A legal entity can be defined as:
An association, corporation, partnership, proprietorship, trust, or individual that has legal standing in the eyes of law. A legal entity has legal capacity to enter into agreements or contracts, assume obligations, incur and pay debts, sue and be sued in its own right, and to be held responsible for its actions.
A limited company (LC) is a form of incorporation that limits the amount of liability undertaken by the company's shareholders. A public limited company (PLC) is a company whose securities are traded on a stock exchange and can be bought and sold by anyone.
Most major corporations consist of many companies that were brought together over a series of years to create a corporate enterprise. The business combination of these companies is carried out through share ownership between the companies.
Each company must report financial statements in accordance with the requirements of the jurisdiction in which they operate. For example, all limited companies incorporated in the UK must report to “Companies House”, the government organization that is responsible for registering limited companies. Public limited companies must also report in accordance with the requirements of the stock exchange on which they are registered. These public limited companies are required to report the consolidated financial results not only of the individual company but also of the companies in which they have an ownership interest.
A company that owns shares of other companies can be referred to as a “holding” company. This holding company might directly own all shares of another company, many shares or only a few shares. A holding company might also own shares in a company that itself owns shares in another company, creating indirect ownership. The extent to which a holding company controls the owned company determines how the results of the owned company are to be combined with the results of the holding company when presenting the consolidated results.
Generally, if a holding company owns in excess of 50% of another company’s voting shares then the owned company is “controlled” by the holding company. If a holding company owns in excess of 20% but no more than 50% of the voting shares of another company then the holding company is deemed to have “significant influence” but not control of the owned company. If a holding company owns up to 20% of the voting shares of another company then the holding company is deemed to have neither significant influence nor control of the owned company.
A legal company generally records their investments in other legal companies using the “cost” method of accounting, except where required by local regulation. Under the cost method of accounting, the share purchase is recorded by the holding company at the initial cost on the date of acquisition and generally remains without change until disposal. When the shares are sold, any gain or loss on the investment is duly recorded. An alternative investment accounting method is the equity method. Under the equity method, the initial cost recorded at the time of acquisition is adjusted periodically based on the holding company’s share of profits or losses recorded by the company in which the investment is held.
This accounting method when applied to reporting by a legal company will be referred to as “Equity Pickup” (EPU) to distinguish it from the equity consolidation method. Equity Pickup is applied to the investments made and recorded by a legal company in their legal company records. The equity consolidation method is used when a legal company aggregates data from the companies in which it has a direct or indirect ownership and reports the consolidated results. The principle behind Equity Pickup accounting and the equity consolidation method is essentially the same but is applied under different circumstances (legal company results vs. consolidated results).
To record the results of Equity Pickup, the holding company’s share of the change in Owner’s Equity for the period (generally profit or loss of the owned company, less the holding company’s share of any dividends declared), is recorded in the holding company’s accounting records as income and as a corresponding increase in the value of the investment in the associated company. Any share of earnings of indirectly held companies is recorded by virtue of the owned company’s reported income having already recorded their equity earnings of all companies that they own.
In complex multi-level ownership structures, a specific sequence of Equity Pickup calculations is required in order to achieve the correct results. For example, if company A owns shares in Company B and Company B in turn owns shares in company C, then the Equity Pickup for company B must be calculated before the Equity Pickup for company A is calculated, to ensure that the earnings and investment adjustment made in company B is subsequently reflected accurately in company A.
The Equity Pickup feature of Financial Consolidation and Close is based on the following configuration settings and requirements:
The Entity dimension hierarchy accurately represents the direct ownership relationships between holding companies and companies for which EPU will be applied.
The entities in the Entity dimension can be identified as legal companies.
There is only one Holding method company under each parent entity and the entity currency of the Holding company and the parent entity is the same currency.
If the EPU reported for each Holding company is to be identified by each legal company in which the holding company has either a direct or indirect ownership interest then:
All legal companies in the Entity dimension must be flagged as intercompany in the Entity dimension and exist as level 0 entities in the Intercompany dimension
If the EPU reported for each Holding company is to be identified by each legal company in which the holding company has only a direct ownership interest, with indirect ownership being grouped within “interim” directly owned holding companies, then:
All legal companies and all parent entities in the Entity dimension must be specified as Intercompany in the Entity dimension and exist as level 0 entities in the Intercompany dimension.
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Watch the following video for information on equity pickup: