Equity Method - Accounting for Goodwill

[Ernest_Seow]

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Thanks. My bad, by extra expenses I’m referring to depreciation expenses. Thanks for correcting.

[S2000magician]

@Ernest_Seow

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Hi Bill,

Howdy, Ernest!

@Ernest_Seow

If there are still residual after this assignment, they will be goodwill?

In essence, yes, though it is not accounted separately; it’s just part of the Investment in Affiliate asset account.

[CADFX]

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Where does it say this in the IFRS/US GAAP handbook? I disagree with you.

IAS28 p10

" Under the equity method, on initial recognition the investment in an associate or a joint venture is recognised at cost, and the carrying amount is increased or decreased to recognise the investor’s share of the profit or loss of the investee after the date of acquisition."

[S2000magician]

@CADFX

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Where does it say this in the IFRS/US GAAP handbook? I disagree with you.

I have no idea where it says this in the IFRS/US GAAP handbook.

I quote from the 2015 Level II CFA curriculum, v. 2, p. 129, paragraph 3:

“When the cost of the investment exceeds the investor’s proportionate share of the book value of the investee’s (associate’s) net identifiable tangible and intangible assets (e.g., inventory, property, plant and equipment, trademarks, patents), the difference is first allocated to specific assets (or categories of assets) using fair values. The differences are then amortized to the investor’s share of the investee’s profit or loss over the economic lives of the assets whose fair values exceeded book values.”

Excess depreciation (or amortization, if you prefer).

Whether it appears in the handbook doesn’t matter; it appears in the curriculum, and that’s the information on which the candidates are being tested.

[CADFX]

@S2000magician

@CADFX

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Where does it say this in the IFRS/US GAAP handbook? I disagree with you.

I have no idea where it says this in the IFRS/US GAAP handbook.

I quote from the 2015 Level II CFA curriculum, v. 2, p. 129, paragraph 3:

“When the cost of the investment exceeds the investor’s proportionate share of the book value of the investee’s (associate’s) net identifiable tangible and intangible assets (e.g., inventory, property, plant and equipment, trademarks, patents), the difference is first allocated to specific assets (or categories of assets) using fair values. The differences are then amortized to the investor’s share of the investee’s profit or loss over the economic lives of the assets whose fair values exceeded book values.”

Excess depreciation (or amortization, if you prefer).

Whether it appears in the handbook doesn’t matter; it appears in the curriculum, and that’s the information on which the candidates are being tested.

The wording of the reference you cited leads me to believe they’re discussing this in the context of a controlling (50%+) position, where the investing company needs to back out the investment account and consolidate the investee’s financial statements. This would make sense because the L2 curriculum focuses on business combinations, translation of foreign subsidiary FS, etc.

Under equity method, you record the investment at cost, and it only changes through 1) net income/loss of investee, 2) Dividends or 3) impairment, so I’m still sticking with my original position that goodwill/depreciation of excess over carrying amount is irrelevant and that it’s incorrect to suggest the investing company records depreciation on the excess under equity method.

[S2000magician]

@CADFX

@S2000magician

@CADFX

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Where does it say this in the IFRS/US GAAP handbook? I disagree with you.

I have no idea where it says this in the IFRS/US GAAP handbook.

I quote from the 2015 Level II CFA curriculum, v. 2, p. 129, paragraph 3:

“When the cost of the investment exceeds the investor’s proportionate share of the book value of the investee’s (associate’s) net identifiable tangible and intangible assets (e.g., inventory, property, plant and equipment, trademarks, patents), the difference is first allocated to specific assets (or categories of assets) using fair values. The differences are then amortized to the investor’s share of the investee’s profit or loss over the economic lives of the assets whose fair values exceeded book values.”

Excess depreciation (or amortization, if you prefer).

Whether it appears in the handbook doesn’t matter; it appears in the curriculum, and that’s the information on which the candidates are being tested.

The wording of the reference you cited leads me to believe they’re discussing this in the context of a controlling (50%+) position . . .

They’re not; this is in the section on the equity method.

