Equity Method Balance sheet Schweser example

CFA Level II FRA
#1

I’m looking at page 78 example on Allocation of purchase price over book value acquired.

In the example, we have two companies. Red (investor) and Blue (investee). The purchase price is $80K for Blue’s 30% ownership. Total book value of Blue is $200K. Red (Investor) bought 30% of that 200k, so it’s 60K. The difference of 20K is allocated to equipment and the rest is goodwill according to the example. On Blue’s balance sheet book value is equal to fair value for all identifiable assets, except equipment which is BV=25K and FV=75K. So the example follows that we take the difference of those two 50K times the % of ownership of Red and allocate that to equipment. So that will be 15K (50K*30%) and the rest to goodwill (5K)

Ok, now to my question, the Balance sheet of Red has and investment beginning balance of 80K (the purchase price). Is this 80K broken down to 60K (bv price), 15K (excess allocation) and 5k (goodwill)? If not, where does the 15K of excess allocated to equipment go? and the 5K in goodwill?

Thanks

#2

The equity method is “one line accounting”: one line on the balance sheet – Investment in Blue – and one line on the income statement – Earnings from Blue. The details of the investment (e.g., excess of FV over BV that is depreciable (or not), and goodwill) are not displayed on the balance sheet, although they probably appear in the footnotes or a supporting schedule.

Note, by the way, that the earnings from Blue constitute a noncash item on the income statement: using the indirect method to compute CFO, they would be substracted from net income.

Also note that the dividends from Blue are considered a return of capital, not a return _ on _ capital; that’s why they are subtracted from the investment in Blue on the balance sheet.