed.

Intercompany transactions require adjustments. If the investor and associate engage in business dealings, profits from these transactions may need to be eliminated to prevent artificial inflation of earnings. For example, if the investor sells goods to the associate at a markup, any unrealized profit on unsold inventory must be removed until the goods are sold to external parties.

Role of Significant Influence

An investor’s ability to shape an associate company’s strategic direction without full control defines significant influence. This can manifest through board representation, participation in policy-making, or material transactions between the two entities. Even without majority ownership, an investor with voting rights on key decisions—such as approving budgets, selecting senior management, or determining dividend policies—can exert meaningful sway over the associate’s operations.

Regulatory bodies like the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) recognize that influence extends beyond ownership percentages. If an investor has a contractual agreement granting veto power over financial policies, this indicates significant influence even with an ownership stake below 20%. Conversely, if an entity holds over 20% of shares but lacks board representation or decision-making authority, it may not meet the criteria for influence under IFRS 28 or ASC 323.

Influence can also stem from technological reliance or supply chain dependencies. If an associate depends on the investor for proprietary technology, exclusive distribution agreements, or a substantial portion of its raw materials, the investor may have leverage over business decisions.

Revenue and Expense Recognition

Revenue recognition in an associate company relationship depends on the nature of transactions between the investor and the investee. If the associate generates revenue from selling goods or services to the investor, these transactions must be conducted at arm’s length. Under IFRS 15 and ASC 606, revenue is recognized when control of goods or services transfers, but related-party dealings require scrutiny to ensure pricing reflects fair market value. Discounts, rebates, or extended payment terms could indicate preferential treatment, requiring adjustments to prevent financial distortions.

Expense recognition follows similar principles. If the investor provides management services, leases assets, or licenses intellectual property to the associate, those expenses must be recorded based on the substance of the arrangement rather than just contractual terms. Under IFRS 16, lease agreements between an investor and its associate must be assessed for classification as operating or finance leases, affecting both expense recognition and balance sheet presentation.

Reporting Transparency

Financial reporting for associate companies must provide transparency so investors, regulators, and other stakeholders can accurately assess the financial position of both the investor and the associate. Since the equity method integrates the associate’s financial performance into the investor’s statements, disclosures must explain the impact of this relationship. Companies must outline the nature of their investment, the percentage of ownership, and any factors contributing to significant influence.

Regulatory standards such as IFRS 12 and ASC 323 require entities to disclose key financial data of their associates, including total assets, liabilities, revenue, and net income. These disclosures help stakeholders understand the financial health of the associate and its contribution to the investor’s earnings. If there are material risks—such as financial distress at the associate level or exposure to foreign currency fluctuations—companies must provide qualitative and quantitative details to ensure informed decision-making.