Equity & Acquisition Methods on Net Income

Hey all, got a question from CFA Institute Financial Reporting - Reading 17, Q28. NinMount acquired 50% of Boswell for 320 million on Dec 2008.

I am trying to calculate the Net income under Equity method and Acquisition method. Theoretically they should be the same, but it’s not under my calculation.

Equity method: License is worth $60 and depreciate over 6 years, 10 dollars a year.

75 (NinMount’s NI) +10/2 (Share in Boswell’s NI) -10 (license depreciation) = 70

Acquisition method: When we add Boswell’s expense, do we take out Deprecation, interest and income tax expense?? My calculation for expenses only include COGS, Selling expenses and Admin expenses: 950+510-495-305-50-15-136-49-320 (minority interest) = 90.

So I don’t know what makes up for the difference??

For simplicity’s sake, let’s just throw out the Ninmount net income of 75 since it’s clear how that will remain the same under the equity and acquisition methods.

Under the equity method, Boswell’s NI will look like this on the Ninmount income statement.

Boswell Net Income * 50% - Excess Amortization of License Depreciation = 10*.5 - 10 = -5

Under the Acquisition method, we should include all the expenses including depreciation. That leaves us with

Boswell Net Income - Excess Amortization of License Depreciation - Minority Interest = 10 - 20 -(-5) = -5

Note in the second example, we’re amortizing twice as much to account for the 100% consolidation of Boswell.

Also note my minority interest is -5 instead of your 320. On the income statement, we’re only subtracting the share net income owed to the minority interest, not the total investment. Hope this is helpful.

thanks for the explanation! I understood the equity method completely, but I have questions on the acquisition method:

  1. Why are we amortizing twice? In the book, it says “the excess of the purchase prive over the fair value of Boswel’s net assets was attributeable to previous unrecorded license”, so that 320 - 1/2 * 580 = 30. Since I figured this is only looking at 50% of the ownership, the total license value would be 30*2 =60, then you amortize it through 6 years, and get $10/yr. So this is already assuming 100% ownership of Boswell?

  2. How did you come up with negative 5 instead of positive 10/2 = 5?

Good questions. You’re right, the excess amortization should end effectively up the same in both cases. Let me know if these formulas make more sense.

Equity method

Boswell Net Income * 50% - Excess Amortization of License Depreciation Allocated to Investor = 10*.5 - 5 = 0

Acquisition method

Boswell Net Income - Total Excess Amortization of License Depreciation - Minority Interest % * (Boswell Net Income - Excess Amortization of License Depreciation) = 10 - 10 - 50% x (10 - 10) = 0

K! I see you took the minority interest based on Boswell’s net income net of amortization! That was where I was missing. Thanks a lot for the help!

Could you Please expalin me how you calculate the License value as $60.

From the reading: “NinMount paid £320 million to purchase a 50 percent stake in Boswell Company. The excess of the purchase price over the fair value of Boswell’s net assets was attributable to previously unrecorded licenses.”

Total equity of Boswell is £580 million. 50% stake is worth 290.

So using one-line consolidation in the equity method, the license value is only £30 million. (320 - 290 = 30).

However, if we’re using the acquisition method, we’re consolidating the full value of the firm. We’re assuming the difference between book and fair value is the licenses (640 - 580 = 60).

Thank you Vida_blue…