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Intercorporate investments — equity method vs consolidation

In this chapter: Investment classifications: financial assets, associate, subsidiary · Equity method · Consolidation · Joint ventures

~3 min readLayer 4 · Professional CertificationsFree

How company A reports its stake in company B depends on level of influence. <20%: financial asset (fair value or cost). 20-50%: associate (equity method). >50%: subsidiary (consolidation). Joint ventures: equity method (IFRS) or proportionate (older standards).

Foundation

Three accounting treatments: **Financial asset** (no significant influence, typically <20%): - Fair-value through P&L (FVTPL): mark-to-market, gains/losses to income. - Fair-value through OCI (FVOCI): unrealised gains/losses to OCI. - Amortised cost: held-to-maturity bonds. **Equity method** (significant influence, 20-50%): - Investment shown at cost + share of investee earnings – dividends received. - Income statement shows pro-rata share of investee net income. - Balance sheet investment grows with retained earnings of investee. **Consolidation** (control, >50% or other control): - Combine all of investee's assets, liabilities, revenue, expenses with parent. - Show non-controlling interest (NCI) for minority owners. - Eliminate intercompany transactions.

Deep Dive

Why it matters: same economic reality, different reported numbers. Example: Parent owns 30% of Associate. - Equity method: Income includes 30% of associate net income. Balance sheet shows single "investment in associate" line. - Pro-forma consolidation: revenue, costs include 30% of all line items (proportional). Different ratios result. IFRS vs US GAAP: similar but differences in: - Joint ventures: IFRS requires equity method since IFRS 11 (2013); US GAAP allows. - Special-purpose entities: control criteria slightly different. Fair-value option: under IFRS 9, investment in associates can be measured at fair value if held by venture-capital or mutual-fund entity.

Advanced

L2 vignette traps: - Goodwill on acquisition: full goodwill (IFRS option, US GAAP standard) vs partial goodwill (IFRS alternative). - Acquisition method: identify fair value of net assets at acquisition; difference = goodwill (asset) or bargain purchase (P&L gain). - Impairment of goodwill: tested annually under IFRS/US GAAP, no amortisation. Consolidation impact on ratios: - Debt/equity rises (subsidiary debt added). - ROA may fall (asset base inflated by NCI portion). - ROE less affected (parent's equity only) — but earnings include 100% of subsidiary.

Regulatory references
  • Ind AS 110 Consolidated Financial Statements
  • Ind AS 111 Joint Arrangements
  • Ind AS 28 Investments in Associates
  • CFA Institute FSA curriculum
Common mistakes & pitfalls
  • Treating all >20% holdings as equity method without checking influence (sometimes 25% holders lack influence; sometimes <20% holders have it).
  • Forgetting goodwill is not amortised under IFRS/US GAAP.
  • Missing impairment indicators on equity-method investments.

Frequently asked

Why does consolidation inflate revenue?
Consolidation brings 100% of subsidiary's revenue, even if parent owns only 60%. NCI reflects the minority claim on net income, but revenue line is undivided.
What is the equity-method "income" treatment?
Pro-rata share of investee net income (positive contribution if investee profits, negative if loss).

Practice questions

Click each question to reveal the answer and explanation.

Q 1
Parent owns 25% of Associate, with significant influence. Treatment:
  1. (a)Fair value
  2. (b)Equity method
  3. (c)Consolidation
  4. (d)Cost
Correct: (b) Equity method
20-50% with significant influence → equity method.
Q 2
Equity-method investment grows when:
  1. (a)Investee pays dividends
  2. (b)Investee earns profit
  3. (c)Parent buys more shares only
  4. (d)Both A and B
Correct: (b) Investee earns profit
Profit increases investment; dividends decrease (return of capital).
Q 3
Consolidation is required when:
  1. (a)Stake > 20%
  2. (b)Significant influence
  3. (c)Control (typically > 50%)
  4. (d)Any stake
Correct: (c) Control (typically > 50%)
Control = consolidation. Usually >50% or contractual control.
Q 4
Non-controlling interest (NCI) appears:
  1. (a)Only on income statement
  2. (b)In equity section of balance sheet + income statement allocation
  3. (c)Eliminated
  4. (d)As goodwill
Correct: (b) In equity section of balance sheet + income statement allocation
NCI shown in equity section and income allocated to parent and NCI separately.
Q 5
Goodwill on acquisition is:
  1. (a)Amortised over 10 years
  2. (b)Tested annually for impairment, no amortisation
  3. (c)Expensed immediately
  4. (d)Always written off in 5 years
Correct: (b) Tested annually for impairment, no amortisation
IFRS and US GAAP: goodwill not amortised, only tested for impairment annually.
Educational purposes only. The numbers, returns, and examples used in this lesson are illustrative. Past performance does not guarantee future results. Mutual fund and securities investments are subject to market risks. This lesson is not investment advice; for advice tailored to your circumstances, consult a SEBI-registered Investment Adviser. Read our full disclaimer.