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CFA Level II · CFA Level II Exam

Intercorporate Investments for CFA Level II: Chapter Guide

Intercorporate investments covers how a company accounts for stakes in other companies. The method depends on influence or control: financial assets at fair value, the equity method for significant influence, and consolidation for control. To solve questions, identify the stake and influence, pick the method, then trace the effect on income, assets and ratios.

What this chapter covers

This chapter is about one question: how should an investor report its stake in another company? The answer depends on how much influence it has. With little influence, the stake is a financial asset under IFRS 9 or US GAAP. With significant influence, usually a 20% to 50% holding, you use the equity method. With control, you consolidate. Joint arrangements sit alongside these, with their own rules. IFRS 11 splits them in two. Joint ventures use the equity method. For joint operations, the party recognises its share of the assets, liabilities, revenues and expenses, which is a proportionate-style treatment. US GAAP generally requires the equity method for joint ventures. Proportionate consolidation otherwise appears mainly in analyst adjustments or limited cases under US GAAP, such as certain extractive or construction industries. Know it because questions use it to show how a different presentation changes ratios.

The chapter also covers business combinations. Under the acquisition method, the acquirer measures the target's identifiable assets and liabilities at fair value and records goodwill as the leftover. You then follow that through consolidated statements, non-controlling interest and goodwill impairment.

The chapter links directly to the rest of Financial Statement Analysis. It uses the same skills as the topics on inventories, long-lived assets and income taxes: spotting how an accounting choice changes reported numbers. It also feeds Equities, where analysts must adjust ratios for comparability, and Corporate Finance, where mergers and acquisitions are valued. Level II tests it through item sets, so you must find the right facts in a vignette and apply the method, not just recall definitions.

Intercorporate investments sits inside Financial Statement Analysis, which carries a topic weight of 10-15%, and vignettes on it reward systematic method more than memory. The same few steps repeat: classify the stake, choose the method, compute the carrying amount or income, then compare ratios across methods. Once you have a routine, these item sets become reliable points. The ideas also help in equity valuation and M&A questions elsewhere in the paper, so the effort pays back more than once.

Intercorporate Investments: topics in the order to study them

  1. 1Classification of Intercorporate InvestmentsStart here because every later topic depends on deciding whether a stake means no influence, significant influence, joint control or control.
  2. 2Investments in Financial Assets (IFRS 9 and US GAAP)This is the simplest case, and it sets the baseline of fair value and where gains and losses are reported before you meet harder methods.
  3. 3Equity Method of Accounting for AssociatesIt is the first method where the carrying amount is tracked over time, so you need the mechanics of share of profit, dividends and basis differences.
  4. 4Joint Ventures and Proportionate ConsolidationIt builds on the equity method. Under IFRS 11, joint ventures use the equity method, while for joint operations the party recognises its share of assets, liabilities, revenues and expenses. US GAAP generally requires the equity method for joint ventures. Proportionate consolidation otherwise appears mainly as an analyst adjustment or a limited US GAAP case, and it is tested because it shows how a different treatment changes ratios.
  5. 5Business Combinations and the Acquisition MethodYou need fair value measurement and goodwill calculation before you can read consolidated statements.
  6. 6Consolidated Financial Statements and Non-Controlling InterestThis applies the acquisition method over time, adding line-by-line combination, eliminations and non-controlling interest.
  7. 7Goodwill Impairment and Analytical ImplicationsStudy it last because it ties everything together: goodwill from the combination, its impairment, and the effect of each method on ratios.

How to prepare Intercorporate Investments

Treat this chapter as one decision tree with calculations at each branch. Build the tree first, then practise the numbers on item-set questions.

  1. Draw the classification tree from memory: no influence, significant influence, joint control, control. Write the usual ownership ranges, and note that they are guides, not absolute tests.
  2. For each method, write a one-line rule for what goes on the balance sheet, what goes in net income, and what goes in other comprehensive income or cash flow.
  3. Practise the equity method roll-forward until it is automatic: opening investment, plus share of profit, minus dividends received, adjusted for any basis difference amortisation.
  4. Work the acquisition method in order: consideration, fair value of identifiable net assets, goodwill. Do it again with a partial acquisition and see how the non-controlling interest measurement choice changes goodwill.
  5. Compare the same company under different methods and note the effect on leverage, margins, return on assets and equity. Questions often ask which ratio rises or falls.
  6. Do timed item sets. Read the questions first, then scan the vignette and exhibits for ownership percentages, dates, fair values and dividends. Mark IFRS or US GAAP wherever the vignette states it.
  7. In the last week, review only your error log and the one-line rules, and redo any calculation you got wrong.

Common mistakes in Intercorporate Investments

  • Classifying by ownership percentage alone.

    Fix: Look for board seats, voting rights, veto rights and participation in policy decisions. Use the percentage as a starting presumption and then test it against the facts.

  • Adding dividends received to income under the equity method.

    Fix: Under the equity method, income is the share of the investee's profit. Dividends only reduce the carrying amount of the investment.

  • Miscalculating goodwill by using book values.

    Fix: Always use the fair value of identifiable assets and liabilities. Check whether non-controlling interest is measured at fair value or at its share of net assets.

  • Forgetting non-controlling interest in consolidated income or equity.

    Fix: Consolidate 100% of the subsidiary's lines, then split net income and equity between the parent and non-controlling interest.

  • Confusing the ratio effects of different methods.

    Fix: Ask which line items change. Equity method shows one net line, while proportionate consolidation and full consolidation add the investee's revenue, assets and debt. Then work out the ratio direction.

  • Mixing IFRS and US GAAP treatments.

    Fix: Note the standard at the top of each question before you start. Keep a short list of the differences and review it often.

Last-day revision: Intercorporate Investments

  • 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.

Intercorporate Investments in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Intercorporate Investments: frequently asked questions

How many questions can I expect on intercorporate investments at CFA Level II?

Questions come only through item sets of four questions each, and topics are placed at random. The exam does not fix how many questions come from a chapter. Prepare for a full vignette on this topic or a few questions mixed into a broader financial statement analysis set.

What is the difference between the equity method and consolidation?

Under the equity method, you show one investment line on the balance sheet and one share-of-profit line in income. Under consolidation, you combine all assets, liabilities, revenues and expenses of the subsidiary line by line and show non-controlling interest. The comparison is analytical only, because an investee the investor controls must be consolidated and the equity method is not permitted for it. In that analytical comparison, net income attributable to the parent and parent equity are generally the same under both methods, given consistent treatment of fair value adjustments and eliminations, but ratios differ.

Does the acquisition method amortise goodwill?

No. Goodwill is not amortised. It is tested for impairment, and any impairment loss is recognised in earnings. The loss reduces net income and assets but does not use cash.

How should I study this chapter if I work full time?

Study in short blocks and in the recommended order, since each topic builds on the last. Use phone time for rules and classification, and keep longer sessions for calculations and item sets. Keep an error log and review it weekly.