Equity Method - Accounting for Goodwill

[erwar]

2 days before the exam and you helped me to understand it!! quick question, this only applies when you record at FV correct? I read that you can record at cost under equity method too. Hopefully you’ll read my question before saturday

thanks beforehand magician

[S2000magician]

This entire discussion is about the equity method at cost, not the fair value option.

If you use the fair value option, then you always show the investment at its fair value, with dividends, interest, and unrealized gains/losses recorded on the income statement. There is no goodwill; if you paid too much, you show an unrealized loss that first year.

[Mr_RS]

Very helpful, thank you!

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Thanks a lot.

[Shark101]

@Mr_RS

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

No, the “Fair Value Option” provides an option to account for Equity Method Investments (“significant influence”) under both reporting standards at FV instead of at cost. There are no restrictions under USGAAP but under IFRS, where the FV Option is only applicable to VC investors, mutual funds, unit trusts and similar.

@Mr_RS

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Acquisition Method will always be consolidation and therefore cannot be HTM or FVPL or AFS. Also, there is a flaw in your question, as acquisition method can only apply to equity investments in other companies (>50%), whereas HTM investments for example can only be Debt instruments. So, you are confusing to concepts here.

Investments: HTM, AFS, FVPL --> less than 20% participation

Associates/JVs: Equity Method (at cost or Fair Value option) --> roughly 20%-50% particiation (“significant influence”)

Acquisitions/Business Combinations: Acquisition Method / Pooling of Interest (discontinued) --> >50% participation (“control”)

[Mr_RS]

@Shark101

@Mr_RS

By saying “the fair value option”, you must be referring to available-for-sale and held-for-trading securities ?

No, the “Fair Value Option” provides an option to account for Equity Method Investments (“significant influence”) under both reporting standards at FV instead of at cost. There are no restrictions under USGAAP but under IFRS, where the FV Option is only applicable to VC investors, mutual funds, unit trusts and similar.

@Mr_RS

What would the accounting look like under the acquisition method? Would it always be cost (for HTM) and fair value (for available-for-sale & held-for-trading securities) as well?

Acquisition Method will always be consolidation and therefore cannot be HTM or FVPL or AFS. Also, there is a flaw in your question, as acquisition method can only apply to equity investments in other companies (>50%), whereas HTM investments for example can only be Debt instruments. So, you are confusing to concepts here.

Investments: HTM, AFS, FVPL --> less than 20% participation

Associates/JVs: Equity Method (at cost or Fair Value option) --> roughly 20%-50% particiation (“significant influence”)

Acquisitions/Business Combinations: Acquisition Method / Pooling of Interest (discontinued) --> >50% participation (“control”)

Thanks man!

[Mr_RS]

@S2000magician

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.

That`s a very good explanation, thank you!

Whenever I will face a similar question the best approach (under the equity method) should be the following?

1. identify the Fair market value + net book value (having accounted for the subsidiary`s liabilities) of the subsidiary

2. write down the purchase price of the parent for the % of the subsidiary

3. multiply % of ownership of parent x fair market value of subsidiary

4. multiply % of ownership of parent x net book value of subsidiary

5. If FMV exceeds net book value by USD 100,000 (just an assumption), we allocate USD 100,000 to PP&E. If the useful life is 10 years, the depreciation p.a. is USD 10,000.

6. Let us assume the purchase price was USD 500,000 and the FMV was USD 400,000. We would then allocate USD 100,000 to goodwill.

[zhshzh44]

Thanks so much for the explanation. This makes understanding the good will in investing in associates so much clearer!