...Chapter 1: The Equity Method of Accounting for Investments 1. There are three ways that a company may account for its investments in other companies. The method of accounting is determined by the degree of influence or control that the investor has over the investee: Criterion Ownership Level Accounting Method Inability to significantly influence Less than 20% Fair value or cost Ability to significantly influence 20% - 50% Equity method or fair value Control (through voting power) More than 50% Consolidated financial statements Control (through variable interests) Primary beneficiary status (no ownership required) Consolidated financial statements 2. The Fair-Value method is used for all equity investments in which the investor does not have the ability to significantly influence the investee. These investments are recorded at cost and periodically adjusted to fair value (i.e., market values). The basic principles are: 1) initial investments in equities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable; otherwise, the investment remains at cost. 2) equity securities held for sale in the short term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings. 3) equity securities not classified as trading securities are classified as available for sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported...
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...Prof. Alfred Liu Chapter 1: Reporting Equity Investments in Other Companies Example 1: The Cost/Equity Method and Increase of Investment Company A made an investment in one of its local competitors, Company B. For the following events, use the appropriate accounting method and record journal entries for Company A. 1/2/2012 – A purchased 10% of B’s shares for $20,000. 12/31/2012 - B reported net income of $100,000 and declared and paid dividends $10,000 to its shareholders. 1/2/2013 - A purchases an additional 20% of B’s common shares for $45,000. 12/31/2013 - B reports net income of $120,000 for 2013 and declared and paid $11,000 dividends to all shareholders. Analysis: The objective of retroactive adjustment – as if the equity method had been used from the first day of investment. Two accounts need to be adjusted: a) Investment account b) Retained earnings (historical equity income) or AOCI. Solution: In 2012, the cost method was appropriate because we didn’t know the market value of the investment. Record the investment on 1/2/2012 for A: Dr. Investment in B 20,000 Cr. Cash 20,000 Net income reported by B in 2012: No journal entry under the cost method. Record the dividends paid by B to A on 12/31/2012: Dr. Cash 1,000 Cr. Dividend income 1,000 Record the increase in investment on 1/2/2013: Dr. Investment in Ivanhoe Mines 45,000 Cr. Cash 45,000 Retroactive adjustments to investment and retained earnings on 1/2/2013: Dr. Investment in Ivanhoe Mines 9,000 Cr. Retained earnings...
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...Solution Manual Chapter 1 - Accounting for Intercorporate Investments 1. a. If the investor acquired 100% of the investee at book value, the Equity Investment account is equal to the Stockholders’ Equity of the investee company. It, therefore, includes the assets and liabilities of the investee company in one account. The investor’s balance sheet, therefore, includes the Stockholders’ Equity of the investee company, and, implicitly, its assets and liabilities. In the consolidation process, the balance sheets of the investor and investee company are brought together. Consolidated Stockholders’ Equity will be the same as that which the investor currently reports; only total assets and total liabilities will change. b. If the investor owns 100% of the investee, the equity income that the investor reports is equal to the net income of the investee, thus implicitly including its revenues and expenses. Replacing the equity income with the revenues and expense of the investee company in the consolidation process will yield the same net income. 2. FASB ASC 323-10 provides the following guidance with respect to the accounting for receipt of dividends using the equity method: The equity method tends to be most appropriate if an investment enables the investor to influence the operating or financial decisions of the investee. The investor then has a degree of responsibility for the return on its investment, and it is appropriate to include in the results of operations...
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...The Equity Method of Accounting for Investments The first several chapters of this text present the accounting and reporting for investment activities of businesses. The focus is on investments when one firm possesses either significant influence or control over another through ownership of voting shares. When one firm owns enough voting shares to be able to affect the decisions of another, accounting for the investment can become challenging and complex. The source of such complexities typically stems from the fact that transactions among the firms affiliated through ownership cannot be considered independent, arm’s-length transactions. As in many matters relating to financial reporting, we look to transactions with outside parties to provide a basis for accounting valuation. When firms are affiliated through a common set of owners, measurements that recognize the relationships among the firms help to provide objectivity in financial reporting. LO4 LO3 LO2 LO1 1 LEARNING OBJECTIVES After studying this chapter, you should be able to: Describe in general the various methods of accounting for an investment in equity shares of another company. Identify the sole criterion for applying the equity method of accounting and guidance in assessing whether the criterion is met. Prepare basic equity method journal entries for an investor and describe the financial reporting for equity method investments. Record the sale of an equity investment and identify the accounting method to be...
