The Equity Participation method basically consists of recording investments by their intrinsic value. It is applied when legal persons or branches of foreign companies seek corporate control, regardless of whether this means greater transfer of profits for the controlled entity at the end of each year and increases their power in the sector. Initially, investors record their ordinary investment at cost and successively, in accordance with the changes in the equity of the associates (originated in the splits) or subordinates (arisen after the mergers), they adjust the value of the investments in what corresponds according to their percentage of participation.
In Colombia, the equity participation method was defined by the Superintendency of Companies and the Securities Superintendency in Joint Circulars 009 and 013 of December 13, 1996, in the following terms: “The procedure is known as equity participation method. accounting by which the entities that are subject to the inspection, surveillance and control of these Superintendencies, register their ordinary investment in another, which will become its subordinate or contained, initially at cost adjusted for inflation, to later increase or decrease its value in accordance with the changes in the equity of the subordinate, subsequent to its acquisition, in what corresponds according to its percentage of participation.
The registration of investments by the equity participation method must be done prospectively as of January 1, 1994, that is, from the effective date of the Accounting Statute issued by Decree 2649 of 1993. Permanent investments must be accounted for by this method in subordinates, according to the following assumptions:
a) That the parent or controlling company has the power to dispose of the results of the subordinate in the following period.
b) That the parent or controlling company does not intend to dispose of the investment within twelve (12) months following the cost of the year for which the respective financial statements are being prepared.
c) That the subordinate has no restriction for the distribution of its profits, among others, when the subordinate is in liquidation or when in the course of a process of restructuring liabilities (law 550 of 1999), such situation has been agreed.
The equity method will no longer be applied as of the moment when it no longer has significant influence or that method is no longer appropriate. (art 15, IAS 28). The equity method will not be applied when the investor is a parent that does not prepare consolidated financial statements (in accordance with IAS 27).
In the initial acquisition of the investment, any difference between the acquisition cost of the investment and the resulting fair value of the net assets of the associate, the share of the investor, is recorded as goodwill in the investment accounts separately.
In operations subsequent to the acquisition, the basis for the calculation is the equity difference that occurs in the associate, comparing the current period with the immediately preceding one. The difference found should be classified into:
1- Results of the exercise
2- Other equity items
Initial accounting of the investment: The investment in an associate must be recognized from the moment it becomes an associate, based on the procedures established in IAS 28 and 27. The initial recognition of a transaction is the process of valuing, presenting and disclose, for the first time, in the financial statements the transactions and other events that the entity incurs. In general, the initial recognition of an acquisition involves: acquiring assets, assuming liabilities, issuing equity instruments or receiving contributions, in such a way that the resulting equity allows the exchange ratio to be set at the fair value of the assets acquired minus the liabilities assumed, without in any case exceeding the market value.
CASE 1: PURCHASE OF SHARES AT THE VALUE OF THE BOOKS
Exercise: To illustrate the equity participation method, suppose a) that on January 2, 20X1, the company Caimanes SA acquired 650 shares of par value of $ 50,000 per share of the company Sardinas SA b) On March 30, 20X1 Sardinas SA, belonging to the Commercial Sector, based on 20X0 profits, paid the remaining dividends for $ 10,000,000. In the year 20X0, a profit distribution of $ 30,000,000 had already been made.
Solution: It is very important to start solving the problem by analyzing the basis of the negotiation, that is, to know the distribution of social rights in the assets of the company Sardinas SA:
650 shares x $ 100,000 / share = $ 65,000,000
The percentage of participation negotiated is determined, in this case, dividing the acquired share capital by the total share capital of the selling company:
(650 shares x $ 50,000 / share) / (1,000 shares x $ 50,000 / share)
= $ 32,500,000 / $ 50,000,000
= 0.65, that is, sixty-five percent (65%)
Consequently, the buyer becomes the parent or controlling company and the seller is now a subsidiary or a subordinate. The corresponding entry is:
a) The purchase entry for the shares is:
($ 6,500,000) /(50,000$/action) = 130 shares, so now you only have:
650 - 130 = 520 shares
And their participation has become:
(520 shares x $ 50,000 / share) / (1,000 shares x $ 50,000 / share)
= $ 26,000,000 / $ 50,000,000
= 0.52, that is, fifty-two percent (52%)
Taking into account all that has been said, the social rights of the new parent or controlling company will remain as follows:
Suppose a) that on January 2, 20X1, the company Caimanes SA acquired 520 shares of $ 90,000 per share of the company Sardinas SA at $ 36,000 above their nominal value. The company Sardinas SA acquires the commitment of a subsequent capitalization of accumulated profits. It is requested to make the relevant entries:
The solution begins with the discrimination of the following information:
Intrinsic value: 520 shares x $ 90,000 / share = 46,800,000
Premium: 520 shares x $ 36,000 / share = 18,720,000
Commercial value of the shares = 65,520,000
From this information, the requested entries are made:
In the event that the controlling Caimanes SA had bought the shares for $ 90,000 to $ 18,000 below the nominal value, the preparation of the related entries would have been:
Intrinsic value: 520 shares x $ 90,000 / share = 46,800,000
Impairment: 520 shares x $ 18,000 / share = (9,360,000)
Commercial value of the shares = 37,440,000
The foregoing does not apply to the contributions that a holding company makes to the associate to establish it, or to increase its share capital, but without modifying its percentage of participation in the associate (Martínez, 2011). The difference between the investment in the associate and the consideration paid should be treated as follows;
a) Recognition of a Goodwill for the excess of the acquisition cost over the investment in the associate.
