Basic question - Return on Equity question, accounting, change, decrease

Andreas42

How is the ratio going to change if the accounting method changes from equity method to consolidation method?

My answer would have been no change but Schweser says ratio will decrease?!

SFoyil

Your equity will increase if you do proportionate consolidation, leading the ROE to go down since NI will be the same.



Edited 1 time(s). Last edit at Monday, May 30, 2011 at 11:38PM by ssr123456.

Kapie

I thought equity is not adjusted under the consolidation method? Is it because of minority interest?

Does it mean:

Equity (total) = Equity (p) + MI (Balance sheet)

tianxin

When I say consolidation, i mean acquisition method

onelife1

Equity is the same under Proportionate Consolidation. If you consolidate. (acquisition method) then your equity will increase because you are writing up the net identifiable assets to fair value and thus increasing the book value/equity of the firm. NI is the same under all methods. If equity increases then your ROE will decline as a result. ROE is lowest under the acquisition method.

FinancialAnaly

Under Equity Method, you only recognize your investment (at cost) on the B/S. No impact on Equity.

Under Proportionate Consolidation, you consolidate your % stake (usually 50%) of the subsidiary's Assets and Liabilities. Since you are only consolidating your share proportionally, there is no impact on Equity.

Under Consolidation, you consolidate the ENTIRE subsidiary, including the % you do not own. Because you have essentially over-allocated the subsidiary's assets, you create an account called Minority Interest to account for % not owned in the Subsidiary. Minority Interest goes directly into S/E - and thus Equity INCREASES.

Therefore, going from Equity Method to Consolidation means your Equity increases. And Net Income is the SAME under all THREE methods. Therefore;

Equity Method ROE = Net Income (same) / Equity (same)
Consolidation ROE = Net Income (same) / Equity (INCREASED by Minority Interest)

Same numerator, higher denominator -- therefore, ROE decreases under Consolidation.

(There are a lot more details to this, but the basics are there!)

ningning1984

Thanks Chuckrox8, so to confirm

ROE will be the same for equity method and proportionate consolidation but will be lower under acquisition

Is this correct?

iteracom

ROA:

Equity Method - HIGHEST
Proportionate Consolidation - MIDDLE
Consolidation - LOWEST

ROE:

E - HIGHEST
PC - HIGHEST (same as Equity)
C - LOWEST


N/I

E - SAME
PC - SAME
C - SAME

Net Profit Margin

E - HIGHEST
PC - MIDDLE
C - LOWEST