Hi everybody, welcome to this Felix live session. My name's Maria Weber. I'm one of the trainers at Financial Edge and I'm going to be taking the session for the next roundabout hour on Non-controlling Interests and Equity Associates. So I am going to be using some Excel files. You can find the Excel files, they should be in the resources section. If you go to the bottom, I think of your screens, there should be a little resources button. If you click on that resources button, it should take you to a link on Felix where you will find the Excel files that I'll be using. We've got the question file, the empty file, and then the full solution file. So I know sometimes these sessions can be a little bit quick because we've got limited time. So if you maybe wanna just sit back, watch what I'm doing or of course feel free to do it as I'm doing it. But if it's maybe a little quick, you've got that full Excel answer file as well that you can have a look through afterwards. So just to show you what you should be seeing if you follow that link or, I think there's also a link in the chat if by some chance you're not seeing that. If you go to Felix under topics and you go all the way to the bottom to Felix live, so Felix topics Felix live, then you should see all the Felix live sessions past and upcoming. You just scroll all the way down to today's session, which is right near the bottom on the right equity method and non-controlling interests. And if you click on that you should see this and that's what that resources link should give you. And the link in the chat should also give you. And then the files are on the bottom right hand side download. So the empty file and then the full file. Please do ask questions. We've got the question and answer box. I'm not sure if you have access to the chat, but however you wanna ask a question, please do ask questions and if you have questions after the fact, please ask them in the feedback form. So please take a couple of minutes to fill that out. You've got a link in the chat as well. And then when the session ends, it should automatically pop up. And if you have any follow on questions, please do use that form. Great. So if we get going, let's just have a quick chat agenda wise on what we are doing. So we focusing on two things, equity method investments and non-con controlling interests. So we are gonna start with equity method investments. We are going to talk about how you create an equity method investment. So what is it and how do you initially recognize it in the financial statements? And then we are gonna say, okay, now that you've recognized this investment, how do you account for it on an ongoing basis? What's the impact on the income statement, balance sheet and cashflow statement? We are gonna do exactly the same thing with non-con controlling interests. Creating it, it's a little bit more complex than with equity method. So we'll spend quite a bit of time on that. And then ongoing impact income statement, balance sheet, cashflow statement. And then finally we'll use the last few minutes to just talk about valuation implications. So moving away from the accounting to just practically speaking, when you're valuing a company, what you need to think about when it comes to equity associates and non-con controlling interests. I do have a short exercise on that, but I don't think we'll have time to actually do it during the session. But you've got that to take away with the answer to work through. And like I keep saying, any questions after the fact, you've got the feedback form and then if it's even after that fact, remember ask an instructor button in Felix that you can always get in touch with us.

Okay, so if I start, I'm just gonna talk through a few slides before we move to the workouts just to set the scene a bit and give us an idea of what we are actually going to be doing. Let's start with talking about an equity method investment and what that is. So in this diagram we've got the holding company sometimes called the parent or the acquirer and they buy shares in another company, they buy an investment in another company. Now we dealing with this left hand block, we not having a look at the right hand block that's control and that we'll deal with when we look at consolidations and non-controlling interests, we are looking at the left hand block, which is where the company buys a stake in another company, but it does not control that company but it's got significant influence. Now there is a definition of significant influence in the accounting standard. I think it refers to participating in the operating and financial decisions of the business, but you don't have control over that. Generally speaking, it's 20% to 50% of the shares, right? If you have an investment in that company and you own 20% to 50% equity method accounting also applies if you have an investment in a joint venture. A joint venture is where you share control of the business with another entity. So it's a 50 50. So you're not solely in control. So you'll see here in abbreviation ea we talking about equity method investments, but you could also see them referred to as equity affiliates or equity associates. And that's why we've got this abbreviation ea, it all means the same thing.

Okay? So that is what an equity investment is. The next question is, okay, we know what an equity investment is, how do we actually account for this? So we start off with the initial recognition in the balance sheet. When the investment is made, we recognize an asset under non-current assets as what we paid for this investment. And then we've also got to, on the contrary, I mean we know a balance sheet has to balance double entry system. So we've gotta put how we finance that. Did we pay cash? Did we take out a loan? Did we issue some shares? So that is then dealing with the financing and that's your initial recognition. Then on an ongoing basis, we recognize our share of the net income of this associate company in our income statement. So if I own 25% of that company, I will show 25% of their net profit in my financial statements and that's my income statement impact. So I show my share of the net income, then this company that I've invested in might pay dividends. When I receive those dividends, that's going to impact my cashflow statement. So that will be cash inflow into my cashflow statement.

