One of my colleagues is siting for L2 and has Schweser. If you can post the relvent page numbers I can have her bring in the book or those pages for me to look at.
2008 Book 2 Econ and FSA / LOS 22c / p. 163 That page starts the specific example we were discussing above. Thanks for all your help on this.
I have come in a little late, but I like to think about the equity method in the same way a partner would keep a capital account. Purchasing starts your capital, earnings add, distributions (dividends) subtract and you end up with your end of year capital account. If you are not comfortable with pshp accouting, it may not help, but it sure helps me.
mwvt9 found the pages that I was talking about. I guess it’s just a very unlikely case - using equity for 50% ownership. Thanks for the patience.
Okay, so here’s the definitive answer. The classic, “simple” equity method is the one I’ve mentioned above that dinesh refers to where it is cost plus pro-rata net income less dividends received. There are 2 variations on that, the partial and the full methods. The partial is the one in the example which is being discussed, where you write-off excess purchase price. I can only see this being used in 50-50 joint ventures, when 2 companies contribute assets to a project, and they need to have appraisals done to make sure that they know exactly how much each entitty contributes for fairness purpses, etc. It also sorta makes sense since under GAAP no one consolidates the entity. In a non-JV situation, a purchasing company is not going in and checking the value and remaining usefull life of every asset, so this isn’t practical. But the problem with the partial method comes into play when you have intercompany sales which can gross up numbers at the equity owner levels, and this is where the full equity method comes in, and you eliminateu nrealized intercompany profit as well. (which tyey don’t seem to cover) Back to schweser. They are taking the position that in all cases where you take an equity interest for more than propotionate book value you use the partial equity method (which they simply refer to as equity) and this is not the case. Almost every company on this planet has a market cap above book value (well, except for Bear stearns), and the simple eqity method dominates. Note that in their earlier discussion on equity method they say ignore market cap. That difference between market cap and BV is never just goodwill, there will almost always be some asset write-up (if the company has material fixed assets). I don’t recall which approach CFAI is looking for, but I think it will almost always be the simple equity method as contrasted against the cost method. I would say that for percentages below 50% stick to the simple method. For a 50% level and only in the context of where they are asking you to contrast equity vs partial consolidation and full consolidation, use the partila equity method they present in the example. (also, you might want to see if the original reading material gives any additional guidance on what they are looking for) Hope this helps.
Thanks Super. I will go back to the CFAI to see exactly what they say. All of Schwesers examples except that one in question use the simple equity method. Which is why there is additional confusion on this subject. The only thing left that is still bugging me is Net income (and equity). I thought under each method NI at the parent level should remain the same and I can’t see how that would happen using the simple equity method as compared to making adjustments with the consolidation methods. Again thanks for your time.
mwvt9 Wrote: ------------------------------------------------------- > The only thing left that is still bugging me is > Net income (and equity). I thought under each > method NI at the parent level should remain the > same and I can’t see how that would happen using > the simple equity method as compared to making > adjustments with the consolidation methods. It can’t be the same for simple equity vs consolidation for exactly the reasons discussed above: no adjustments to asset valuations and proportionate recognition of their depreciation/amortization. If you buy <50%, you aren’t the parent, you are just an investor with some level of control.
Of course! I am an idiot.