On The Horizon - April 9, 2013

Author:Ms Grant Thornton's Audit Practice Group
Profession:Grant Thornton LLP

Current practice issue

Applying the equity method

When making an investment that requires accounting using the equity method, a company often pays an amount that is greater than its share of an investee's underlying equity. FASB Accounting Standards Codification® (ASC) 323, Investments: Equity Method and Joint Ventures, requires an investor to account for the difference in its cost and the underlying net assets of the equity investee as if the investee were a consolidated subsidiary. Accordingly, an investor should account for the difference as it would when applying business combination accounting, with subsequent additional amortization (depreciation) recognized as an adjustment to its share of the investee's income or loss.

The following example illustrates how a company would apply this guidance.

On January 1, 20X1, Company A acquires a 30 percent investment in the common stock of Company B for $15 million (including acquisition costs) in a transaction with a third party. Company A has significant influence over Company B and uses the equity method to account for its investment. On the date of Company A's investment, the net book value of Company B is $30 million. The applicable tax rate is 40 percent.

Company A must account for the difference between the $15 million carrying value of its investment and its $9 million ($30 million times 30 percent) share of Company B's recorded equity. In performing an analysis similar to a purchase price allocation, Company A determines that $2 million of the difference is attributable to the excess of fair value over book value of certain fixed assets having a five-year life, and that another $3 million is attributable to the fair value of certain intangible assets not reflected on Company B's books with an estimated life of 10 years. These two items result in a deferred tax liability of $2 million ($5 million taxable temporary differences times 40 percent). The remaining $3 million relates to goodwill.

In recording its equity in the earnings of Company B in 20X1, Company A would reduce its 30 percent share of Company B's earnings by $420,000, representing the depreciation of additional fixed asset amounts ($400,000) and amortization of the intangibles ($300,000), less the deferred tax benefit of $280,000 ($700,000 reduction in book/tax basis difference times 40 percent).

Although an equity method investor is required to recognize an other-than-temporary impairment of its total investment in...

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