Accounting for M&A, Credit, & Equity Analysts


Everything investment professionals need to know about accounting—in a practical desk reference format

In today's world of constantly changing accounting rules, models, and practices, investment professionals need an authoritative, all-in-one, fast-access reference for the latest knowledge and information. Accounting for M&A, Equity, and Credit Analysts provides comprehensive and easy-to-understand answers to the everyday accounting ...

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Accounting for M&A, Credit, & Equity Analysts

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Everything investment professionals need to know about accounting—in a practical desk reference format

In today's world of constantly changing accounting rules, models, and practices, investment professionals need an authoritative, all-in-one, fast-access reference for the latest knowledge and information. Accounting for M&A, Equity, and Credit Analysts provides comprehensive and easy-to-understand answers to the everyday accounting questions that come up time and again in the investing arena.

Noted M&A accounting authority James E. Morris has spent years dispensing accounting advice on Wall Street, and he knows which questions consistently baffle even the most experienced investment pros. He answers those questions and hundreds more as he provides clear and concise explanations of areas including:

  • Subtle, less understood aspects of common accounting areas and procedures
  • Purchase accounting for business combinations—essential not only for M&A analysts but for credit and equity analysts as well
  • Accounting for employee stock options, and its effect on both earnings and cash flow

Today's investment accounting landscape is undergoing tumultuous and unprecedented change. Professionals who fail to keep up with that change risk being left behind. Accounting for M&A, Equity, and Credit Analysts updates you on virtually every important facet of investment accounting, and provides the handy reference you need to instantly know what the numbers are really saying to you—and, just as important, what they are not.

"This is not, by any means, another financial accounting textbook. Instead, I intend it as a sort of spotlight, illuminating what I have found in my investment experience to be the 'black holes' of accounting. It is merely the collected answers to the questions that analysts (associates, vice presidents, managing directors and clients as well) have asked me during the time I spent giving accounting advice on Wall Street."

—From the Preface

Investment professionals too often regard the acquisition of accounting knowledge as a necessary evil—and, therefore, too often know less than they should. This lack of knowledge often leads to simple misunderstandings or even out and out errors that, at best, serve as minor speed bumps in a high-stakes transaction and, at worst, lead to the delay or even derailing of the deals in question.

Accounting for M&A, Equity, and Credit Analysts helps investment professionals as well as undergraduate and graduate students of and investment banking ensure that they will always be able to quickly and confidently get their hands on the right answers to virtually every accounting question. Providing easy-access accounting information without needless detail and CPA doublespeak, this invaluable reference distinguishes itself from other texts of its type in four major areas as it:

  • Bypasses common-knowledge accounting basics to concentrate only on information vital to investment analysts
  • Takes an investment banking perspective as opposed to one solely focused on Generally Accepted Accounting Principles (GAAP) and reporting
  • Integrates financial modeling and spreadsheet approaches that are essential to forecasting and analysis
  • Provides in-depth coverage of items in enterprise valuation and business combination transactions

In the investment profession, few factors are as valuable or overlooked as solid knowledge in accounting. Unfortunately, when professionals seek to increase their accounting expertise, they are too often faced with either cartoonish workbooks or incomprehensible, 600-page textbooks.

Accounting for M&A, Equity, and Credit Analysts provides investment professionals, analysts, and bankers with only the information they need to understand how accounting impacts their everyday environment. The first investment accounting desk reference to bridge the gap between what is taught in business school and what is actually needed in the real world, it allows investment pros to focus on and truly understand the vital accounting details they encounter every day—and helps them ensure that minor accounting misunderstandings or mistakes won't mushroom into major deal-killers.

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Product Details

  • ISBN-13: 9780071429696
  • Publisher: McGraw-Hill Professional Publishing
  • Publication date: 6/3/2004
  • Edition number: 1
  • Pages: 288
  • Sales rank: 854,608
  • Product dimensions: 7.30 (w) x 9.90 (h) x 0.90 (d)

Meet the Author

James E. Morris, C.P.A., C.F.A. (Baltimore, MD) is a project manager

of financial analysis for the U.S. Nuclear Regulatory Commission.

He also trains analysts and associates to value companies.

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Read an Excerpt

Accounting for M&A, Equity, and Credit Analysts

By James Morris

The McGraw-Hill Companies, Inc.

Copyright © 2004The McGraw-Hill Companies, Inc.
All rights reserved.
ISBN: 978-0-07-142969-6



Equity Method of Consolidation


When dealing with firms that account for investments using the equity method of accounting, analysts often find the reality of applying the equity method to be more complex than the simple one-line consolidation they had envisioned. Beyond that initial hurdle lies the complexity of accurately projecting the effect of equity method investments on the firm's earnings-per-share and cash flow.

To work through some of the more common areas of uncertainty, I begin with a basic introduction of the equity method, recognition of affiliate income, and the receipt of dividends. The next level involves considering the tax implications of the equity method; a common trap is ignoring the taxes because equity earnings and the associated taxes are noncash when, in actuality, they are only noncash for now and impact future cash flows. Following are two more subtle and less well-understood topics: equity method goodwill and intercompany transactions. Finally, we examine the analysis of cash flows from equity method investments and how all of the aspects of the equity method of accounting for investments are properly modeled together in a projection/valuation framework.


