## Learning Outcomes

After reading this article, you will be able to explain how equity accounting reflects unrealised profits on transactions between an investor and its associate or joint venture. You will understand the adjustments needed for upstream and downstream transactions, how to identify principal and associate sellers, and the effect on consolidated profits and statement of financial position. You will practise identifying and eliminating unrealised profits as required in the ACCA Financial Reporting (FR) exam.

## ACCA Financial Reporting (FR) Syllabus

For ACCA Financial Reporting (FR), you are required to understand how to account for investments in associates and joint ventures using the equity method, including intra-group sales and unrealised profit adjustments. In particular, ensure you are confident with:

- Defining 'associate' and understanding significant influence under IAS 28
- Applying equity accounting for associates and joint ventures
- Identifying upstream (associate to parent) and downstream (parent to associate) transactions
- Calculating and eliminating unrealised profits in inventory or non-current assets
- Adjusting group consolidated financial statements for these transactions

## Test Your Knowledge

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, look more closely at that area during your revision._

1. When a parent sells goods to its associate and some inventory remains unsold at year end, where is the unrealised profit eliminated in the consolidated financial statements?
2. How are upstream and downstream transactions between an investor and an associate defined?
3. True or false? The full amount of unrealised profit in inventory is always removed from group retained earnings.
4. What adjustment is required if an associate sells property to the parent above carrying value and the property is still held at year end?

## Introduction

Associates and joint ventures are accounted for using the equity method under IAS 28 and IFRS 11. When a parent company or group transacts with an associate or joint venture, profits on these transactions may not be realised at the group level if the asset is still held at the reporting date. These unrealised profits must be eliminated on consolidation.

Understanding how to adjust for these profits in both upstream (associate to investor) and downstream (investor to associate) transactions is a requirement for ACCA FR students. Command of these adjustments ensures group profits and asset values are not overstated in the consolidated accounts.

> **Key Term: associate**
> An entity over which the investor has significant influence, but not control or joint control. Significant influence is generally presumed when the investor holds 20% or more of the voting power.
> **Key Term: equity method**
> A method of accounting whereby the investment is initially recognised at cost, and adjusted thereafter for the investor's share of the associate’s post-acquisition profits or losses and other comprehensive income.
> **Key Term: unrealised profit (PUP)**
> A profit arising from an intra-group transaction that has not been realised outside the group, such as where one entity sells goods to another entity within the group and those goods remain unsold at the reporting date.
> **Key Term: upstream transaction**
> A transaction where the associate sells assets to the investor (or its group).
> **Key Term: downstream transaction**
> A transaction where the investor (or its group) sells assets to the associate.

### Unrealised Profits in Associate and Joint Venture Transactions

### Transactions Between Investor and Associate

Intra-group transactions between the group and its associate may create profits that are not realised from the group’s standpoint if the asset is not sold to an external party by the reporting date. To ensure profits are not overstated, these unrealised profits must be removed in the consolidated financial statements.

### Upstream vs Downstream Transactions

- **Downstream:** Investor (or group) sells to associate/joint venture.
- **Upstream:** Associate/joint venture sells to investor (or group).

The direction of the sale determines which part of post-acquisition profits the unrealised profit affects and where the elimination is recorded.

> **Exam Warning:**
> For upstream transactions, only the group’s share of PUP is adjusted in group profits; the non-controlling or external interest retains their portion. For downstream transactions, the _entire_ unrealised profit is removed from the group’s retained earnings.

### Equity Accounting Adjustments for Unrealised Profits

Under the equity method, the group initially records its investment at cost. Post-acquisition, this is adjusted for the group's share of the associate's profit or loss. Unrealised profits in unsold inventory or non-current assets must be eliminated to the extent attributable to the group.

### Downstream Transactions (Parent to Associate)

The parent (investor) is the seller. If inventory or non-current assets remain unsold by the associate at reporting date, any unrealised profit should be:

- Removed in full from group retained earnings in the consolidated statement of financial position (SFP)
- Deducted from the carrying amount of the investment in associate

This ensures group profit is not overstated for profits not yet realised outside the group.

