Equity Method of Accounting: Minority Stakes on the Financial Statements

[@piterino3781]

Hi! Thank you very much for the video. My question is - why do we add the Equity Investment Earning from the Associate Company to the Net Income? Don't we need to tax the income as well - why is it exempt from the income taxes in your example? I would have intuitevly added it to the EBT, not influencing the EBITDA or EBIT, but ifluencing the Net Income.

[@financialmodeling]

Net Income from Associate Companies is already taxes... at the Associate Company level. There's no full consolidation, so we go by the Associate Company's taxes.

[@jatinnawani6075]

Great content, thank you

[@financialmodeling]

Thanks for watching!

[@courtney2394]

Just to clarify, when you say unrealised gains and losses appear on the income statement but are reversed on the CFS, do you mean the Unrealised G's/L's on the CFS are basically the inverse sign of what appears on the IS? Thanks

[@financialmodeling]

Unrealized Gains and Losses on Equity Investments do not appear on the Income Statement. Only Realized Gains and Losses do, and they are reversed on the CFS by flipping the sign.

[@courtney2394]

@@financialmodeling Thanks for that - just a quick follow-up; in PayPal's earnings last night, they outlined how they booked $0.58 of unrealised gains from their MercadoLibre investment in EPS for Q220'. Why is this UG in the Income Stat? Any colour would be appreciated. Thanks

[@financialmodeling]

@@courtney2394 PayPal spent ~$750 million to acquire a stake in MercadoLibre in 2019, when MercadoLibre was already worth around $25 billion. $750 million / $25 billion = some percentage much lower than 20%, so the equity method of accounting does not apply. PayPal is classifying this investment as a "security" and therefore recording unrealized gains and losses on it on its Income Statement since the Trading Security or FVPL treatment applies in this case.

[@courtney2394]

@@financialmodeling Completely understood. Thanks

[@LoveStudio3388]

What happens if dividend income received is already greater than the investment account. How to account for the excess?

[@financialmodeling]

Equity Investments would turn negative in this case if the associated Dividends exceed the entire amount on the Balance Sheet and there is no corresponding Net Income to boost the line item. It doesn't mean much because the book values of many Balance Sheet items could be negative, even if the market values are not.

[@LoveStudio3388]

@@financialmodeling i actually found the answer. The standard doesnt say much of “dividends in excess of the carrying amount of investment” if there is no obligation to make additional investment, the excess is recorded in profit or loss as regular dividend income

[@njabulov.hadebe9102]

Why are dividends from equity investments shown under the cash flow from operating activities section on the cash flow statement?

[@financialmodeling]

They're not always shown there, but they often are under U.S. GAAP. I think the logic is that the company is trying to show the "net" effect of Equity Investments, i.e., reverse the Net Income from Equity Investments and then show the Dividends from them as a positive, so that the entire impact appears in one section of the CFS.

[@fordaysafterxmas]

For less than 20% ownership investments with no significant influence, do you just record on the balance sheet at cost and record dividend received as debit to cash and credit to investment income on income statement?

[@financialmodeling]

Yes, but the dividends received do not show up on the Income Statement in most cases. They should really be on the CFS somewhere. Only the Percentage Owned * Net Income appears on the IS.

[@ceciliazhang6788]

Great Video! One quick question: Why the equity investment earnings need to be reverse sign on the CFO? If that's the part of earnings the parent Co received from sub Co?

[@financialmodeling]

Thanks. Because the Parent's statements are still separate from Sub Co.'s, so it does not actually receive its portion of Sub Co.'s Net Income in Cash.

[@NickyCsInnovators]

Thank you

[@Dollarideas]

Would you mind sharing the excel behind? Super useful video

[@financialmodeling]

Look at the description. youtube-breakingintowallstreet-com.s3.amazonaws.com/105-23-Equity-Method-of-Accounting.xlsx

[@namankulshreshtha6042]

Hi Brian, could you please tell me under which tutorial head in your course have you explained in a similar manner the concept of Minority Interest? This video was a life saver. I have the subscription to your course comprising of Adv Modelling, Fin. Modelling fundamentals and Fin. modeling mastery. I am in bit of a rush and sifting through the entire course to find details on the same isn't viable. Please assist. Thanks!

[@financialmodeling]

Look in Module 3 of the Financial Modeling Mastery course... and please contact us via email instead of leaving a comment on KZbin, which is checked maybe once a month.

[@namankulshreshtha6042]

@@financialmodeling Thanks for responding, I was able to find it in time. Got through the interviews at 2 Big bulges, much thanks to you. :) Cheers!

[@lzra8111]

Is this included in the breaking into wallstreet course?

[@financialmodeling]

Yes

[@bonnieli9508]

How come the “Equity Investment” line item on the B/S decreases when dividends receive (from SubCo) increases?

[@financialmodeling]

The Equity Investments line acts as a "mini-Shareholders' Equity" for the minority stake. Just like normal Shareholders' Equity, it increases when Net Income flows in and decreases when Dividends are paid. The difference is that it's only for this minority stake and doesn't represent all the shareholders in the other company.

[@asimpattnaik7357]

Can anyone please expain why realized gains and losses are reversed on the Cash flow statement. It is a cash transaction and has been accounted for in the income statement-- so why is it deducted from the cash flow from operations?

[@financialmodeling]

Because *relative to the current period*, the Gain or Loss is non-cash. If a company sells an equity investment for $80 when it purchased it for $100, it doesn't literally "lose money" in the current period - it only loses money relative to what it paid in some prior period. Another way to think of it is that you're re-classifying the Gains and Losses from Operations into Investing Activities.

[@asimpattnaik7357]

@@financialmodeling I get your point that the gain/loss is not for the current period which explain why it was deducted from the CFO. But I was looking for where it has been accounted for in the CFI-- Where has it been incorporated in the current model. Please help! Btw all your channel videos are super helpful

[@financialmodeling]

@@asimpattnaik7357 The Purchase / Sale of Equity Investment line already reflects it if the ownership stake decreases. Cost Basis Just Before Change (+/-) Gain or Loss on Sale equals that line item within CFI.