Accounting chapter 12, part B- investor has significant influence
what evidence is recognized as indications that an investor may be unable to exercise significant influence depsite more than 20% stock ownership
1. The investee challenges the investor's ability to exercise significant influence (thru litigation or complaints to regulators) 2. the investor surrenders significant shareholder rights in a signed agreement 3. the investor is unable to acquire sufficient information about the investee to apply the equity method 4. the investor tires and fails to obtain representation on the board of directors of the investee
What further adjustments might be needed in obtaining an asset with significant control
1. When the expenditure to acquire the investment exceeds book value of the underlying net assets acquired, adjustments to both investment account and investment revenue might be needed. 2. adjustments for additional depreciation 3. adjustments for other assets and liabilities 4. no adjustment for land or goodwill.
A financial instrument is
1. cash 2. evidence of an ownership interest in an entity 3. A contract that a) imposes on one entity an obligation to deliver cash or another finacnial instrument and b) conveys to the second entity a right to receive cash or another financial instrument or 4. a contract that a0 imposes on one entity an obligation to exchange financial instruments on potentially unfavorable terms and b) conveys to a second entity a right to exchange other financial instruments on potentially favorable terms.
International financial accounting requires the equity method for use with significant influence investees with two exceptions. They are
1. they require the accounting policies of investees be adjusted to correspond to those of the investor when applying the equity methods which the US does not require 2. there is no fair value option
Significant influence is presumed (unless evidence to contrary) when investor owns what percentage of investee stock
20-50%
Why are unrealized gains and losses on available for sale securities not reported in the income statement but instead are in OCI and then shown in ACOI p. 666
AFS are not acquired for purpose of profiting from short term market price so gains and losses from holding them while prices change are viewed as insufficiently relevant performance measures to be included in ett income. Instead those amounts are shown in other comprehensive income (OCI) and accumulated in an owners equity account AOCI. It is likely the holding gains in some periods will be offset by losses in other periods. When the investment is sold, the net amount of gain or loss is removed from AOCI and recognized in net income
What are other titles to account for investment revenue of increased investee's net income in investor's records
Amounts are not always called investment revenue or loss but might be "equity in earnings (losses) of affiliate
How does the investor deal with receiving dividends
Because investment revenue is recognized as earned by investee, it would be double dipping to recognize revenue for dividends. Instead, the dividend distribution is viewed as a reduction of the investee's net assets. As the investee distributes net assets as dividends, the investor's investment in the investee's net assets is reduced.
When an investment is acquired mid year how is the equity method modified
Changes in the investment account the first year are adjusted for the fraction of the year the investor has owned the investment. Ex. p. 687
For reporting purposes what is the relationship between parent and subsidiary companies
For reporting purposes (not legal) they are considered one legal entity and their statements are consolidated. Both operate as separate legal entities and the subsidiary reports separate statements while the parent reports consolidated financial statements
Why are HTM securitites treated differently from other investment securities p.657
If an investor has the positive intent and ability to hold securities to maturity, investments in debt securities are classified as HTM and reported at amortized cost in the balance sheet. Increases and decreases in fair value are not reported in financial statements because the changes are not as relevant to an investor who will hold it to maturity. Changes in the fair value between the time a debt security is acquired and the day it matures to a prearranged maturity value arent as important if sale before maturity is not an alternative
How does the investor adjust for inventory that has a fair value that exceeds its book value at time of the investment in the comapny
If the fair value of purchased invenotry exceeds its book value we assume the inventory is sold in the next year and reduce investment revenue in the next year by the entire difference.
For example assume that an investor's share of investee net income, reduced by dividends was 4M during a period when the equity method was not used, but with additional purchases it became appropriate. What journal entry would record the change
Investment in equity securities 4M Retained earnings (invest rev. from equity method) 4M
How does an investor make depreciation adjustments in investment with significant control
Investor must adjust its investment revenue for additional buildings. Investment revenue.....30 K Investment % x (fair value- book value) divided by life of asset depreciated.
