Advanced Accounting Chapter 1

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

1. Participates in policy-making decisions of the investee 2. Has representation on the investee's board of directors 3. Only significant influence (not control) determines whether to apply the equity method

Journal entry to record collection of cash dividend

Debit "Cash" Credit "Dividend Receivable"

Journal to Record a dividend declaration by Little Company

Debit "Dividend Receivable" Credit "Investment in Little Company"

Which of the following are included in net income for an investment in equity shares accounted for under the fair- value method? 1. excess acquisition-date fair over book value amortization 2. Investee other comprehensive income 3. Dividends from the Investee 4. Recognition of intra-entity gross profits accompanied by sales to outside entities

Dividends from the investee

As of the date the equity method became applicable for an investment, the investor allocated its purchase price to its share of the investee's assets and liabilities based on their individual _______________value

Fair Market

Accrual Accounting

Gives businesses the opportunity to list credit and cash sales in the same reporting period that the sales occur

When should an investor recognize an important 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

(IASB)

International Accounting Standards Board

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

In applying the equity method

The investor recognizes its proportionate share of the investee's income

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

Through a credit to Equity in Investee Income

T/F: 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

T/F: When an investor sells inventory that had been purchased from its equity-method investee, the investor recognizes any related deferred gross profit.

Yes, the gross profit from Intra-entity sales between an investor and investee are initially deferred and then recognized when sold to an outsider or consumed in operations

An investor that accounts for an equity investment under the cost method records income from the investment based on its share of _____ declare from the investee

dividends

When the investee declares a cash dividend, its owners'

equity decreases

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

intra- entity

Although goodwill arising from a business combination is subject to periodic impairment reviews, goodwill implicit in an equity method 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 _____ bias

prospective

Equity Method

The equity method is the standard technique used when one company has a significant investment in another. When a company holds approximately 20% or more of another company's stock, it is considered to have significant control, which signifies the power one company can exert over another.

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

If an investor firm controls another firm through variable interests, the investor must include the controlled firm's financial information in its_____ financial statments

consolidated

When an investor established control over an investee, financial reporting requires the _________ of the investor's and investee's financial statment

consolidation

An investor originally purchased 5% of an investee and appropriately applied the fair-value method to account for its investment. Later, the investor purchased sufficient additional shares to qualify the investment for the equity method. How should the investor account for the newly qualified equity investment?

Add the cost of the shares to the current bases of its previous 5% investment

When an equity method investee declares a dividend, how should the investor company record the event

As a credit ti the Investment account

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, the investor company

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

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

the equity method uses accrual recognition

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

Fair value is defined by the ASC (Master Glossary) as

"price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date."

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 fair value of $250,000. How much goodwill should Holden record as a result of this transaction?

($600,000 + $250000) x 40%=$340,000 so goodwill = $0

A criticism of the 20%-50% ownership guideline for applying the equity method is that

1 . contractual agreements may be more indicative of significant influence or control than ownership percentage 2. A firm may argue that less that 50% ownership indicated a lack of control and this avoid consolidation of an investee

Even though a business firm owns 25% of another company's voting shares, the equity method should not be applied if

1. After several tries, the investor in unable to gain a seat on the investee's board of directors 2. The investor is unable to exercise significant influence over the investee 2. The 75% owners of the investee make decisions without consulting the investor

What are some common consequences of financial statements on the reporting firm?

1. Certain Financial statement performance metrics may affect the ability of a firm to raise capital in debt or equity markets. 2. Managerial compensation may depend on reported net income. 3. Failure to maintain certain financial statement rations may cause a firm to violate debt covenants

Which of the following procedures are followed in applying the cost method of accounting for an investment on another firm's equity securities?

1. In limited circumstances, a cost method investment may be increased when similar securities experience price increases 2. The investment must be periodically assessed for impairment 3. The investor's share of the investee's dividend declarations is recorded as income

The IASB and FASB standards on equity method accounting are similar in that they both

1. Rely on the notion of significant influence 2. treat investee dividend distributions to the investor as a decrease in the carrying amount of the investment 3. recognize the investor's share of the profit or loss of the investee as a part of the investor's earnings

Under the fair-value method of accounting for an investment in an investment in another firm's ownerships shares, the investor increases its investment account when

1. The fair value of the investee's shares increases 2. the investor purchases shares of the investee

When an investor sells a portion of an equity-method investment

1. The investor recognizes a gain or loss on the sale 2. The investment account should reflect a balance current as of the date of sale 3. The investor continues to apply the equity method if the investor continues to have the ability to exercise significant influence over the investee

Why does the equity method record investee dividends declared as reductions to the investment account

1. The investor's equity in the investee decreases when it becomes entitled to receive a dividend 2. The investment account mirrors changes to the investee's equity section resulting from income and dividends.

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?

1. The investor's proportionate ownership of the investee 2. The seller's gross profit percentage 3. The amount of the intra-entity sale remaining in ending inventory

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

1. an irrevocable election to elect value as the measurement attribute for an equity investment 2. The valuation of the equity method investment at fair value as of the investor's balance sheet date 3. The inclusion in net income of changes in the fair value of an equity investment

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

1. discontinue use of the equity method and not establish a negative balance 2. leave the investment account balance at zero until subsequent investee profits eliminate all unrecognized losses 3. accrue no additional losses

Generally accepted accounting principles (GAAP) recognize four different approaches to the financial reporting of investments in corporate equity securities:

1.Fair-value method. 2.Cost method for equity securities without readily determinable fair values. 3.Consolidation of financial statements. 4.Equity method.

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

1.Investor representation on the investee's board of directors 2.technological dependency between the investor and investee 3.Investor participation in the policy-making process of the investee

What are some general criticisms of the equity method for investments in the ownership shares of another firm

1.Significant influence and control may not be properly defined by existing quantitative guidelines 2. By not including the investee's assets and liabilities in the investor's financial statement amounts, performance metric may be biased 3.The liabilities of equity- method investees do not appear in the body of the investor's financial statements.

Under the fair-value method of accounting for an investment in another firm's ownership shares, the investor recognizes income when

1.The investee declares a dividend 2.The fair value of the investee's shares increase

Journal Entry to accrue earnings of a 20 percent owned investee ($200,000 × 20%).

Debit "Investment in Little Company" Credit "Equity in Investee Income"

To record the annual expense of an investment that has a limited life, the investor reduces the investment balance in th same way it would amortize:

Debit Equity in Investee Income Credit Investment in Chico Company

when provisions and contracts grant Firm A decision-making power over Firm B's operating and financing policies

Firm A must include firm B in its consolidated financial statements

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

How can a company actively manage reported amounts by keeping voting share ownership of another firm below 50%?

In applying the equity method, the liabilities of the investee company are not combined with those on the investor's balance sheet

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

Intra - entity sales

Under the equity method, the investor records a credit to the investment account if a net _________ is reported on the investee's income statement

Loss

Define OCI

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