Equity Vs Proportionate Consolidation

[sunpak]

Why would the shareholder’s equity be same under both the methods?
If assets of the joint venture are added to the BS, then how could equity be the same?

 

[MarcusAntoninus]

Think of this in the different stages of the investment

• When initial investment is made
• How these values change over time
• Then after 1-year how the values change

Initial Investment
Equity Method = “one line consolidation”
So you are Firm X and you spend $100 buying a 20% interest in Firm A

• Cash goes down by $100
• Add a line item in Assets for the investment in Firm A = $100

1-year Later
Firm A reports $150 in total earnings for the year & paid $40 in dividends

• Firm X adds its earnings pickup to the I/S ( $150 * 20% = $30 )
• Firm X dividends from Firm A = $8
• Firm X B/S line item change is then = $100 + $30 - $8 = $122 at year end
• Firm X total change in retained earnings will be adding their net income (less dividends) to the balance sheet

When you do proportionate consolidation you are allocating your % ownerships of a firm’s assets & liabilities to the balance sheet.
1-year Later
Firm Y invests in Firm B*
* Same $100 amount and 20% ownership

• Firm Y reports revenue, expenses, etc = their % ownership of Firm B on the I/S
• Firm Y reports A/R, A/P, LT Debt, Inventory, etc = their % ownership of Firm B on the B/S
• Firm Y retained earnings change = net income - dividends

Keep this in mind as well.
Net Income = Equity Method = Proportionate Consolidation
Shareholder Equity = Equity Method = Proportionate Consolidation
ROE = same under both
However most other ratios will be different!