Chapter 1

The Equity Method Of Accounting For Investments

11. In accounting, goodwill is derived as a residual figure. It refers to the investor's cost in
excess of the fair market value of the underlying assets and liabilities of the investee.
Goodwill is computed by first determining the amount of the purchase price that equates to
the acquired portion of the investee's book value. Payments attributable to increases and
decreases in the market value of specific assets or liabilities are then determined. If the
price paid by the investor exceeds both the corresponding book value and the amounts
assignable to specific accounts, the remainder is presumed to represent goodwill. Although
a portion of the acquisition price may represent either goodwill or valuation adjustments to
specific investee assets and liabilities, the investor records the entire cost in a single
investment account. No separate identification of the cost components is made in the
reporting process. Subsequently, the cost figures attributed to specific accounts (having a
limited life), besides goodwill and other indefinite life assets, are amortized based on their
anticipated lives. This amortization reduces the investment and the accrued income in future
years.

12. B Purchase price of Steinbart shares.................................................

Book value of Steinbart shares ($1,200,000 40%)......................

$530,000
(480,000)

..................................................................Trade
name..........................................................
..................................................................$50,000
Life of trade name.............................................................................

20 years

Annual amortization..........................................................................

$2,500

2010 Gross profit rate = $30,000 $100,000 = 30%

2011 Gross profit rate = $54,000 $150,000 = 36%
2011Equity income in Steinbart:
Income accrual ($110,000 40%)....................................................
Amortization (above)........................................................................

$44,000
(2,500)

Recognition of 2010 unrealized gain

($25,000 30% GPR 40% ownership).....................................

3,000

Deferral of 2011 unrealized gain

($45,000 36% GPR 40% ownership......................................................
Equity income in Steinbart2011..............................................

(6,480)
$38,020