When an equity method investment is sold, how is a gain or loss recognized
It is recognized if the selling price is more or less than the carrying amount (book value) of the investment and is recognized for the difference between the selling price and the carrying amount. cash 1.446M Loss on sale of investments(to balance) 99K Investment in stock (account balance) 1.545M
What is the impact as to how the two approaches recognize unrealized holding gains and losses
It results in different book values for the investment at the time the investment is sold and therefore results in different realized gains or losses at that time.
Why wont an investor adjust land or goodwill in asset where have significant influence
Land does nto depreciate and good will is an intangible asset that is not amortized.
what is the single entity concept
Much like consolidation, the equity method views the investor and investee collectively as a special type of single entity, as if the two companies were one, however the investor does not include separate financial statement items of the investee on an item by item basis as in consolidation.
Regardless of approach is there any difference in cash flows and total net income recognized over the life of the investment
No- so the question is not how much total net income is recognized but when that net income is recognized.
t/c under the equity method, the investment account represents the investor's share of the investees net assets initially acquired, adjusted for the investor's share of the subsequent increase in the investee's net assets (net assets earned and not yet distributed as dividends)
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Why are unrealized gains and losses on trading securities reported in the income statement p. 661
TS are acquired for purpose fo profiting from short term market price changes so gains and losses from holding them while prices change are often viewed as relevant performance measures that should be included in net income.
At what amount are the acquired company's assets included in consolidated financial statements
The acquired company's assets are included at their fair values at the date of acquisition rather than their book values on that date.
The carrying amount of the investment under the equity method is
The carrying amount is its initial cost + the investor's equity in the undistributed earnings of the investee.
What principal governs the acquisition of assets purchased where are able to exercise significant influence
The cost principal. The entry is the same as if did not get singificant influence. Ex. Investment in ARjent Stock 1.5M cash 1.5 M
When a change to the equity method is appropriate what accounts must change
The investment account should be retroactively adjusted to the balance that would have existed if the equity method always had been used. As income would also have been different, retained earnings would be adjusted as well.
What are the two significant differences between fair value and equity method approaches
The two approaches differ in 1. whether to record investment revenue when dividends are received and 2. whether to reecognize unrealized holding gains and losses associated with changes in the fair value of the investment
How is investment revenue recorded
Under the equity method, the investor includes in net income its proportionate share of the investee's net income because as the investee earns additional net assets, the investor's equity interest in the asset also increases. Investment in Arjent stock 150K Investment revenue (%own X increase in investee net assets)..............................................................................150K
Visa's influence over an investee was reduced in 2013. Visa changed from accounting for the investment by the equity method to accounting for the investment as available for sale. The investment had been carried at 12M under the equity method but its fair value was 99 million. How was this accounted for
When Visa made the change it recognized an 87M gain in other comprehensive income just as if the investment had initially cost 12 M and had appreciated 87 M in value during the year.
Explain why Code accounts for some of its investments by the equity method and what that means p. 683
When an investor does not have control but still is able to exercise significant influence over the operating and financial polices of the investee, the investment should be accounted for by the equity method. Apparently Code owns between 20-50% of the voting shares of some companies in which it invests. By the equity method, Code recognizes investment income in an amount equal to its percetage share of the net income earned by those companies instead of the amount of that net income it receives as cash dividends. The rationale is that as the investee earns additional net assets, Cokes share of those assets increase.
What is significant influence:
When effective control is absent but the investor can still exercise significant influnce over the operating and financial policies of investee, i.e. control large share of stock compared to others.
Can companies choose the fair value option for significant influence investments as they can for non significant influence investments
Yes
If the acquisition price for the subsidiary is more than the sum of the separate fair values of the acquired net assets (assets less liabilities) the difference is recorded as
an intangible asset-goodwill
If the investee reports a net loss how is this reported by the investor with significant control
an investment account would be decreased by the investor's share of the investee's net loss (adjusted for additional expenses)
Under the equity method how does the investor report its equity interest in the investee
as a single investment account-
In the statement of cash flow how are receipt of dividends reported from an investment with significant control
as an inflow of cash in the operating activities section
why is the equity method sometimes called "one line consolidation
because it essentially collapses the consolidation approach into single lines in the balance sheet and income statement while having the same efffect on total income and shareholders equity.