Now we know that income statement, balance sheet and cashflow statements are all linked and ultimately everything makes its way onto that balance sheet. So what does my balance sheet end up looking like? Well, I would have say cash received from the equity associate in my balance sheet, but then that equity associate investment itself, I adjust the value of it. I say this is the value I started with. I then add my share of the income that has been generated in that company because technically that belongs to me. I own a portion of that company, so I'm entitled to a portion of their net profit. So I add that onto my investment and then I say, okay, but wait a minute, they've actually given me some of this back in the form of a dividend. And so I then deduct the dividends received and that gives me the ending balance of that non-current asset in my balance sheet. Okay, I know at this point this is probably sounding very theoretical. I think it's always easier if we put some numbers to it. So let's have a look at our workouts. For those of you that have just joined, welcome. You will find under the resources section at the bottom of your screens usually or at the top a link to Felix where you will find these downloads. So I'm going to be working in the empty file and we've got a number of tabs here. I'm gonna be on the third tab or the first of the workout tabs, which is this one here, workout equity method.

So let's look at the information we've been given. We've got two companies, A, Inc, and B Inc. We are given a very simple balance sheet for the two companies. So current assets and property, plant and equipment. And then we've got current liabilities, long-term liabilities and equity. So these are two separate companies here we have the transaction A Inc buys 20, not 20, 30% of the equity of B Inc. Okay? So there we go. We've got our 30%, this is an equity, associate equity affiliate equity method investment, whatever you wanna call it. So they buy 30% of B and they pay 15 for that and it is a cash deal. So they're not taking out a loan, they're not issuing shares, they're paying cash for this investment. So the first thing we're gonna do is we're gonna recognize the initial investment and that was step one on that slide we were just looking at. So if we scroll down a little, we have got the balance sheet for A Inc and we need to record both entries. Let's record the investment that they have made.

And this investment is not a current asset, it's not property plants and equipment. We need a separate line item. So this could be called different things like I said, let's say equity method investment or equity associate equity affiliate. And we put it in at the price we pay, which is 15.

Now we can see our balance sheet is not balancing. So what I'd already done just to speed up the workout a little bit is if you look at that after investment column I've just summed across, so balance sheet before investment and then any adjustments we are making to that. So I've summed it across and totaled that. So we can see balance sheet's not in balance, but that is because we haven't put in the financing of that investment. How did we pay for it? If I took out a loan, I would go add two long-term liabilities. In this case I didn't. I paid cash. So all I do is undercurrent assets, which is where my cash would be sitting. I'm going to put negative 15 because the cash goes down and now we have our balance sheet back in balance. Okay? So that is my initial recognition of a significant influence holding that I've got financing on the one hand and the investment on the other hand, any questions, please don't hesitate to put them in the Q&A pod.

If we now work on work on if we now move on to workout two, we are looking at the subsequent impact on income statement, balance sheet, et cetera. So we've got new information here that tells us it's now one year after the deal B Inc. That is the company we have invested in. And remember we have got a 30% holding in B Inc. That whole company B has generated net income of 12 and paid a dividend of 6. Okay? So that is what the whole company but has earned and 30% is our holding. Whoops, this thing is not enjoying my hand on the screen. So our holding is 30% and that data is for the whole company. Now I've been given the balance sheet of a before we've accounted for this or not the balance sheet, sorry, rather the income statement. So I've got the income statement of A for the year before we've accounted for this and I'm asked to update that income statement. And I'm also asked to update the balance sheet. What would this investment look like in the balance sheet? Okay, we are assuming nothing else has happened for the sake of simplicity. So let's deal with the income statement first.

Pretty standard income statement here. We've got sales, COGs, gross profit, then I've got SG&A and I've got by operating profit line. And then I've got net interest expense, profit before tax, tax and net income. Now we need to recognize our portion of the net income of this company B. And we're gonna have to insert a line in our income statement for this. Now you might see this come into an income statement in different places. Typically where you would see it is below the operating profit line. This isn't operating profit. If we think of a company like Coca-Cola, their business is making and selling drinks. It's not investments. So this is below the operating profit line.

So I'm gonna put it directly below, I'm just gonna include a line called equity income or equity method income.

And we including our share of bees net income, we are told that the net income for B and my writing is covering it slightly. The net income for B is 12.

My percentage of that I'm entitled to 30%.

And so that means 3.6 million assuming we are working in millions is my share. So I put that in my income statement.

