Need Help Understanding a FAR Concept

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  • #188983
    Anonymous
    Inactive

    The equity method of accounting requires the investor’s proportionate share of the investee’s reported net income to be adjusted for acquisition differentials. Thus, the difference at the date of acquisition of the investee’s stock between the fair value and carrying amount of inventory is such an adjustment when the inventory is sold. A similar adjustment for land is required when the land is sold. Assuming that the FIFO inventory was sold during the year and the land was not, Park’s proportionate share of Tun’s reported net income is decreased by the inventory differential allocated at the date of acquisition.

    How is the Excess of FV to Carrying amount a decrease in net income? Isn’t selling an item with a higher FV than before a gain?

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  • #610619
    NYCaccountant
    Participant

    The inventory for consolidation purposes is valued at fair value, which is higher than book value. When the inventory is sold, they record COGS at book value, which is correct, but for consolidation purposes is wrong. Because the fair value was higher for consolidation purposes, you include the extra expense in the COGS, which reduces net income and reduces your share of equity in the other company. Think of it this way – when you initially bought the company, you probably valued the inventory at 100k, while it's book value was 80k. Now assume this was the only asset the other company had, you sold the 80k worth of inventory, which was expensed, but still have 20k worth of value attributed to nothing because the inventory does not exist anymore. So for consolidation purposes, you have to expense the extra 20k of value, cause inventory does not exist anymore. This reduces net income. I use the term consolidation purposes for this example because it's important to note these are two different companies, although they are technically not consolidating their financials.

    AUD - 99
    BEC - 84
    FAR - 93
    REG - 87
    NYC born and raised.

    FAR - 93
    REG - 87
    BEC - 84!!!!
    AUD - 99!!!!!! CPA exam complete.

    #610620
    Anonymous
    Inactive

    Thank you!

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