CFA Level II · CFA Level II Exam

Intercorporate Investments: formula sheet

Full chapter guide

Key formulas

No significant influence: Ownership below about 20% → financial asset; Presumption only. IFRS 9 governs under IFRS. US GAAP uses fair value through net income for most equity securities, and amortised cost or fair value for debt securities.
Significant influence: About 20% to 50% → associate → equity method; Indicators: board representation, policy participation, material transactions, managerial interchange, technology dependence. Can apply below 20%.
Control: Control (usually above 50%) → subsidiary → consolidation; Control means power over relevant activities, exposure to variable returns and the ability to use power to affect returns. Potential voting rights count if currently exercisable.
Joint control: Contractual sharing of control → joint venture → equity method; IFRS 11 requires the equity method for joint ventures. Joint operations are accounted for by recognising the investor's share of assets, liabilities, revenue and expenses.
Equity method carrying amount: Ending investment = Beginning + share of investee net income − dividends received; Dividends reduce the investment. They are not income.
IFRS 9 debt classification: Hold to collect + SPPI → amortized cost; Hold to collect and sell + SPPI → FVOCI; otherwise → FVTPL; The fair value option can override amortized cost or FVOCI to FVTPL at initial recognition to remove an accounting mismatch.
Interest income, amortized cost: Interest income = beginning carrying value × effective rate at purchase; Carrying value moves toward face value. Cash coupon = face value × coupon rate. Amortization = interest income − cash coupon.
Equity under IFRS 9: Default → FVTPL; irrevocable election (not held for trading) → FVOCI, with no recycling; Dividends go to profit or loss. Fair value changes go to OCI under the election.
US GAAP debt categories: HTM → amortized cost; Trading → fair value, gains in net income; AFS → fair value, unrealized gains in OCI; US GAAP equity securities with readily determinable fair values go through net income.
Reclassification of IFRS 9 debt: Allowed only on a change in business model; applied prospectively from the reclassification date, measured at fair value on that date; Prior gains or losses are not restated. Between amortized cost and FVOCI, the effective interest rate is unchanged. From FVOCI to amortized cost, cumulative OCI is removed against the asset's fair value.
Joint venture accounting (IFRS 11): Joint venture → equity method; The parties have rights to net assets. Proportionate consolidation is not permitted for joint ventures under IFRS.
Joint operation accounting (IFRS 11): Recognise own share of assets, liabilities, revenue and expenses; The parties have rights to assets and obligations for liabilities. The effect is the same as proportionate consolidation.
Equity method investment balance: Ending investment = Beginning investment + Share of net income − Dividends received; Dividends reduce the investment. They are not income. Initial cost may include goodwill.
Proportionate consolidation line item: Reported item = Parent's own item + Ownership % × Venture's item; Applies to every asset, liability, revenue and expense line. Do not add the venture's equity.
Invariants across methods: Net income and shareholders' equity are identical under both methods; Only the gross-up changes. Use this to check your work.
Ratio direction under proportionate consolidation: Higher: total assets, liabilities, revenue, liabilities-to-equity. Same: net income, equity, ROE. Lower: ROA, net margin; Net income is unchanged while assets and revenue are larger, so ROA and net margin are always lower than under the equity method. Only the leverage direction depends on the venture having liabilities. Always compute rather than assume.
Goodwill (full goodwill): Goodwill = Consideration transferred + Fair value of NCI − Fair value of identifiable net assets; Required under US GAAP; optional under IFRS. Add the fair value of any previously held stake if the deal is achieved in stages.
Goodwill (partial goodwill, IFRS only): Goodwill = Consideration transferred + (NCI % × Fair value of identifiable net assets) − Fair value of identifiable net assets; Equivalent to consideration minus the acquirer's % share of net identifiable assets.
Fair value of identifiable net assets: Fair value of identifiable assets − Fair value of liabilities assumed; Include newly identified intangibles and deferred taxes; exclude the target's existing goodwill.
Bargain purchase gain: Gain = Fair value of identifiable net assets − (Consideration + NCI measurement); Recognised in profit or loss after reassessing the measurements.
Fair value adjustment: Excess of fair value over book value = Fair value of net assets − Book value of net assets; Extra depreciation on written-up assets reduces post-deal earnings.
NCI on balance sheet (fair value method): NCI = NCI fair value at acquisition + NCI share of subsidiary net income since acquisition − NCI share of dividends; Under partial goodwill (IFRS option), the starting value is NCI % × fair value of identifiable net assets.
NCI share of net income: NCI income = NCI % × subsidiary net income (adjusted for fair value amortisation and any upstream unrealised profit); Parent's share = consolidated net income − NCI income.
Goodwill (full goodwill): Goodwill = consideration transferred + fair value of NCI − fair value of identifiable net assets; Partial goodwill uses NCI % × identifiable net assets instead of NCI fair value.
Unrealised profit in ending inventory: Unrealised profit = intercompany profit margin × inventory still held by the buyer; Remove from inventory and from consolidated income. Upstream: allocate NCI % of it to NCI. Downstream: charge it to the parent.
Consolidated sales with intercompany sales: Consolidated sales = parent sales + subsidiary sales − intercompany sales; Cost of goods sold is also reduced by the intercompany sales amount, adjusted for unrealised profit.
Consolidation vs equity method: Equity method: investment = cost + share of income − dividends; consolidation: 100% of line items; Parent net income is usually equal under both; ratios such as margins and debt-to-equity differ.
IFRS impairment loss (CGU): Loss = Carrying amount of CGU − Recoverable amount, if positive; Recoverable amount = higher of fair value less costs of disposal and value in use. Allocate loss to goodwill first, then other assets pro rata.
US GAAP impairment loss (reporting unit): Loss = Carrying amount of reporting unit − Fair value of reporting unit, limited to goodwill balance; Single comparison of the unit's fair value with its carrying amount.
Goodwill at acquisition (full goodwill, IFRS): Goodwill = Consideration + Fair value of NCI − Fair value of identifiable net assets; Partial goodwill method uses NCI's share of identifiable net assets instead. IFRS permits full or partial goodwill; US GAAP requires full goodwill.
Post-impairment ratio effects: New equity = Old equity − (Loss − Tax benefit, if any); new total assets = Old assets − Loss; Equity falls by the loss net of any tax benefit. With no tax effect, the full loss is deducted from equity. Most goodwill impairments are not tax deductible, so use a tax benefit only if the vignette gives one. Use the new figures to recompute ROE, ROA, debt-to-equity and asset turnover. This gives the reported, post-impairment ratios.
Analyst adjustment: Adjusted ROE = (Net income + Impairment loss) ÷ Equity before the impairment; The analyst-adjusted ROE uses pre-impairment net income and pre-impairment equity, so it shows operating performance as if no impairment had occurred. Keep it separate from reported ROE, which uses post-impairment net income and equity. In the IFRS example, adjusted ROE = 120 ÷ 1,000 = 12%, while reported ROE is −20 ÷ 860 = −2.33%. Also consider removing goodwill entirely from equity and assets.