Now we just need to update our subtotal because my profit before tax, we inserted a line and we haven't actually taken this equity income into account. So I've taken my operating profit, we deduct net interest expense and we are going to add this equity affiliate income in.

You might also see this equity affiliate income being added after the tax line. So you might see it just before net income. But what is important to note is this tax expense is not being adjusted and that's because this equity income we are putting in is already after tax, right? We taking B Inc's bottom line and we are just taking our portion of that. So there's already tax deducted on that net income that we've added in. Okay? So that is income statement impact one line equity income from associates.

What we also have to do is update the balance sheet. So what I'm gonna do is I'm just going to copy to speed things up, I'm gonna copy this balance sheet from above. And remember we are assuming nothing else has happened, I'm just gonna put the equity affiliate in here. I'm not gonna do any other entries, but I'm just gonna go up, pick all of that up, copy it and paste it below here.

And don't worry if your spreadsheet's looking a bit messy, I'll, you've got the full solution file as well.

I'm just gonna carry on adding columns on the right.

So let's deal with this net income first, right? So we are gonna show our portion of net income and we said we are gonna add that to this equity method investment, right? So here's my equity method investment, there's my equity method investment, I'm going to add this net income of 3.6 because that increases the value of my investments. I'm entitled to that. So that 3.6 is getting added. I'm just gonna delete some colors here just to make things a bit clearer. Okay? So I'm adding that 3.6 net income, But my balance sheet is going to be out of balance. I can't just add net income on the one side to my assets and not do anything else.

Remember anything that affects my income statement ultimately affects equity because the bottom line of my income statement flows through to retained earnings, which is equity. So that 3.6 is gonna mean that shareholder's equity also goes up by 3.6. I've made this profit, my income statement's now higher by 3.6, which means retained earnings will be higher by 3.6. So I add that onto shareholders equity. So that's me recognizing the net income. Now what I need to do is I need to recognize the dividend and remember dividends don't go through the income statement.

We are told if we go up to the top that this company B has paid a dividend of six, that's the total dividend that's been paid. My share of that dividend is 30% and that means my cash is gonna go up, this will go in my cashflow statement and cash balance undercurrent assets will go up. So 30% times that dividend of 6. So that's 1.8.

Again, if I just left this as it is, my balance sheet would be out of balance. What's the contra entry? The contra entry is I have been given some of that 3.6 that's owed to me. I put owed in inverted commas because we know it's not really a liability but that equity income belongs to me. I've been given 1.8 of that back. So I subtract that from my investment because now I've been given that as cash and that's now sitting in my bank account.

And then if we just work out the ending balance sheet, just for completeness sake, let's just double check that everything balances. If we add across, we've got cash going up because of that dividend, nothing has happened to PP&E and my ending balance of the equity method investment is now 16.8 and my total balance sheet is 303.6. And then if we just sum across all the items on the bottom part of the balance sheet and check my totals just to double check that everything is in balance, we can see that we are happy.

So that is equity affiliates and the accounting for them.

Any questions, please put them in the chat if you may be thinking or typing a question. In the meantime, let me quickly just show you what we've just looked at. If I just pick Coca-Cola, I'm just gonna go to their latest annual report, the 10 K. Let's just jump to our balance sheet. So what we are talking about, Coca-Cola owns stakes in other companies. One of those companies, if you look at the detail in the notes is actually Monster Coca-Cola owns, I think it's 20% of monster. So that would be included with all the other significant influence investments in this line here in their balance sheet equity method investments, 19.7 billion, that's part of my non-current assets in the income statement underneath operating income or operating profit, we've got equity income or loss from all of these associates that Coca-Cola has a stake in. And there we've got 1.7 billion coming in over there and that's equity associates.

So we've done first two things on the agenda. Let's now move on to doing NCI and it's a little bit more complex.

So where are we in this diagram? We are not looking at the left hand side, we are looking at the right hand side where we've bought a stake in a company and we control that company. Usually it's where you own more than 50%, right? You've got the controlling vote, you control the company.

