Acquisition vs. Equity Method

I just did a problem in a practice exam and it asked whether income would be different under the Equity and Acquisition methods.

The answer to the question was:

Both the acqusition method and equity method will report the same net income. The acquisition method (under either partial or full goodwill) will report higher assets than the equity method and hence ROA would be lower under the acquisition method compared to under the equity method

Interesting, I always thought that an acquirer would consolidate ALL net income as it owns more than 50%, not just the assets. Can someone explain this to me?


2 points here:

ROA= Return on Assets , i.e. Net Income / Assets…

Equity Method: Just includes the “extra earnings” in Net income… so… ROA = (Net income + “extra earnings” ) / Assets

Acquisition Method: Includes both, “extra earnings” and Balance Sheet items… so… ROA= (Net Income + "extra earnings) / (Assets + “extra assets from the target”)

So the denominator is bigger under the acquisition method, hence ROA is lower :smiley:



In acquisition method, aren’t you supposed to include ALL earnings since you are acquiring the whole firm and it should be consolidated, not a portion (extra earnings in your example)??

I always thought that if your acquire, all Income and balance sheet items are included in the acquirer’s financials.

The equity method _ also includes an asset _: Investment in Subsidiary. This asset starts as the portion of the net assets (assets – liabilities) of the subsidiary purchased by the parent, and are adjusted each year for the earnings of the subsidiary and the dividends paid by the subsidiary.

The primary difference is that the acquisition method includes not the net assets, but the gross assets: the liabilities are not subtracted from the assets; rather, the liabilities are reported as part of the parent’s liabilities. Furthermore, the assets are not merely the portion purchased by the parent; rather, the assets are 100% of the assets of the subsidiary.

The upshot, however, is as you say: total assets under the acquisition method are greater than total assets under the equity method, while net income under the acquisition method is the same as net income under the equity method. Thus, ROA under the acquisition method is lower than ROA under the equity method.

Got it… but when you consolidate, you include the TOTAL net income and income statement items in the parent’s financials correct? This is what confused me.

Yes, but if the parent doesn’t own 100% of the subsidiary, you subtract the minority interest in the subsidiary’s net income. Net income will always be the same under the equity method and the acquisition method.

so if a company owned slightly more than 50%, does it have a choice to consolidate or use acquisition method? I don’t understand how a company would be required to use acquisition method when there is also the option to consolidate when using acquiring more than 50%. That would mean to include ALL income statement items

The percentage of ownership isn’t the deciding criterion; _whether or not the parent has control _ is the deciding criterion. If the parent has control (even with less than 50% ownership), consolidation is required. If the parent lacks control (even with more than 50% ownership), the equity method is allowable.

I had this exact question about NI between equity and acquisition method then I found this thread. I just have to say that S2000 is a straight up G. Thank you!!

the key to remember is that how you do it does not give you more/less net profit . its just a different accrual path .

the net profit is always the profit. wheather one includes the acquired asset in with their assets or they put a net value in an equity line will give different accrual ratios, but it doesnt change the profit.

Thank you Magician Sir for the expalanation.My doubt is also Cleared.