When do I need to amortise the excess purchase price under the equity method?

Question

AcadiFi · Accepted Answer

Amortisation of the excess purchase price is **REQUIRED** under both US GAAP (ASC 323) and IFRS (IAS 28), but only for the portion attributed to **identifiable assets with finite useful lives**. Goodwill and indefinite-life assets are NOT amortised.

**The amortisation matrix:**

| Excess attributed to: | Amortise? | Why? |
|---|---|---|
| Depreciable PP&E (machines, equipment) | YES, over remaining useful life | Matches the depreciation pattern of the underlying asset |
| Inventory | YES, when sold | Matches the cost flow when inventory leaves |
| Finite-life intangibles (patents, customer relationships) | YES, over useful life | Matches the consumption of the intangible |
| Land | NO | Land has indefinite life |
| Indefinite-life intangibles (brand names without contractual limit) | NO | Indefinite life |
| **Goodwill** | NO | Indefinite life by convention |

```mermaid
flowchart TD
    A[Excess Purchase Price] --> B[Identifiable Assets]
    A --> C[Goodwill - residual]
    B --> D[Finite Life]
    B --> E[Indefinite Life]
    D --> F[Amortise over remaining life]
    E --> G[Do NOT amortise]
    C --> G
    style F fill:#c9a84c,color:#0a0a0f
    style G fill:#c9a84c,color:#0a0a0f
```

**Worked example (matching the lecture):**

Lucia pays $500K for 20% of William. William's book value of net assets is $1.2M. William's PP&E has $	ext{FV} - 	ext{BV} = \$300	ext{K}$ with 10-year remaining life.

Step 1: $20\% 	imes \$1.2	ext{M} = \$240	ext{K}$ (share of book value)
Step 2: \$500K − \$240K = \$260K (excess)
Step 3: $20\% 	imes \$300	ext{K} = \$60	ext{K}$ attributed to PP&E
Step 4: \$260K − \$60K = \$200K goodwill (residual)

**Annual amortisation:** \$60K / 10 years = \$6,000/year

This $6,000 reduces equity income each year for 10 years.

**Year-1 income statement impact (assuming William has $100K NI, $15K dividends):**

| Item | Amount |
|---|---|
| Share of William NI ($20\% 	imes \$100	ext{K}$) | $+\$20{,}000$ |
| Less: amortisation of excess on PP&E | $-\$6{,}000$ |
| **Equity income reported** | **+$14,000** |

**Investment carrying value at year-end 1:**

| Item | Amount |
|---|---|
| Beginning investment | $500,000 |
| Plus: share of NI | $+\$20{,}000$ |
| Less: amortisation of excess | $-\$6{,}000$ |
| Less: share of dividends ($20\% 	imes \$15	ext{K}$) | $-\$3{,}000$ |
| **Ending carrying value** | **$511,000** |

**After 10 years:**

The $60K excess attributed to PP&E is fully amortised. From year 11 onwards, there's no more amortisation drag — equity income equals share of NI directly. The $200K goodwill remains forever in the investment account (subject to impairment).

**What if PP&E useful life is uncertain?**

The investor uses the same useful life that the investee uses. If the investee depreciates PP&E over 10 years, the investor amortises the $60K excess over 10 years too — consistent. If the investee changes its depreciation policy mid-life, the investor follows.

**What if the investee sells the PP&E partway through?**

Then the remaining unamortised excess must be **recognised immediately** as either a gain (if asset sold above book value reflecting the step-up) or a loss (if sold for less than implied step-up basis). Either way, the unamortised excess is removed from the investment account.

**Exam pitfall:**

Many candidates forget the amortisation step entirely and compute the investment carrying value as $B + \sum (	ext{share of NI}) - \sum (	ext{share of dividends})$. The correct formula is:

$$B + \sum (	ext{share of NI}) - \mathbf{\sum (	ext{amortisation of excess})} - \sum (	ext{share of dividends}) = E$$

That extra subtraction is the #1 missed calculation on equity-method exam questions.

When do I need to amortise the excess purchase price under the equity method?

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Practice Questions

Excess attributed to:	Amortise?	Why?
Depreciable PP&E (machines, equipment)	YES, over remaining useful life	Matches the depreciation pattern of the underlying asset
Inventory	YES, when sold	Matches the cost flow when inventory leaves
Finite-life intangibles (patents, customer relationships)	YES, over useful life	Matches the consumption of the intangible
Land	NO	Land has indefinite life
Indefinite-life intangibles (brand names without contractual limit)	NO	Indefinite life
Goodwill	NO	Indefinite life by convention

Item	Amount
Share of William NI ( $20\% \times \$100\text{K}$ )	$+\$20{,}000$
Less: amortisation of excess on PP&E	$-\$6{,}000$
Equity income reported	+$14,000

Item	Amount
Beginning investment	$500,000
Plus: share of NI	$+\$20{,}000$
Less: amortisation of excess	$-\$6{,}000$
Less: share of dividends ( $20\% \times \$15\text{K}$ )	$-\$3{,}000$
Ending carrying value	$511,000