Intercorporate Investment

Basic Corporate Investment Categories

Catagories

The following graph describes the catagories of investment in terms of accounting.

Long-Term Equity

As noted above, there are 4 catgories of Long-term equity investment, depending on power of control:

• Investments in financial assets: No significant control or influence
• Investments in Associates: Exert significant influence
• Joint Venture: Control is shared
• Business Combinations: Obtains a controlling interst.

Percentage of ownership is typically used to determine the appropriate category:

• $(0,20)$ Lack of influence
• $(20,50)$ Significant influence
• $(50,100)$ Control

	Financial Assets	Associates	Joint Ventures	Business Combination
Degree of Influence	no significant influence	significant influence	shared control	control
Percentage of Interest	< 20%	20% - 50%	varies	> 50%
Term of Investee	-	associate	-	subsidiary
Accounting Treatment	AMC, FVOCI, FVPL	Equity Method	Equity Method	Acquisition Method

IMPORTANT

In acquisition case, note if the companies have common controllers.

Review Note

Classification

Debt

• Held to collecto contractual CF $\to$ AMC (Amortized Cost)固定价值(DCF with issue rate)
• Hold to collect and sell $\to$ FVOCI计入其他损益(Fair value)
• Trading $\to$ FVPL计入利润表(Fair value

Equity

• Hold to collect and sell $\to$ FVOCI计入其他损益
• Trading $\to$ FVPL计入利润表

NOTE

• Holding income (interest income) is fixed Amortized cost $\times$ Issue rate, recording in I/S

• G/L differes: AMC will ignore, FVOCI in OCI, FVPL in I/S

Reclassification

• IFRS not wallow equity reclassification
• Debt reclassification is allowed when businees model has changed

Disclosure

Disclosure of fair value is required under all cases

Accounting Treatment

Equity method of accounting

NOTE

Definition of associate/joint: significant influence but not control

B/S accounting

• BV of quity investment recorded at cost
• +Adjusted NI (Reported NI - FV Amortization - Unrealized profit)
• -Dividend
• =End BV of Equity Investment

I/S Accounting

• Acquirer's NI
• +Acquiree's Adjusted NI
• =Consolidated NI

Embedded Goodwill

Embedded Goodwill = Purchase Cost $-\mathrm{\%}\times$ FVNIA (Fair Value Net Identifiable Asset)

Fair Value Amortization

FVA = $\frac{\text{FV(PPE)}-\text{BV(PPE)}}{N}$直线折旧法

Unrealized Profit (Deferred Profit)

Downstream: Acquirer $\to$ Acquiree

Upstream: Acquiree $\to$ Acquirer

Both downstream and upstream should not be processed as NI. They should be deducted in I/S.

Impairment

	IFRS	US GAAP
Impairment Test	carrying value > recoverable amount	carrying value > fair value
Impairment Loss	recognized in I/S	recognized in I/S
Reversal	permit	prohibit

Analytical Issues of Equity Method

• Understate Debt Ratio
• Overstate Net Profit Margin (NI/REV=(NIA+NIB)/REVA)

Acquisition Method

NOTE

Definition of subsidary/VIE: Investor has control over the investee's buiness activity

Types: A+B = (A+B), A+B = A

VIE or SPE is a legal structure where a comppany wants to maintain control over another entity but doesn't own

B/S Conditions

• Paritial purchase with excess: Full GW > Partial GW, Full MI > Paritial MI
• Full purchase: Full GW = Partial GW, Full MI = Partial MI = 0
• Discount: Gain on I/S

I/S Consolidation

A’s I/S after acquisition:

Item	Value
Income	X
Expense	Y
Net Income	Z

B’s I/S after acquisition (after Fair Value Adjustment):

Item	Value
Income	x
Expense	y
Net Income	z

A’s Consolidated I/S After Acquisition:

Item	Formula
Income	X + x
Expense	Y + y
Net Income	Z + z
Net Income Distributed to Parent	Z + % × z
Minority Interest	(1 - %) × z

Steps:

1. FV Adjustment of B’s I/S (FV amortization and deferred profit)
2. 100% Consolidation
3. Calculate Net Income distributed to Parent

Goodwill Impairment

	IFRS	US GAAP
Object	Units	Goodwill
Impairment Test	Book Value (Unit) > Recoverable Amount (Unit)	Book Value of (GW) > Fair Value (GW)
Impairment	1. Goodwill is reduced to 0	Goodwill is reduced to 0,
	2. Other assets will be impaired proportionately	No Further Impairment on Other Asset
Reverse	Not Allowed	Not Allowed

Comparison with Equity Method (Assuming % < 100)

Financial Reports & Ratios	Equity Method	Acquisition Method
Assets & Liability	Lower: A / L	Higher: (A + a) / (L + l) ↑
Equity	Lower: E	Higher: E + M ↑
Revenue & Expenses	Lower: X / Y	Higher: X + x / Y + y ↑
NI (Net Income)	The Same: Z	The Same: Z + 3% (assumed) =
Net Profit Margin	Higher: NI / X	Lower: NI / (X + x) ↓
ROE & ROA	Higher: NI / Avg A	Lower: NI / Avg (A + a) ↓