In this episode, we talk with our Chief Content Officer about the new “Accounting for Business Combinations and Other Equity Investments” course.

Designed to meet the growing demand for accounting knowledge for finance professionals, we cover topics including full consolidation for majority ownership, equity method accounting for significant influence, and fair value accounting for smaller stakes.

The episode also covers differences between IFRS and US GAAP, with practical insights on using Excel for consolidations. This technical course is aimed at professionals who need to develop This concise, two-hour course aims to provide learners with the skills needed to analyze equity investments in financial statements confidently. Listen in for more details!

Transcript

Asim (00:13)
Hello and welcome to the What’s New at CFI podcast. I’m Asim Khan, and I’m joined today by my colleague, Scott Powell, who’s the chief content officer of CFI and one of its co -founders. Welcome to the podcast, Scott.

Scott (00:24)
Thanks, Asim, it’s always nice to chat with you.

Asim (00:27)
I’m excited today, Scott, because we’re talking about something that’s of great interest to me and I am sure to all of our learners. It’s a course you’ve just published called Accounting for Business Combinations and Other Equity Investments. Can you tell us a bit more about it, please?

Scott (00:39)
Yeah, so we’ve had numerous requests from our learners to build out our accounting curriculum. And so we’re really responding to demands or asks from our learners. And one of the things that we are aiming on doing is creating a whole portfolio,

accounting courses for finance and banking professionals. So I want to stress that we’re not doing accounting for accountants but accounting for finance and banking professionals and accounting for business combinations and other equity investments is something we constantly get asked to do because people ask questions like I don’t know how to model non-controlling interest.

Or and that’s all a part of what we cover in this course. And the other thing I’d just say for context is we could have called this course just accounting for equity investments because that’s what it truly is. It’s just that if you own 100 % of the equity of another company, we have to combine those assets, which is why we have that title business combinations. Whereas if we only own 2 % of the equity of another company, we have to use another accounting method.

Asim (01:43)
So in the first case you mentioned where a company owns more than 50 % of some other company, those results of that investment are fully consolidated on the financial statements?

Scott (01:57)
Yeah, it’s a great question. So the key thing here, and it surprises people, is that under IFRS and US GAAP, if you own more than 50%, so let’s say you own 60 % of the equity of a company, you might think rationally that therefore we should take 60 % of the assets and 60 % of the income, but that’s not the way we do it.

As long as you control the business, the accounting rules require you to combine 100 % of the assets and liabilities on the balance sheet and 100 % of the revenues and the expenses on the income statement.

Asim (02:33)
And as you’re a chartered accountant in two countries, you probably are in the best position to answer this. Why is that? Why did the accounting profession take this stance? Is it because once you own 60%, say, it would be no big deal to acquire the 40 % that you do own and then you’d easily own 100 % of it, or is it something else?

Scott (02:41)
Yeah.

It is really about control. One of the big stories behind a lot of the accounting rules is thinking about the big picture rather than the rules. And the idea is if you control the votes on a board, you ultimately control the assets and liabilities of that business. So we’re actually consolidating to demonstrate control as opposed to ownership.

Asim (03:22)
That’s a key distinction, right? Control and non -ownership. Okay, great. And then just kind of climbing down the ownership ladder, we have the case where a company owns 20 to 50 % of some other entity, and that’s accounted for under what’s called the equity method investment. And how does that work and how does that differ from the full consolidation case?

Scott (03:23)
Yeah, you got it.

Yeah, so I’m going to focus again on the big picture here. So we’ve talked about one of the questions you should ask is do we control the business and we were deemed to control it if we own more than 50%. The next level down is called do we actually maybe not control it but own enough that we have a significant influence. So that’s the bigger question that we’re asking here. But we’ve defined it both under US GAAP and IRFRS as between 20 and 50 % typically is where

an investor has significant influence. And what I mean by significant influence is if you own 40 % of a company, I bet you you’re going to have one or two directors on the board representing your interests. Things like that. And therefore, you can influence the board and likewise the company’s direction. But you’re not controlling it.

Asim (04:29)
And my memory serves under FASB, at least the GAAP case, the language reads, and I think I’m quoting pretty much verbatim, that in the absence of evidence to the contrary, there is significant influence. So it’s presumed that you have significant influence, right?

Scott (04:44)
You got it.

You got it.

