Follow ownership through the financial statements

Learning goals

• Calculate the closing equity-method carrying amount.
• Explain why reduce the investment by 3 applies to this case.
• Identify the case-specific assumption or failure mode before taking action.

Draft · approximately 50 minutes, excluding further revision.

Shared case and decision context

Orchid acquires 30% of an associate for 120 and has significant influence but no control. The associate earns 40 and pays dividends 10. No acquisition-basis differences, impairment or intercompany profits apply. A separate controlled acquisition has consideration 200, NCI fair value 50 and identifiable net assets 220.

Economic or professional mechanism

Under the equity method the investor recognizes its share of the associate’s earnings and reduces the investment for dividends received. Dividends are not a second income stream on top of the recognized share of profit. Consolidation instead combines controlled assets and liabilities and presents the outside ownership as NCI; legal ownership percentage alone is not a complete control test.

Apply, challenge and communicate

The equity-method carrying amount becomes 129. In the separate full-goodwill example goodwill is 30. Acquisition-date fair-value adjustments, their amortization and elimination of unrealized intercompany profits can change later earnings. Compare leverage, margins and ROA only after understanding consolidation scope and the treatment of associates.

Compare standards before comparing investment ratios

Both IFRS and US GAAP use significant influence and control concepts, but detailed classification and measurement rules differ. IFRS permits reversal of some impairment losses on equity-method investments when recoverable amount rises, subject to the applicable rules; US GAAP generally prohibits reversal for the equity-method investment. IFRS uses a single expected-credit-loss framework for amortized-cost assets with staging, whereas US GAAP CECL recognizes lifetime expected losses for its covered amortized-cost assets. Do not infer identical earnings from an identical ownership percentage. Reconcile instrument category, impairment policy and consolidation conclusions first.

Acquisition-basis depreciation and the equity-method roll-forward

Extend the associate example with a separate acquisition-date fact: the investor’s 30% share of an identifiable depreciable asset’s fair-value uplift is 12, its remaining life is six years and no tax effects apply. The investor’s annual excess depreciation adjustment is 2. Equity-method income becomes 30%×40−2=10; the closing investment becomes 120+10−3=127. The adjustment uses the investor’s share of the uplift, not 30% of that share again.

Dividends reduce the investment because the earnings were already recognized through the share-of-profit line. Acquisition goodwill included within the equity-method carrying amount is not separately amortized as a depreciable asset. Before comparing associate-heavy and consolidated groups, bridge the line-by-line assets/debt versus a single investment balance and distinguish accounting presentation from the investee’s economic leverage. This extension deliberately omits impairment, tax and intercompany eliminations so each additional assumption is visible.

Formula and assumptions

Equity-method close=opening+share of profit−share of dividends; full goodwill=consideration+FV(NCI)−FV(net assets)

Case analysis with explicit assumptions

1. Orchid acquires 30% of an associate for 120 and has significant influence but no control. The associate earns 40 and pays dividends 10. No acquisition-basis differences, impairment or intercompany profits apply. A separate controlled acquisition has consideration 200, NCI fair value 50 and identifiable net assets 220.
2. Method: Equity-method close=opening+share of profit−share of dividends; full goodwill=consideration+FV(NCI)−FV(net assets)
3. Case result: 129. The equity-method carrying amount becomes 129. In the separate full-goodwill example goodwill is 30. Acquisition-date fair-value adjustments, their amortization and elimination of unrealized intercompany profits can change later earnings. Compare leverage, margins and ROA only after understanding consolidation scope and the treatment of associates.

Errors to catch

• Do not replace the stated assumptions with an unstated shortcut. Reconcile units, timing and the claim being valued or duty being assessed.
• Treat 30% ownership as automatic consolidation is not a defensible conclusion for these case facts.

Original knowledge check

Answer every question before checking. Review explanations after submitting; retry starts a new attempt.

Sources and coverage status

These original lessons are drafts. Public outlines are used to check scope; the official learning-outcome text and proprietary question banks are not reproduced here. Follow the source for exam-year requirements and updates.

• Reference · www.cfainstitute.org
• Reference · www.ifrs.org
• Reference · www.ifrs.org