Acct 426 Exam 2

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Items included in AOCI (Accumulated other comp income) on the balance sheet

- accumulated derivative net gains and losses, - foreign currency translation adjustments, and - certain pension adjustments

The investment and income account for the partial equity method for a parent company

- adjusted only for accrued income and dividends declared by the acquired company - income accrued as earned; no other adjustments recognized

five entries that consolidate companies but aren't actually recorded in the account balances of either company

- Stockholders' equity account - eliminated - allocations unamortized - recognized - income from subsidiary - eliminated by parent - dividends - eliminated - expense for amortization - recognized

Applying the acquisition method involves using fair value to recognize and measure the following:

- The consideration transferred for the acquired business and any noncontrolling interest. - Separately identified assets acquired and liabilities assumed. - Goodwill, or a gain from a bargain purchase.

Under the equity method, investor's share of investee dividends declared are recorded as

a decrease in the investment account, not income

For both income and retained earnings using the initial value and partial equity method, what is required for the consolidated financial statements?

a full accrual-based measurement

What is the equity method for a parent company?

full accrual accounting - creates a total income figure reflective of the entire combined business entity

Goodwill vs. gain on bargain purchase when consideration transferred for a business combination does not match

goodwill = consideration > net assets gain on bargain purchase = consideration < net assets

under the fair-value option, changes in the fair value of the elected financial items are included in what?

included in earnings

How do you calculate how much is in the investment account?

initial investment + reported income - dividends declared/paid - amortization

How is a permanent decline in the investee's fair market value recorded?

it is recorded as an impairment loss and the investment account is reduced to the fair value

How is the method for reporting investments in other companies selected?

it is selected based upon the degree of influence the investor (stockholder) has over the investee

What happens when a business combination is just taking control without dissolution?

it is when one company achieves legal control over another by acquiring a majority of voting stock, but dissolution doesn't take place. Each company remains in existence as an incorporated operation

can an investment account have a negative balance?

no it cannot, once it reaches zero, no more loss can be accrued. Future equity income will be offset by these losses prior to recording equity income

when a majority of voting stock is held, the investor-investee relationship is so closely connected that the two corporations are viewed as a single entity therefore,

one set of financial statements is prepared to consolidate all accounts of the parent company and all of its controlled subsidiaries as a single entity

on a worksheet, what account is eliminated so subsidiary's actual assets and liabilities can be consolidated?

parent's investment account

How does the fair-value option improve financial reporting?

provides entities with the opportunity to mitigate volatility in reporting earnings caused by measuring related assets and liabilities differently without having to apply complex hedge account provisions

AOCI is reported in stockholders' equity and represents what?

represents a source of change in investee company net assets that is recognized under the equity method.

Equity method accounts requires what?

requires that investor record its share of investee OCI and irregular items trandational found in net income

Other comprehensive income (OCI) is defined as

revenues, expenses, gains, and losses that under GAAP are included in comprehensive income but excluded from net income

What is the cost approach?

the approach that estimated fair value by reference to the current cost of replacing an asset with another or comparable economic utility

What is the market approach?

the approach that estimates fair value using other market transactions involving similar assets or liabilities

What is the income approach?

the approach that relies on multi-period estimates of future cash flows projected to be generated by an asset

When does GAAP require the fair value of assets acquired and liabilities assumed in a business combination to be determined?

the date of acquisition

What is a bargain purchase?

the fair value of he consideration transferred by the acquirer is less than the fair value received in an acquisition,which is considered more relevant for asset valuation than the consideration transferred

What is the primary motivations for many business combinations?

the increasingly competitive environment

What is the ownership level and applicable accounting method if someone has the ability to significantly influence a company?

- 20% - 50% - equity method or fair value

Assets may be undervalued on the investee's books because

- FV of some assets and liabilities are different from their BV - the investor may be willing to pay extra because future benefits are expected to accrue from the investment - extra payment that cannot be attributed to a specific asset or liability is assigned to the intangible asset goodwill.

Regardless of investor's degree of ownership, the equity method is not appropriate if investments demonstrate the following:

- an agreement exists btw investor and investee by which the investor surrenders significant rights as a shareholder - a concentration of ownership operates in the investee w/o regard for the views of the investor - the investor attempts but fails to obtain representation on the investee's board of directors

The parent's record-keeping is limited to what two periodic journal entries?

- annual accrual of subsidiary income - receipt of dividends

The investment and income account for the equity method for a parent company

- continually adjusted to reflect current owner's equity of acquired company - income accrued as earned; amortizations and other adjustments are recognized

Accounting for a decrease in investment using the equity method from the investor's point of view

- decreases its investment account carrying value for its share of investee cash dividends - recognize its share of the earnings or losses of an investee in the periods for which they are reported by the investee in its financial statements

What other costs are incurred in business combinations, regardless if dissolution takes place?