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...____________ 1. Gaw Company owns 15% of the common stock of Trace Corporation and used the fair-value method to account for this investment. Trace reported net income of $110,000 for 2011 and paid dividends of $60,000 on October 1, 2011. How much income should Gaw recognize on this investment in 2011? A. $16,500. B. $9,000. C. $25,500. D. $7,500. E. $50,000. Yaro Company owns 30% of the common stock of Dew Co. and uses the equity method to account for the investment. During 2011, Dew reported income of $250,000 and paid dividends of $80,000. There is no amortization associated with the investment. During 2011, how much income should Yaro recognize related to this investment? A. $24,000. B. $75,000. C. $99,000. D. $51,000. E. $80,000. On January 1, 2011, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.'s voting common stock which represents a 45% investment. No allocation to goodwill or other specific account was made. Significant influence over Lennon was achieved by this acquisition. Lennon distributed a dividend of $2.50 per share during 2011 and reported net income of $670,000. What was the balance in the Investment in Lennon Co. account found in the financial records of Pacer as of December 31, 2011? A. $2,040,500. B. $2,212,500. C. $2,260,500. D. $2,171,500. E. $2,071,500. A company should always use the equity method to account for an investment if: A. it has the ability to exercise significant influence over the operating policies of the investee. B....
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...Chapter 1 the equity method of accounting for investments Answers to Questions 1. The equity method should be applied if the ability to exercise significant influence over the operating and financial policies of the investee has been achieved by the investor. However, if actual control has been established, consolidating the financial information of the two companies will normally be the appropriate method for reporting the investment. 2. According to Paragraph 17 of APB Opinion 18, "Ability to exercise that influence may be indicated in several ways, such as representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. Another important consideration is the extent of ownership by an investor in relation to the extent of ownership of other shareholdings." The most objective of the criteria established by the Board is that holding (either directly or indirectly) 20 percent or more of the outstanding voting stock is presumed to constitute the ability to hold significant influence over the decision-making process of the investee. 3. The equity method is appropriate when an investor has the ability to exercise significant influence over the operating and financing decisions of an investee. Because dividends represent financing decisions, the investor may have the ability to influence the timing of the dividend. If dividends were recorded as income...
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...Accounting for Investments under FASB No. 115 – A Review |For commercial enterprises |Presentation on Financial |Change in Fair Value | |(nonprofit entities follow SFAS No.124) |Statements | | | | |Temporary |Other than | | | | |Temporary Loss | |Does the investor have substantial influence or control? | | | | |Investor owns 20% to 50% of stock and has significant influence but |On BS at historical cost plus |N/A |Realized loss on | |not control of the corporation |share of earnings since | |IS, new basis on | | |acquisition less dividends | |BS | |Use Equity Method |received (amortization may also be| | | | |required) | | ...
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...market value. Q9-2. An unrealized holding gain (loss) is an increase (decrease) in the fair value of an investment security that is still owned. Q9-3. Unrealized holding gains and losses related to trading securities are reported in the current-year income statement (which flows to retained earnings). Unrealized holding gains and losses related to available-for-sale securities are reported as part of a separate component of stockholders' equity called Accumulated Other Comprehensive Income (AOCI). Q9-4. Significant influence gives the owner of the stock the ability to significantly influence the operating and financing activities of the company whose stock is owned. Normally, a 20% through 50% ownership of the company's voting stock provides evidence of significant influence. The equity method is used to account for investments with significant influence. Such an investment is initially recorded at cost; the investment is increased by the proportionate share of the investee company's net income, and equity income is reported in the income statement. The investment account is decreased by dividends received on the investment, and is reported in the balance sheet at its book value. Unrealized gains or losses on the investment are not recognized in the financial statements. Q9-5. Because Yetman Company's investment in Livnat Company is an investment with...
