Investments and consolidation
The Equity Method Engine
Equity income is your share of net income minus excess amortization; dividends only shrink the investment.
How the exam words it
- -The stem gives an ownership percentage between 20 and 50 percent, investee net income, and dividends, and asks 'what is the equity income for the year?'.
- -The price paid exceeds book value and the excess is 'attributable to equipment with a remaining life', so amortization is in play.
- -It asks for the journal entry or the ending investment balance.
- -An intercompany sale leaves unrealized profit in inventory, or the investee's value declines other than temporarily.
The playbook
- 1Equity income = ownership percentage times investee net income, minus amortization of the excess purchase price assigned to depreciable assets.
- 2Dividends received credit the investment balance; they are never income.
- 3Defer your ownership share of unrealized intercompany profit remaining in ending inventory.
- 4Prorate for a mid-year purchase, stop recognizing losses once the balance hits zero, and write down other-than-temporary declines through income.
The trap
Adding dividends to equity income. Dividends are a return of investment that reduces the investment account; income is only the share of investee net income.
How the exam varies it
The same pattern, re-skinned along these axes:
Plain share versus excess amortization versus intercompany profitEquity income versus ending investment balanceFull year versus mid-year, income versus losses beyond the balance
Drill this pattern
8 questions of The Equity Method Engine from across the AUD topics. Clear it by getting 5 right with a streak of 3.