When we have control over another company, we need to consolidate that other company into our results regardless of whether we own 60%, 70% or 80%, we consolidate 100% of that subsidiary. Now if you've never seen consolidation accounting before, okay, this is gonna be quite a whirlwind and I'm not going through consolidation accounting in an hour, we don't have time for that. We are just focusing on the NCI you would wanna watch on Felix under accounting, if you go to your corporate finance accounting, If you scroll down a bit introduction to full consolidation because that explains how you consolidate. Let's just have a very quick overview or recap and then we'll focus just on the NCI bit that we wanna get to. So with a balance sheet consolidation, you take the holding company or the parent or the acquirer, whatever you wanna call it, and you add 100% of the targets balance sheet to your balance sheet, okay? Even if you only own 80% and then you've got to adjust for transaction effects. So we had to have paid for this somehow. Did we pay in cash? Did we pay with shares? Did we pay with debt? So incorporate that. We also need to make some other adjustments. One of those adjustments is goodwill and we'll have a chat about that. Now we also eliminate the investee's equity. So this is all part of consolidation accounting, but for purposes of what we are doing now, we take a hundred percent of the subsidiary. I've already mentioned this point about looking at how we've paid for something because that is not only going to impact our balance sheet, it's gonna impact the income statement going forward as well. So this sources and uses of funds table, we need funds to buy the shares of the company and we might even refinance the debt. So we'll need even more funny, more funny sees Friday afternoon guys more money for that. So we might need more funds, but then where do we get the money from? I could use cash. Cash on my balance sheet would go down, but that also means I'd have less interest income in future because that cash is gone. If I use debt it means debt comes on the balance sheet but I'm gonna have more interest because of the debt. So we've gotta take these things into account. When it comes to the income statement consolidation, the principle is exactly the same as the balance sheet. We take the parent company's financials, parent company's income statement and we add 100% of the target's income statement. And then again we adjust for these transaction effects. So things like the interest that we would deal with, things like synergies, right? Big driver of M&A and that gives us our consolidated income statement. So where does non controlling interest come in because that's the focus of what we're gonna be doing next. Non-controlling interest comes in where we don't buy a hundred percent of the shares of the target, we only buy 80% or 70% or 60%. And so what we have done is effectively wrong. We've added in a hundred percent into the income statement. We've added a hundred percent into the balance sheet. But we have to recognize actually we don't own a hundred percent. Some other shareholders outside my company own the remaining 30% or 40% and that's what NCI is. NCI in the old days back when I studied, used to be called minority interest. So if you've heard that term, it's now called non-controlling interest. Now you might wonder why do I wanna talk about goodwill apart from the fact that I love talking and I could talk all day but we've only got an hour. So why have I got a goodwill slide? The reason is because there's two ways of accounting for that non-controlling interest and the method you use to account for your non-controlling interest has an impact on the goodwill that is recognized. So two methods of accounting for NCI under IFRS at least and the way you account for its impacts the goodwill. We're gonna do an example now before we get there, big picture. What is goodwill? Goodwill is the extra amount the buyer pays over the fair value of the equity they're buying. Okay? So if we look here, what's the price I'm paying to buy my stake in this target? What is the equity that I'm buying at fair value? You might see in the accounting standards they use more fancy language. I think they refer to the fair value of the identifiable assets and liabilities. The difference between the two is goodwill. So we effectively revaluing the whole balance sheet to fair value and then we saying okay, well did I pay more than that If I did, that's goodwill and that goes as an asset on the balance sheet.

Let's now tackle accounting for this non-controlling interest.

Big picture overview on the slide and then we'll do two examples that show both methods. So method one for accounting for non-con controlling interest is only a choice with IFRS. If you account under US Gaap, there's only one method of doing it. So method under IFRS that you could choose is you take the percentage of identifiable net assets. Remember we said that's a fancy word for the fair value of equity of the target, okay? So in this example, company A buys 80% of company B. So that means the non-controlling interest is 20% the fair, uh, the identifiable assets net assets is 400. That's the fair value of equity is 400. So what do I account the NCI at? What do I put in as the value of NCI? Well if fair value of equity is 400 that we buying NCI is 20% of that when it comes to the goodwill, there's only goodwill on the parent company stake. So the parent company paid 500, they paid 500 for 80% of the equity that's valued at 400. And so the difference between that is the goodwill, that's method one.

Method two is what you have to use for US gaap and it's a choice for IFRS. Method two is where you show the NCI at fair value. So here we've got the fair value of NCI is 90 and guys that's an actual valuation, right? It's subjective unless the target is a listed company with a share price, okay, you're gonna have to the directors, someone's gonna have to come come up with a value of that NCI. So fair value of the NCI is 90. So if we look on the next slide, which we'll do in an example now the new bit, the different bit is that we've also got goodwill on the NCI stake.

So this whole left hand side is the same as method one. The acquirer pays 500, net assets are three 20, goodwill is 180.

