AFM291 Chapter Notes - Chapter 7: Public Company, Equity Method, Modern Portfolio Theory
26 Jun 2018
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3. Joint Ventures
joint venture: a type of joint arrangement in which the rights and responsibilities of the parties
to the arrangement are limited to the net assets of the investee
joint ventures do not have direct control over the assets nor direct exposure to the liabilities of
the venture
Accounting Treatment – Equity Method
Equity method: can be thought of as a condensed consolidation that shows the financial
position and results of operations of the investee on a net basis on the balance sheet and
income statement in one line (each)
The balance sheet value of the investment equals the purchase cost adjusted by the investor’s
share of the investee’s post-acquisition changes in net assets, and the income recognized equals
the investor’s share of the investee’s net income
4. Associates
Significant influence: the power to participate in the financial and preparing policy decision of
the investee (but not to the extent of control/joint control) -> able to affect the strategic
direction of a company
Associate (investee/affiliate): an entity over which the investor has significant influence
Significant influence exists if the investor holds 20% - 50% (inclusive) of the voting power of the
investee and no significant influence otherwise
Why do we presume that there is no significant influence below 20%?
o 1) An investor often does not require more than 50% of votes to be in a position to
appoint/elect members onto the investee’s board of directors, particularly for publicly
traded firms with diffused ownership
o 2) the extent of the investment itself provides strong positive evidence not just a
presumption that the investor does have significant influence
Portfolio theory concludes that investors can achieve better risk-return trade-offs by diversifying
investments so if the only reason for an investment is to obtain the highest return at the lowest
risk, an enterprise can do better by having a portfolio of many investments rather than one large
holding in a company
If a company does have a higher level of investment in another company it indicates that it is
willing to bear the additional risk of the concentrated investment in return for the ability to
influence the direction of the invest
Accounting Treatment – Equity Method
Significant influence is not control so the investor and investee cannot be considered one
economic unit
See example on page 301
The equity method can be thought as a condensed consolidation that shows the investor’s share
of the net assets and net income of the investee
Document Summary
Equity method: can be thought of as a condensed consolidation that shows the financial position and results of operations of the investee on a net basis on the balance sheet and income statement in one line (each) Significant influence: the power to participate in the financial and preparing policy decision of the investee (but not to the extent of control/joint control) -> able to affect the strategic direction of a company. Associate (investee/affiliate): an entity over which the investor has significant influence. Significant influence exists if the investor holds 20% - 50% (inclusive) of the voting power of the investee and no significant influence otherwise. Significant influence is not control so the investor and investee cannot be considered one economic unit.
