The Equity Method is appropriate where the investor is deemed to have

The equity method is appropriate where the investor

  • University of Texas
  • ACCT 3302
  • Notes
  • rhuynh80
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- The Equity Method is appropriate where the investor is deemed to have significant influence over the investee, generally when the investor owns between 20-50 percent of the voting stock. - Consolidated Financial Statements where the investor is deemed to control the investee. In the US this requires a shareholding of more than 50 percent of the voting stock. In Australia, it is the capacity to control that is important and this is determined by looking at all the facts surrounding the case and not just focusing on share ownership. Coca-Cola Company (Coke) holds 42% of Coca-Cola Enterprises’(CCE) shares. Therefore, Coke would be deemed to have significant influence over CCE, thus requiring Coke to report its interest in CCE using the equity method in the US. To determine how much control Coke has over CCE we need to understand the relationship of these two entities. Coke sells concentrate to CCE ($3.1 billion in 1998); this is revenue to Coke and cost of goods sold to CCE. CCE bottles and sells the beverage to the retail market so the $3.1 billion (plus the additional costs and margin) are included in CCE’s revenue. Coke also supplies marketing and infrastructure development support for CCE. At times, Coke may even serve as a supplier of short-term funding. Based on the strong relationship between the two entities, stating that Coke had significant influence over CCE is an understatement. Rather, it seems that Coke controls CCE and that they are one economic entity, thus leading us to question whether the equity method provides proper reporting of this relationship. Note that in Australia Coke would almost certainly have to consolidate CCE. In February 1999 FASB proposed modifying the 50% threshold that had been used to distinguish whether one firm has significant influence or outright control over another firm. The proposal shifted the focus from a numerical benchmark to more subjective criteria intended to demonstrate Coke’s “control” over the CCE’s resources and activities. The proposal currently states: “Control . . . involves the presence of two essential characteristics: (a) a parent’s non-shared decision-making ability that enables it to guide the ongoing activities of its subsidiary, and (b) a parent’s ability to use that power to increase the benefits that it derives and to limit the losses that it suffers from the activities of that subsidiary” If Coke were required to consolidate CCE the effect would be to increase substantially the revenue and assets of Coke Consolidated, but net profit would be unchanged. When we
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3 of 4 consolidate, we add together the accounts of the parent and the subsidiary (after eliminating the effects of inter-company transactions, including any unrealized profits). In the P&L statement we then deduct the outside equity interest in group profit leaving the parent entity’s interest. This final profit figure will be the same under equity accounting because under equity accounting we also exclude any unrealized profit on inter-company transactions, leaving us with the profit earned by the parent (including its share of the investees profit).
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