Can someone walk me through the equity method with excess purchase price allocation?

The equity method is required when an investor has significant influence (typically 20-50% ownership). The key complexity is handling the excess of purchase price over the investor's share of book value.

Step-by-Step Process:

Scenario: Granite Capital acquires 30% of Bluestone Analytics for $15 million on January 1. Bluestone's book value is $40 million. The fair value differences are:

Excess Purchase Price Calculation:

• Purchase price: $15.0M
• Share of book value: 30% x $40M = $12.0M
• Excess: $15.0M - $12.0M = $3.0M
• Allocated to equipment: $1.2M (amortized over 5 years = $240K/yr)
• Allocated to customer list: $1.8M (amortized over 10 years = $180K/yr)
• Remaining goodwill: $3.0M - $3.0M = $0

Year 1 Journal Entries (assuming Bluestone earns $8M net income and pays $2M dividends):

1. Record share of investee income:

• DR Investment in Bluestone: $2,400,000 (30% x $8M)
• CR Equity Income: $2,400,000

1. Record share of dividends:

• DR Cash: $600,000 (30% x $2M)
• CR Investment in Bluestone: $600,000

1. Amortize excess purchase price:

• DR Equity Income: $420,000 ($240K + $180K)
• CR Investment in Bluestone: $420,000

Net equity income reported = $2,400,000 - $420,000 = $1,980,000

Investment carrying value at Year 1 end:

$15,000,000 + $2,400,000 - $600,000 - $420,000 = $16,380,000

Key Points:

• Dividends reduce the investment balance (not income)
• Excess amortization reduces both equity income and the investment balance
• Goodwill embedded in the equity method investment is not separately reported on the investor's balance sheet
• If the investee reports a loss, the investor records its share as a loss

Exam Tip: Level II item sets typically provide the purchase price, book values, fair values, and useful lives. You must calculate the excess, allocate it, and compute adjusted equity income.

Practice equity method problems in our CFA Level II question bank.