Under IAS 28, how does an investor account for an associate's losses when the losses exceed the carrying amount of the investment?

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AcadiFi · Accepted Answer

IAS 28 prescribes a specific sequence for absorbing losses from an associate or joint venture accounted for under the equity method. When the associate's losses are large enough, the investor's carrying amount can reach zero — but the analysis does not necessarily stop there. **Loss Absorption Sequence** The investor applies its share of the associate's losses in the following order: 1. **Reduce the carrying amount of the equity investment** to zero. This includes any goodwill embedded in the investment. 2. **Apply remaining losses against long-term interests** that form part of the net investment in the associate — typically long-term loans or preference shares for which settlement is neither planned nor likely in the foreseeable future. 3. **Recognize a provision (liability)** only if the investor has incurred **legal or constructive obligations** or has made **payments on behalf of the associate**. Once the investment and all long-term interests are reduced to zero, and no obligation exists, the investor **discontinues recognizing** further losses. The unrecognized losses accumulate off-balance-sheet. **Resuming Profit Recognition** When the associate subsequently reports profits, the investor does NOT immediately recognize its share. Instead: - Profits are first applied to **recover the cumulative unrecognized losses**. - Only after the unrecognized losses are fully absorbed does the investor resume recognizing its share of profits in the income statement. **Worked Example — Alderton Capital's 30% Investment in Nexova Energy:** | Year | Nexova Net Income (Loss) | Alderton's 30% Share | Investment Balance | Long-Term Loan | Unrecognized | |---|---|---|---|---|---| | Y1 | ($60M) | ($18M) | $25M → $7M | $10M (unchanged) | $0 | | Y2 | ($80M) | ($24M) | $7M → $0 | $10M → $0 | $7M | | Y3 | ($30M) | ($9M) | $0 | $0 | $16M | | Y4 | $100M | $30M | $0 → $14M | $0 | $16M → $0 | \`\`\`mermaid flowchart TD A["Associate Reports
Losses"] --> B["Reduce Investment
Carrying Amount"] B --> C{"Investment
= Zero?"} C -->|"No"| D["Continue Recognizing
Share of Losses"] C -->|"Yes"| E["Apply Against
Long-Term Interests"] E --> F{"LT Interests
= Zero?"} F -->|"No"| G["Continue Against
LT Interests"] F -->|"Yes"| H{"Legal/Constructive
Obligation?"} H -->|"Yes"| I["Recognize
Provision"] H -->|"No"| J["Stop Recognizing
Losses"] J --> K["Track Unrecognized
Losses Off-B/S"] K --> L["Future Profits First
Recover Unrecognized"] \`\`\` In Year 4, Alderton's $30M share of profits first absorbs the $16M unrecognized losses, then the remaining $14M restores the investment carrying amount. **Exam Points:** 1. The long-term loan must genuinely form part of the "net investment" — trade receivables and short-term advances do not qualify. 2. The investor never creates a negative investment balance unless it has legal or constructive obligations. 3. This is a favorite exam construct — track the numbers through a multi-year table. Master the equity method loss absorption in our CFA Level II course.

Under IAS 28, how does an investor account for an associate's losses when the losses exceed the carrying amount of the investment?

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