- direct combination costs (accounting, legal, investment banking, appraisal fees) - indirect combination costs (internal cost such as allocated secretarial or managerial time) - amounts incurred to register and issue securities

What are the three methods a parent company can account for their investment in a subsidiary?

- equity method - initial value method - partial equity method

If part of an investment is sold during the period, what happens?

- equity method is applied until date of transaction - on transaction date, the investment account balance is reduced by the % of shares sold - no retroactive adjustment is recorded if change between methods is required

Differences may exist btw a company's book value and fair value because

- fair value is based on multiple factors, including but not limited to profitability, new products, expected dividend payments, projected operating results, and general economic conditions - stock prices are based, partially, on the perceived worth of a company's net assets, amounts that often vary from underlying book values - asset and liability accounts on the balance sheet tend to measure historical cost rather than current value - reported figures are affected by the accounting methods selected and lead to different book values - when purchase price exceeds book value of an investment acquired, the difference must be identified

measurements of financial performance often affect the following

- firm's ability to raise capital - managerial compensation - ability to meet debt covenants and future interest rates - managers' reputations

Extensions of equity method applicability

- if investment falls short or exceeds 20-50%, equity method is appropriately used for financial reporting - conditions can exist where the equity method is appropriate despite a majority ownership interest

FASB ASC Section 810-10-05, Variable Interest Entities

- included entities controlled through special contractual arrangements (not through voting stock interests) - intended to combat misuse of SPEs (special purpose entities) to keep large amounts of assets and liabilities off the balance sheet, known as "off-balance-sheet financing"

Accounting for an increase in investment using the equity method from the investor's point of view

- increase investment account as the investee earns and reports income - uses the accrual method to record investment income - recognizing it in the same time period as the investee earns it

What three accounts for the parent company varies based on the method used?

- investment account - income recognized from the subsidiary - parent's retained earning

Report a change to the equity method if:

- investment was recorded used the cost of FV method reaches the point where significant influence is established - investment qualifies for the use of the equity method, the investor adds the cost of acquiring additional interest in the investee to the current basis and adopts the equity method of accounting - this prospective approach avoids the complexity of restating prior period amounts

When do you use the Equity method to report investments in a other companies?

- investor has the ability to exercise significant influence on investee operations - ownership is btw 20-50%

When do companies use the Fair - Value method for reporting investment in other companies?

- investor hold a small percentage of equity securities of investee - investor cannot significantly affect investee's operations - investment is made in anticipation of dividends or market appreciation

What is the ownership level and applicable accounting method if someone has the inability to significantly influence a company

- less than 20% - fair value or cost method

What is the ownership level and applicable accounting method if someone has control through voting interests?

- more than 50% - consolidated financial statements

What are the significant differences between the initial value method and the equity method?

- parent's separate statements do not reflect consolidated income total when the initial value method is used - Bc equity adjustments are not recorded, neither parent's reported net income nor its retained earnings provides an accurate portrayal of consolidated figuress

Why consolidate financial information when two or more companies combine to create a single economic entity?

- provide more meaningful information than separate statements - more fairly present the activities of the consolidated companies - may retain their legal identities as separate corporations

Recording fair-value method: initial investment in equity securities when significant influence and control are not present are:

- recorded at cost (unless fair value is determinable) - changes in fair values and dividends declared are recognized as income

The investment and income account for the initial value method for a parent company

- remains at acquisition-date value assigned - dividends declared recorded as dividends income

Criteria for Utilizing the equity method according the FASB ASC Topic 323

- representation of the investee's board of directors - participation in the investee's policy-making process - material intra-entity transactions - interchange of managerial personnel - technological dependency - other investee ownership percentages

Why do firms buy common stock of other firms?

- temporary investment to earn a return on idle cash - gain voting privileges to influence how a firm operates

What characteristics have the potential to enhance profitability in increasingly competitive environments?

- vertical integration - cost savings - quick entry for products into markets - economies of scale - more attractive financing opportunities - diversification of business risk - business expansin

downstream sales of inventory (investor sales to investee) journal entries

1. Dr. Equity in investee income Cr. Investment in X company (gross profit x % sale x % ownership) 2. reverse to move profit into the year of sle to outside customers

upstream sales of inventory (investee sales to investor) journal entries

1. Dr. investment in X company Cr. Equity in investee income (net income x % ownership) 2. 1. Dr. Equity in investee income Cr. Investment in X company ( $sold - $cost = gross profit / $sold = gross profit rate x remaining balance)

What four methods of reporting investments in other companies does GAAP recognize?

1. Fair-value method 2. cost method for equity securities w/o readily determinable fair values 3. consolidation of financial statements 4. equity method

What are the three valuation techniques for fair-value companies can use?

