Question

On July 1, 2019, ABB Company, Inc. purchased 30% of the outstanding ordinary shares of ABC Company for P5,160,000 cash, including transaction cost of P160,000. ABB Company gained ability to exercise influence over ABC Company as a result of this acquisition. On the date of acquisition, the fair value of ABC’s net assets was P12,400,000. ABB Company has determined that the excess of the cost of the investment over its share of ABC’s net assets is attributable to goodwill. ABC’s profit for the year ended December 31, 2019 was P3,600,000. During 2019, ABC Company declared and paid ABB cash dividends of P400,000. There were no other transactions between the two companies. There was no indication of goodwill impairment.  

The following are the 2 questions:

1. What is the carrying value of the investment at December 31, 2019?  

2. Assuming that the excess of acquisition cost over carrying value of the net assets acquired is attributable to depreciable assets with a remaining life of 10 years, what is the net share of ABB Company on the income reported by ABC Company during 2020?

Answer 1

The equity method is a type of accounting used for intercorporate investments. This method is used when the investor holds significant influence over the investee but does not exercise full control over it, as in the relationship between a parent company and its subsidiary.

Although an investor is deemed to have significant influence over an investee if it owns between 20% to 50% of the investee’s shares or voting rights. If, however, the investor has less than 20% of the investee’s shares but still has a significant influence in its operations, then the investor must still use the equity method and not the cost method.

1)  carrying value of the investment at December 31, 2019

equity shares = 5,000,000 excluding transaction cost

share of profits = 1200000 (4000000*30)

divident received = (120000) (400000*30%)

Carrying value = 6080000 ( for 30%)

2) net share of ABB Company on the income reported by ABC Company during 2020

Net Assets of ABC company

Equity = 12400000

Retained earnings = 3600000

total assets = 16000000

ABB company share@30% =16000000*30%= 4800000

carrying value =6080000

excessof aquisition paid =6080000-4800000=1280000 is the excess of acquisition cost over carrying value of the net assets acquired is attributable to depreciable assets with a remaining life of 10 years.