Definition
Investment in Associates refers to the financial involvement by an organization in a non-controlling interest of another entity, generally ranging between 20% to 50% of voting shares. Essentially, it implies that the investor holds significant influence over the investee, but not full control. The investment is usually reported in the investor’s balance sheet as a long-term asset and it is often assessed by the equity method.
Key Takeaways
- Investment in associates pertains to the purchase of shares in a company to obtain significant influence in its operations, typically in the range of 20% to 50% ownership. This influence allows the investor to participate in the financial and operating policy decisions of the associate, but not control them.
- Such investments are accounted for using the equity method, where the initial investment is recorded at cost, then increased or decreased periodically to account for dividends and the investor’s share of the associate’s net profit or loss. This method reflects the economic reality of the investor’s interest in the associate company.
- An investment in an associate is reviewed regularly for signs of impairment. If an impairment is identified, the amount of investment in the associate is reduced and an impairment loss is recognized in the investor’s income statement.
Importance
Investment in Associates is a significant financial term, often used in the context of accounting and corporate finance.
It represents the investment a company has made in another entity, where the investing firm holds significant influence, though not full control, usually defined by owning 20-50% of the voting rights.
This is crucial because, unlike a subsidiary where a firm has full control, this type of investment allows a company to take part in the associate’s decisions and share in its profits, thereby diversifying its investment portfolio, expanding its market presence, acquiring strategic technology, or accessing unique resources.
It further poses less risk compared to outright acquisition, yet provides opportunities for influential participation, synergy creation and potential returns.
It illustrates the level to which a company is involved beyond its boundaries and the significance of these participations to its net worth and earnings, which is essential for shareholders, lenders, and analysts.
Explanation
Investment in associates fundamentally serves the purpose of reflecting a company’s financial interest and influence in an entity over which it has significant influence, but not full control. This type of investment is part of a strategic alignment to form synergies, gain expertise, or access new markets.
By investing in associates, a company can build significant business relationships, share risks, and profits without the necessity to directly control operations. This type of investment is used as a long-term strategic tool to create value and deliver returns without the need for full ownership.
A typical characteristic of an investment in associates is that the investing company can exert influence on management decisions of the associate company, including budget approval, policy changes, and substantial transactions. This structure lets the investing company have a hand in the associate company’s operations and strategic direction, providing an opportunity to share in financial gains while maintaining separate legal entities.
Examples of Investment in Associates
Tech Giants Investing in Start-ups: Renowned tech companies like Google, Apple, and Microsoft often make investments in small to medium sized tech start-ups, becoming their associates. An example would be Google’s investment in Uber. This not only helps the start-ups grow, but also extends the tech giants’ influence in different areas of technology.
Joint Ventures: Shell, a multinational oil and gas company, and Cosan, a leading Brazilian bioenergy company, formed Raizen, one of the world’s largest low-carbon, commercial bioenergy companies. This is an example of investment in associates where both companies have significant influence but not full control over the entity.
Berkshire Hathaway and Coca Cola: A famous example of an investment in an associate is Berkshire Hathaway’s investment in The Coca-Cola Company. Berkshire Hathaway, led by Warren Buffet, has maintained a substantial investment in Coca-Cola for many years, without seeking complete ownership or control. This strategic investment provides Berkshire Hathaway with a share of Coca-Cola’s profits and also allows for influence over company decisions.Remember, investments in associates are typically accounted for using the equity method, which means the investing company reports its share of the associate’s profit or loss in its own income statement.
FAQs about Investment in Associates
What is an ‘Investment in Associates’?
An ‘Investment in Associates’ refers to a scenario where a company owns shares in another company and controls between 20-50% of its operating policies typically. This company of which the shares are owned is called the ‘associate’.
How is control established in an investment in associates?
Control is established usually through the company owning a significant amount of voting power, normally 20-50%. However, even if less than 20% is owned, if the company can prove significant influence over the associate, it may still count as an investment in associates.
How are investments in associates accounted for?
Investments in associates are usually accounted for using the equity method rather than consolidating the associate’s financial statements into the investor’s financial statements. Under the equity method, the investment is initially recorded at cost, and this value is increased or decreased periodically to account for dividends and the profit or loss share of the associate.
What types of transactions require an adjustment to the carrying amount of investment in associates?
Types of transactions that require an adjustment include distributions received from the investee, the investor’s share of the investee’s profit or loss, and changes resulting from revaluations or impairments of the investee’s assets.
What is the difference between investment in associates and subsidiaries?
While an ‘Investment in Associates’ implies significant influence over the associate, the concept of ‘Subsidiaries’ goes a step further, suggesting that the parent company has a controlling interest in the subsidiary, typically 50% or more of the voting rights.
Related Entrepreneurship Terms
- Equity Method
- Significant Influence
- Joint Venture
- Goodwill
- Non-Controlling Interest