b) Recognition as Recoveries of the expense for provisions for the excess of the investment value over the acquisition cost.
The following illustration exercises on the equity participation method will refer to the spin-off of the company Originaria SA, whose remaining parts, represented by a holding company that we will call Controversial SA (52%) and another associated portion that, if desired, For a better distinction, we could name Asomada SA (48%).
Exercise: Suppose a) that on January 2, 20X1, the Controversial SA company acquired 520 shares of $ 90,000 per share of the Originaria SA company at $ 18,000 below their nominal value, paying the sum of $ 36,640,000 but that even so, the fair value paid is below the market value of the shares. The company Originaria SA acquires the commitment of the subsequent capitalization of accumulated profits. It is requested to make the relevant entries:
Exercise: Let us suppose that the subordinate or associated company has decreed the creation of a Reserve for the repurchase of shares for a value of $ 18,000,000. The entry by the controller (52%) will be:
Market price: 200 shares x $ 153,000 / share = 30,600,000
Reserved value: 200 shares x $ 90,000 / share = 18,000,000
Difference = 12,600,000
52% of the Value to be distributed = 6,552,000
The entry must be made for only 52% of the difference between the sale value of the shares and the reserved par value. This is a potential profit in the holding company that will only come true when it is capitalized by distributing it as shares, or when it is paid at the time of the liquidation of the controlled company together with the accumulated profits from times prior to the acquisition. At the time prior to the transaction, the entry by the parent will be:
Market value: 200 shares x $ 72,000 / share = 14,400,000
Reserved value: 200 shares x $ 90,000 / share = 18,000,000
Difference = 3,600,000
52% of the Value to be distributed = 1,872,000
When any loss of value is determined, having exhausted the Surplus for valuations (3805 Of investments), then the provision (1299 Shares) must be created to protect the value of the shares for the rest of the excluded value, whose value of the expense would enter be part of the income statement. Now, if instead of the previous example, we had had that the share price was at the price of $ 10,400 and that the sum of $ 7,500,000 had accumulated in the Surplus account for valuations, then the entry for only 52 % of the difference between the listed value and the par value of the shares, should be:
Market price: 200 shares x $ 10,400 / share = 2,080,000
Reserved value: 200 shares x $ 90,000 / share = 18,000,000
Difference = 15,920,000
52% of the Value to be distributed = 8,278,400
1. Variations in the income statement for the year: Once the net income for the year is known and after applying the corresponding percentage of participation that the controlling entity has within the total capital stock of that controlled company, if the result obtained is positive, This will imply that the accounting of the controlling company must debit the account 1345 Dividends receivable and credit the account 1205 or 1210-Investments.
Assuming that the Operating Profits for the year of the spun-off company Originaria SA (O) have been $ 11,653,846, its distribution between the controlling companies Controversial SA (C) and the associated company Asomada SA (A) would have to be made as follows mode:
In general, the elaborations for the analysis of the equity variations that take place in the activities with subsidiaries or associates and controllers, should start from the accounting information compiled in the Trial Balance. It may be possible to carry out the same analyzes from the Financial Statements, however the procedure becomes more complex and confusing and therefore is not highly recommended. The following work paper shows the activities described so far, identified by capital letters in parentheses:
TABLE N ° 14
As can be seen, when applying the equity method, the associate's comprehensive profits or losses must be adjusted for the effects derived from changes in the market value of the investment recognized by the holding company in the year in which this occurs. If the investment reaches a market value of zero, the dividends that may be received from the associate, would be recognized as income in the period in which they are collected, in order not to make the balance of the account negative. investment. If the associate obtains gains in the future, the holding company should only recognize them as part of the permanent investment for the amount that exceeds the unrecognized losses (Martínez, 2011).
