# Equity Method

I am confused. This is a line taken right out of schweser. “Under the equity method, the investor also reports a proportionate share of the investee’s net assets”. however, in all the examples I’ve seen, none of the investee’s assets are moved to the balance sheet of the parent. Which is it? Is schweser contradicting itself or am I misunderstanding something? Thanks in advance for any response.

it’s not about investee’s assets but a proportionate share in NET assets

so in all the examples i have seen, if you buy a portion of a company, and you use the equity method, your assets do not change at all. all assets are the same, but you just add to assets and equity the amount that you paid for the company? Is that correct?

Look at the example of p. 135. The investment in the subsidiary is on the balance sheet. It is based on the percentage of ownership * the net assets. Then as income is earned in the sub the parent is must include a proportiate share of the income on the income statement. Note that this amount goes below operating income, but is included in net income. There might be a tricky question on operating ratios. Whatever amount flows through the income statment will increase the investment of the balance sheet minus any dividends paid. EDIT: You beat me to it.

gustobub2 Wrote: ------------------------------------------------------- > so in all the examples i have seen, if you buy a > portion of a company, and you use the equity > method, your assets do not change at all. all > assets are the same, but you just add to assets > and equity the amount that you paid for the > company? Is that correct? Your assets don’t really change in agg. amount. You have paid say 1000 for the invesmtent in the sub. So your cash goes down 1000, but your investment is S is up 1000. You aren’t bringing up the assset of the sub to your balance sheet like in a true consolidation.

mwt9 captured the picture it really depends if how much you paid for is reflected on balance sheet initially if price paid> that net tangible assets you atribute the difference to intangile assets if you still have an amount left you attribute it to goodwill, then you check for impariments yearly. the bottom line is that you relfect a portion of income from subsidiary income- div= amount that increases yearly your share in the subsidiary

florinpop Wrote: ------------------------------------------------------- > initially if price paid> that net tangible assets > you atribute the difference to intangile assets if > you still have an amount left you attribute it to > goodwill, then you check for impariments yearly. Florinpop - There is no goodwill involved when you are talking about the equity method. This only comes into play when you acquire controlling interest and consolidate. You are mixing up your concepts.

Super just goodwill does not come into play? I see there is an example where company A buys 50% of B worth 400 for 1900. they account for the 1500 difference as being assigned to depreciable assets(of course goodwill is not here). so if you overpay for a % ownership in equity method you do not account for goodwill but if it’s over 50% you can attribute some of that value to goodwill?

florinpop, Under the equity method you have one line on your balance sheet called something like “Investment in unconsolidated affiliates”, or just “Investments”. It’s your cost plus your proportionate share of the investee’s earnings less dividends that were paid back to you. There is no writeup of assets because they don’t get placed on your balance sheet. The example you are talking about with 50% is probably deemed a controlling interest so its following consoldiation rules. there is no concept of “overpaying” here. When you buy a controlling interest you are paying for that company’s capacity to generate an earning stream in the future which exceeds the FMV of its assets… maybe due to exceptional efficiencies, market share, name recognition, etc., and you control how that is used. Whether its equity level or a single share, you ignore the fact that your piece of the market cap of the company is likely in excess of the FMV of the net assets.

oh great…now i’m confused… if you record what you pay as Investment in subsidiaries, under the equity method,…then where is the amount Percentage Ownership*Net Assets going??

We have a new account in the ‘Assets’ section of ‘Balance Sheet’ as below Investment in unconsolidated subsidiaries = Original cost of the investment + proportional share of the subsidiaries earnings - dividends paid out by subsidiaries to the parents So if the subsidiary was worth \$3333.33 (Net assets) and the Parent company ‘P’ has 30% ownership in subsidiary ‘S’. Then the initial cost of the investment in the subsidiary will be = Percentage of Ownership * Net Assets = 0.30 * 3333.33 = \$1000 And now if the company earned \$400 with the DPR of 25%, means that 25% of earnings will be distributed as dividends. Hence 400*0.25 = \$100 is the ROI, but not all is owned by ‘P’. Only 30% of these dividends are routed back to ‘P’ So, Investment in unconsolidated subsidiaries = 1000 + 400*0.30 - 100*0.30 = 1090 And we never consider Goodwill in Equity Method. This is what I have understood from Schweser (but got confused after reading this thread). Please confirm/correct me if I have gone wrong somewhere??

