I am getting lost in Equity, Consolidation and joint venture methods treatments of assets, liabilities, sales, expenses

CFA Level II
#1

Also their effect on income statement and balance sheet.

#2

Pretty general statement mate. People can’t help unless you specify a question you need an answer to…

#3

I agree, OP. Wish there was some kind of cheat sheet. Definitely going to spend a bunch of hours going through that section again.

#4

Assume Company A has 80% interest in Company B

Equity Method:

  1. Balance Sheet- Company A reports reports 80% interest in Company B a single line item under assets on the balance sheet. Liabilities and equity stay the same.
  2. Income Statement- 80% interest x Company B’s Net income gets included in Company A’s net income. Revenues and expenses stay the same

Acquisition Method:

  1. Balance Sheet: 100% of Company B’s assets and liabilities get reported on Company A’s balance sheet. Next calculate the portion not owned, minority interest. 100-80%=20% minority interest. 20% x Company B’s Equity= minority interest added to Company A’s Equity. Eg. if Company B has $100K Equity then $20K (100 x 20%) will be added to Company A’s Equity under minority interest. This is why equity increases under the acquisition and not the equity method.
  2. Income Statement: 100% of revenues and expense of Company B are combined with the the revenues and expenses of Company A. Again, like with the balance sheet, you have to calculate minority interest and base it off Company B’s Net income. If Company B has Net Income of $1000 then minority interest reported on Company A’s income statement is $2000.

Joint Ventures require equity method under IFRS and GAAP except in rare circumstances. The other method besides the equity method for joint ventures is proportionate consolidation.

  1. Balance Sheet: Under proportionate consolidation Company A will report 80% of Company B’s Assets and liabilities. No minority interest is necessary. Equity is ignored.
  2. Income Statement: Company A will report 80% of Company B’s revenues and expenses. No minority interest is necessary.

I will upload a picture later that will you help understand this.

1 Like
#5

Wow thanks. This is a good summary.

#6

You’re welcome.

I wasn’t able to upload the picture, so I’ll just type it out.

In most situations, the effects on the balance and income statement that result from each accounting method are:

  1. All three methods report the same net income
  2. Equity method and proportionate consolidation method report the same equity. Acquisition method will be higher by the amount of minority interest.
  3. Assets and liabilities are highest under the acquisition method and lowest under the equity method. The proportionate consolidation method is somewhere in-between those 2.
  4. Revenues and expenses are highest under the acquisition method and lowest under the equity method; again the proportionate consolidation method is somewhere in-between those 2.

The being said, the Net Profit Margin, ROA metrics are both highest under the Equity method because Sales and Assets are lower, and NI is the same under the other 2 methods. ROE will be the same as proportionate consolidation because equity in both cases remain unchanged, and they both have the same NI.

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#7

Thats a lot of effort. Really appreciate it buddy!