ACQUISITION METHOD

CFA Level II
#1

Per Book 2 p.135 - Blue Box problem

Is the calculation of Goodwill difference with the new Acquisition Method?

My understanding was that

Goodwill = Purchase Price - excess purchase price - net identifiable assets

However, in this example it looks like its just Purchase Price - Net identifiable assets

Am I wrong in assuming that there is another Goodwill calculation method for Acquitions?? Maybe I’m just missing something obvious and I’ve been studying too long, not sure…

#2

Yes - there’s full and partial goodwill methods. Full goodwill is the same as the one from the equity method. I’d go back and consult the curriculum

#3

This is driving me crazy too. Do we use book value or fair value? The example i see says full goodwill is fair value minus fair value of assets not book value?

#4

Goodwill = purchase price* – fair market value of net assets**

*For partial goodwill, this is the actual purchase price; for full goodwill, it’s the actual purchase price ÷ % purchased.

**For full goodwill, this is the fair market value of the assets – the fair market value of the liabilities; for partial goodwill, it’s (fair market value of the assets – fair market value of the liabilities) × % purchased.

#5

thanks S2000magician - in the equity method we use actual purchase - fair value of net assets as well, right?

#6

You’re welcome.

No. In the equity method you don’t care about the sub’s assets and liabilities because you’re not consolidating; you record the investment at the price you paid – Investment in Subsidary – no goodwill, no nothing. Later, your investment increases by the net income from the sub (less excess depreciation), and decreases by dividends received.

#7

Hi, you should clarify this statement, bec I see where gordon gecko is getting confused re: equity method. While you don’t book goodwill under equity, you book your investment at the fair value you purchased it at. So if you buy 25% of company A for 500k, but it’s book value is 1 million, then you allocate it between identifiable assets (amortized) and non identifiable (goodwill, not amortized). This all goes into inv account. See this comment below from 2010. "Under Equity Method, Investment is reported as a Single Line Item of Asset. The components of this Asset are:

  1. Book Value: It is the proprtionate total of book value of the individual assets/liabilities of the company you purchased.

  2. Excess Fair Value of Tangible Assets: Assets of the company whose stocks you have bought would be reported at historical costs in their books. When you purchase stocks in this associate, they will be charging you Fair Value and not the Book Value of those assets. Also, this component helps you later to add excess depreciation expense in your I/S, based on excess fair value you are recognizing.

  3. Goodwill: Anything extra you paid over the fair value of net tangible assets becomes the third component of your single line reported figure. This component cannot be amortized as you did for your second component, but it needs to be tested for impairment.

Regarding goodwill, in subsequent periods after your purchase, you will calculate a price if you had to purchase the same association again. That will be the fair value of your holdings. Now, if the carrying cost in your single item figure is more than this value, you will reduce your gooodwill component to that extent and recognize a loss in Income Statement. You could continue doing so in subsequent periods, till your goodwill component becomes 0.

Hope this helps a bit."