Ch. 1 SmartBook

Holden company pays $340,000 for a 40% investment in Sparrow Company. The investment provides Holden with the ability to exercise significant influence over Sparrow's operations. At the date of the investment, Sparrow has a book value of $600,000. Sparrow has a patent (5-year remaining life) with a zero carrying amount but a fair value of $250,000. How much goodwill should Holden record as a result of this transaction?

($600,000 + $250,000) x 40% = $340,000, so goodwill = $0

An intra-entity inventory sale occurs between an investor and its equity-method investee. What factors determine the amount of gross profit from the sale to be deferred as of the end of the year?

-The seller's gross profit percentage; The investor's proportionate ownership of the investee; The amount of the intra-entity sale remaining in ending inventory.

When an investor sells inventory to its 40%-owned investee (an intra-entity sale), why is 40% of the refit recognition delayed until the inventory is sold to an outside party?

40% of the investor's sale is effectively with itself.

Because certain intangible assets are considered to have indefinite lives, they are not subject to ___________.

Amortization

Goodwill is:

An intangible asset

How does an investor record income from its investment in an equity-method investee?

As a credit to "Equity in Investee Income"

Under the equity-method, the amount of gross profit deferred from an intra-entity sale is limited to the investor's ___________ share of the investee.

Ownership

To provide consistency in application, what is the FASB's general quantitative guideline for application of the equity method?

Ownership of 20-50% of the voting stock of an investee.

The equity method in accounting for an equity investment is applied when the investor company:

Participates in policy-making decisions of the investee; has representation on the investee's board of directors

Which of the following represent reasons why a firm's stock price differs from its underlying book value?

Perceived worth of the firm's net assets; General economic conditions; Expected future profitability of the firm.

Although goodwill arising from a business combination is subject to periodic impairment reviews, goodwill implicit in an equity method investment is not. Equity method investments are tested in their entirety for ________ declines in value.

Permanent

If an increase in an investment now provides an investor with the ability to exercise significant influence over an investee, the change to the equity method of investment accounting is applied on a _________ basis.

Prospective

Which of the following accounting approaches is used when an investment share is increased and the investment now qualifies for the equity method?

Prospective approach

Zell Company sells inventory at a $10,000 gross profit to its equity method investee, Aaron company. Before the end of the year, Aaron resells all of this inventory to an outside, unrelated entity. As a result of these activities, Zell company should _____________.

Recognize the entire $10,000 gross profit on its income statement.

When an equity-method investee company's activities require recognition of other comprehensive income (OCI), the investor company _____________.

Records its proportionate share of the investee's OCI as AOCI on its financial records.

When an equity-method investee company's activities require recognition of other comprehensive income (OCI), the investor company ____________________.

Records its proportionate share of the investee's OCI as AOCI on its financial records.

What factors indicate if the equity method should be used for an investment in another firm's equity securities?

Technological dependency between the investor and investee; Investor representation on the investee's board of directors; Investor participation in the policy-making process of the investee.

The sole criterion for application of the equity method for an investment in the ownership shares of another company is ________.

The ability to exercise significant influence over an investee even though the investor holds 50% or less of the common stock

Goodwill is recorded when:

The amount paid for a company is greater than its purchased net assets.

Under the equity method, why does the investor not recognize its share of dividends declared by an investee as income?

The equity method embraces the accrual model for income recognition.

Why is it necessary to identify the sources of the difference between the price paid for an investment and its underlying book value in applying the equity method?

The equity method will likely expense excess costs allocated to different asset categories over different useful lives.

What is goodwill associated with an equity method investment?

The excess of the cost of the investment that cannot be attributed to a specific investee asset or liability.

Under the equity method, the investment account increases when __________.

The investee recognizes and reports net income

If an investment qualifies for the equity method following a series of purchases, what valuation basis should the investor employ in applying the equity method?

The investment's total fair value as of the date the investment qualifies for the equity method.

When an investor sells a portion of an equity-method investment, ______________.

The investor continues to apply the equity method if the investor continues to have the ability to exercise significant influence over the investee; The investor recognizes a gain or loss on the sale; The investment account should reflect a balance current as of the date of sale.

When a company invests in the activity-traded equity shares of another company, but cannot influence the decisions of the investee, the investor company accounts for its investment using the _______ value method.

Fair

When an equity method investment suffers a permanent decline in value, the investor recognizes an impairment loss and writes down the investment account to _________ value.

Fair

In the absence of any significant influence, which of the following investment methods might be appropriate?

Fair-Value Method

As of the date the equity method become applicable for an investment, the investor allocates its purchase price to its share of the investee's assets and liabilities based on their individual __________ __________ values.

Fair; Market

True or False: Under the equity method for investments with significant influence, the direction of the sale between the investor and investee (upstream or downstream) can only increase but cannot decrease the final amounts reported in the financial statements.