1. market approach 2. income approach 3. cost approach

What two fair value assessments are allowed by GAAP that may affect cost method amounts reported on the financial statements?

1. periodic assessment for impairments to determine if the fair value of the investment is less than its carrying amount 2. recognition of "observable price changed in orderly transactions for the identical or a similar investment of the same issuer" as unrealized holding gains (or losses)

When one company gains control over another, a business combination is created, and a single set of consolidate financial statements must be prepared. How?

1.Parent's and subsidiary's financial data are brought together. 2.Financial position, results of operations, and cash flows are reported for the combined entity. 3.Reciprocal accounts and intra-entity transactions are adjusted or eliminated to ensure reported balances represent the single entity.

What is to be consolidated and when if dissolution occur?

All appropriate account balances are physically consolidated in the financial records of the survivor. Permanent consolidation occurs at the combination date

How does consolidation affect the accounting records if dissolution occurs?

Dissolved company's records are closed out. Surviving company's accounts are adjusted to include appropriate balances of the dissolved company

Journal entry to record expenses of the current period any direct combination costs

Dr. Professional services expense Cr. Cash/Accounts payable

Journal entry to record as expenses of the current period any indirect combination costs

Dr. salaries and administrative expenses Cr. Cash/Accounts payable

How does consolidation affect the accounting records if separate incorporation is maintained?

Each company continues to retain its own records. Worksheets facilitate the periodic consolidation process without disturbing individual accounting systems.

What is to be consolidated and when if separate incorporation is maintained?

Only the financial statement information (on work papers, not the actual records) is consolidated. The consolidation process is carried out at regular intervals whenever financial statements are to be prepared

How are the SAIDE entries different for the initial value method?

S A E - are the same I - eliminated parents Dividend income account and sub's Dividends declared account D - not needed

How are the SAIDE entries different for the partial equity method?

S A E - are the same I D - different

What can cause a decrease in investment value?

a loss of major customers, changed in economic conditions, loss of a significant patent or other legal right, damage to the company's reputation

Since neither of the initial or partial equity method uses the full accrual-based measurement, what is needed?

a new worksheet adjustment (entry C) to convert the parent's beginning-of-the-year retained earning balance to a full-accrual basis

What is a statutory consolidation?

a newly created entity receives assets or capital stock of two or more original companies that can dissolve while remaining as separate divisions of newly created company

What is a business combination?

a transaction or other event in which an acquirer obtains control over one or more businesses to create a single entity that requires consolidated financial statements

What is the partial equity method for a parent company?

accrual accounting without equity adjustments - usually gives balances approximating consolidation figures but easier to apply than equity method

statutory merger through asset acquisiion

acquired assets and often liabilities while acquired company dissolves and goes out of business

statutory merger through capital stock acquisition

acquires all stock and then transfers assets and liabilities to its own books. Acquired company dissolves as a separate corporation, often remaining as a division of the acquiring company

When accounting for goodwill subsequent to the acquisition date, GAAP requires what?

an impairment approach rather than amortization

What is a statutory merger?

any business combination in which only one of the original companies continue to exist

What is the FASB's reason why goodwill should be impaired instead of amortized?

because goodwill can decrease over time, but it is not in a rational and systematic manner

What is the initial value method for a parent company?

cash basis accounting - easy to apply and gives a good measurement of cash flows generated by the investment

What does a worksheet combine?

combines separately recorded revenues and expenses of parent and subsidiary

If an entity can exercise control over investee, regardless of ownership level, what is required?

consolidation of financial statements

What entries relate to current periods and which ones relate to previous years?

current - IDEP previous - SA

In addition to the SAIDE entries, entry P is prepared to eliminate what?

eliminate intra-entity payable

what measurement is embraces for the acquisition method?

fair-value for measuring and assessing business activit

The acquisition method is for when?

for when separate incorporation is maintained

How does the FASB ASC (810-10-15-8) describe "control"

the usual condition for a controlling financial interest is ownership of a majority voting interest, but, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50% of the outstanding voting shares of another entity is a condition pointing toward consolidation

what happens if fair value (including goodwill) is larger than the carrying value (including goodwill?

then goodwill in not impaired and remains at its current carrying amount

what happens if fair value (including goodwill) is less than the carry value (including goodwill?

then goodwill is impaired by the difference

What is a worksheet and consolidation entries used for?

used to eliminate the investment account and record the subsidiary's assets and liabilities to create a single set of financial statements for the combines business entity

What is a variable interest entity (VIE)?

vehicle for control exercised through contractual arrangements with a sponsoring firm that may not own the VIE but becomes its "primary beneficiary" with rights to its residual profits

When is consolidation of financial statements required?

when investor's ownership exceeds 50% of an organization's outstanding voting stock

When does the consolidation of financial information into a single set of statements become necessary?

when the business combination of two or more companies creates a single economic entity


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