As users of financial statements, many investors tend to mix up associates, joint ventures, subsidiaries, and other jargon of accounting which confuses some pe0ple and turns others off. However, these concepts are easy to understand and will be broken down in today’s article.

A colleague of mine recently reviewed Cargo Handlers Limited’s (CHL) financials and asked why there was no cost of sales, especially with them having an associate company. CHL bought 30 per cent of Buying House Cement Limited (BHC) in December 2019 for $104.25 million. International Accounting Standards (IAS) 28 – Investments in Associates and Joint Ventures, more specifically IAS 28.3, defines an associate as an entity over which an investor has significant influence, being the power to participate in the financial and operating policy decisions of the investee, but not control or joint control of those policies. In accordance with IAS 28.5, significant influence is presumed to exist when an investor holds 20 per cent or more of the voting power of another entity. Conversely, it is presumed that significant influence does not exist with a holding of less than 20 percent. Associates are usually 20 to 50 per cent ownership and are measured under the equity method. However, some entities may be exempted from using the equity method; however, we won’t focus on that today.

The equity method is a method of accounting whereby the investment is initially recognised at cost and adjusted thereafter for the post-acquisition change in the investor’s share of the investee’s net assets. The investor’s profit or loss includes its share of the investee’s profit or loss and the investor’s other comprehensive income includes its share of the investee’s other comprehensive income. In CHL’s fourth quarter, it recorded $8.39 million as share of profit which meant BHC earned $27.98 million in net profit for that period. CHL itself provides stevedoring and equipment leasing services which incurs no cost of sales expense. Since CHL only accounts for BHC as an associate, there would be no cost of sales resulting from BHC.

A subsidiary is an entity that is controlled by another entity (known as the parent) as defined by IAS 27. Control is usually identified when the parent owns more than half of the voting rights (50 per cent ownership) in the subsidiary. Control extends beyond just nominal ownership and can include the ability to govern the financial and operating policies of the entity under an agreement or the ability to cast the majority of votes at a meeting of the board of directors.

Mayberry Investments Limited (MIL) is the parent entity to Mayberry Jamaican Equities Limited (MJE), in which it owns 63.99 per cent of the issued ordinary shares with two directors of MIL sitting on the board of MJE. Jamaican Teas Limited (JAMT) is the parent company of QWI Investments Limited, but only owned 40.61 per cent of QWI. JAMT administers the affairs of QWI Investments Limited under a long-term administration services agreement with the investment committee of QWI comprising two senior persons from JAMT’s board. Other examples of subsidiaries and parents below 50 per cent but exhibited control include Jamaica Producers Group Limited (parent) and Kingston Wharves Limited plus Proven Investments Limited with Access Financial Services Limited up to September 2019.

Through this parent and subsidiary relationship, consolidated financial statements account for equity attributable to owners and non-controlling interests. When a company doesn’t have 100 per cent ownership of a subsidiary (wholly owned), it is required under International Financial Reporting Standards (IFRS) 10 to represent the ownership it controls and the rest it doesn’t have an interest in. Consolidation involves removing intragroup transactions and assets plus combining the economic substance of a subsidiary with that of the parent.

A perfect example of this is with Sagicor Group Jamaica Limited’s (SJ) 2020 audited financials. Although the consolidated net profit declined by 71 per cent to $4.48 billion, the net profit attributable to shareholders only declined by 12 per cent to $13.78 billion with a negative $9.3 billion in non-controlling interests (NCI). The reason for the decline in the consolidated net profit was due to Sagicor Real Estate X-Fund Limited which SJ only owned 29.31 per cent. Under consolidation, SJ had to represent all of X-Fund’s earnings on its income statement and separate it after to show the profit attributable to owners/shareholders. X-Fund had a consolidated net loss of $15.39 billion which largely stemmed from impairment charges and its share of loss in Playa. SJ had to represent the $5.47 billion share of loss on its income statement as well. Thus, the net profit attributable to shareholders and equity attributable to shareholders are the best ways to discuss the performance of a company with numerous subsidiaries.

A joint venture, according to IFRS 11.4,7, is an arrangement over which two or more parties have joint control, being the contractually agreed sharing of control, ie, unanimous consent is required for decisions about the relevant activities. IAS 28 discusses how one should account for joint ventures which is basically the same as associates with some exceptions. An example of joint venture accounting is with Sagicor Costa Rica SA, which SJ owns 50 per cent. In SJ’s nine-month results up to the end of September 30, 2021, it reported $705.1 million in its share of profit from the joint venture. Though Sagicor Costa Rica earned $1.41 billion in net profit for the period, SJ is only able to represent 50 per cent of that figure on its income statement.

Understanding these various business accounting terms means that you’ll be clear about how subsidiaries and other businesses a company has an equity interest in is accounted for on the income statement, balance sheet and cash flow.

— By David Rose