As a rule of thumb (meaning in general) Is the equity method current ratio higher than the proportionate consolidation method because equity method has lower liabilities (only the parent’s liabilities) …?
equity method you have both lower liabilities but also lower assets. i think in general the statement is made that “leverage ratios” look better under equity vs prop consolidation or consolidation for this sort of reason- equity is the same under any method, but since liabilities are up with prob consolidation, something like a D/E ratio will look more favorable under the equity method. for current ratio, CA/CL, do you see it written somewhere that it says in general the ratio is more favorable under equity method? i would think this one would have a little asterics like *it depends* on what the parent company’s CA and CL’s are vs what the company you’re consolidating looks like, no?
Yeah, I usually just go by the rule that consolidation (or prop consol) makes pretty much all of your ratios look worse. If there’s any exception to this I can’t think of it right now… (that is, except ROE which never changes of course)
what if the parent co had CA = 1 and CL = 1. current ratio = 1 what if you buy half of company B that has CA = .5 and CL = .1 equity method keeps you at a current ratio 1 prop consol would take you to 1 + .25/ 1 + .05 = 1.19 (so better under prop consol) i’d think in general you go with equity method has the better ratios- especially when anything like D/E or ROA… but not sure with current ratio that you could make that blanket statement and feel great about it. the 3 things to HAMMER in your head even if you don’t understand a word on this section: EQUITY, NI, and ROE will be the same under ANY method. it’s always there and tested. don’t fall for it.
thanks y’all. Studying hard over here, baby crying, wife mad at me…
we can only make general statements if the ratios include NI, Equity …as banni said… otherwise its always specific to case…
with current ratio, the ratio is always greater than 1 (unlessthe company is insolvent or liquidiating. so if assets and liab go up then the ratio will always go down.
The show NY: wouldn’t it depend on the rate at which CA and CL go up? a) what if you issued stock to buy MASSIVE inventory. b) what if you took a short term loan to pay off your current years long term debt. anyways, i think its case by case. Usually prop consolidation will give you worse profit margins / Return on Assets. and better debt / equity ratios.
pepp, you do make a good point. however, i dont see the text addressing this scenario so unless a problem specified a situation that you described, i would assume that Current Ratio will in fact be higher under equity.
I also believe that no matter under what method, NI, Equity, ROE will be the same. However, looking at book volume 2, page 26, in example 7, Company A Venturer’s equity under the equity method is lower than proportionate method… anyone know why? thanks much =)
Hi everyone, Good discussion. yseric - I believe in example 7 on page 26, book 2, you are referring to why 2,850,000 under the equity method, and not 3,000,000 being the same as prop consol. Equity is infact the same under both methods. 2.85 million under the equity method is Debt + equity. If you subtract out the total liabilities in that example (Accounts payable and long term debt) you’d find that equity is 1million for both cases.
thanks so much target 2010…=)