Now we've also got goodwill on the NCI goodwill on the NCI they are buying or they're entitled to 20% of those net assets which is 80. The fair value of that stake is 90. And so there's goodwill on that stake. And so we would put the NCI into the balance sheet at the 90, but then we also gonna recognize goodwill of 10 on that stake, bringing the total deal goodwill to one 90.

Okay, enough of the slides, I know this is very theoretical but I feel it's good to just try get the idea out there before we look at a workout. But let's now implement this in a workout to show what I have been talking about. I know I'm a broken record, but any questions please don't hesitate to put in the chat or the Q&A.

So I'm moving on now to the next tab along. So at the bottom we've got consolidation and NCI, if we have a look at workout one, we've got Florence Inc buying 80% of the equity capital of Rome. So Rome is the target company that we are buying for 3,355. So if we are buying 80%, that means we control it, it's a subsidiary, we need to consolidate it, we are gonna consolidate a hundred percent, but then we are gonna recognize that the NCI is 20%, we don't own 20% of this. We then told how the transaction is funded, 55 million of cash equity of 825 and the balance with debt that's gonna impact the balance sheet and the income statement. Going forward, what we need to do is we need to do a sources and uses of funds table a goodwill calculation and then the consolidated balance sheet.

So starting off with the use of funds, us as Florence, we need to come up with 3,355, right? That amount over there that we said we are paying for our equity stake.

How are we paying for this equity stake? They tell me 55 million of cash on the balance sheet that I've already got. I'm gonna use, I'm am going to issue shares equity for 825 million and then the remainder is gonna be financed with debt. So I need to take the amount of money, I need the 3,355, I need to take out the cash, I need to take out the debt, take out the equity and then the remainder is what I need to finance with debt. So that's 2,475 of new debt that I'm going to issue to fund this.

Let's do the goodwill calculation. And in workout one we are following, we are following. I literally can't talk anymore. The last session today is gonna be fun, okay? Method one where we put NCI at the percentage of the net assets, right? And under method one there's only goodwill on the acquirer stake. There's no goodwill on the NCI stake. Okay? So we following method one. So what's the goodwill? Okay, purchase price is the 3,355. That's what we paying for our 80% stake. What are we buying? We are buying, if we go down Rome is the target. We've got a full balance sheet for the target. We are buying the equity of Rome.

Now what we're not doing in this example because it would be too big of an example, is we would need to fair value that equity. So we would have to step up or step down assets or liabilities. So for example, buildings, buildings might be carried at cost on the books, but we need to or not cost depreciated amount. We need to look at what could those buildings actually be sold for. We market value things. So we would market value the balance sheet and come up with a market value of equity effectively. Let's assume this represents market value. We are just skipping that step. Okay? So let's go add the equity of the target. So equity of the target, we've got the share capital or the common stock and we've got the retained earnings of the target. So that's equity of the target of 1,773.2.

I am only buying 80% of that. So when I'm working out the goodwill, I'm going to compare what I pay with what I buy and I only buy 80% of that. It's just reveal the formula here.

So what is the deal goodwill? I've paid 3,355 for equity of 1,418. And so the deal goodwill is 1,936.4.

How do I value the NCI This method, method one, which is a choice for IFRS. We said we are gonna value NCI at their share of the net identifiable assets, which is another way of saying fair value, market value of equity. So we take that equity that's been purchased, sorry the a hundred percent equity of the whole target target and we say the NCI are entitled to 20% of that, that's the NCI stake.

And so the NCI here would be put into the balance sheet at 354.6.

So let's see what this is actually gonna look like in the balance sheet.

Consolidated balance sheet we take Florence, the holding company, the parent, we add 100% of Rome, right? We're gonna add 100% and then we put in the NCI to show actually we don't own a hundred percent, the other 20% is owned by outside shareholders. So what I've done is, I'm just gonna zoom out a little bit. I have already done the calculations for the combo balance sheet, right? Adding across Florence plus Rome plus any adjustments we are making, let's put the adjustments in. We'll do this one example properly and then the next example we won't do the whole balance sheet. So let's do one properly. So okay, let's deal with all of the impact of what's going on. Let's deal with the financing of this transaction first. First we used 55 of cash. So cash is going to go down by 55.

So row 29 minus 55 cash is going down.

We issued equity. If you look in row 14 equity of 825, okay? So common stock 8 25, there's gonna be more equity. So linking up to row 14 and then the remainder was financed with debt. This is long-term debt.

And so we go pick up from our sources of funds in row 15, the long-term debt of 2,475. Okay? So that is my financing done.

