Question

When a company purchases shares (equity) in another company, the investment amount may exceed their share of the book value of the underlying net assets of the investee. How does the investing company account for this excess amount under the equity method?                            I don't understand someone told me that it should be accounted as goodwill. But under the equity methods it means that the investing company owns only 20-50%. Why the excess amount should be accounted as goodwill? I thought goodwill should be accounted only when the company buys whole other company, not part of it???

Answer 1

If there is complete acquisition of one company by another company, and investment in Other company (that is purchase consideration) exceeds the book value of the underlying net assets of the selling company, the difference is recognized as goodwill.

But when investment is made only in part of shares of another company, and if investment exceeds 20% of the outstanding voting stock of the investee company, it is presumed that the investor constitute the ability to hold significant influence over the decision making power of the investee. In such case, equity method is used to account for changes in investment.

Under equity method, if investment exceeds their share of the book value of the underlying net assets of the investee, then the investing company account for this excess amount as other comprehensive income, since it is unrealized gain.