Accounting for Financial Modeling

Accounting for Investments:

Equity Method
 Investments
Company A
“Investor”

Balance Sheet:
Balance Sheet: Balance Sheet:
Acquisition
Cost Method Equity Method
(Consolidation)

Company B Company C Company D

equity investment: equity investment: equity investment:

no influence or control significant influence, no control control
(less than 20% ownership) (20% - 50% ownership) (over 50% ownership)

debt securities
 Equity Method of Accounting
When investment results in significant influence but not full control over the investee (C Corp), we use
equity method to account for the investment on the balance sheet

Under the equity method, investment is measured at purchase price (equity investment, equity
investment in affiliates or associates)

Proportional affiliates net income is reflected on the investor’s income statement as affiliate income

The value of the affiliate investment on the balance sheet is adjusted for affiliate income (+) and
affiliate dividends (-)
 Example

1. Suppose that a company purchase equity securities

for 100 at the beginning of year 1 (ownership 20% in
Period Year 1 Year 2 Year 3 Year 4
investee);
Investment beginning balance 100.0 102.0 102.4 102.7
Affiliate net income attributable to investor 2.0 2.4 2.8 3.2
2. Assume that investee equity is 500 (purchase
Affiliate dividends atrributable to investor - 2.0 2.5 3.0
price equal book value);
Investment closing balance BS 102.0 102.4 102.7 102.9
3.The investee reported net income of 10 in year 1,
which increased by 2 in each subsequent year; Period Year 1 Year 2 Year 3 Year 4
Affiliate net income 10.0 12.0 14.0 16.0
4.The investee paid dividend of 10 in year 2, 12.5 Affiliate net income attributable to investor IS 2.0 2.4 2.8 3.2
in year 3, and 15 in year 4;
Period Year 1 Year 2 Year 3 Year 4
5. Assume no tax is payable on investee’s income Affiliate dividends declared - 10.0 12.5 15.0
and dividend attributable to investor; Affiliate dividends atrributable to investor CFS - 2.0 2.5 3.0

6. Show the carrying value of the investment on

the balance sheet.