R.14 - Intercorporate Investments

Question 1

Investments in other companies

Example of Equity Method problem

Answer 1

2016

I/S is prorate NI + Divs = $150

• $120 NI
• $30 Div

B/S End Investment = $1,090

• Beg Inv = $1,000
• • RE $90 (120 NI - 30 Div)

Question 3

Investments in other companies

< 20% Ownership

Answer 3

< 20% ownership is a Financial Asset (passive investment, no-significant influence)

Accounting treatment is 3 Shoe Boxes (3SB)

• Held-to-Maturity (amortized cost) debt only
  
  • B/S: = CV
  • I/S: Interest(full), realized g/l
• Available for Sale (FV through OCI) D&E
  
  • B/S: FV / OCI reflects cumulative U/R gain, _/_ OCI is u/r g/l for period
• Trading Securities (FV through profit/loss) D&E
  
  • B/S: FV
  • I/S: Interest + U/R g/l. (when sold, deduct u/r gain/loss from sale gain so not double taxed!)

Question 4

Investments in other companies

Acquisition Method

(Application, B/S, I/S)

Answer 4

Application

• Influence > 50%

B/S (4-steps)

1. Adjust Parent’s B/S to FMV per investment financing activity (cash, debt, stock?). No investment acct.
2. Adjust Sub’s B/S to FMV and remove Equity (All! Common, RE, Paid-in-cap, etc!)
3. Create MI minority interest for (non-purchased share of equity still owned by sub)
4. Calculate GW goodwill [full-GAAP vs full-or-part IFRS]
5. Combine A&L 100% of both firms (net of inter company transactions). Include all of Parent’s Equity.

I/S (3-steps)

1. Adjust Sub’s I/S to FMV (if needed)
2. Add Parent’s % share of Sub’s NI (post-acquisition) and/or Remove sub’s earnings from parent (dividends)
3. Combine Rev & Exp 100% (net of inter company transactions)

Question 5

Investments in other companies

Partial and Full Goodwill

• Define each
• How do they relate to each other (IRFS/GAAP, values, etc)?

Answer 5

Partial goodwill

GW_partial = $ - [%_(owned) x FMV_NA]

_{<span> </span>} = [PurchasePrice] - [Prorata share_{(% owned)} of FV Net Assets]

MI = %_(not-owned) x FV_NA

• ​Allocated to cash generatign units (if recoverable amount of unit is < carrying value, recognize difference as impairment
• Impairment:
  
  • Loss recognized in I/S as line-item. ​
  • = BV - Recoverable amount of cash generating unit
  • 1-step

Full goodwill: considers total value of sub when calculated. US GAAP requires full. IRFS allows as option

GW_Full = FV_sub - FV_NA

= [^Purchase$ / _{% owned}] - FV_NA

MI_Full = %_(not-owned) x FV_SUB

• Allocated to reporting units, i.e. operating segment or component.
  
  • ​Think US GAAP for this
• Impairment: 2-steps

Question 6

Investments in other Corporations

Key Comparisons of Equity Method (EM) vs Acquisition Method (AM)

Answer 6

EM vs AM

< Equity (by amount of minority interest)

< Assets & Liabilities

< Sales & Expenses

= NI

> Net Profit Margin

> ROE

> ROA

Question 7

Investments in other Corporations

Investment Ownership Types

Answer 7

Question 10

Investments in other companies

Equity Method

(Applicable scenarios, B/S, I/S, Analyst issues)

Answer 10

Applicable w/ Significant Influence…generally >20% but ≥ 50% owned and includes joint ventures. Called 1-line item consolidation b/c only one entry each on B/S and I/S.

B/S

• 1-line: investment is Asset listed at-cost + prorata Earnings - prorata DIVs (Note - dividends shown separately as Cash on B/S)
• Analyst issues
  
  • Nettings assets against liabilities may obscure liabilities and understate leverage

I/S

• 1-line: prorata earnings
• Analyst issues
  
  • only share of NI shown
  • earnings may not distribute dividends