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...introduced as Exposure Draft E28, Accounting for Investments in Associates and Joint Ventures, in July, 1986. The history of IAS 28 is as follows in the table below which shows the last amendment being in 2011 with an effective date of January 1, 2013. History of IAS 28 (as amended in 2011) July 1986 | Exposure Draft E28 Accounting for Investments in Associates and Joint Ventures | April 1989 | IAS 28 Accounting for Investments in Associates | 1 January 1990 | Effective date of IAS 28 (1989) | 1994 | IAS 28 was reformatted | December 1998 | IAS 28 was amended by IAS 39 Financial Instruments: Recognition and Measurement effective 1 January 2001 | 18 December 2003 | Revised version of IAS 28 issued by the IASB | 1 January 2005 | Effective date of IAS 28 (2003) | 10 January 2008 | Some significant revisions of IAS 28 as a result of the Business Combinations Phase II Project relating to loss of significant influence | 22 May 2008 | IAS 28 amended for Annual Improvements to IFRSs 2007 about impairment testing | 1 January 2009 | Effective date of May 2008 amendments to IAS 28 | 1 July 2009 | Effective date of January 2008 amendments to IAS 28 | 12 May 2011 | IAS 28 (as amended in 2011) Investments in Associates and Joint Ventures issued. This version supersedes IAS 28 (2003) Investments in Associates. | 1 January 2013 | Effective date of IAS 28 (as amended in 2011) | | IAS applies to all investments in which an investor has significant influence but...
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...Investments in Marketable Equity and Debt Securities (SFAS #115, for fiscal years beginning after 12/5/1993) |Reporting Category |Classification Criteria | |Held to Maturity |Debt securities the investor has the positive intent and ability to hold to maturity | |Trading Securities | | | |Debt or equity securities | | |held for immediate resale | |Securities Available for Sale |Debt or equity securities not classified as either securities held to maturity or | |(“catch all”) |trading securities | Debt Securities: (creditor relationship) US Gov. bonds and notes, municipal securities, corp. bonds/notes/paper, convet. debt. Equity Securities: (ownership interest) common, preferred, or other capital stock, share rights, warrants, and call or put options. Reporting Categories For Investments |Types of Securities |Characteristics ...
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...the cost and equity methods or accounting for an investment. Equity method of accounting of investment is the accounting of investment in which value of each stock/share is counted based on the book value of the stock as reported by the investee corporation. Cost method of accounting of investment is the accounting method in which the purchase price of the stock is taken as the value of the investment. Both are used to report financial assets, liabilities and give and are options available to account for investment holdings. Under the cost method, equity securities with readily determinable fair values must be adjusted at year-end under FASB statement 115. The investor will then recognize income from the investment when the issuer as a dividend distributes income. The cost method is utilized when insignificant influence of the investor exists. The equity method is which the value of each stock or share is counted based on the book value of the sock and is reported by the investee corporation. Under what circumstances would you use the cost or equity method of accounting for an investment? The equity method of accounting treatment of investment is used when the investor in the corporation is able to exercise significant control over the operation and policies of the corporation i.e., when the investor owns at least 20% of voting stock on the corporation, then equity method of accounting treatment is used. Furthermore, The equity method is a method used for external...
