Goodwill (Equity Method) and Partial Goodwill (Acquisition Method)

CFA Level II
#1

Am I correct to say that calculating goodwill under the equity method = partial goodwill under the acqusition method?

  • both uses the investors ownership %

  • both minus the fair net assets (identifiable net assets in EM and just net assets in AM).

accounting is still driving me nuts.

#2

Yes

Equity Method Investment

Firm Z invests $1,000 in Firm A for 20% stake

  • Firm A Assets = $5,000
  • Firm A Liabilities = $1,000
  • Firm A Assets are believed to be worth $5,500 at fair market value by Firm Z
  • Firm Z — cash goes down by $1,000
  • Firm Z — investment in Firm A created for $1,000 (single-line item)

Within this single line item there is likely an “implied” value to goodwill

  • Net Assets = 5,000 - 1,000 = $4,000 * 20% = $800
  • FMV Adjustments = $500 * 20% = $100
  • Implied Goodwill = = xx
  • Cost Paid (Single Line on B/S) = = $1,000

So then logically if you calculate goodwill it will be $100 = xx

To double check this and make sure you understand how you allocate this “implied” goodwill, step back and assume Firm Z is acquiring 100% of Firm A

They pay the same value for Firm A

  • 1,000 for 20% = $5,000 for 100%
  • Firm Z acquires Net Assets of 5,500 - 1,000 = $4,500
  • So the creation of $500 in Goodwill is needed to account for the premium paid over the fair market value

And what’s 20% of that $500 in goodwill?

The same $100 figure you are implying is built into the single-line item for the investment in Firm A under the equity method!

Hope this helps!