On January 4, 2011, Bailey Corp. purchased 40% of the voting common stock of Emery Co., paying $3,000,000. Bailey properly accounts for this investment using the equity method. At the time of the investment, Emery's total stockholders' equity was $5,000,000. Bailey gathered the following information about Emery's assets and liabilities whose book values and fair values differed: Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Emery Co. reported net income of $400,000 for 2011, and paid dividends of $200,000 during that year. What is the amount of excess amortization expense for Bailey's investment in Emery for the first year?

Question

On January 4, 2011, Bailey Corp. purchased 40% of the voting common stock of Emery Co., paying $3,000,000. Bailey properly accounts for this investment using the equity method. At the time of the investment, Emery's total stockholders' equity was $5,000,000. Bailey gathered the following information about Emery's assets and liabilities whose book values and fair values differed:  Any excess of cost over fair value was attributed to goodwill, which has not been impaired. Emery Co. reported net income of $400,000 for 2011, and paid dividends of $200,000 during that year. What is the amount of excess amortization expense for Bailey's investment in Emery for the first year?

Quizplus · Accepted Answer

To calculate excess amortization expense, we need to first allocate the excess of cost over fair value ($800,000) as follows: 
- $600,000 to Emery's identifiable net assets (proportionate to Bailey's ownership percentage) 
- $200,000 to goodwill 
Then, we can calculate the annual excess amortization expense as the amount of goodwill amortized over its useful life. Assuming a useful life of 10 years, the annual amortization expense is $20,000 ($200,000/10).
Bailey's share of this expense is 40%, or $8,000. Since this expense is recorded as a reduction to investment income, Bailey's net income from Emery is $392,000 ($400,000 - $8,000). Therefore, the excess amortization expense for the first year is $84,000 ($92,000 - $8,000).