Significant influence

The accountant of Cornett Chocolates Ltd, Ms Fraulein, has been advised by her auditors that the entitys investment in Concertinas Milk Ltd should be accounted for using the equity method of accounting. Cornett Chocolates Ltd holds only 20.2% of the voting shares currently issued by Concertinas Milk Ltd. Since the investment was undertaken purely for cash flow reasons based on the potential dividend stream from the investment, Ms Fraulein does not believe that Cornett Chocolates Ltd exerts significant influence over the investee.

Required

Discuss the factors that Ms Fraulein should investigate in determining whether an investorassociate relationship exists, and what avenues are available so that the equity method of accounting does not have to be applied.

The relevant paragraphs from AASB 128 are:

Paragraph 2:

Significant influence is the power to participate in the financial and operating policy decisions of the investee but is not control or joint control over those policies

Paragraphs 6 and 7:

6. If an investor holds, directly or indirectly (eg through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (eg through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence.

7. The existence of significant influence by an investor is usually evidenced in one or more of the following ways:

(a) representation on the board of directors or equivalent governing body of the investee;

(b) participation in policy-making processes, including participation in decisions about dividends or other distributions;

(c) material transactions between the investor and the investee;

(d) interchange of managerial personnel; or

(e) provision of essential technical information.

Points to discuss:

1. Why the investment is undertaken by Swiss Chocolates is irrelevant. The definition of significant influence is based on the capacity to participate, not the actual or intention to participate.

2. Whether Swiss Chocolates actually exerts influence is irrelevant.

3. The 20% is a guideline only.

4. Factors will include those in paragraph 7. Further an analysis of the 80% holding by other parties is very important. If it is closely held, then the ability for Swiss Chocolates to participate is limited.