@CADFX

Under equity method, you record the investment at cost, and it only changes through 1) net income/loss of investee, 2) Dividends or 3) impairment, so I’m still sticking with my original position that goodwill/depreciation of excess over carrying amount is irrelevant.

I’m not disputing your knowledge of accounting rules.

I’m disputing your understanding of the Level II CFA curriculum.

Your original position will lose points on the Level II CFA exam, per their explicit text in the curriculum.

[CADFX]

I stand corrected.

[Wojtek]

CADFX, please examine par 32 IAS 28.

You will see there, references to what the Curriculum and others in this post are talking about: goodwill as well as adjustments to depreciation as they relate to the equity method.

regards

[Gurifissu]

@S2000magician

@CADFX

@S2000magician

@CADFX

@mfrasc

Hi Ernest,

If I were you I would check the blue box Examples 4 and 5 for this section in CFA Curriculum as they answer most of your questions, you can also read the theory before these examples for more details. Your impairment question is answered in section 5.5 “Impairment”

To answer your questions:

1. Goodwill is lumped together in investment account. The impairment test is done on the entire investment account line item, there is no impairment test just for the Goodwill within the investment account. Yes, the investment account and p&l will be reduced by the amount of the impairment.

2. Your example does not make sense. There are no extra expenses, there is however subsequent depreciation on the amount over each asset, like PP&E for example. As you mention, your $30 will be in investment account and P&L, but also the depreciation of excess over asset will reduce this $30 in both the investment account and P&L.

Thank you

Where are you getting the excess depreciation over asset? This doesn’t exist for equity method investments. The only line that matters from the investee’s FS is net income

If I’m understanding what you wrote (“This doesn’t exist for equity method investments.”), you’re mistaken.

If the fair market value of the assets exceeds the book value of the assets, then you assign that excess value to those assets and depreciate them over their remaining useful lives under the equity method.

Where does it say this in the IFRS/US GAAP handbook? I disagree with you.

I have no idea where it says this in the IFRS/US GAAP handbook.

I quote from the 2015 Level II CFA curriculum, v. 2, p. 129, paragraph 3:

“When the cost of the investment exceeds the investor’s proportionate share of the book value of the investee’s (associate’s) net identifiable tangible and intangible assets (e.g., inventory, property, plant and equipment, trademarks, patents), the difference is first allocated to specific assets (or categories of assets) using fair values. The differences are then amortized to the investor’s share of the investee’s profit or loss over the economic lives of the assets whose fair values exceeded book values.”

Excess depreciation (or amortization, if you prefer).

Whether it appears in the handbook doesn’t matter; it appears in the curriculum, and that’s the information on which the candidates are being tested.

I am not sure I quite grasp it. If the proportionate share of the investor’s FV of the identifiable assets of the investee is lower than the cost the investor sustained when buying its share, we allocate the difference to the INVESTEE’s balance sheet, spreading this difference across the investee’s identifiable assets from whence the difference came?

The investor, if I am correct, would then go on to depreciate its investment line item (on its BS) related to its proporationate share in the investee over time, until the line item falls to the BV?

[S2000magician]

Suppose that the subsidiary has only one asset: PP&E. FMV = $1.5 million, BV = $1.2 million. 10 years remaining useful life, zero salvage value. Their liabilities are $500,000. So the FMV of the sub is $1 million and the NBV is $700,000.

The parent buys 40% of the subsidiary for $450,000. The NBV of their share is 40%($700,000) = $280,000, and the FMV of their share is 40%($1,000,000) = $400,000. They allocate $120,000 (= $400,000 − $280,000) to the PP&E, and depreciate it straight-line over 10 years: $12,000 per year. The extra $50,000 (= $450,000 − $400,000) is, essentially, goodwill, which is just part of Investment in Affiliate.

[Gurifissu]

So the depreciation expense ($12,000 annually) is taken by the investor, am I correct?

[S2000magician]

You are correct.

The sub doesn’t even know about it.

