Equity Method Accounting: Investment Carrying Value, Goodwill, and Amortization

The equity method is one of the highest-frequency topics on CFA Level II Financial Statement Analysis. It applies when one company holds significant influence over another — typically a 20-50% ownership interest — but does not consolidate. Every exam cycle, candidates lose points on equity-method questions because they confuse it with the fair-value method (used below 20%) or full consolidation (used above 50%). This article walks through the three-lesson series with worked examples for each.

When Does the Equity Method Apply?

flowchart TD A[Investor owns shares of Investee] --> B{Ownership %} B -->|< 20%| C[Fair-Value Method:<br/>Mark to market each period] B -->|20-50%| D[Equity Method:<br/>One-line consolidation] B -->|> 50%| E[Full Consolidation:<br/>Combine balance sheets line-by-line] style D fill:#c9a84c,color:#0a0a0f

The 20% threshold is a presumption, not a hard rule. If you can demonstrate significant influence with less than 20% (a board seat, technology dependence, key intercompany transactions), the equity method still applies. Conversely, owning 30% of a strict joint-venture entity may NOT trigger equity-method accounting if you lack influence — joint-venture accounting governs.

Lesson 1 — The Investment Carrying Value Roll-Forward

In the lesson, the instructor walks through a four-year example with Lucia Order Inc. acquiring 30% of William Inc. for $500,000 on day one. The fundamental roll-forward formula is:

\text{Investment}_{\text{End}} = \text{Investment}_{\text{Begin}} + (\%_{\text{share}} \times \text{NI}) - (\%_{\text{share}} \times \text{Dividends})

Applied year by year:

Year	NI (William)	Div (William)	Share Income ( $\times 30\%$ )	Share Div ( $\times 30\%$ )	End Carrying Value
Initial cost	—	—	—	—	$500,000
2088	$250,000	$50,000	$75,000	$15,000	$560,000
2089	$300,000	$60,000	$90,000	$18,000	$632,000
2019*	$350,000	$70,000	$105,000	$21,000	$716,000
1991*	$400,000	$80,000	$120,000	$24,000	$812,000

(*The years in the lecture jump around as the instructor improvises — the structure is what matters.)

The instructor verifies the answer with the BASE rule:

\text{Beginning} + \text{Additions} - \text{Subtractions} = \text{Ending}

\$500{,}000 + \sum (0.30 \times \text{NI}) - \sum (0.30 \times \text{Div}) = \text{Investment}_{\text{End}}

\$500{,}000 + (0.30 \times \$1{,}300{,}000) - (0.30 \times \$260{,}000) = \$500{,}000 + \$390{,}000 - \$78{,}000 = \$812{,}000 \checkmark

The BASE check is mandatory before reporting the final number on an exam. If the year-by-year roll forward and the BASE summary disagree, you have made an arithmetic mistake — most often in cross-multiplying the 30% factor.

Lesson 2 — Goodwill When Purchase Price Exceeds Book Value

In Lesson 2, the instructor extends the example: Lucia pays $500,000 for 30% of William Inc., but the book value of William's net assets is only $220,000. The investor is paying more than the proportional book value of the assets — so where does the extra money go?

The answer follows a three-step waterfall:

flowchart TD A[Purchase Price $500K] --> B[Step 1: 30% × Book Value of Net Assets $220K = $66K] B --> C[Excess Purchase Price = $500K − $66K = $434K] C --> D[Step 2: Attribute to Identifiable Net Assets at Fair Value] D --> E[Plant & Equipment FV − BV = $60K, × 30% = $18K] D --> F[Land FV − BV = $20K, × 30% = $6K] E --> G[Step 3: Residual = Goodwill] F --> G G --> H[Goodwill = $434K − $18K − $6K = $410K] style H fill:#c9a84c,color:#0a0a0f

Walkthrough:

Compute the investor's share of book value: $30\% \times \$220{,}000 = \$66{,}000$ .

Excess purchase price: $500,000 − $66,000 = $434,000.

Attribute excess to assets with fair value > book value:

Plant & equipment: $\text{FV } \$215\text{K} - \text{BV } \$119\text{K} = \$96\text{K}$ appreciation. Investor's share: $30\% \times \$96\text{K} = \$28{,}800$ . Note: The lecture uses different numbers ($60K excess, $18K attributed) — make sure you use the question's actual numbers, not memorised ones.
Land: $\text{FV } \$140\text{K} - \text{BV } \$120\text{K} = \$20\text{K}$ appreciation. Investor's share: $30\% \times \$20\text{K} = \$6{,}000$ .

Goodwill = residual: $434,000 − attributable adjustments = $410,000 (using the lecture's numbers).

Crucially: in the equity method, goodwill is NOT recognised separately on the balance sheet. It is embedded in the investment carrying value. The investor's balance sheet just shows "Investment in William $500,000" — the $410K of goodwill is hidden inside that number.

