However, the author emphasizes that the case studies, because they generally use organizational and sociological theories, differ from those that seek to describe accounting practices Major, Leitner-Hanetseder, S. In this sense, this research is more aligned with the descriptive methodological approach rather than the case study design. In the financial statements, firms had to restate the financial statements, as well as the reconciliation between the originally published accounting amounts using the proportionate consolidation and the restated accounting amounts after the adoption of CPC 19 R2 using the equity method.
From the technical point of view, the ideal would be to present in more detail the various components of these groups, but with the information disclosed, this was not possible. As it can be seen, this is another loss of information caused by the replacement of proportionate consolidation by the equity method. Specifically, we will identify the adjustments that are necessary to recompose the values that would be reported by the proportionate consolidation method, from the information presented by using the equity method.
As already mentioned, the financial statements of and were analyzed in a comparative way. However, the reference values are for the financial statements ending in As can be seen from Table 2 , the differences can reach relevant amounts.
For the values of equity and net income, the differences appear as irrelevant because the equity method represents a simplified form of consolidation. Thus, it is verified that the elimination of the proportionate consolidation method, with the adoption of CPC 19 R2 , had a significant impact on its financial indicators.
This, for example, can mean sensitive changes in industry rankings and even the need to renegotiate covenants. Thus, this adjustment must be done to avoid duplication of values. However, at proportionate consolidation, the value of goodwill must be transferred from the investment account to the intangible asset. Net asset surplus value - This is not the case. However, in the consolidation, this amount is transferred from the investment account to the asset and liability accounts that generated this surplus value.
Therefore, when estimating the accounting amounts using the proportionate consolidation method based on the information obtained by the equity method, the net asset surplus value should be adjusted in the proportional assets and liabilities of the joint ventures, having as counterpart the investment account, since it will be eliminated. It should be noted, however, that the net asset surplus value generates deferred income tax.
In the investor's balance sheet, this net asset surplus value is recorded net of deferred tax. However, when consolidation occurs even that proportional , this net asset surplus value will be reclassified to the asset and liability accounts that generated it, but this transfer occurs in the gross amount without deducting deferred income tax.
In contrast, a deferred income tax account will be recognized in the non-current liabilities of the consolidated balance sheet. However, if they existed, these amounts should be eliminated in the proportionate consolidation. In the case of intercompany transactions, part of the amount, which corresponds to the interest of the other investor of the joint venture, is considered to be realized and, therefore, the value of the transaction must be eliminated proportionally.
This type of advance is usually accounted for in the investment account or in another account of the non-current assets of the investor.
However, this difference does not impact the value of the adjustment, it only changes the order of presentation. In the case of the joint venture, this advance will be accounted for in a liability account. When consolidation occurs, these amounts are eliminated: the amount accounted in the investor's assets against the amount accounted in the liabilities of the joint venture. However, an observation must be made, since the advance for future capital increase can be considered both as a liability or an equity instrument.
This classification will depend on the terms and conditions of the advance. If it is considered as a liability of the joint venture, it will be necessary to eliminate the investor's assets against the liabilities of the investee, as explained above. However, if it is considered as an equity, it will not be necessary to make any adjustment, either in assets or liabilities, since the value of the advance will already be included in the value of the joint venture's equity and, by equivalence, in the equity value of the investment of the investor in the joint venture.
When this investment is eliminated against the equity of the joint venture, the value of the advance is also eliminated. Given that additional dividends generate only an internal change in equity, they do not cause impacts for the equity method purposes. Whether it was accounted for as an equity instrument, no adjustment is required, as described before.
In the statements prepared by the equity method, when the investor's share in the losses of the joint venture equals or exceeds the carrying amount of its investment, the investor must discontinue the recognition of its participation in future losses and, thus, no longer recognizing the investment in the asset. After reducing the carrying amount of such investment to zero, the investor may recognize additional losses by recognizing a liability only to the extent that it has in fact incurred legal or constructive obligations on behalf of the joint venture.
Thus, from the revenue of the joint ventures, intercompany transactions are eliminated, such as the purchase and sale of goods and products. Subsequently, the percentage of interest is applied.
At the end of , the first year of adoption of CPC 19 R2 , there were publicly traded companies in the Brazilian capital market with investments in joint ventures. For this purpose, it was analyzed the group of 45 companies, which represents all the publicly traded companies in the Brazilian market with investments in joint ventures, that were affected by the adoption of CPC 19 R2 exclusively by the change from proportionate consolidation to the equity method, and that restated the comparative financial statement with sufficient information in the explanatory notes about their joint ventures.
In the case of revenue amounts, this number is 29 companies out of 39 companies with information available, since 6 of the 45 companies did not disclose the value of the revenue. The adoption of CPC 19 R2 , effective on January 1, , brought significant changes, but one of the most controversial was the elimination of the proportionate consolidation method as a valid alternative for the recognition of investments in joint ventures and the consequent mandatory use of the equity method.
This decision of the IASB was very controversial, since many countries applied the proportionate consolidation method, and in general, academic research suggests that this method produces information of greater relevance.
It is believed that, although the proportionate consolidation presents some conceptual inconsistencies with the asset and liability definitions of the Conceptual Framework, this is the method that produces information of greater relevance to the user. The use of the equity method to recognize investments in joint ventures can produce a distorted view of the company's real economic and financial situation, especially regarding the level of indebtedness.
In some situations, although the liabilities are effectively the joint venture, the investor company may be co-responsible for these obligations, even if not legally. Consequently, in our opinion, these obligations should be reflected in the investor companies' financial statements. As a practical example, it is worth highlighting the environmental disaster that occurred in , with the rupture of the Samarco dam, a joint venture between Vale and BHP Billiton.
Even having only joint control and not full control, both Vale and BHP Billiton were jointly responsible for Samarco's liabilities. These liabilities are not presented in the financial statements of Vale and BHP Billiton, since the investment in Samarco is accounted for by the equity method, producing a distorted view of the financial situation of these companies.
The change from proportionate consolidation to the equity method can produce significant impacts on the values reported by investors, and these impacts were evident in the Brazilian market, in which almost all companies used proportionate consolidation. Investing Essentials. Your Privacy Rights. To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.
We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Personal Finance. Your Practice. Popular Courses. What Is Proportional Consolidation? On Jan. Proportional consolidation considered income, expenses, assets, and liabilities in proportion to a firm's percentage of participation in a joint venture. The income statement records income and expenses in the same way. Partners prepare the consolidated financial statements using the same reporting date.
In the U. While nations may not agree on what type of accounting treatment to use -- the U. For example, according to the website Science Direct, the proportionate consolidation method is better for explaining price volatility, while the equity method is better at explaining bond ratings.
Haggs wonders which accounting method Simpson uses to calculate the book value of the BC investment for the year ending December 31, Which is the correct method? A Consolidation method. B Equity method. C Cost method. A Equity method. B Consolidation method. B Pooling-of-interests method. C Consolidated method. My answers: Q1. So Equity Method.
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