What Is an Associate Entity in Accounting?

When one company invests in another, the level of influence determines how the investment is classified. An associate entity is an investment where the investor has significant influence, meaning it can participate in policy decisions without having outright control. This classification separates these investments from passive holdings, where the investor has little say, and from subsidiaries, where the investor has full control.

Criteria for Significant Influence

The determination of “significant influence” is central to classifying an investment as an associate. Accounting standards provide specific benchmarks to assess this influence. A primary indicator is quantitative: if an investor holds between 20% and 50% of the voting power in another company, significant influence is presumed to exist.

This 20% to 50% ownership threshold is a rebuttable presumption, not an absolute rule. Influence can be demonstrated with less than 20% ownership or disproven despite ownership exceeding this level. The assessment also relies on qualitative factors that provide evidence of the investor’s ability to participate in the investee’s policy decisions.

Qualitative indicators that help establish significant influence include:

• Representation on the investee’s board of directors or an equivalent governing body.
• Active participation in the policy-making process, including decisions about dividends.
• The existence of material transactions between the investor and the investee.
• The interchange of managerial personnel between the two entities.
• The provision of technical information from the investor to the investee.

Accounting for an Associate Entity

An investment classified as an associate is accounted for using the equity method, which is designed to reflect the investor’s ongoing economic interest in the associate’s performance. The process begins on the acquisition date, when the investment is recorded on the investor’s balance sheet at its purchase cost. This initial cost forms the baseline for all subsequent accounting adjustments.

The carrying amount of the investment is adjusted each reporting period to reflect the investor’s share of the associate’s financial results. If the associate reports a net profit, the investor increases the carrying amount of its investment by its ownership percentage of that profit. For instance, if an investor owns 30% of an associate that earns a $100,000 profit, the investment account is increased by $30,000, and this amount is also recognized as income on the investor’s income statement. Conversely, if the associate incurs a loss, the investment account is decreased.

Suppose Investor A acquires a 30% stake in Company B for $300,000. The initial entry on Investor A’s balance sheet is an investment of $300,000. In the first year, Company B reports a net profit of $50,000. Investor A would increase its investment account by its 30% share, which is $15,000 ($50,000 x 30%), bringing the carrying amount to $315,000. This $15,000 is also reported on Investor A’s income statement.

Dividends received from the associate are treated as a return of the investment, not as income. When the investor receives a dividend, it reduces the carrying amount of the investment on its balance sheet. Continuing the example, if Company B declares and pays a total dividend of $10,000, Investor A would receive $3,000. This cash receipt is recorded by decreasing the investment account from $315,000 to $312,000. This treatment prevents double-counting profits, as the underlying earnings were already recognized when the associate originally earned them.

Financial Statement Presentation and Disclosure

On the balance sheet, the investment accounted for using the equity method is presented as a single line item within non-current assets. This line represents the initial cost of the investment plus the cumulative share of profits and losses, less any dividends received.

Similarly, on the income statement, the investor’s share of the associate’s profit or loss is also shown as a single line item. This is often titled “Share of profit of an associate” or similar wording. This approach separates the earnings generated through the investor’s own operations from those derived from its investment.

To supplement the information in the financial statements, detailed disclosures are required in the notes. Accounting standards, such as IFRS 12, require disclosures that give financial statement users a deeper understanding of the investment. Requirements include disclosing the name of the associate, the nature of its business, and the investor’s ownership percentage.

Furthermore, companies must provide summarized financial information for the associate, including its total assets, liabilities, revenues, and profit or loss. If the associate’s shares are publicly traded, the investor must also disclose the fair value of its investment alongside its carrying amount, providing an additional data point for analysis.