Page 21 - FINAL CFA II SLIDES JUNE 2019 DAY 5.2

Suppose that on January 1, 2010, Company P acquires 80% of READING 14: INTERCORPORATE INVESTMENTS
the common stock of Company S by paying $8,000 in cash to
the shareholders of Company S. The pre-acquisition balance
sheets of Company P and Company S are shown below: MODULE 14.6: BUSINESS COMBINATIONS: BALANCE SHEET

The table below compares the acquisition method and the equity method on
Company P’s post-acquisition balance sheet.

Under the equity method, Company P will report its 80% interest in Post-acquisition, Company P’s current assets are lower by the $8,000 cash
Company S in a one-line investment account on the balance sheet.
used to acquire 80% of Company S. Under the acquisition method, the
current assets are $56,000 ($48,000 P current assets + $16,000 S current
In an acquisition, the assets and liabilities of Company P and
Company S are combined, and the stockholders’ equity of assets − $8,000 cash). With the equity method, current assets are $40,000
Company S is ignored. It is also necessary to create a minority ($48,000 P current assets − $8,000 cash). Where does the $8000 go?
interest account for the portion of Company S’s equity that is not
owned by Company P. To the departing shareholders from whom the shares were purchased.
When using the acquisition method, Company P reports 100% of Company S’s assets and liabilities
even though Company P only owns 80%. The remaining 20% of Company S is owned by minority
investors and the difference is accounted for using a noncontrolling (minority) interest account. The
minority interest is created by multiplying the subsidiary’s equity by the percentage of the subsidiary not
owned by the parent. In our example, the minority interest is $2,000 ($10,000 S equity × 20%).
Noncontrolling interest is reported in stockholders’ equity.