Why is leverage and liabilities lower if we use the equity method instead of the aquisition method…I don’t really understand this statment here: 'Under the equity method, liabilities and leverage are lower than under the acquisition method, while net profit margin, ROE, and ROA are higher.)
Under the equity method no consolidation is required ie you dont need to add line by line basis of B/S and I/S of investment in associate. you just reflect an investment account in your B/S. But in acquisition method you need to add each and every item of your subsidary’s B/S to your B/S and same for I/S.In both the cases your net income will be same.Your liabilities will be higher in acquisition method because you add your subsidary’s liabilities aswell and equity will be higher also because of minority interest being reflected in your B/S if you dont have 100%control.
Try some numbers:
- Your assets: $100
- Your liabilities: $60
- Your equity: $40
- Sub’s assets: $50
- Sub’s liabilities: $30
- Sub’s equity: $20
You pay $10 for 50% of the sub. Under the equity method:
- Your assets: $100 (= $100 (without sub) − $10 (cash paid) + $10 (50% of sub’s net assets))
- Your liabilities: $60
- Your equity: $40
Under the acquisition method:
- Your assets: $115 (= $100 (without sub) − $10 (cash paid) + $25 (50% of sub’s assets))
- Your liabilities: $75 (= $60 (without sub) + $15 (= 50% of sub’s liabilities))
- Your equity: $40
Calculate some ratios.
super helpful thank u!!