FAR Question – Equity Method

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  • #3304054
    Ivy
    Participant

    Hi everyone, Can anyone help me with this question? The answer is “D”. Do we need to recognize the goodwill under the equity method??

    Bang Inc. acquired 40% stake in Boom Inc. for $120,000 in the beginning of year 1. None of the other investors have more than 20% stake in Boom Inc. The book value and fair value of Boom Inc. is $200,000 and $250,000 respectively. The difference in the book value and fair value is attributable to higher fair value of equipment by $30,000 and land by $20,000. The equipment is depreciated over next 10 years using straight line method. Goodwill is also impaired by 10% during the year and the land is also sold by Boom Inc. If Boom Inc. declares a dividend of $10,000 out of the total earnings of $80,000, what would be the investment income (or charge) recorded in the statement of income of Bang Inc. for the year concerning the investment in Boom Inc?

    a $28,800
    b $32,800
    c($11,200)
    d $20,800

    Explanation:
    Impairment of goodwill = 10% of $20,000 = $2,000.
    Depreciation on increased fair value of equipment (Bang Inc’s share) = 40% x $30,000 / 10 years = $1,200.
    No depreciation is charged on land. Land is sold during the year. Bang Inc. will write off its share of increased fair value of land, i.e. $8,000 (i.e. $20,000 x 40%).
    Equity in earnings=$2,000 + $1,200 + $8,000

    #3304066
    CPAHOPE
    Participant

    No, goodwill is not recognized under the equity method, you recognize under the consolidation method. Remember, goodwill arises when a company purchases FV of equity of an another company. The difference between the purchase price and the fv of equity is the goodwill. If the purchase price is less than the fv of equity, then the company would recognize as a gain.

    The question is asking for the investment income which means goodwill is not included since goodwill belongs under the balance sheet.

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    #3305957
    michaela.xu
    Participant

    Hi CPAHOPE, so if Goodwill is not included in equity method, why did the answer include goodwill impairment of $2,000, AND amortization of FMV over cost for the assets? It seems to me that answer key is double counting amortization/impairment of the same thing.

    #3305972
    CPAHOPE
    Participant

    Hey michaela.xu,

    Thats a good point. Im just saying off from my Wiley textbook. It never gave an example where it involved goodwill under equity method so maybe im assuming you dont recognize goodwill? Although i passed i still want to know.

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    #3306104
    Michael Liccio
    Participant

    I understand the confusion of double counting the goodwill, remember earnings of Boom is not net income, so this does not include amortization of goodwill. Boom will reduce their earnings of 80k by amortization of goodwill to get to net income, then Bang gets their 40% of the net income. After this is done Bang needs to depreciate their share of the Equip. because think of it as Bang recorded the equipment at FV (part of the one line item on Bang BS of 120k), so Bang needs to increase the depreciation more than what Boom has recorded. The final piece is land sold, which reduces the investment value, so Bang needs to decrease their share of that, so 40% of 20,000.

    40% 80,000.00 32,000.00 — Earnings
    40% 20,000.00 (8,000.00) — Land sold
    40% 30,000.00 12,000.00 10% (1,200.00) — Additional Equip depreciation
    40% 50,000.00 20,000.00 10% (2,000.00) — Goodwill to get to N.I.
    20,800.00 Adj.

    #3306110
    thelatebloomer
    Participant

    I think the concept that is unintuitive here is that the goodwill is recognized from the acquiree's perspective, and you're given the piece about impairment to represent an expense to those earnings. I haven't done a ton of these problems yet but when they simply use the term ‘total earnings,' you have to differentiate from ‘net earnings' and realize that they're giving you a bunch of expenses to reduce those earnings. If you were to separate the acquiree from the acquirer and calculate net income first, then apply the 40% stake, it makes a lot more sense. These separate 40% expense components make the problem way messier. This whole problem seems designed to confuse you. If extra consideration is paid beyond the FV, goodwill has to be recognized. Even though it's not consolidated, goodwill still has to be recognized, and now you know it's impaired and by how much. And then after that you also have to remember that dividends would reduce the investment after the fact, and in this case is distractor information. Kind of an ugly problem that tests you on a lot of different angles.

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    #3309097
    govind.nagaraj
    Participant

    Hello,

    Goodwill is not recognised, but the impairment on goodwill will reduce the income. Pls refer the below JEs-

    1. For share of income in investee [80,000 x40%]

    Investment Dr- 32000 , Equity in investment Cr- 32000

    2. For Impairment of Goodwill [20,000×10%] , Depreciation of PPE [30,000×40%x10%] & Land written off as sold [20,000×40%]

    Equity in Investment Dr- 11,200 , Investment Cr – 11,200

    So the next Equity in Investment hitting Income Statement is $32,000-11,200 = 20,800

    #3309100
    govind.nagaraj
    Participant

    Please read it as “Equity in Earnings” in the JEs

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