In general, losses should be recognized by the parent, as follows:.
a) Reduce the balance of the permanent investment, including the part corresponding to goodwill, until it is zero, b) If there is any surplus after applying the above, decrease the accounts receivable from partners and shareholders that the entity does not intend to specify in a foreseeable period
c) If there are still surpluses, it should be recognized as a liability only to the extent that the holding company has incurred legal or implicit obligations on behalf of the associate.
d) If the associate obtains gains in the future, the holding company should only recognize them for the amount that exceeds the losses not recognized in the previous paragraphs.
Finally, since this type of situation was not considered in the examples, it is worth remembering that when preparing the results of the exercise, the following should be excluded:
1- Profits or losses arising from operations between the associates and the parent company, or those associated with each other, that have not yet been carried out by the parent company through operations with third parties, that is, with persons other than the parent company and its associated, recognized in memorandum accounts and disclosed in notes to the financial statements.
2- The profits that correspond to the preferred capital, that is, those contributions with a guaranteed dividend.
2. Variations in the other equity accounts: The variations obtained by applying the percentage of participation that the controlling entity has within the variations of the equity accounts of the controlled company (“32-Capital Surplus”, “33-Reserves”, "34-Revaluation of equity", "37-Results of previous years" and "38-Surplus from valuations" without including the variation in the account "31-capital stock" nor the account 36-profits of the year), will be recognized as a greater or lesser value of the investment with a credit or charge to the Surplus Participation method. Consider, for example, the comparative case of the controlling company Controversial SA:
Once the value of account 1205 or 1210 has been updated in the above manner, the controlling entity will take that large total balance that the account shows and will compare it with the intrinsic value certified by the controlled company. In this way, you can also record the respective “provision” (account 1299) or “valuation” (account 1905) of the investment.
I- Comparison between investment registration methods
In the following entries and their explanations, the following assumptions have been taken as premises:
1) that in the company in which it is invested, the market value of the assets and liabilities is equal to their book value and, that the book value of the acquired capital is equal to the cost of the investment, 2) that no significant transactions are carried out between the investor and the company in which it invests that imply the recognition of profit or loss between them, and
3) that there is no change in the percentage of common shares acquired by the investor.
Exercise: Let us suppose that the consolidated results of the spun-off company Originaria SA are summarized in the following table:
In this example, the consolidated earnings of Originaria SA during Years 1 to 4 total CU42,000,000, while the dividends distributed during the same period total CU88,000,000. It can be seen that the accumulation of dividends of CU22,000,000 per year distributed up to Year 3 includes a capital dividend of CU39,000 (ie 66,000 - 27,000) and up to Year 4 it includes a capital dividend of CU46,000,000 (88,000,000 - 42,000,000).
Exercise: Let us admit that the company Originaria SA has spun off. 52% of the assets and liabilities has been acquired by Controversial SA at the beginning of Year 1 for CU26,000,000 The necessary journal entries in the books of the parent Controversial SA to account for its investment in the consolidated company Originaria SA (although it now it barely owns 48%) under the cost and equity participation methods are:
Controversial SA acquires 52% of the outstanding shares of Originaria SA
Controversial SA has acquired a certain interest on operating profits (52% of $ 24,000,000)
Originaria SA reported earnings of CU40,000,000: at the end of Year 2.
Controversial SA has acquired a certain share of operating profits (52% of $ 40,000,000)
Originaria SA paid dividends to partners of CU22,000,000 at the end of Year 3.
The following tables show the amount of income recorded each year and the balances at the end of each year in the investment account.
1. One week after the acquisitions, the company Titirigüey SA, declares the creation of a reserve for the repurchase of shares in the amount of $ 132,000.
2. Nine months later, about to sell them, the price of 15 shares reacquired at $ 17,135 had fallen to $ 6,782 while according to the books in the Surplus account for investment valuations it was at $ 122,000.
3. The income statement requires the adjustment of the provision expense.
4. The distribution of profits for the year is decreed.
It asks:
a- Prepare, in journal format and in Worksheet, the entries that would be made to obtain the consolidated financial statements as of December 31, 20X1, assuming that the equity method is used to account for the investment.
Bibliography
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