Financial Statement Analysis

Investments in financial assets.

Investments in financial assets. An ownership interest of less than 20% is usually considered a passive investment. In this case, the investor cannot significantly influence or control the investee.

Investments in associates

Investments in associates. An ownership interest between 20% and 50% is typically a noncontrolling investment; however, the investor can usually significantly influence the investee's business operations. Significant influence can be evidenced by the following:

• Board of directors representation.

• Involvement in policy making.

• Material intercompany transactions.

• Interchange of managerial personnel.

• Dependence on technology.

Business Combinations

Business combinations. An ownership interest of more than 50% is usually a controlling investment. When the investor can control the investee, the acquisition method is used.

It is possible to own more than 50% of an investee and not have control. For example, control can be temporary or barriers may exist such as bankruptcy or governmental intervention. In these cases, the investment is not considered controlling.

Conversely, it is possible to control with less than a 50% ownership interest. In this case, the investment is still considered a business combination.

Joint Venture

Joint ventures. A joint venture is an entity whereby control is shared by two or more investors. Both IFRS and U.S. GAAP require the equity method for joint ventures. In rare cases, IFRS and U.S. GAAP allow proportionate consolidation as opposed to the equity method.

Reclassification under IFRS 9

NO UNLESS BUINSESS REMODEL:
Amort → FVPL

• unrealized G/L recognized in income statement

FVPL → Amort

• transferred at FV on transfer date, and FV will become carrying amount and amortize from there

Loan Impairment under IFRS 9

MUST ESTIMATE LOSTS FORWARD LOOKING 12M and LIFE TIME EXPECTED LOSSES FOR NON PERFORMING LOANS

When can we use Equity Method at Fair Value

• US GAAP - allows investments to be recorded at fair value

• IFRS only allows for VC firms, MF, and similar entities

  • only those who can accurately measure FV with modeling

What are the 3 analytical problems with the equity method?

• Earnings inflated — reports % of full earnings, not just dividends received

• Debt hidden — investee's liabilities buried in one balance sheet line

• Margins distorted — investee profits included but revenues excluded

Upstream vs. Downstream — what gets eliminated and how?

Both eliminate unconfirmed profit using the same formula:

Total Profit × % Unsold × % Ownership

• Upstream = investee sold to investor (profit in investee's books)

• Downstream = investor sold to investee (profit in investor's books)

U.S. GAAP vs. IFRS on impairment of equity method investments?

	GAAP	IFRS
Trigger	Fair value < carrying value AND other-than-temporary	One or more loss events
Reversal	❌ Never	✅ Allowed

what acctg method of business combinations

acquisition method