The equity method of accounting for investments describes how corporations and other entities account for the investments they make in other firms. It is the appropriate accounting method for them to use when the investments that they make are large enough to exert significant influence yet too small to require full consolidation accounting. The equity method is generally used for investments of greater than 20-percent ownership (delineating where significant influence is assumed to exist) and less than 50-percent ownership (delineating where consolidation is required). These are nominal measures and, as we see later in this chapter, it is possible for investors to structure aspects of their ownership to extend the range over which they may use the equity method. Figure 1–1 illustrates the accounting relationship between an investor and its investee that it consolidates using the equity method.

Accounting Standards

Accounting Principles Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock (APB 18), summarizes the process of accounting for an investment using the equity method as:

* An investor initially records an investment in the stock of an investee at cost, and adjusts the carrying amount of the investment to recognize the investor's share of the earnings or losses of the investee after the date of acquisition.

* The amount of the adjustment is included in the determination of net income by the investor, and such amount reflects adjustments similar to those made in preparing consolidated statements, including adjustments to eliminate intercompany gains and losses, and to amortize, if appropriate, any difference between investor cost and underlying equity in net assets of the investee at the date of investment.

* The investment of an investor is also adjusted to reflect the investor's share of changes in the investee's capital.

* Dividends received from an investee reduce the carrying amount of the investment.

* A series of operating losses of an investee or other factors might indicate that a decrease in value of the investment has occurred that is other than temporary and that should be recognized even though the decrease in value is in excess of what would otherwise be recognized by application of the equity method.

Accounting Under the Equity Method-Fundamental Approach

The fundamental approach for accounting for investments under the equity method is referred to as a one-line consolidation. Using the one-line consolidation approach, the investor presents her portion of the investee's net income as a single line on the income statement and the inferred value of the investment in the investee (historical cost plus the accumulated share of earnings) as a single line on the balance sheet. So, for the simplest of investments, the investor represents the impacts of the entire investment with one line on the income statement and one line on the balance sheet.

Less commonly, when the investee presents either discontinued operations, extraordinary gains and losses, or the effects of changes in accounting principle on its income statement separately after net income, the investor reports them the same way.

EXAMPLE 1–1. Accounting for the Investor's Portion of Investee's Net Income

Assume that on 31-Dec-20x0 Investor paid 1200 for 25 percent of the common stock of Investee. Investor recognizes the investment on its 31-Dec-20x0 balance sheet in the account titled Investment in affiliates as 1200. (Any income tax effects are initially ignored for this discussion.)

Investee's net income for the period ending 31-Dec-20x1 is 400. Investor recognizes 25% x 400 = 100 in its income statement in the account titled Equity in earnings of affiliates. The balance sheet account increases by the amount from the Equity in earnings of affiliates income statement account making the 31-Dec-20x1 balance 1300.

EXAMPLE 1–2. Accounting for Investor's Portion of Investee's Extraordinary Items

Assume the same fact pattern as above except that Investee also reports an extraordinary gain of 200. Investor recognizes 25% x 400 = 100 in its income statement as equity in earnings of affiliates (same treatment as above) and also recognizes 25% x 200 = 50 as equity in extraordinary gain of affiliates. If Investee has reported any items for discontinued operations or effects of changes in accounting principle, they would be presented similarly on Investor's income statement.

If Investee pays a common dividend, Investor reduces its investment account by the amount of the dividend received. Note that receipt of the dividend is not recognized as income in Investor's income statement and is actually a capital transaction affecting only the balance sheet accounts (because we are ignoring, for the moment, any income tax effect). Investor treats the dividend distribution as a capital transaction because the dividend is merely a cash distribution of income that Investor has previously recorded as equity in earnings of affiliates.

EXAMPLE 1–3. Accounting for Investor's Receipt of Dividends from Investee

Assume the same fact pattern as in Example 1–2 above, except that on 31- Dec-20x1 Investee pays a total dividend of 80 to all holders of common stock. The first two entries are the same as in the previous example:

The new entry accounts for the cash received as a cash dividend from Investee that reduces the amount carried in Investor's Investment in affiliates account.


When assessing the tax effects of equity investments, our first reaction is to sometimes think that the Investee has already paid income taxes on its earnings and that, because of that, there should be no additional tax impact to Investor. While it is true that Investee pays income taxes on its earnings, under U.S. tax law, any gain that Investor realizes on its investment is generally subjected to a second level of taxation, i.e., double taxation; those tax effects must be reflected in Investor's accounting. The general tax effects of an equity method investment include the:

* Recognition of book taxes in each period to reflect the accrued tax burden associated with the equity in earnings of the affiliate

Excerpted from Accounting for M&A, Equity, and Credit Analysts by James Morris. Copyright © 2004 by The McGraw-Hill Companies, Inc.. Excerpted by permission of The McGraw-Hill Companies, Inc..
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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Table of Contents




List of Abbreviations          

Chapter 1 Equity Method of Accounting for Investments          

Chapter 2 Minority Interests          

Chapter 3 Deferred Income Taxes and Income Tax Reporting          

Chapter 4 Deciphering the Deferred Tax Footnote          

Chapter 5 Estimating the Tax Basis of a Firm's Assets          

Chapter 6 Pension and Other Postretirement Benefits          

Chapter 7 Deciphering the Pension Footnote          

Chapter 8 Analyzing the Firm's Pension Cash Flows          

Chapter 9 Employee Stock Options          

Chapter 10 Restructuring Charges          

Chapter 11 Discontinued Operations          

Chapter 12 Net Operating Loss Deductions          

Chapter 13 Purchase Accounting for Business Combinations          

Chapter 14 Deemed Asset Sales under IRC Sections 338(h)(10) or 338(g)          




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