Why are adjustments needed for additional depreciation in investment with significant control
because when the investee determines net income it bases depreciation expense on book values but investor needs to depreciate its share of the fair value of the buildings at the time it made its investment.
what reporting method is used if the investor has control
consolidation
Initially, the investment for substantial influence is recorded at -
cost
what reporting method is used if the investor has significant influence
equity method- it is used when an investor cannot control but can significantly influence the investee.
what are derivatives
financial instruments (like financial futures, interest rate swaps, forward contracts and options) that derive their values or contractually required cash flows from some other security or instance.
The carrying amount of an investment for substantial influence is increased by what event and decreased by what event
increased by the investor's percentage share of the investee's net income (or decreased by its share of a loss) and decreased by dividends paid
In the statement of cash flows, the purchase and sale of the investment for significant control is reported as outflows and inflows of cash in what section
investing activities section
If a company acquires more than 50% of voting stock of another company it is said to have controlling interest. The investor is called the - and the investee is referred to as -
investor is parent investee is subsidiary
When a company invests in the equity securities of another company, the way we report the investment depends on how the investment relationship is classified between investor and investee. What are the various classifications a
lacks significant influence, usually less than 20% Has significant influence usually 20-50% equity ownership Has control, usually greater than 50% ownership.
The way an investment does not impact cash flows but does have an impact in what three ways
net income, investment book value and the amount of gain or loss recognized in the future when the investment is sold
Does a company who chooses to use the fair value option have to use it for all investments
no
We know reporting methods depend on the type of investment when the investor lacks significant influence. Does the type of investment impact the reporting method if the investor gets significant influence or control
no
If an investor has more than 20% of stock but does not have significant influence, would the equity method still be appropriate
no - the investment would likely be treated as AFS
If theinvestor's proportionate share of investee losses exceed the carrying amount of the investment should the investor continue to apply the equity method
no it should discontinue applying the equity method until the investor's share of subsequent investee earnings has equaled losses not recognized furing the time the equity method was discontinued.
When an investor's level of influence changes it may be necessary to switch from the equity method to another method. When this situation happens, is any adjustment made to the remaining carrying amount of the investment
no, instead the equity method is simply discontinued and the new method applied from then on. The balance in the investment account when the equity method is discontinued would serve as the new cost basis for writing the investment up or down in the future
Are Investments that otherwise would be accounted for under the equity method but for which the fair value option has been elected reclassified as trading securities
no- Instead they are shown on their own line in the balance sheet or are combined with equity method investments with the amount at fair value shown parenthetically. Still they are reported at fair value with changes in fair value reported in earnings as if they were trading securities.
Is there any difference to record the purchase of an investment between fair value and equity method approaches
no- identical entries Investment in stock 1.5 M cash 1.5 M
Is the fair value of the investment shares at the end of the reporting period reported when using the equity method
no. The investment account is reported at its original cost, increased by the investor's share of the investee's net income (adjusted for additional expenses like depreciation) and decreased by the portion of those earnings actually received as dividends.
While FASB has an ongoing project to deal with financial instrument accounting methods how are they handled in the interim
primarily in the form of additional disclosures
what is "amortizing the differential"
process done after the date of acquisition where both the investment account and investment reveenue are adjusted for differences between net income reported by the investt and what that amount would have been if consolidation procedures had been followed- mimics the process of expensing some of the difference betweent he price paid for the investment and the book value of the investment.
Under the equity method how does the investor recognize investment income
the investor recognizes investment income equal to its percentage share (based on stock ownership) of the net income earned by the investee rather than the portion of that net income received as cash dividends. Stated differently, as the investee earns additional net assets, the investor's share of the net assets increases.
what are consolidated financial statements
they combine the separate financial statements of parent and subsidiary each period into a single aggregate set of financial statements as if one company- they ential item by item consolidation
T/F: if the sale of the equity method investment meets the criteria for a discounted operation it is reported in the financial statements as a discontinued operation
true-if questions, see chapter 4
Is the decision to use the fair value option irrevocable
yes
If a company has less than 20% ownership are there situations where it is able to exercise significant influence such that the equity method should apply
yews- for instance by havng an officer of the investor corp on the board of directors of the investee corporation or by haing 18% of voting shares where no other single investor owns more than 50%
