Hi guys,
I’m looking at the example provided on page 79 of Book 2 Sweszer. Company P invests $8,000 in cash to acquire 80% of company S. At the end of the year, company S earns $4,000 net income and pays $1,000 dividends. On the I/S for P, equity method reports an additional line: 80% of the 4,000 NI = $3,200. Aquisition method reports combined P&S’s revenues and expenses, then adds a minority interest line of 20% of - $4,000 = - $3,200.
On the B/S for P, equity method will probably reduce current assets by the $8,000 loss of cash, then adds $8,000 investment in S, then $3,200 of P’s share of S’s net income less $800 of unowned dividends. Equity would go up by whatever amount that makes the balance sheet balance.
However, I’m struggle to think about the B/S for P under the acquisition method. How do the current assets, minority interest and equity lines show up for P?
Jubinell:
Equity method:
At the time the investment is made (in P’s balance sheet): cash goes down by $8,000 and the Investment in S goes up by $8,000.
At the end of the year, the investment in S increases by $3,200 (80% of $4,000) with the corresponding entry being in S’s Income statement, which of course gets transferred to Equity. So ultimately, Equity goes up by $3,200 as well to keep the balance sheet balanced.
The dividend received increases S’s cash by $800 and reduces the Investment in S by the same amount.
Acquisition method:
Under the acquisition method, the assets and liabilities of S are incorporated onto P’s consolidated balance sheet. As we don’t know how that $4,000 of net income was actually generated, there may be many answers to your question.
Lets’ make a simple assumption: the gain resulted from S selling some inventory for cash proceeds of $4,000 in excess of the inventory’s carrying amount, thus causing S’s assets to increase by $4,000. That swell in S’s consolidated assets would translate into an equal increase in the assets reported on P’s consolidated balance sheet.
The $4,000 of S’s gain on the transaction flows through P’s consolidated income statement. Anything reported in the group I/S ultimately impacts P’s consolidated Equity: $3,200 is reported as Retained Earnings (the portion of S’s gain which is attributable to P’s shareholders) and the remaining $800 goes to the Minority (Non-controlling) Interests line. Ultimately, the balance sheet still balances: assets up by $4,000 and Equity (Retained earnings and Minority Interests) up by the same amount.
Hope this helps.
Nice summary.
@jubinell
Also check out the Elan 11th hour guide for FRA…it helped me clarify the moving parts between the different methods.
Thegenral i am facing huge problems in intrcorporate investments?
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or do i have to shell out 20$ to buy the video