False

When an investor purchases an investment for an amount in excess of the investee's book value, how is the excess amount allocated?

First to specifically identified assets and liabilities with any remainder allocated to goodwill.

Under the equity method for investments with significant influence, the direction of the sale between the investor and investee (upstream or downstream) ____________ the final amounts reported in the financial statements.

Has no effect on

When should an investor recognize an impairment loss for its equity method investment?

If evidence exists that the investor will not be able to recover the investment's carrying amount and the decline in value is other than temporary.

An excess price paid by an investor company over the percentage book value of the investee attributable to a depreciable asset will likely affect the equity method ________ recognized by the investor company over time.

Income

True of False: If an investor sells sufficient shares to cause it to lose its ability to exercise significant influence over an investee, the equity method would cease to be applicable.

True

True of false: Despite a majority voting stock ownership, the equity method may be appropriate if noncontrolling rights are so restrictive that control may not reside with the majority owner.

True

True or False: Equity method accounting requires that the investor recognize its shares of investee other comprehensive income and accumulated other comprehensive income.

True

True or False: When an investor sells inventory to an outside party that had been purchased from its equity-method investee, the investor recognizes any related deferred gross profit.

True

When does a company like Coca-Cola account for its investment using the equity method?

When the investment provides the company with the ability to exercise significant influence over the decisions of the investee.

At the beginning of the current year, Martin Corporation purchases 20% of the outstanding shares of Foster Company for $200,000 which gave Martin the ability to significantly influence Foster. The price paid reflected Foster's book and fair values of its assets and liabilities. During the current year, Foster reports net income of $25,000 and declares dividends of $15,000. At the end of the current year, what amount should Martin report as investment income from its ownership of Foster's shares?

$5,000 = $25,000 x 20%

The deferral of gross profits from sales from an investor (Company A) to its equity-method investee (Company B) affects which of the following accounts on the books of the investor.

Equity in investee income; Investment in Company B

Which of the following is not a method recognized by GAAP as an approach to the financial reporting of investments in corporate equity securities?

Debt method

Under the equity method, the investor's amortization of the excess of cost over investee book value will _________.

Decrease the investor's net income

Under the equity method, the investor's amortization of the excess of cost over investee book value will _____________.

Decrease the investor's net income

An investor sells inventory to its investee, at a profit. At year end, the investee has not disposed of this inventory. How should the investor account for the gross profit from this intra-entity inventory sale?

Defer the investor's proportionate ownership share of the intra-entity gross profit.

Which of the following are included in net income for an investment in equity share accounted for under the fair-value method?

Dividends from the investee

The ability to exercise significant influence over the operating and financial policies of an investee company is the sole criterion for application of the ______ method.

Equity

What account should an investor use to defer its proportional share of intra-entity gross profits remaining in ending inventory from sales to an investee?

Equity in Investee Income

Under the equity method, as the owners' equity of an investee company increases through the earnings process, the investment account of the investor company _________.

Increases

The term used to describe inventory sales between an investor company and its equity-method investee is ___________ - ________ inventory sales.

Intra-entity

Which of the following explains why an investor company may pay an amount in excess of the percentage book value acquired of an investee?

Inventory costing methods may understate the fair value of the acquired firm's inventory; The historical amounts of the acquired firm's assets may be less than their fair values.

Why does the equity method consider investee dividends as an inappropriate measure of investment income to an investor?

Investee dividends provide for a cash basis of income recognition, not an accrual basis; Through its significant influence, an investor can influence the timing of investee dividends and thus manipulate income.

When an entity method investee sells inventory to its investor at a gross profit and a portion of the inventory remains unsold to outside parties at year end, the investor's Equity in Investee Income account _________.

Is decreased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities.

The Coca-Cola Company accounts for its investment in Monster Beverage Corporation using the equity method because _________________.

It possessed significant influence over Monster Beverage

When an equity-method investment account balance is reduced to zero due to a current year investee loss, the investor should ________________.

Leave the investment account balance at zero until subsequent investee profits eliminate all unrecognized losses; Discontinue use of the equity method and not establish a negative balance; Accrue no additional losses.

When an equity-method investment account balance is reduced to zero, the investor should discontinue use of the equity method rather than establish a ___________ balance.

Negative

When an investor sells inventory to its equity-method investee, how is the reported sales balance on the investor's income statement affected?

The sales account remains unaffected.

The fair-value option for reporting investments that would otherwise be accounted for under the equity method requires _____________.

The valuation of the equity method investment at fair value as of the investor's balance sheet date; An irrevocable election to elect fair value as the measurement attribute for an equity investment; The inclusion in net income of changes in the fair value of an equity investment.

How should an investor recognize previously deferred gross profits from purchases from its equity-method investee?

Through a credit to Equity in Investee Income