We now need to put in some adjustments that we make on consolidation. And if you haven't yet studied about consolidation accounting, don't free watch those Felix videos. Get in touch if you have questions. But one of the things we need to do is we eliminate the target's equity because we've now bought that equity. So we take out that target's equity, so we are going to reverse that 748, get rid of it and we are going to take out the retained earnings, get rid of it. Instead we bringing in all of the assets, all of the liabilities and what we paid for it. Okay? So we take those two things out, that's a consolidation adjustment. Then we need to put our goodwill in and we calculated the goodwill. Goodwill is a non-current asset. So for goodwill we are gonna put in our goodwill amounts that we calculated in row 24, which is the deal goodwill.

And then finally we need to put in the NCI, we've brought in a hundred percent of the assets and liabilities of Rome. We don't own a hundred percent. So we've got to recognize there's this other claim on these assets and liabilities and that 354.6 comes under NCI.

We owe that, not owe. Again, I use the word owe likely 'cause it's not a liability, it's NCI but that is owned by people outside our business. And always important to check when you're doing any kind of modeling, any kind of balance sheet, your balance sheet must be in balance otherwise you've done something wrong. Okay? So this is method one. We account for the NCI as a percentage of the net identifiable assets of the target that are being bought. So the fair value of the target's equity, there's no goodwill on that NCI stake, there's only goodwill on the parent company stake. Let's finish off this little section with workout two and let's just focus on what's different. I'm not gonna do the whole balance sheet, you've got the solution, you can have a look through that. So same information for workout two, only new bit of information is this, the fair value of NCI is considered to be 675 million. So here we are doing method two, okay, I'm going to just copy down the uses and sources of funds from the top. Okay, to save a bit of time, it's exactly the same. If we go to row nine and just copy all the way down to row 15 transaction's the same, we're just accounting for the NCI differently, okay? So we're gonna copy that down.

And then the calculation for the acquirer's stake is the same as what we did before except the language is different. This is goodwill on the acquirer's stake as opposed to deal goodwill. If you go here up to the top, this is called deal goodwill because that's the only goodwill there is. We are looking at goodwill on the acquirer stake only here calculation is exactly the same. Let's quickly do it again in case you want another quick practice. So purchase price, the acquirer is paying 3,355.

What are they buying? Well they're buying the target. Let's look at what 100% of that target's equity is worth. And this equity would be adjusted for step ups and step downs of assets and liabilities. But let's assume in this case book value's the same as the fair value. So we add the two equity amounts and then we say okay well we only buying 80% of that equity, so multiply by 80%.

And so goodwill on the acquirer stake is the amount the acquirer pays minus the value of the equity that they're buying. And so that's exactly the same. The 1,936.4, same figure that we had before.

This is where things get different.

Now we are looking at goodwill on the NCIS stake and we are accounting for the non-controlling interest at fair value. And we were told if we scroll up, fair value is 675 million million. And remember this you have to do for US gaap. If you're looking at a US company, this is the method you have to use IRS, you've got a choice method one or two. So here we put in fair value of 6 75, what are they entitled to? Well 20% of the equity of the target. So we've got 100% of the equity of the target in row 65 column CNCI is entitled to 20% of that. And so there's goodwill on the NCI stake as well. We've got the 675 fair value of NCI minus the net assets of 20%. And so we've got goodwill on the NCI stake as well of 320.4, which means the total deal goodwill is the goodwill on the parent stake, which is the 1,936.4 plus that goodwill on the NCI stake. And so we've got deal goodwill of 2,256.8.

So I'm not gonna complete the whole balance sheet in the interest of time, it's gonna be exactly the same entries that we did for the first balance sheet except for this value of NCI and value of goodwill. My value of goodwill is now the deal goodwill, which is bigger 'cause we recognize in goodwill on the NCI stake as well. And instead of putting the NCI in at their share of the assets, so in the previous example we put in the 3 5 4, we put that NCI in. So where's NCI row 87, the NCI goes in at the fair value of 6 75. Okay? But that's all in the solution. So you can work through that afterwards and get in touch if there are any questions.

