Question

1. Differentiate between (a) the equity method, (b) the initial value method and (c) the partial equity methods with core assumptions and with supported illustrations?
(Make you own assumption to support your illustrations)

2. With reference to IAS 21 The Effects of Changes in Foreign Exchange Rates compare and contrast between the two translation methods (a) temporal method exchange rate and (b) current rate method exchange rate with supported illustrations?

Answer 1

As per the guidelines given, I am supposed to do only the first question, since there are more than one separate questions asked.

Answer 1

1. The Equity method

In this method, the acquiring company uses the equity method when it purchases a significant minority equity stake -- generally a minimum of 20 to 25 percent -- in another firm, the investee. The equity method is an accounting methodology used to account for holdings of less than 50 percent in which the investor exerts pronounced influence. This influence involves strategic, financial and operational decisions of the investee.

Example

TLC Inc. purchases 30% of ZMR Corp for $500,000. At the end of the year, ZMR Corp reports a net income of $100,000 and a dividend of $50,000 to its shareholders.

When TLC Inc. makes the purchase, it records its investment under “Investments in Associates/Affiliates”, a long-term asset account. The transaction is recorded at cost.

Dr.	Investments in Associates	500,000
	Cr.	Cash	500,000

TLC Inc. receives dividends of $15,000, which is 30% of $50,000, and records a reduction in their investment account. The reason for this is that they have received money from their investee. In other words, there is an outflow of cash from the investee, as reflected in the reduced investment account.

Dr.	Cash	15,000
	Cr.	Investments in Associates	15,000

Finally, TLC Inc. records the net income from ZMR Corp as an increase to its Investment account.

Dr.	Investments in Associates	30,000
	Cr.	Investment Revenue	30,000

The ending balance in their “Investments in Associates” account at year-end is $515,000. This represents a $15,000 increase from their investment cost.

This reconciles with their portion of ZMR’s retained earnings. ZMR has Net Income of $100,000, which is reduced by the $50,000 dividend. Thus, ZMR’s retained earnings for the year are $50,000. TLC’s portion of this $50,000 is $15,000.

1. Initial Value Method

• Uses cash basis for income recognition
• Dividends received are recognized as income
• No recognition to income by subsidiary
• Investment in sub remains on permanent on books at initial fair value

1. The Partial Equity method

This method is also known as Proportional Consolidation Method. This method of accounting records the assets and liabilities of a consolidation of a company’s balance sheet in proportion to the percentage of participation a company maintains in the venture. In calculating those assets and liabilities, the company would list all income and expenses from the consolidated statement and includes them on its balance sheet and income statement.

For example, if Company X has 50% controlling interest over Company Y, Company X would record the investment at 50% of the assets, liabilities, revenues, and expenses of Company Y. So if Company X has revenues of $100 million and Company Y has revenues of $40 million, Company X would have in total $120 million.