[erwar]

2 days before the exam and you helped me to understand it!! quick question, this only applies when you record at FV correct? I read that you can record at cost under equity method too. Hopefully you’ll read my question before saturday

thanks beforehand magician

[S2000magician]

This entire discussion is about the equity method at cost, not the fair value option.

If you use the fair value option, then you always show the investment at its fair value, with dividends, interest, and unrealized gains/losses recorded on the income statement. There is no goodwill; if you paid too much, you show an unrealized loss that first year.

[Mr_RS]

Very helpful, thank you!

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Thanks a lot.

[Shark101]

@Mr_RS

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

No, the “Fair Value Option” provides an option to account for Equity Method Investments (“significant influence”) under both reporting standards at FV instead of at cost. There are no restrictions under USGAAP but under IFRS, where the FV Option is only applicable to VC investors, mutual funds, unit trusts and similar.

@Mr_RS

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Acquisition Method will always be consolidation and therefore cannot be HTM or FVPL or AFS. Also, there is a flaw in your question, as acquisition method can only apply to equity investments in other companies (>50%), whereas HTM investments for example can only be Debt instruments. So, you are confusing to concepts here.

Investments: HTM, AFS, FVPL --> less than 20% participation

Associates/JVs: Equity Method (at cost or Fair Value option) --> roughly 20%-50% particiation (“significant influence”)

Acquisitions/Business Combinations: Acquisition Method / Pooling of Interest (discontinued) --> >50% participation (“control”)

[Mr_RS]

@Shark101

@Mr_RS

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

No, the “Fair Value Option” provides an option to account for Equity Method Investments (“significant influence”) under both reporting standards at FV instead of at cost. There are no restrictions under USGAAP but under IFRS, where the FV Option is only applicable to VC investors, mutual funds, unit trusts and similar.

@Mr_RS

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Acquisition Method will always be consolidation and therefore cannot be HTM or FVPL or AFS. Also, there is a flaw in your question, as acquisition method can only apply to equity investments in other companies (>50%), whereas HTM investments for example can only be Debt instruments. So, you are confusing to concepts here.

Investments: HTM, AFS, FVPL --> less than 20% participation

Associates/JVs: Equity Method (at cost or Fair Value option) --> roughly 20%-50% particiation (“significant influence”)

Acquisitions/Business Combinations: Acquisition Method / Pooling of Interest (discontinued) --> >50% participation (“control”)

Thanks man!

[Mr_RS]

@S2000magician

Suppose that the subsidiary has only one asset: PP&E. FMV = $1.5 million, BV = $1.2 million. 10 years remaining useful life, zero salvage value. Their liabilities are $500,000. So the FMV of the sub is $1 million and the NBV is $700,000.

The parent buys 40% of the subsidiary for $450,000. The NBV of their share is 40%($700,000) = $280,000, and the FMV of their share is 40%($1,000,000) = $400,000. They allocate $120,000 (= $400,000 − $280,000) to the PP&E, and depreciate it straight-line over 10 years: $12,000 per year. The extra $50,000 (= $450,000 − $400,000) is, essentially, goodwill, which is just part of Investment in Affiliate.

That`s a very good explanation, thank you!

Whenever I will face a similar question the best approach (under the equity method) should be the following?

1. identify the Fair market value + net book value (having accounted for the subsidiary`s liabilities) of the subsidiary

2. write down the purchase price of the parent for the % of the subsidiary

3. multiply % of ownership of parent x fair market value of subsidiary

4. multiply % of ownership of parent x net book value of subsidiary

5. If FMV exceeds net book value by USD 100,000 (just an assumption), we allocate USD 100,000 to PP&E. If the useful life is 10 years, the depreciation p.a. is USD 10,000.

6. Let us assume the purchase price was USD 500,000 and the FMV was USD 400,000. We would then allocate USD 100,000 to goodwill.

[zhshzh44]

Thanks so much for the explanation. This makes understanding the good will in investing in associates so much clearer!

[Jackson]

How about accounting treatment for negative basic difference?

Example: Company ABC purchase company XX for 40% with 2million. FV of company XX is 5 million and CV is 6 million. The negative basic difference is -400,000(FV 5million x40% - CV 6million x40%)