Equity Method vs. Consolidated vs. Proportionate Consolidated

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jdane416

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Can someone please help me out by explaining what exactly the difference between these methods are, when to use, and how to tell which is being used? I’ve been doing reviews from Schweser Book2 and I just can’t seem to nail this topic down at all (especially for problems involving looking at a Balance Sheet and determining method used).
Any help would be greatly appreciated. Thanks.
 
Does anyone come on here to actually talk about exam questions anymore? The only posts I ever see are in regards to “How much time should I study” or “Is this enough time to study” or “How do I study”. People, get over it, man up and just start studying already.
Back to the topic at hand, can anyone help me with this?
 
only reason i didn’t type here was i could be writing all day. it’s a pretty broad question. if you’re company A and you’re investing in company B- let’s say 25% or 50% or going into to some joint venture with company B, you’re going to have to account for these things on your financial statements. eq/prop consol/consol are the more or less rules of how to do this. rough guidelines are 0-20% passive minority- the whole avail for sale, HTM, etc if you have no control, 20-50% w/ control equity, 50/50 type venutures prop consol- except not allowed by US GAAP so there it’s still equity, over 50% and control, consolidation… etc… those sorts of rules you’ll find in schweser. it’s about how much of the company you own, influence over the company, and then how to account for the investment on your balance sheet, I/S, etc.
is there a specific practice prob question that you want to go through? i’ve found on this board that most of the time, the more you can drill down to a specific question vs the i don’t get the whole concept of XYZ, the better results you’ll get back. i’m happy to look at any questions and try to help if i can. my books are at home, but i’ll be studying tomorrow and can take a look.
 
bannisja -
Thanks for the reply. There was a question from the QBank that I had been working on earlier that caused me to bring this up. Unfortunately I don’t have the software on my work computer but when I get home tonight I’ll post the problem.
 
jdane416 Wrote:
——————————————————-
> Can someone please help me out by explaining what
> exactly the difference between these methods are,
> when to use, and how to tell which is being used?
Consolidation: Used when you have control of a company (usually controlling interest is greater than 50%, but this is a guideline and not a steadfast rule. If the question states “assume control” or something to that affect, that would be your clue that consolidation is going to be required). All revenues, Expenses, Assets and Liabilities are recognized on the statements. HOWEVER, if you don’t own 100% of the company you are consolidating, it wouldn’t be prudent to include all of its income, expenses, assets & liabilities in your statements without making an adjustment. As such, you need to account for the amount you don’t own with Minority Interest (or equivalently for IFRS, noncontrolling interest). If you are just looking at a balance sheet and you happen to see a minority interest (or noncontrolling interest) account, than there has been some consolidation of a company that is not 100% owned.
Proportionate Consolidation: Can be utilized under IFRS when there is a joint venture (the book actually states that it is the preferred method under this methodology). The equity method is also allowed under IFRS. Under US GAAP, equity method should be used. With proportionate consolidation, you recognize the proportion that you own of the investee in your statements only (i.e., 50% of its revenues, expenses, assets, liabilities…). As you are already accounting for the amount that you own (and not including the proportion that you don’t), there is no need to make a noncontrolling interest adjustment.
Equity Method: Generally used when you own 20 - 50% of a company. However, the 20 - 50% is just a guideline, not a steadfast rule. It is actually whether a company can exert significant influence over the other company (representation on the BOD, participation in the policy-making process, material transactions between the two parties, interchange of managerial personnel or technological dependency). You recognize the investee on your balance sheet, initially at cost, as an asset (generally as a non-current investment). The investor’s share of the investee’s reported net income, adjusted for certain cost amortizations, shows up as a single line on the income statement. Dividends received are a return on capital and bypass the income statement.
Not sure what exactly you want to know, but that’s a brief summary. I haven’t looked at this stuff in a month so I might be a tad off base, but I’m pretty sure that’s all correct. If in the question, they state control, think consolidation. If they state significant influence, think equity method. If they state joint venture, think equity method if its US GAAP. If the JV is being accounted for under IFRS, hopefully they will state in the question whether they want proportionate consolidation or the equity method (because it really could be either).
 
looks good Jenson, it is important to note like he said that the 20-50 guideline is just that. if you see the words significant influence over another company, you would choose the equity method over the cost method even if there is less than 20% ownership of another company
 
jdane,
Could you advise how much time I should spend studying these various methods before I might be able to nail this topic down?
 
