CFA CFA Level 2 Net Profit Margin under Equity Method and acquisition method

Net Profit Margin under Equity Method and acquisition method

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    • Avatar of wannabe1988wannabe1988
        • CFA Level 1

        Hi esteemed forumers. I have a quick question. Why is it net profit margin for equity and acquisition method is different? In my note, it was said net profit margin is higher (relatively) under equity method compared to acquisition method. Since both methods do not actually take sales (or revenue) of investee into account, why is it sales is relatively lower for equity method than acquisition then? I understand that NI is the same under the two methods.

        Thank you in advance!

      • Up

        Sales/Revenue booked under equity method is proportionate to the equity it holds in the company. So say Company X holds 60% of Company Y (with revenue $100,000), revenue reported for Company X would be $60,000 (60% * $100,000). Sales/Revenue booked under acquisition method accounts for the entire acquired company ($100,000 in this case), so would be higher under acquisition.

        The reason why net income is always the same under both methods is that:

        • the equity method only books the portion of revenue and costs according to the stake it holds in the company
        • the acquisition method books everything, but then takes out the portion owed to minority/non-controlling interest

        So both methods end up with the same net income.

        This is the way I think about it: The acquisition method assumes ‘you are in control of the whole company’. The holding company is responsible for all decisions, and therefore revenue attribution (or lack of) is entirely to the controlling company. Equity method assumes ‘you’re there for the ride’ so revenue etc is proportionately attributed. Revenue, net profit margins etc are all business metrics and are dependent on your assumptions. Net income, however, is a factual number (i.e. how much money you’re getting from this acquisition/investment) and should always be the same no matter what method of accounting you’re using. Just like no matter how you do your taxes, the amount of money you get to spend from your paycheck is still the same.

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