FINANCIAL REPORTING & ANALYSIS: INTERCORPORATE INVESTMENTS

CFA Level II Cheat Sheet

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OWNERSHIP & ACCOUNTING METHOD

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EQUITY METHOD FORMULA & MECHANICS

Carrying Value at Year-End: $$\text{Ending Investment} = \text{Beginning} + \text{Share of NI} - \text{Dividends Received} - \text{Amortization of Excess}$$ Key Points:

• Income statement: Only one line—investor's share of NI (no visibility into revenue/expenses)

• Balance sheet: Investment shown as single asset, net of dividends

• Dividends = return of capital (NOT income)

• Excess FV over BV must be identified, allocated, and amortized

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CONSOLIDATION vs. EQUITY METHOD: RATIO EFFECTS

|---|---|---|---| → Analyst Action: For equity method investments, proportionally consolidate (multiply by ownership %) to assess true economic leverage and asset base. ---

PURCHASE PRICE ALLOCATION (PPA)

Goodwill = Acquisition Price − FV of Net Identifiable Assets

Post-Acquisition Effects on Financials:

• Depreciation/Amortization ↑: Step-up in PP&E, identifiable intangibles → lower EBITDA margins, lower NI

• Asset Base ↑: Return on Assets (ROA) reduced

• Goodwill ↑: Balance sheet larger (relevant for impairment testing)

Analyst Flag: Goodwill-heavy acquisitions signal overpayment risk. Compare goodwill % to synergy justification. ---

GOODWILL IMPAIRMENT

|---|---|---| One-Step Impairment (US GAAP): $$\text{Impairment Charge} = \text{Carrying Value} − \text{Fair Value (reporting unit)}, \text{ capped at goodwill}$$ Red Flag: Large impairment charges suggest management overpaid or synergies failed. ---

VARIABLE INTEREST ENTITIES (VIEs) & CONSOLIDATION OVERRIDE

|---|---|---| Analyst Risk: Off-balance-sheet VIEs → understated leverage and overstated ROA. Always adjust for:

• Add VIE debt to parent debt

• Add VIE assets to parent assets

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NON-CONTROLLING INTEREST (NCI)

Definition: Minority equity stake in consolidated subsidiary Financial Statement Placement:

• B/S: Separate line in equity section

• I/S: NCI in net income deducted from consolidated NI

Key Ratio Effect:

• Consolidated NI = Parent NI + NCI share − then NCI deducted

• Return to Parent Shareholders must exclude NCI income

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HIGH-YIELD DECISION TREE

`` Start: Company A holds equity in Company B ├─ Does A have >50% voting control? │ ├─ YES → CONSOLIDATE (100% of B's items + NCI for minority) │ └─ NO → Continue │ ├─ Does A have significant influence (20–50%) or management contracts? │ ├─ YES → EQUITY METHOD (share of NI, investment on B/S) │ ├─ Does A control B without voting (VIE/SPE)? │ │ ├─ YES → CONSOLIDATE as primary beneficiary │ │ └─ NO → Continue │ └─ NO → Continue │ └─ A has passive investment (<20% or no influence) └─ FAIR VALUE METHOD (mark-to-market, no equity method) `` ---

COMMON PITFALLS & EXAM TRAPS

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Ownership %	Influence	Method	Key Feature
<20%	Passive	Fair Value (FV)	No equity method; mark-to-market
20–50%	Significant	Equity Method	Share of NI on I/S; investment adjusted on B/S
>50%	Control	Full Consolidation	100% of all line items + Non-Controlling Interest
Joint Venture	Joint Control	Equity Method or Proportionate Consolidation	IFRS 11: equity method preferred
Metric	Consolidation	Equity Method	Impact
Revenues	100% of subsidiary	Parent only	Consolidation ↑ revenues
Assets	100% of subsidiary assets	Single investment line	Consolidation ↑ assets, ↓ asset turnover
Net Income	After subsidiary amortization/depreciation	Share of NI only	May differ on amortization timing
Margins	Subsidiary expense embedded	Hidden (NI aggregated)	Consolidation more transparent to ratio distortion from PPA
Leverage	100% of subsidiary debt	Off-balance-sheet	Consolidation shows true debt; equity method understates leverage
Aspect	US GAAP	IFRS
Amortization	NO (public co.)	NO
Testing Frequency	Annual (or triggering event)	Annual (or triggering event)
Impairment Calculation	Carrying value − Fair value of reporting unit	Recoverable amount test (higher of value-in-use / FV less costs)
Reversal	NOT permitted	NOT permitted for goodwill
Control Metric	US GAAP (ASC 810)	IFRS 10
Criterion	Primary beneficiary absorbs majority of expected losses/returns OR has power to direct key decisions	Power over investee + exposure to variable returns + ability to use power to affect returns
Consolidation	Yes, by primary beneficiary	Yes, when control criteria met
Voting %	Irrelevant (can be <50%)	Irrelevant (can be <50%)
Trap	Correct Approach
Forgetting amortization of excess under equity method	Always extract excess FV,