Okay, I'm very conscious of the time. I wanna move on to quickly talking about on an ongoing basis what's gonna happen in the income statement and the balance sheet. So this is just the initial recognition, I'm not gonna go to the slides. Let's just do this with an example in workout three looking at the income statement. Okay, so this is a separate example, not looking at the Florence Rome, but we were looking at, we've got Calabria planning to buy 90% of Puglia and I'm sure my pronunciations are embarrassing, but we just look past that. Okay? So that means that the NCI is therefore 10%, they wanna understand what the pro forma income statement is gonna look like for the next 12 months. So pro forma means after the deal, what will things look like? The deal is an equity for equity swap. The reason that's important is because if I'm looking at an income statement, remember we said if we funding this thing with debt or with cash, there's gonna be an impact on interest, right? Extra interest paid on the new debt interest lost on the cash that we had. So in this case they're saying there's no interest impact because it's actually funded with equity and then they give us goodwill, which is irrelevant for the income statement, okay? Using the information below, build out the income statement. So we've got the parent company Calabria, we've got Puglia, which is the target company. And what we do when we consolidate is we add 100%. So I've already done that summing across, I've gone and added Calabria plus Puglia a hundred percent of that.

Now in a deal, normally there's synergies that you would have to add in. We don't have any synergies in this example. Also financing impact, which we mentioned would be that interest impact we don't have in this example, but let's focus on the NCI. We've gone and added a hundred percent of everything and then right at the end we go correct it and we say okay, of this a hundred percent of Puglia that we've added in, only 90% actually belongs to us. The other 10% belongs to shareholders outside our group. And so what you do, we look at the target, okay? So we are gonna come to the target, we are gonna look at the net income of the target, that 4 4 7 0.1, that bottom line. And we are gonna say what belongs to the NCI is 10% of that net income amount. And that's all we do. We've got one line where we say what belongs to the NCI is 10% of that. I've put it in as a positive because if you look at your formula, it takes the net income and it subtracts what belongs to the NCI. So what belongs to the parents shareholders is lower and that is how you account for a non-controlling interest in the income statement. It's their share of that target company's net profit that you then gotta take out.

Last thing on this NCI is, if we look at work out four, how does this get accounted for on an ongoing basis in the balance sheet? So this is a separate example to Calabria and Puglia what we were looking at. But we on just let's say initial recognition when this consolidate, when this acquisition happens, okay, non-controlling interest gets onto the balance sheet at 6 75, what happens the year after? Okay? And that's what this workout four is dealing with. So workout four, we've got lagano, they've got non-controlling interest in their financial report. So this is a historic non-controlling interest. So this is year zero. If we look at their financials in their income statement, they had net income attributable to NCI of 2 8 6 oh in the balance sheet, that amount for non-controlling interest was 42,800. And in the cashflow statement there were dividends that were paid on the non-controlling interest. So what will this look like at the end of year one? Going forward a year they say okay, well we're doing a forecast NCI share of net income is gonna grow by 5%.

Okay, so let's take that 286, oh grow it by 5% and the dividend payout ratio is 20%.

Okay? So of that 3003 net income 20% is going to be paid out as a dividend.

So how does this impact the balance of the NCI in the balance sheet? And guys, this is exactly the same as how we would account for an associate, an equity associate. We say, well that was sitting in the balance sheet at 42,800, that was their claim on the business, 42,800 to that we add their share of the net income, which is the 3003. And then we say, okay, but we're gonna subtract the dividends we've given you because that then reduces your claim because we've given you some of that income actually as a dividend. So we subtract the dividends. So the accounting is actually the same as the calculation we do for equity affiliates, okay? It just appears in a different place, okay? And it's a non-con controlling interest. So it is a very different thing, it's just the mathematics of the accounting is the same.

Okay, so we need to wrap up, I do still wanna talk a little bit about valuation for the last few minutes just before I move away from the spreadsheet. This is the valuation workout that I mentioned at the start. I didn't think we would have time for and we don't have time for unfortunately, but have a look through that valuation exercise. I'll have a brief chat about valuations. Now before we go through that, I just wanted to show you in Coca-Cola's financials. So where would this appear? If we go to the balance sheet earlier we were looking at equity affiliates, equity associates under the assets side of the balance sheet.

