I thought I got it, but the mock had to throw me a curve ball! Cfa 2011 mock am #44 Why do they deduct the amortization from the equity ,method? I got answer c but clearly, that’s only half way there, you gotta take out other stuff too! I thought it was original investment + proportional net income - proportional dividends Any ideas?
Your investment represents your proportionate control of the company. Control = Equity Equity = Asset - Liability, ie Net Assets Although they don’t have an explicit Equity line, you know Equity = Net Assets. So if your Investment (cash paid) > proportionate share of Equity, then you paid “too much” (based on historical cost). Because historical cost is just that, this is the time you can measure the assets you purchased at Fair Value. Any excess price you paid will then be allocated to those assets whose Fair Value exceeded their Book Value. In this case, PP&E and Land both exceed their book value. Any remaining excess that can’t be allocated goes to Goodwill. Going forward, you can depreciate any of that excess allocated towards those assets. But REMEMBER, land can NEVER be depreciated! So even though Land and PP&E took some of that allocation, only the PP&E allocation can be depreciated. Thus in the years following the transaction, both Investor & Investee will recognize a depreciation expense of that excess premium, by their respective ownership amount - this case being 32.5% for Suburban. Another note, excess can also be allocated towards Inventory but it must then be expensed. To sum up, excess premium paid should be allocated to identifiable assets whose Fair value exceeds Book Value. The remaining excess goes to Goodwill. PPE excess can be depreciated Inventory excess must be expensed Land excess cannot be depreciated.
How do you know this stuff? I have either a) learned but forgot it entirely b) never seen it and I’m missing a book or two
Canadian Analyst, The formula you have is correct for a company purchased at BV with no premium paid. mr. flinstones pointed out you have to account for that excess in purchase price and assign it to certain assets if possible. Once you’ve written up the assets to FV any remainder between the purchase price less the FV of net identifiable assets equals your goodwill. Because we’re using the equity method there is no line item for GW on the BS. Because some assets were marked up to FV when you invested into the company you now have to deduct your pro-rata share of excess depreciation from the income statement.
I’m totally unprepared so no worries. Rather than trying to memorize random rules, (if you have the time), try to understand the concepts more. Believe it or not, these accounting rules are somewhat intuitive - you just have to break it down the way I did above…
Ok is an impairment equal to carrying value - fair value or is it book value - fair value? They seem to be different sometimes and are equal sometimes, its getting confusing
Canada Analyst, We have been together in this forum for the past 3 months and I agree CFA mocks are kinda breeze this year. I got 60 morning and 56 afternoon too…really bad given two days left. However I am not worried coz i got the same range for lelvel 1 mock same style last year. This is what u and i need as a tactic not strateggy: Use the next 24 hours left to consolidate on easy stuff that u knew already. make sure u get every point of these easy stuff and then maybe get 60pc of the breeze topics…u will be good and we might meet in l3 chatroom after July. best luck and God bless neghbour, I am in the Toronto reference library for the final consolidation Dobs
Haha I’m Canadian but I live in the US! Thanks though! I’m going to try to make the most of it and keep doing mock questions until Friday night! Ps goodnluck, torontos going to be one busy test center!
Not to make it any more confusing, but different impairment rules for different assets. You have impairment rules for: Inventory Long-lived Asset Investments (Intercorp) (There may be more but this is all I can remember)… Here are the rules =) Inventory, Impairment occurs when… IFRS: Lower of Cost or NRV NRV = Selling Price - Selling Cost GAAP: Lower of Cost or Market Market = Replacement Cost (so don’t get thrown off you see Replacement) Replacment Cost basically is a value that must be within NRV-NP and NRV (if above NRV, bring down to NRV, if below NRV-NP, bring up to NRV-NP). Also remember, IFRS allows you to reverse any writedowns but it can’t exceed the amount of the original writedown. For GAAP, writedowns are NOT allowed. Long-Lived Assets, Impairment occurs when… IFRS: CV > Recoverable Recoverable: Max of (Fair Value - Selling Cost, Value-in-Use) Value-in-Use: PV of Asset Cash Flows Impairment = Carrying Value - Recoverable Gaap: CV > Sum of Asset’s Undiscounted Cash Flows Impairment = Carry Value - Fair Value In terms of Writing UP the Asset, GAAP uses Cost Model; can never exceed historical cost. IFRS uses Revaluation (or Cost). Revaluation allows it be written up to its Fair Value. Investments - Impairment occurs when… IFRS: Carrying Amount < Recoverable Amount GAAP: Carrying Amount > Fair Value AND the decline is perceived to be permanent Neither allow reversals of losses. ALOT of info, but thought it’d be more helpful to give you a comprehensive answer so you don’t get mixed up when reading Impairment rules for other categories. Just remember GAAP is always more strict when it comes to these type of rules (whether you have to test against Undiscounted CFs which is more than Discounted, or the fact that they won’t allow reversals to even occur, or if so it’s limited to Historical as opposed to Fair Value).
Thanks, that does help I knew most of it so no worries, I’m not more confused. It’s actually good to see it in perspective like that
Under IFRS you can reverse losses on HTM and AFS debt securities. Never for equity under GAAP or IFRS.
^ Good catch, forgot about investment securities…