Super I am myself a little confused. Schweser is talking about purchase method. so they are talking about com A that buys 50% comp B. although net assets of b is 800 so 50% is 400 they buy it for 1900 - that is an extra 1500. then they say the 1500 is atributable to depreciable in 3 years assets which creates an additional 500 depreciation. So I guess the trick is that is a 50% aquisition under purchase method but Schweser uses Equity method.I understand that equity method only creates one account on parent balance sheet but there is a mark up and they atributte it to depreciable assets. I guess I should reread that section whenever I have time. Anyways is page 163, SS 5 in schweser

florinpop is talking about the amounts paid over book value for a certain percentage of a subsidiary. If the subsidiary is worth 1000 for book purposes and you buy 30% of it for 1000 then you have to allocated 700 to DEPRECIATION. This is then written off over the remaining life of the assets and reduces the income from the investee that is shown in hte parents net income (using the equity method). A similar process is used for consolidation and prop consolidation, but it will manifest itself in the expenses that are consolidated from the subsidiary. I think you are getting confused with the purchase method for accounting for a MERGER. So if the parent bought 100% of the subsidiary and paid more than book value then excess is attributed to sperately identifiable intangible assets (while the book value is attrebuted to the tangible assets). This amount for intangibles is amortized over the years. If there is still excess value paid it is allocated to goodwill. This is not amortized, but subject to annual impairment. This is my understanding.

mwt9 that is what I was talking about. so would it be ok if it’s equity to assume difference is attributable to depreciable assets but if its consolidation you can allocate a portion to goodwill as well if necessary?

I think that would be correct. I am not sure about say a consolidation when you own only 51% versus a aquisition/merger when you own 100% or close to that. I know it holds for the M/A, but not sure about the consolidation at lesser %. Super’s comments above seem to point to the fact that your statement would hold. Wish I could be more help.

Florinpop, if its equity, there is no additional depreciation. PERIOD. Dinesh’s post above is exactly right. This is the point where the text sucks (assuming its the same crap as last year). They have one section that talks about the purchase method, and another that talks about consolidation, when thye are basicaly the same thing (a search will find my comments on this last year). Basically, there are 3 levels of ownership. The lowest one is what we do on the retail basis - we buy some shres thur Schwab or Fidelity, have unrelaized holding G/L, relaized G/L when we sell the security, and earn dividend income. The next level is the point of significant influence which is accounted for under the equity method (exactly as described by Dinesh) which generally is done for ownerhsip levesl between 20-50% where it doesn’t give you control. If you get a controlling interest 2 things happen. First you account for the transaction on your books using the purchase method (or in the past POSSIIBLY pooling if it qualified), and then since you in all likelihood did not disolve the legal entity that was the acquiree, you have to find a method to prepare financila statements that reflect the aggreagte position of the combined, or CONSOLIDATED entity. This is the whole process where tou have to look at excess price paid over book , possible additional depreciation, goodwill etc.

Super, I tried to search and couldn’t find your post. What was it titled? This is frustrating. Schweser has an example that shows Acquirer Inc buying 50% interest in Target Inc. for \$1,900, which they say is greater than 50% of Target’s book value fo \$400 (total book value of \$800). They then assume that the \$1,500 diffence is assigned to depreciable assets with a useful life of 3 years. They then go on to describe how the transaction would be accounting for using the equity, prop consolidation and full consolidation. They are definetly saying that the amount over BV paid is assigned to depreciable assets and they write it off against the 50% of Target Inc income that they are entitiled to based on ownership %. In the example Target has net income of \$1,500 so Acquirer Inc gets \$750, but they then write off \$500 (\$1500 is excess over book dep of 3 years) for a income from equity investee of \$250. This gets them to a NI of \$1250 for Acquirer. They then go on to show the prop consol and consol. Here is my main question: Net income is supposed to be the same under all methods - Equity, prop consoldiation and consolidation. How could NI be the same with the equity method if we didn’t write off the \$500 each year? Because NI is showing as \$1250 with the additional dep with the prop consoldiation and consolidation. Stick with me if I am dense…