Equity Method Schweser Question increase, investment, acquired, balance, company

spreads

Question 46 in Schweser Exam 3, Morning Session has an equity method problem where they compute equity income by multiplying acquired company’s earnings by pro-rata portion owned; that’s fine. But then they subtract depreciation due to the increase in PP&E over fair value of PP&E (fairvalue was 1.2 million; balance sheet says 2 million now).
Why do they do this? I thought you just put the investment as a long-term asset at cost on the balance sheet plus earnings minus dividends, and you put the pro-rata earnings on the income statement as “equity income.” Is this even right or am I bass ackwards?

cyber21

There was a similar question on the exam last year (I missed it).
There is mention of the depreciation issue (I believe this is what you’re getting at) in Schweser. I don’t have my books with me or I would find the page…I’ll let someone else explain – This area isn’t a strength for me.

LiquidAssets10

This is always done. Equity method - if parent paid more than the pro-rata share of fair market value of net assets of sub. - the difference is attributed to Goodwill and is embedded within the single line item called “Investment in subsidiary”. Now if that excess is attributable to tangible assets on the subsidiary - that excess must be depreciated.
That extra depreciation reduces both the equity Income (Income statement) and also affects the Investment in Subsidiary line item. See pg 121 on Schweser for an example.