Looking at page 78 in the schweser FRA book.
For the example, they want us to calculate Red’s income at the ned of the year from its investment in Blue.
I understand the ne t income. But… WHy do you take out additional depreciation from excess of purchase price allocated to Blue’s equipment?
To then get the Equity Income? Why does depreciation have to do with this?
My understanding is that the intention behind doing this is to make the investment account on balance sheet represent the proportionate share in the investee at book value.
At the time of the intial purchase of the associate investment, the excess over the book value of the associate is bifurcated into
*Excess attributable to goodwill and
*Excess attributable to fair value above book value.
This excess of fair value above book value is depreciated/amortized so that the investment account represents the proportionate share in the investee at book value once this excess of fair value above book value is fully amortized. Goodwill is already present in the investment account.
I realize it is not easy to explain it but that is the way it is.