Amortization of excess price- Balance Sheet and Income Statement

CFA Level II FRA
#1

In the equity method, when we allocate the excess of purchase price to amortization, we record this excess both in the balance sheet and income statement. For example, lets assume that we (investor) own 25% of ABC and we paid $150,000 for the purchase price. ABC’s book value and fair value are equal except that its PPE is worth an additional $40,000 in the market. ABC’s book value is $80,000 and fair value is $120,000.ABC’s net income is $200,000 and pays dividends of $10,000. The PPE is depreciated over 5 years.

  1. In the income statement, we record an investment revenue of $50,000, but we also need to record the amortization of the excess price for the PPE. We paid an additional of $40,000, so the $40,000 depreciated over 5 years is $8,000. Now my question is if we are responsible for the extra $40,000, why do record an amortization expense of $2000 (0.25*$8,000) per year rather than $8,000?

  2. We record in the balance sheet an initial cost of $150,000+ $50,000 ( our portion of NI= 200,000+0.25) - $2500 (our portion of dividends= $10,000*0.25) -$2,000= $195,500. However, why does the depreciation of $2000 affect the investment value on our balance?

  3. If the book value of ABC was $120,000, and the fair value was $80,000, would we record the excess of $40,000 on our balance sheet and income statement? If so, why if the ABC is already fully depreciating $120,000?

Thanks for your help

#2

When you say that its PP&E is worth an additional $40,000, is that for 100% of their PP&E or for only the 25% of the PP&E that we purchased?

#3

I am not sure to following the question.

Lets assume is both scenarios

#4

waiting

#5

Busy.

Don’t nag.

#6

ok i guess when you are less busy or whoever can…

i was just asking for help…nothing else

#7

  1. Because you always have to consider your proportionate share. The other 75% does not belong to you so you do no expense it.

  2. Because it is not recorded on the investee’s income statement, the investor needs to record it. Since you are acquiring the fair value, you need to depreciate the difference. That difference does not appear on the investee’s income statement, so you reduce it from the investor’s balance sheet and income statement (net it out of the proportional share of income). You recognize the net income, but the net income is overstated because of the additional depreciation required due to using fair value.

  3. Not sure I understand the question, but my guess is no. You would report 120K.

#8

If the extra $40,000 applies to 100% of the subsidiary’s assets, then the parent will amortize (depreciate) only $10,000 over 5 years: $2,000 per year.

If the extra $40,000 applies only to the 25% of the subsidiary’s assets that the parent has purchased, then the parent will amortize (depreciate) $40,000 over 5 years.

#9

Hi Bill @S2000magician, can you help me understand the economic/accounting rationale for amortizing the excess of purchase price over proportionate share of investee’s net assets, under the equity method?

I struggle to understand the rationale since we are not consolidating here.

Thanks!