Non controlling interest is under the liabilities and equity side, right? There's my NCI right underneath equity attributable to Coca-Cola shareholders. They've added 100% of all the subsidiaries, but they don't own a hundred percent of all the subsidiaries of what they've added in 1,539 actually belongs to outside shareholders. So that's the non-controlling interest on the balance sheet in the income statement at the very bottom line of the income statement, don't confuse it with the equity income. That's what Coca-Cola receives from its equity affiliates or not receives. That's what's its, it's entitled to non-con controlling interest that we've just been talking about is right here at the bottom. We've added in a hundred percent of the earnings of the subsidiaries, but actually part of that belongs to outside shareholders. So we take it off at the bottom. In this case actually for 2023, Coca-Cola had a loss. Not Coca-Cola, the stake of the NCI is a loss, okay? But in the other years it is a profit. Okay? So that's just seeing it in a real set of financials. Okay guys, let's use the last seven minutes to have a chat about valuation. So completely shifting mindset, we are moving away from accounting to talking about valuing a business. If you're not familiar with valuations, you know you've got your Felix videos under corporate finance valuations, but we need to be able to maneuver between equity value and enterprise value. And this diagram, which is called the bridge, just shows the adjustments that you make to go from enterprise value to equity value and vice versa. So if we were starting with equity value, which is market cap, that's equity value and we wanna get to enterprise value, which is effectively the value of the operations of the business. We need to add all the other funding items in addition to equity. So we've got non-con controlling interest, maybe pre shares debt like instruments like leases pensions potentially, and then pure debt. And then we subtract off all of the financial and non-operational or non-core assets. So cash, short term investments, et cetera. What we are focusing on is we focusing on these two things that associates, that's our equity method. Investments on the asset side of the balance sheet and the NCI non controlling interest. Now when we doing this bridge, technically we should put things at market values because we trying to work out the market value of the equity or the enterprise. And so the question is what we looking at in the balance sheet for associates and non-controlling interest that could actually be materially different to the market value because we account, we've just shown, we accounted book value effectively what we paid, okay? Or the initial recognition of NCI plus net income minus dividends, that could be quite far removed from the market value of that investment. So if it's immaterial, you probably won't bother making the adjustment. But if these things are sizable, it's always more accurate to try get a market value. So on this slide we are not gonna do the example, you've got that workout on the valuations tab, but I mean this is just saying, look, if we look at the book value of NCI book value of NCI, here is 1,414. And remember that's an equity value. If you compare that to the earnings that belong to the NCI of 496, we get a price to earnings multiple of 2.9 times. Now that sounds very, very low. So chances are that's not reflecting a market value. So how do we come up with the market value and these steps apply equally to an associate. So even though this heading says non-controlling interests, you apply the same logic. If I were trying to get a market value for an associate's investment, first question you're gonna ask yourself is, is this subsidiary that I'm looking at or is this equity associate a listed company? If it's listed, I need to then have a look at the share price and I multiply it by the percentage holding, right? Whatever the NCI is or whatever holding I have as an equity affiliate. So an example of that would be Coca-Cola owning a stake in Monster. They own 20%. Okay, what's monster share price times 20% of all the shares outstanding. Okay? That would be the market value.

If however, the company is not listed, right, the subsidiary or the equity associate is not listed, look in the financials because sometimes it's provided as a footnote in the financials. If it is provided in the financials, I'm not gonna go there now, but you can see Coca-Cola does actually disclose of its equity affiliates, it discloses fair values or market values for some of them. Not all of them just check. And that's exactly the point here. You've just gotta check that it represents all of the equity affiliates, okay? You need to know what you're looking at. Otherwise you might need to make a few adjustments. If the company does not disclose in the financials what the fair value is, then we need to try do our own valuation. And to do that, we can take the net income attributable to the NCI or if I'm looking at an equity associate, what's our share of that net income? If it is positive, if there is net income, if there's a loss, we can't place a market value on it. So that's just the very bottom line. Then use book value. If there's no positive income, just use book value. But if there is some income attributable to the NCI or the equity affiliate that's positive, then we're gonna do a multiple based valuation. So do we know the sector that this company we are looking at belongs to? If we do know the sector, go look at the PE multiple for the sector and apply that to the earnings. If we don't know the sector, then we need to just make an assumption that it is in a similar business to the parent and then we would use the parent's PE multiple. So this isn't, you know, a hundred percent accurate science. This is just trying to come up with a market value. As always, there's judgment involved, a lot of subjectivity. There's a point on the slide saying we might actually lower the multiple a bit to reflect lower liquidity for these stakes. So this isn't, you know, black and white, accurate, accurate valuation. There is gonna be some judgment and subjectivity involved, okay? But this is not the accounting side of things. Moving into the valuation realm, guys, with one minute to spare. That is it from my side. So I hope you have found the session useful. Please don't hesitate if you have any questions, I'll keep the room open for a minute or two if you wanna put them in the q and a pod now. Or please do fill out that feedback form and ask any questions in there. But thank you very much for your participation. I hope you enjoy the rest of your day and I hope to see you again soon. Next week's Felix live is going back to basic, so basic I think accounting if you are interested in that. But obviously keep a lookout for the future sessions all listed on our website. Thanks very much and enjoy the rest of your day.