At the acquisition date, the excess of the purchase price over the proportionate share of the investee’s book value is allocated to the investee’s identifable assets and liabilities based on their fair values. Anyremainder is considered goodwill.
Question 1: How does the investor (the acquier) account for goodwill? Will it be recorded as goodwill under non-current assets? Or will it be lumped in together under the investment account? Subsequently, if there is impairment to the goodwill, the investment account (Balance Sheet) and the P&L will be reduced by the impairment accordingly?
Question 2: When the excess of purchase price is being allocated to investee’s identifable assets and liabilities, how does the investor account for the extra expenses that arise from these assigned amounts? Net it off against the 1 liner share of net profit in its P&L?
For example, A invest 30% in B. B’s net income is 100. A will report 30 as proportionate share of net income in both its P&L and Balance Sheet (via investment account). Suppose further that due to assignment of excess purchase price, there is additional expenses of 10. Am I right to say we reduce the proportionate share of net income by 10? i.e. investor now report 20 as proportionate share of net income in both its P&L and Balance Sheet? Or the 10 is reported as a seperate expense in the P&L and what will then be the effect on the Balance Sheet?
I don’t have the book with me but if you own 30% the equity method is used, where:
Your cost base is the consideration paid, you don’t allocate FV to individual assets
Asset is increase via %ownership*net income
Asset is reduced by %ownership*dividends\
Guidance on goodwill appears in IFRS3 - Business Combinations, where an acquirer must be identified and thus have greater than 50% ownership
IAS28 discusses equity method for less than controlling positions:
“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. The investor’s share of the investee’s profit or loss is recognised in the investor’s profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor’s proportionate interest in the investee arising from changes in the investee’s other comprehensive income. Such changes include those arising from the revaluation of property, plant and equipment and from foreign exchange translation differences. The investor’s share of those changes is recognised in the investor’s other comprehensive income”
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:
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.
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.
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."
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.
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.
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?
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.