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Background: An entity is an investor in an associate in accordance with AS 23 Accounting for Investments in Associates in Consolidated Financial Statements. The investor accounts for its interest in the associate using the equity method in AS 23. The investor enters into a lease agreement with the associate, classified as a finance lease under AS 19 Leases. The gain on the lease transaction exceeds the carrying amount of the investor’s investment in the associate.
The author notes two views for the accounting for the gain elimination:
View A: The gain from the transaction is eliminated only to the extent that it does not exceed the carrying amount of the investor’s interest in the associate. This view is by analogy to AS 23.18 where an entity’s share of losses of an associate ceases to be recognised when the investment carrying amount is reduced to zero. Paragraph 18 of AS 23 states “If, under the equity method, an investor’s share of losses of an associate equals or exceeds the carrying amount of the investment, the investor ordinarily discontinues recognising the share of further losses and the investment is reported at nil value.”
View B: All the investor’s share of the gain is eliminated. This view is supported by AS 23.13, which states that gains/losses from transactions are recognised only to the extent of the unrelated investors’ interests in the associate. Paragraph 13 states “In using equity method for accounting for investment in an associate, unrealised profits and losses resulting from transactions between the investor and the associate should be eliminated to the extent of the investor’s interest in the associate.”
Author supports View B. The second question therefore is – how should the gains to be eliminated, in excess of the carrying amount of the interest in the associate? Two methods are identified:
Method 1: As deferred income
Method 2: As a deduction from the related asset recognised by the investor.
Author supports Method 1, because ‘deferred income’ shows the nature of the eliminated gains and it would enable users to readily obtain information about the amount of eliminated gains in excess of the investors interest in the associate.
Author’s Recommendation: Author considers that AS 23 lacks guidance on the accounting for the elimination of any gain in excess of the carrying amount of the investment. The Institute of Chartered Accountants of India may consider amending AS 23 via a narrow-scope amendment to add specific guidance on how to account for the corresponding entry for the eliminated gain in excess of the carrying amount of the investor’s interest in the associate.
