Inter-corporate Investment

Summaries

Cost or Market Methods: for <20% ownership

Equity Method:

1)      For >20%, <50% ownerships, of have significant influence even <20%

2)      Report proportionate shares of net income (in income statement before dividend) and net asset (in balance sheet as investment in company X). Only cash flow between investor and investee is included.

3)      Market value ignored

4)      If the investee has loss, the investor has to write down the loss ONLY when the loss is permanent!

5)      Compared to cost method, this give better financial ratios if the investee has profit.

6)      Otherwise, the firm will try to own < 20% for an investee that’s not earning

Consolidated Method:

1)      >50% ownership

2)      Add all the asset and liability together (But remember that for current asset, it has to be subtracted by the investment paid to investee share holders) (Don’t add equity)

3)      Need to add minority interest at liability ((1-% ownership) * net asset of investee)

4)      All the expenses, asset, liabilities of the subsidiary are added to the parent’s. Only cash flow between investor and investee is excluded!

In summary, net income and net asset (equity) are the same for both methods. But consolidated method has larger liability and asset. So, return on Equity is the same but return on asset is different.

Proportionate Consolidation – for joint ventures

1)      Like consolidation method, includes everything, however proportionally

2)      Remember to adjust revenue, COGS, A/R, A/P buy the proportionate values of inter company transactions

3)      No minority interest