### Upstream Transactions (Associate to Parent)

Here, the associate is the seller. Any unrealised profit remaining at the year-end (for example, goods still in the investor’s inventory) is:

- Eliminated from the group’s share of the associate’s post-acquisition profits
- Only the investor’s share of the profit is removed from consolidated profit (not the full amount)
- The adjustment is also deducted from the investment in associate

This means any external interests in the associate retain their share of the profits.

> **Revision Tip:**
> Remember: For downstream, eliminate 100% of the PUP from group profits; for upstream, eliminate only the group share of the PUP.

### Non-Current Assets

When a non-current asset is transferred between investor and associate, any unrealised profit is eliminated as for inventory. In future periods, excess depreciation resulting from the increased carrying value is adjusted in profit or loss and the investment in associate.

### Calculation of Unrealised Profits (PUP) in Inventory

![Unrealised profit adjustments on investor–associate transactions, from identifying unsold intra-group assets to downstream and upstream eliminations and excess depreciation.](https://static.pastpaperhero.com/images/acca-fr-associates-and-joint-ventures-ias-28-ifrs-11-upstream-and-downstream-transactions-unrealised-profits_00.png)

_Equity method treatment of unsold inventory or non-current asset profits distinguishes full downstream elimination from group-share upstream elimination._

1. Identify the intra-group sales during the period and the unsold asset amount at reporting date.
2. Calculate the profit included: use seller’s mark-up or margin.
3. Determine the unrealised profit amount relating to assets still held.
4. For downstream (parent sales): eliminate full amount from group retained earnings and investment in associate.
5. For upstream (associate sales): eliminate group’s share only by reducing group’s share of associate’s profit and investment in associate.

### Worked Example 1.1

**Scenario:** Parent Co owns 30% of Associate Co. During the year, Parent Co sells goods to Associate Co for \$10,000 at a 25% profit margin. At the year-end, \$4,000 of these goods remain unsold in Associate Co's inventory.

What is the unrealised profit adjustment in the consolidated financial statements?

> **Answer:**
> Profit in closing inventory = \$4,000 × 25% = \$1,000.
> As this is a downstream transaction, the entire \$1,000 is eliminated from group profits and deducted from the carrying amount of the investment in associate.

### Worked Example 1.2

**Scenario:** Associate Co sells goods to Parent Co for \$12,000 at a 20% mark-up. At year-end, Parent Co still holds \$3,000 of these goods in inventory. Parent Co owns 40% of Associate Co.

Calculate the adjustment for unrealised profit.

> **Answer:**
> Profit in unsold inventory = \$3,000 × (20/120) = \$500.
> As this is an upstream transaction, only 40% (the group’s share) is eliminated from the consolidated profit: \$500 × 40% = \$200. This amount is deducted from the group’s share of associate profit and from the investment in associate.

### Worked Example 1.3

**Scenario:** During the year, Parent Co sells equipment to its 25%-owned joint venture for \$40,000, making a profit of \$6,000. The equipment is still held by the joint venture at year-end.

What elimination is required?

> **Answer:**
> As this is a downstream, non-current asset sale, eliminate the full \$6,000 profit from group profits and deduct it from the investment in joint venture. In subsequent years, adjust for excess depreciation in the joint venture’s results, adding it back to group profits.

## Summary

Intra-group transactions with associates and joint ventures may result in profits that have not been realised outside the group. For correct equity accounting, such unrealised profits must be removed in the group accounts. For downstream transactions, the total profit is deducted from group results and investment in associate. For upstream transactions, remove only the group’s share of profit. These adjustments ensure consolidated profits are not overstated.

## Key Point Checklist

_This article has covered the following key knowledge points:_

- Define and identify upstream and downstream transactions between investor and associate
- Explain the treatment of unrealised profits for both types of transaction under equity accounting
- Demonstrate PUP elimination, including calculation of group share in upstream transactions
- Adjust investment in associate and group profits for PUP
- Apply correct adjustments for non-current asset transfers between group and associate

## Key Terms and Concepts

- associate
- equity method
- unrealised profit (PUP)
- upstream transaction
- downstream transaction


Associates and joint ventures (IAS 28/IFRS 11) - Upstream and downstream transactions (unrealised profits)