In this lesson, you'll learn how to reflect Net Income and Dividends from Equity Investments - also known as Associate Companies or Investments in Equity Interests or Partially Owned Subsidiaries, among other names.
By http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
Once again, we'll use Liberty Media's acquisition of 27% of
Charter Communications for the case study here.
According to accounting rules (under both US GAAP and IFRS), when
a parent company owns between 20% and 50% of another company and
exerts "significant influence" (among other rules), it is required to
apply the "Equity Method of Accounting for Investments."
This means that the ownership in this other company is recorded as an
Asset on the Balance Sheet, and that:
1. On the Income Statement, the parent company (Liberty Media) must ADD
its percent ownership * Charter Communication's Net Income at the bottom.
2. On the Cash Flow Statement, the parent company then SUBTRACTS that portion
of the Net Income... because it's non-cash.
Think of it like this: if you buy stock in a company and the company earns
Net Income, do you physically receive that Net Income in cash?
You only get cash if the company chooses to issue some of that Net Income in
the form of Dividends... and it's exactly the same here.
If the other company has recorded a Net Loss, then you'd just record
% Ownership * Net Loss on the Income Statement, making Net Income at the
bottom lower... and then add back that number on the CFS.
3. Then, you ADD the parent company's portion of dividends received from
the other, partially owned company.
Because the parent company actually DOES receive those dividends in cash, so
they SHOULD increase its cash balance.
So you record Other Company's Dividends Issued * % Ownership as an addition
on the Cash Flow Statement.
As a result of all this, cash at the bottom of the CFS increases by the portion
of dividends the parent company receives from the other company.
4. Finally, on the Balance Sheet:
Here, you just ADD the portion of Net Income from the other company, and
SUBTRACT the portion of Dividends to the Equity Investment line item.
Example: You own 30% of another company.
The Investments in Equity Interests line item is $1,000 currently.
The other company records $100 in Net Income and issues $20 in dividends.
Therefore, Investments in Equity Interests increases by $100 * 30%, or $30,
and decreases by $20 * 30%, or $6, so overall it goes up by $24.
If you had a Net Loss from the other company, that would cause this line item
to decrease instead.
This line item is sort of like a "mini-Shareholders' Equity" but for 20% to 50%-owned
There's probably an official accounting explanation somewhere, but that's how I
think of this concept.
In Part 3 of this series, we'll walk through what happens when Liberty Media
increases its ownership in Charter.
And then in Part 4, we'll walk through what happens when Liberty Media sells its
ownership in Charter and no longer owns any stake in the company.