This is the last part in the series covering different methods of consolidation with examples. In this part we will cover equity method and one scenario based on it.
Equity Method:
Equity method is applied whenever we own 20 to 50 percent stake in the target company.
Step 1
Recording the cost of investment at fair value
Investment in Subsidiary Account should be debited.
It will be an asset account.
Step 2
Investor Company recognizes its share of the associate’s net income
Net profit/loss should be added/subtracted in ‘Investment in Associate’ account
Separate line item in income statement
- Equity in investee income
Step 3
When the investee company declares dividend the ‘Investment in Associate’ account would be credited.
Scenario Equity Method
On 1st April 2010, Company P buys 20 percent of Company S for Rs. 200 million
Investment in S 200
Cash 200
On 31st March2011, Company S reports net income of Rs 50 million. Now since we own 20 percent stake in the target company, our investment in the target company will increase by 10 i.e. 20 percent of 50 million.
Investment in S 10 ( =50*.20)
Equity in S’s Income 10
On 31st March 2011, Company S declares dividend Rs 10 million. As we own 20 percent stake in the target company we will get 20 percent of 10 million i.e. 2 million. Cash in the parent company will increase and investment in the target company will go down.
Cash 2
Investment in S 2
Also,
Please find below the links of all blogs in this series:
Part 1: Demystifying Financial Consolidation Part I
Part 2: Demystifying Financial Consolidation Part II
Part 3: Demystifying Financial Consolidation Part III
Part 4: Demystifying Financial Consolidation Part IV
Part 5: Demystifying Financial Consolidation Part V
Part 6: Demystifying Financial Consolidation Part VI
