I just want to clear something up in my head. In Schweser, it states that equity is the same between all accounting methods for intercorporate investments. However, in the cosolidation (purchase) method, minority interest is included in equity causing it to increase (at least in IFRS). Is schweser referring solely to the parent’s shareholders’ equity? Or am I understanding this wrong? Thanks for the clarification, TheChad
Probably a misunderstanding. The idea is that it does not matter what kind of method you apply, the equity will be the same for the parent company, under all methods. And so will be NI, hence ROE.
The difference is instead of having an investments in affliates entry under assets, you have a minority interest entry inbetween the equity and liabilities sections (mezzanine) of the BS, but like map1 said, equity is the same.
Thanks for the answers guys. I understand that in GAAP accounting, the minority interest shows up outside of equity (as JP stated, between liabilities and equity), however, in a consolidation under IFRS, minority interest is categorized under equity outside of the parent company’s shareholders’ equity (thus total equity is increased). Any thoughts or am I still missing something? Thanks, TheChad
That’s correct for the location under IFRS
JP_RL_CFA Wrote: ------------------------------------------------------- > That’s correct for the location under IFRS That being said, I return to my initial question… for a consolidation under IFRS, am I correct in assuming that total equity can change (increase) versus other accounting methods, while the parent’s shareholders’ equity remains the same? Thanks again, TheChad
honestly, I’m really not sure. I was under the assumption that the mezzanine was a part of Equity just displayed seperately on the balance sheet for easier visibility
I am also under that impression, which would mean that the total equity for a consolidation under GAAP would also increase versus other accounting methods. Can anyone else shed any light onto this subject? Best, TheChad
I believe equity is the same because in the other methods you adjust Net income which adjusts retained earning. It just provides more disclosure.
Net income using consolidation is the same as the other accounting methods. The balance sheet is where I am having trouble making sense of everything. Assuming a cash purchase, here is what I understand to be true: Equity Method: Cash decreases Investment in associate increases: Assets are the same Liabilities are the same Equity is the same Proportionate Consolitation: Cash decreases All other assets increase by proportionate amount All liabilities increase by propoprtinoate amount Assets are higher Liabilities are higher Equity us the same Consolidation: Cash decreases All other assets increase by full amount All liabilties increase by full amount Minority interest increases (Equity or mezzanine) Assets are higher Liabilities are higher Equity is higher The example in the CFAI text in book 2 p 38 provides a good example of the impact of minority interst on equity. Best, TheChad
I don’t think net income changes either. I believe that minority interest is the offset to increased assets, sort of like a contra-asset? I see explicitly here that ROE is the same under both consolidation and equity methods, that implies net income and equity are constant.
Ok, here is the catch: “minority interest is included in equity” Minority interest is a DEDUCTION in equity, it represents the interest not owned by the parent which will make it equivalent to equity under the “equity method”
TheAliMan Wrote: ------------------------------------------------------- > I don’t think net income changes either. I believe > that minority interest is the offset to increased > assets, sort of like a contra-asset? > > I see explicitly here that ROE is the same under > both consolidation and equity methods, that > implies net income and equity are constant. Thanks for the reply. I agree with you in that NI doesn’t change and that minority insterest is used to offset the additional assets. However, it is listed in the equity section in IFRS and between Liabilities and Equity using GAAP accounting. For it to be a contra-asset, it would have to be in the assets section. I know that schweser says that ROE should be the same under consolidation as the other methods, but I am just trying to understand how since minority interest is categorized as equity (at least for IFRS). I can understand that it is not counted as equity in U.S. GAAP and am fine with the calculation of ROE, however, IFRS is the one that I am having problems with. Best, TheChad
Yes, I wasn’t thinking. See my last post.
TheAliMan Wrote: ------------------------------------------------------- > Ok, here is the catch: > > “minority interest is included in equity” > > Minority interest is a DEDUCTION in equity, it > represents the interest not owned by the parent > which will make it equivalent to equity under the > “equity method” So you are saying that schweser’s definition of equity in this context is only referring to the parent company’s equity? Below is a simple example of where I am confused: ************************************************************************ Company A plans on purchasing 80% of company B for $80,000. All of company B’s assets and liabilities have a book value that are equal to their fair value. The beginning balances of each of the companies are as such (Assume IFRS accounting) Company A: Cash: $100,000 Other Assets: $80,000 Total Assets: $180,000 Total Liabilities: $180,000 Total Equity: $0 Company B: Total Assets: $200,000 Total Liabilities: $100,000 Total Equity: $100,000 After the transaction, company A will pay $80,000 for 80% of company B’s net assets of $100,000. The balance sheets afterwards are as such under the consolidation method: Company A: Cash: $20,000 Other Assets: $280,000 Total Assets: $300,000 Total Liabilities: $280,000 Minority Interest: $20,000 Total Equity: $20,000 Under the Equity method, Company A would look like: Company A: Cash: $20,000 Other Assets: $80,000 Investment in Co. B: $80,000 Total Assets: $180,000 Total Liabilities: $180,000 Minority Interest: $0 Total Equity: $0 *********************************************************************** As you can see, the minority interest must be added to equity in order for the BS to balance and that there is a difference between the equity method and the purchase method. Am I doing something wrong? Best, TheChad
Chad, Your method is correct. Under Consolidation Method, your equity is $20,000, but the PARENT’S Equity is 0. Look at it this way: You are acquiring 80% of the assets of a company, meaning 20% of the ownership is not owned by you. Under consolidation, your total equity is $20,000 but the _parent’s_ equity (what you would use to make ratio analysis calculations) is the number after the _deduction_ of minority interest, since minority interest doesn’t represent the equity of the parent’s shareholders. Ask yourself this: if you are deducting the net income by the minority interest portion, why wouldn’t you do the same with equity? Therefore, Total equity - minority interest = 0 This is equivalent to the equity in the ‘equity method’ which is also zero. The minority interest is there under Consolidation Method because you are presenting the TOTAL assets of the subsidiary, therefore you also have to the balance the assets owned by the non-controlling company in your balance sheet (in either liabilities or equity depending on accounting standards). In recap, and as mentioned above by JP and map1, it doesn’t really matter where its listed, either under liabilities as a positive amount, or under equity to be subtracted for ratio calculation. It’s there to balance reporting the full amount of the consolidated assets, but not used in the ratio analysis in ROE since we are only focusing on analyzing the parent and not non-controlling entities.
Perfect, that was the answer I was looking for. Thanks for everyone’s help. Best, TheChad
No thank you. Helped me out at the same time 