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...Abbott Laboratories—Equity Method Investments Teaching Notes: This case shows students how the equity method of accounting works. Abbott Lab’s footnote disclosure includes simple financial statement and income statement information for the joint venture. This provides a textbook example of the equity method. The case asks students to consider the effect on Abbott’s financial statements had the company reported under IFRS, which allows firms to select between equity method and proportionate consolidation when accounting for joint ventures (entities with joint control). Creating pro forma financials is a useful skill not only to reflect potential IFRS conversion but to enable meaningful comparisons across reporting jurisdictions. Thus, even if the SEC does not require IFRS for domestic registrants, students will benefit from studying non-GAAP reporting requirements. The case starts with the economic and business reasons behind joint ventures. Our teaching philosophy is that accounting does not happen in a vacuum – it is the language of business. We take every opportunity to have students consider the economics of the transaction first and then apply accounting rules. This is good practice for students who will have to make increasingly many judgments with the coming of principles-based accounting. Students have little trouble determining how Abbott Laboratories accounts for its 20-50% owned subsidiaries. They find it much more challenging to trace the effects thereof through the...
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...their maturity dates. True 2. All investments in debt securities whose fair values are not readily determinable are carried at historical cost. True 3. False All securities considered available for sale should be reported as current assets in a classified balance sheet. True 9. False Both trading securities and securities available for sale are reported at their fair values. True 8. False Routine transfers of debt and equity investments among the trading, available for sale, and held to maturity portfolios need not be disclosed in the financial statements. True 7. False Purchases and sales of securities are always reported as investing activities in a statement of cash flows. True 6. False Net unrealized holding gains (losses) are reported in the income statement for trading securities. True 5. False Both debt and equity securities can be categorized as trading securities. True 4. False False Unrealized gains and losses are included in other comprehensive income for securities that are classified as available for sale. True False 10. When available-for-sale securities are sold, the full amount of any gain or loss realized on the sale is included in before-tax net income. True False 11. Companies must always use the equity method when they hold between 25% and 50% of the common stock of an investee. True False 12. The equity method is in many ways a partial consolidation. ...
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...Does a Company Really Decide which Investment Method to Apply? Students can come up with literally dozens of factors that should be considered by Pilgrim in making the decision as to the method of accounting for its subsidiary, Crestwood Corporation. The following is simply a partial list of possible points to consider. Use of the information. If Pilgrim does not monitor its own income levels closely, applying the equity method would seem to be a waste of time and energy. A company must plan to use the additional data before the task of accumulation becomes worthwhile. Size of the subsidiary. If the subsidiary is large in comparison to Pilgrim, the effort required of the equity method may be important. Income levels would probably be significant. However, if the subsidiary is actually quite small in relation to the parent, the impact might not be material enough to warrant the extra effort. Size of dividend payments. If Crestwood pays out most of its earnings each period as dividends, that figure will approximate equity income. Little additional information would be accrued by applying the equity method. In contrast, if dividends are small or not paid on a regular basis, a Dividend Income balance might vastly understate the profits to be recognized by the business combination. Amount of excess amortizations. If Pilgrim has paid a significant amount in excess of book value so that annual amortization charges are quite high, use of the equity method might be preferred to show the...
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...As of December 28, 2013 , the fair value of our marketable equity investments and our equity derivative instruments, including hedging positions, was $6.3 billion ( $4.4 billion as of December 29, 2012 ). Our marketable equity investment in ASML was carried at a total fair market value of $5.9 billion , or 94% of our marketable equity portfolio, as of December 28, 2013 . Our marketable equity method investments are excluded from our analysis, as the carrying value does not fluctuate based on market price changes unless an other-than-temporary impairment is deemed necessary. To determine reasonably possible decreases in the market value of our marketable equity investments, we have analyzed the historical market price sensitivity of our marketable equity investment portfolio. Assuming a loss of 25% in market prices, and after reflecting the impact of hedges and offsetting positions, the aggregate value of our marketable equity investments could decrease by approximately $1.6 billion , based on the value as of December 28, 2013 (a decrease in value of approximately $1.6 billion , based on the value as of December 29, 2012 using an assumed loss of 35% ). Many of the same factors that could result in an adverse movement of equity market prices affect our non-marketable equity investments, although we cannot always quantify the impact directly. Financial markets are volatile, which could negatively affect the prospects of the companies we invest in, their ability to raise...
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