Jensen -
Thanks for the help. I guess my biggest problem is just being able to read a financial statement and “uncover” this information. The problem that’s been bothering me is included below:
(Sorry, this isn’t posting very well. For those with QBank, its Question ID#: 89473)
Joseph Haggs, CFA, is an analyst working for Garvess Jones, a large publicly traded investment-baking firm. Haggs covers the Internet sector. Recently, one of the more successful companies Haggs covers, Simpson Corporation, made an aggressive move to acquire another Internet company, Bailey Corporation (BC). BC is a company specializing in graphics and animation on the World Wide Web and has 1,000,000 shares outstanding. Simpson also holds minimal investments in other technology companies both public and private. In 1999 Simpson saw an opportunity to substantially increase its share in BC. Simpson feels that their sophisticated animation can greatly improve Simpson’s market share and sees an acquisition as an opportunity to expand their business. The relevant financial data are in the following tables.
Bailey Corporation
Selected Financial Data, Years Ended December 31
(in Thousands)
Item 1998 1999 2000
Sales $50,000 $60,000 $70,000
Less: cost of goods sold (COGS) 37,000 43,700 47,250
Earnings before interest & taxes (EBIT) 13,000 16,300 22,750
Less: Interest 10,000 13,000 19,000
EBT 3,000 3,300 3,750
Less: Taxes 1,000 1,100 1,250
Net Income $2,000 $2,200 $2,500
Dividends Paid $1,000 $1,200 $1,500
Total Shares Outstanding 1,000,000
Simpson’s Purchase Transactions in BC’s Stock
Date January 1, 1998 January 1, 1999 January 1, 2000
Number of Shares 10,000 290,000 700,000
Price per Share 10 11 15
Because this is the largest acquisition in Simpson’s history, Mr. Haggs’ supervisor has asked him to prepare a report for Garvess Jones’ clients detailing the affects of the acquisition on Simpson’s financial statements.
Haggs wonders which accounting method Simpson uses to calculate the book value of the BC investment for the year ending December 31, 1999. Which is the correct method?
A) Consolidation method.
B) Equity method.
C) Cost method.
——————————————————————————–
Haggs wonders which accounting method Simpson uses to calculate the book value of the BC investment for the year ending December 31, 1998. Which is the correct method?
A) Equity method.
B) Consolidation method.
C) Cost method.
——————————————————————————–
Haggs wonders which accounting method Simpson uses to calculate the book value of the BC investment for the year ending December 31, 2000. Which is the correct method?
A) Equity method.
B) Pooling-of-interests method.
C) Consolidated method.
——————————————————————————–
Haggs wants to make sure that he assumes the proper accounting method when he does his analysis. The acquisition of BC stock will lead to Simpson’s total net cash flow equaling which of the following for the year ending December 31, 1999?
A) $−3,190,000.
B) $−2,830,000.
C) $360,000.
 
My answers:
Q1. As of Dec 31, 1999 —>
Simpson’s owns 300K shares out of 1000K shares - so 30% ownership. (based on number of shares only). This would imply it is in the 20-50% ownership. So Equity Method. Choice B.
Q2: As of Dec 31, 1998 –>
10K shares - so 10/1000 = 1% shares. So it would be a passive investment – which would be at Cost. Choice C.
Q3: as of Dec 31, 2000 –> 100% ownership. So Consolidated Method – Choice C.
Q4: Equity Investment as of Dec 31, 1999 –>
11*290000 = 3,190,000
Less % of Dividends paid: 30% of 1200000=360,000 Answer B
Are these correct?
So Net Cash flow = 3190-360=2,830,000
 
here goes (this officially kicks off AF study season)
1. owns 30%, equity method, B
2. only owns 10k shrs, cost method, C
3. owns it all, consolidation, C
4. asks for CASH FLOW, so you paid for 290k shrs x $11/shr = (3,190,000)
but you get cash flow in of the dividend, own 300k shrs in 1999, divs are 1200 or 1.2 a shr, so 1.2 x 300k = $360k on the pos side.
net is (2,830,000) i get B
cpk, i’m starting to learn… agreeing with you is a good idea.
what I’d LOVE to do is go through the whole investment account from year 2.
cash (3,190,000)
investment 3,190,000
net income adds 660k to the invesment
divs drop the investment 360k but add to cash 360k.
so net cash for the year as we said is (2,830,000) and cpk, agree invesment acct then end of year would be 3,490,000?
just want to make sure that part i have locked down as well.
 
that looks right to me.
total investment account at year end = 3190 (Investment) + 30%(2200-1200) = 3190 + 300 = 3490K
 
cpk123 and bannisja — You guys are both CORRECT.
Thanks for the help. I can’t believe it was really as simple as just looking at shares of ownership. I kept getting that last part wrong because I was trying to calculate investment and not just Cash Flow for the year… careless.
 
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