Question

When consolidating a subsidiary under the equity method, which of the following statements is true with regard to the subsidiary subsequent to the year of acquisition?

A) All net assets are revalued to fair value and must be amortized over their useful lives.

B) Only net assets that had excess fair value over book value when acquired by the parent must be amortized over their useful lives.

C) All depreciable net assets are revalued to fair value at date of acquisition and must be amortized over their useful lives.

D) Only depreciable net assets that have excess fair value over book value must be amortized over their useful lives.

E) Only assets that have excess fair value over book value must be amortized over their useful lives.

Anser is B but why? & why is it not D?

Answer 1

Option (B) is correct

Under equity method, excess of net asset's fair value over the book value when acquired by the parent must be amortized over their useful lives.

Option (D) is not correct, as parent company does not acquire depreciable net assets only. It acquires all assets including depreciable assets.

When the Parent company acquires the subsidiary, then there may be two sets of differences. First is between the fair value and the book value of the net assets acquired and second difference may be between the purchase price paid and the fair value of the net assets acquired. Net assets here means total assets acquired (and not the depreciable assets only, but total assets) less liabilities, as the parent acquires total net assets.

Regarding the first type of difference, the difference between the fair value and the book value of the net assets acquired is amortized over their useful life.

Second type of difference, i.e. when the purchase price is more than the fair value of net assets acquired, the difference is treated as goodwill, which is tested for impairment annually.