Quick revision

Classification depends on influence or control, not only on the ownership percentage; 20% to 50% is a presumption for significant influence.
Financial assets under IFRS 9 are measured at amortised cost, fair value through other comprehensive income, or fair value through profit or loss, depending on the business model and cash flow test.
Equity investments under IFRS 9 are generally at fair value through profit or loss. For those not held for trading, an irrevocable election allows fair value changes to go to OCI. Amounts in OCI are never reclassified to profit or loss, even on disposal; only dividends are recognised in profit or loss.
Equity method: investment = cost + share of investee profit − dividends received, adjusted for basis difference amortisation.
Under the equity method, dividends reduce the investment and are not income.
Equity method income is one line in the income statement; consolidation combines every line.
Acquisition method: goodwill = consideration transferred + fair value of any previously held interest + non-controlling interest (measured under the chosen method) − fair value of identifiable net assets.
Full goodwill method measures non-controlling interest at fair value; partial goodwill method measures it at its share of identifiable net assets. Under IFRS the choice is made for each acquisition. US GAAP requires non-controlling interest at fair value, which gives full goodwill.
Consolidation eliminates intercompany transactions and balances, and shows non-controlling interest in equity and in income.
Goodwill is not amortised; it is tested for impairment, and an impairment loss reduces earnings and assets without a cash effect.
IFRS 11 requires the equity method for joint ventures; for joint operations, the party recognises its share of assets, liabilities, revenues and expenses. US GAAP generally requires the equity method for joint ventures. US GAAP permits proportionate consolidation only in limited cases, such as certain extractive or construction industries; otherwise it is mainly an analyst adjustment. Compared with the equity method, proportionate consolidation lifts revenue, assets and debt, while net income and equity are generally the same.
Always state which standard applies, since IFRS and US GAAP differ on several treatments in this chapter.

Common mistakes

Classifying only by ownership percentage Fix: Treat them as presumptions. Check board seats, contracts, potential voting rights and restrictions on the investee.
Treating dividends from an equity-method investee as income Fix: Under the equity method, dividends reduce the investment account. Income is the share of investee net income.
Putting unrealized FVOCI gains into net income. Fix: Fair value change on FVOCI goes to OCI. Only interest, impairment and foreign exchange effects on debt go to profit or loss.
Calculating interest income as face value × coupon rate. Fix: Interest income is carrying value × effective rate for amortized cost and FVOCI debt. The coupon is only the cash received.
Saying proportionate consolidation changes net income or equity. Fix: Remember that only gross amounts change. Net income and equity are the same under both methods. The extra assets are matched by extra liabilities.
Treating every arrangement through a separate vehicle as a joint venture. Fix: Check the rights and obligations. If the parties have rights to assets and obligations for liabilities, it is a joint operation even through a vehicle.
Using book value of the target's net assets instead of fair value. Fix: Always look for a fair value adjustment table and apply it before calculating goodwill.
Including the target's existing goodwill in net identifiable assets. Fix: Goodwill is not identifiable. Remove it from the target's net assets before computing new goodwill.
Consolidating only the parent's % share of the subsidiary's assets and income. Fix: Full consolidation always adds 100%. NCI then shows the outside share.
Treating NCI income as an expense that reduces consolidated net income. Fix: Consolidated net income includes NCI. NCI is an allocation of it, not a cost.

Exam tips

Read the vignette for qualitative influence clues before using the percentage. Item sets often hide the deciding fact in a footnote or exhibit.
Check whether the question says IFRS or US GAAP before choosing the method for financial assets and joint ventures.
Know the effect on ratios: consolidation adds the subsidiary's assets and liabilities in full, while the equity method shows a single line investment.
With no penalty for wrong answers, always answer every question and eliminate options with the wrong method first.
Read the vignette for the business model words: hold to collect, collect and sell, or trading. They decide the category.
Check the standard named. IFRS 9 and US GAAP give different treatment for equity and for AFS.
When asked about net income versus total comprehensive income, remember the FVTPL and FVOCI difference is only in net income.
Use the effective rate on carrying value for interest income. Watch for questions where the coupon is a distractor.