Asim (04:51)
So it’s not like you have to go make the case that, hey, we’ve got to, you know, it’s just, it’s kind of given. Okay. Then the next step down, we have a fair value. So if you own less than 20%, more than zero, it’s fair value accounting. And can you break down for us the IFRS case and the GAAP case, because they’re slightly different.

Scott (04:54)
No.

Yeah, it’s interesting because I normally try and minimize talking about either US GAAP in detail or IFRS in detail. Because for most things, they do align. So, everything we talked about so far, they are very much aligned.

The problem is when it comes to fair value accounting and the reason I decided I needed to put this distinction in is that if you’re comparing a company reporting under IFRS versus US GAAP, there is a significant difference. Now, high level, what do we mean by fair value? Often we used to record things on the balance sheet at their cost or their book value.

What accounting rules requires to do with equity investments is actually not record them at cost for the most part but fair value which means their market value. If we were to sell it today, what would we get for it? So it’s their market value. So that’s what we mean by fair value. Now one of the things that’s different between IFRS and US GAAP is that…

If you hold the equity, your investment, for trading purposes, it has to be fair value and those fair value changes have to go through the income statement or P &L, profit and loss account. And it’s actually called fair value through the P &L. Now, if you’re not holding the equity investment for trading purposes, you have a once in a lifetime option at the beginning to elect to not do fair value accounting.

Or you have to do it, but you get to put it through something called OCI or other comprehensive income. So you have that one chance, but still you have to mark to market at fair value. Okay, yeah. The difference in US GAAP is US GAAP has to be fair value through the income statement or you can put it at cost if, if,

Asim (06:50)
And then, yes.

Scott (07:03)
it’s a private equity investment, so it’s hard to value. There’s no market value for it. So there is a cost option under US GAAP.

Asim (07:11)
I see, so for illiquid investments, right? Or ones where you can’t identify readily a fair value. Now, you mentioned other comprehensive income in the IFRS case, so that runs through the stockholder section, equity section of the balance sheet, correct?

Scott (07:13)
You got it.

You got it. So if you examine shareholders equity, you’ll often you’ll see you know share capital often. You could see treasury stock. But you’re going to see a line called accumulated other comprehensive income and that’s where it’s going through. And it is a separate statement that often we overlook. But if you open a 10k or you open an annual report IFRS annual report, you’ll find an OCI statement.

Asim (07:53)
And in the gap case then, there’s no classification as OCI, is that correct? Everything goes through the income statement, even the illiquid stuff. So I guess if it’s a level two asset, and you go into the really nice description of level one, two, and three assets, the company would have to periodically somehow value the asset or do they just kind of keep it at the cost forever more?

Scott (08:04)
Correct.

Yeah, so basically if it’s extremely illiquid and we can’t even measure it reliably based on whatever level, then we can record it at cost basically. But the thing was, I know we’re getting into the trees, but it used to be there was an option to put it through OCI, but that was shut down for equities.

Asim (08:43)
Okay, good. So I mean this kind of gives us the complete picture then of fair value under IFRS and GAAP. Another great thing about this course, and I don’t mean to make light of this, Scott, is that it’s not, you know, multiple hours long. It’s I think like in two hours you can get through it and the exercises and really come away with a strong understanding of how to account for equity investments.

Scott (09:06)
Thanks for flagging that because one of the initiatives I know you know but I don’t know if our learners know is our learners have asked for shorter courses that are more tailored to a very specific topic and the idea is really like, I have an hour or two I can do something over my lunch break, I could do something at the end of my workday no one’s going to have seven to fifteen hours at the end of a workday but they can often spare an hour so.

We are, watch for more of these bite, what I’m gonna call more bite-sized courses that are between an hour and two hours, because we’re all trying to aim for that. And the second thing is, we’re trying constantly to make our courses more engaging. So, one of the things we did with this course is get you in Excel, working through consolidations in Excel with me, so that you’re learning by doing, rather than just watching me on screen.

Asim (09:54)
That’s really terrific. And I think once through this course, a learner can feel confident about cracking open a 10K and doing the analysis, because you’ve walked through it in quite a good level of detail. So Scott, thank you so much for your time today. It was lovely chatting with you, as always. And we’ll see you next time, which will be very soon, I’m sure.

Scott (10:19)
I’m sure it will be soon. Really nice talking to you as well, Asim.

Asim (10:21)
Okay. Thanks!