This differs from full consolidation, where goodwill appears as its own line item on the consolidated balance sheet.

Lesson 3 — Amortizing the Excess Attributed to Depreciable Assets

The third lesson adds depreciation considerations. If the excess purchase price was attributed to a depreciable asset (like plant and equipment), the investor must amortise that excess over the remaining useful life of the asset, reducing equity income each year.

Modified example: Lucia pays $500,000 for 20% of William. William's plant and equipment has $\text{FV} - \text{BV} = \$300{,}000$ and remaining useful life of 10 years, straight-line depreciation.

Step 1 — Compute goodwill:

Component	Amount
Purchase price	$500,000
$20\% \times \text{book value } \$1.2\text{M}$	$240,000
Excess	$260,000
Attributed to P&E ( $20\% \times \$300\text{K}$ )	$60,000
Goodwill (residual)	$200,000

Step 2 — Annual amortisation of the P&E attribution:

\$60{,}000 \text{ attributed to P\&E} \div 10 \text{ years remaining life} = \$6{,}000 \text{ per year}

This $6,000 reduces equity income each year for 10 years.

Step 3 — Equity income reflecting amortisation:

If William's net income for the year is $100,000 and dividends are $15,000:

Item	Amount
Share of NI ( $20\% \times \$100\text{K}$ )	$+\$20{,}000$
Less: amortisation of excess on P&E	$-\$6{,}000$
Equity income reported	$14,000
Less: share of dividends ( $20\% \times \$15\text{K}$ )	$-\$3{,}000$
Net change in investment carrying value	$+\$11{,}000$

So the investment account goes from $500,000 to $511,000 at year-end, NOT $500,000 + $17,000 = $517,000 (which is what you'd get without amortisation).

Goodwill is NOT amortised under the equity method. It is tested for impairment annually, but absent impairment, the $200,000 goodwill stays in the investment carrying value forever.

flowchart TD A[Excess Purchase Price] --> B[Allocated to Identifiable Assets] A --> C[Residual: Goodwill] B --> D[Depreciable: Amortise over remaining life] B --> E[Non-Depreciable Land: NOT amortised] C --> F[NOT amortised - impairment test only] style D fill:#c9a84c,color:#0a0a0f style E fill:#c9a84c,color:#0a0a0f style F fill:#c9a84c,color:#0a0a0f

The Big Picture: Equity Income vs. Cash Received

A frequent source of confusion: the equity income reported on the income statement is the share of investee net income (adjusted for amortisation). The cash received from the investee is the share of dividends. These two are different amounts and they have different income-statement effects.

Example: If you own 30% of an investee that earns $1,000,000 and pays $200,000 in dividends:

Equity income on your income statement: $300,000 (your share of NI)
Cash received: $60,000 (your share of dividends)
Net effect on investment balance sheet: $300,000 − $60,000 = +$240,000

The investment account ROSE by $240,000 — because the $300,000 of equity income exceeded the $60,000 of dividends received. Dividends are NOT income under the equity method; they are a return of capital that reduces the investment balance.

Common Exam Pitfalls

flowchart LR A[Equity Method Pitfalls] --> B[Treating dividends as income] A --> C[Forgetting amortisation of excess on depreciables] A --> D[Amortising goodwill] A --> E[Using share % of FV not share % of BV in step 1] A --> F[Mixing equity method with consolidation entries]

Dividends are NOT income. They reduce the investment balance, full stop. Many candidates instinctively add dividends to equity income — wrong.
Always amortise the excess attributed to depreciable assets (plant, equipment, finite-life intangibles). Goodwill is the exception.
Goodwill is not amortised. Only tested for impairment.
Step 1 uses book value, not fair value. You compare purchase price to ( $\%_{\text{share}} \times \text{book-value net assets}$ ) first. The fair-value adjustments come later, attribution-side only.
Equity-method investments are reported NET in one line. Do not consolidate the balance sheet.

What to Practise Next

Build an equity-method roll-forward spreadsheet for a 5-year scenario. Add an excess attributable to depreciable PP&E and amortise it. Then add a fair-value pickup on land (which does NOT amortise). Verify that $\text{beginning} + \text{share of NI} - \text{amortisation} - \text{share of dividends} = \text{ending investment value}$ , year after year.

Practise more equity-method problems in our CFA Level II question bank. Have a tricky multi-year scenario you want to think through? Ask the community on our Q&A forum.

Equity Method Accounting: Investment Carrying Value, Goodwill, and Amortization (CFA Level II)

Equity Method Accounting: Investment Carrying Value, Goodwill, and Amortization

When Does the Equity Method Apply?

Lesson 1 — The Investment Carrying Value Roll-Forward

Lesson 2 — Goodwill When Purchase Price Exceeds Book Value

Lesson 3 — Amortizing the Excess Attributed to Depreciable Assets

The Big Picture: Equity Income vs. Cash Received

Common Exam Pitfalls

What to Practise Next

Ready to level up your exam prep?

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