Chapter 1

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? Multiple choice question. Add the cost of the shares to the current basis of its previous 5% investment. Include both purchases in the investment account at cost. Adjust all shares owned as if the equity method had always been applied with an offsetting amount to current net income. Adjust all shares owned as if the equity method had always been applied with an offsetting amount to retained earnings.

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

A criticism of the 20%-50% ownership guideline for applying the equity method is that Multiple select question. the 20%-50% ownership guideline cannot indicate significant influence. contractual agreements may be more indicative of significant influence or control than ownership percentage. a firm cannot exert control over another firm in absence of a majority voting stock ownership. a firm may argue that less than 50% ownership indicates a lack of control and thus avoid consolidation of an investee.

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

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

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 Multiple choice question. defer the entire $10,000 gross profit. recognize the entire $10,000 gross profit on its income statement. recognize gross profit to the extent of its proportional ownership interest in Aaron Company. defer the $10,000 gross profit to the extent of its proportional ownership interest in Aaron Company.

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 Multiple choice question. records its proportionate share of the investee's OCI as "equity in investee income" on its financial records. simply ignores any investee OCI in applying the equity method. records its proportionate share of the investee's OCI as AOCI on its financial records.

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

The fair-value option for reporting investments that would otherwise be accounted for under the equity method requires Multiple select question. the valuation of the equity method investment at fair value as of the investor's balance sheet date. the inclusion in net income of changes in the fair value of an equity investment. amortization for the excess of acquisition-date fair over book value. an irrevocable election to elect fair value as the measurement attribute for an equity investment

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

The IASB and FASB standards on equity method accounting are similar in that they both treat investee dividend distributions to the investor as a decrease in the carrying amount of the investment. apply the equity method for financial reporting when the investor possesses control over the investee. rely on the notion of significant influence. recognize the investor's share of the profit or loss of the investee as a part of the investor's earnings.

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

True or false: Because reported income can affect market perceptions of the underlying value of publicly traded shares, managers will often assess prospective effects of equity method income prior to making an equity-method investment in another firm's shares.

true

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

true

True or 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

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?

$5,000.00

When an investor sells inventory to its 40%-owned investee (an intra-entity sale), why is 40% of the profit recognition delayed until the inventory is sold to an outside party? Multiple choice question. 40% of the investor's sale is effectively with itself. The investor does not have significant influence over the investee. Intra-entity sales are not considered any differently than sales to outside parties.

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

When an investor sells inventory to its 40%-owned investee (an intra-entity sale), why is 40% of the profit recognition delayed until the inventory is sold to an outside party? Multiple choice question. Intra-entity sales are not considered any differently than sales to outside parties. The investor does not have significant influence over the investee.

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

What are some common economic consequences of financial reporting on the reporting firm? Multiple select question. Increases in a firm's net income will always result in an increase in the market value of its equity shares. Certain financial statement performance metrics may affect the ability of a firm to raise capital in debt or equity markets. Failure to maintain certain financial statement ratios may cause a firm to violate debt covenants. Managerial compensation may depend on reported net income.

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

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

Dividends from the investee.

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

Dividends from the investee.

According to International Accounting Standards, when an investor has significant influence over an investee, the investor must account for its investment using the____________________ method.

Equity

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

When should an investor recognize an impairment loss for its equity method investment? If the investee recognizes an impairment loss on its income statement for one or more of its assets. investments as a whole, not for individual investee assets. 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. When either a permanent or temporary drop in the fair value of the investment occurs. Reason: Impairment losses are recognized only for "other than temporary" declines in fair value.

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.

How can a company actively manage reported amounts by keeping voting share ownership of another firm below 50%? Multiple choice question. In applying the equity method, the liabilities of the investee company are not combined with those on the investor's balance sheet. Using the equity method, investee's sales can be included on the investor's income statement. By avoiding consolidation, a firm employing the equity method will report larger values for total assets and liabilities.

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

Which of the following accounting approaches is used when an investment share is increased and the investment now qualifies for the equity method. Multiple choice question. Catch-up approach Retrospective approach Prior-period adjustment Prospective approach

Prospective approach

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? Multiple select question. The investor's proportionate ownership of the investee. The amount of the intra-entity sale remaining in ending inventory. The seller's gross profit percentage. Whether the intra-entity sale was upstream or downstream.

The amount of the intra-entity sale remaining in ending inventory.

An investor's excess investment cost over its percentage of investee book value is attributable to a limited-lived tangible asset. How should the investor account for this excess cost in recognizing investment income under the equity method? The excess investment cost over investee book value attributable to a limited-lived tangible asset has no effect on investment income. The investor increases its depreciation expense associated with the excess cost attributable to the limited-lived tangible asset. The equity in investee income is reduced by the depreciation associated with the excess cost attributable to the limited-lived tangible asset. The equity in investee income is increased by the depreciation associated with the excess cost attributable to the limited-lived tangible asset.

The equity in investee income is reduced by the depreciation associated with the excess cost attributable to the limited-lived tangible asset.

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 reports the underlying assets and liabilities of the investee in the investor's balance sheet. The excess cost of book value is immediately expensed on the date the investment is purchased. The equity method will likely expense excess costs allocated to different asset categories over different useful lives.

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

Which of the following procedures are followed in applying the cost method of accounting for an investment in another firm's equity securities? The investment must be periodically assessed for impairment. In limited circumstances, a cost method investment may be increased when similar securities experience price increases. Investment income is recognized when the investee reports its net income. The investor's share of the investee's dividend declarations is recorded as income.

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

When an investor sells inventory to its equity-method investee, how is the reported sales balance on the investor's income statement affected? Multiple choice question. The sales account balance is reduced to the extent that the goods have not been resold to outside entities. The sales account is reduced by the investor's proportional ownership of intra-entity sales. The sales account is reduced by the amount of intra-entity sales. The sales account remains unaffected.

The sales account is reduced by the amount of intra-entity sales.

When an investor sells inventory to its equity-method investee, how is the reported sales balance on the investor's income statement affected? Multiple choice question. The sales account balance is reduced to the extent that the goods have not been resold to outside entities. The sales account remains unaffected. The sales account is reduced by the amount of intra-entity sales. The sales account is reduced by the investor's proportional ownership of intra-entity sales.

The sales account remains unaffected.

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? Multiple select question. Whether the intra-entity sale was upstream or downstream. 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.

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 does a company like Coca-Cola account for its investment using the equity method? A company must use the equity method for any investment in equity shares regardless of the level of influence or control. When the investment provides the company with the ability to exercise significant influence over the decisions of the investee. When the investment provides the company with complete control over the decisions of the investee. A company uses the equity method for all equity investments in foreign investees.

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

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

dividend

According to International Accounting Standards, when an investor has significant influence over an investee, the investor must account for its investment using the________method.

equity

When an equity 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 Multiple choice question. is decreased for 100% of the gross profit from the original intra-entity sale. remains unaffected. is increased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities. is decreased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities.

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

When an equity 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 Multiple choice question. is increased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities. remains unaffected. is decreased for 100% of the gross profit from the original intra-entity sale. is decreased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities.

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 fair-value option for reporting investments that would otherwise be accounted for under the equity method requires Multiple select question. the inclusion in net income of changes in the fair value of an equity investment. an irrevocable election to elect fair value as the measurement attribute for an equity investment the valuation of the equity method investment at fair value as of the investor's balance sheet date. amortization for the excess of acquisition-date fair over book value.

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

When an investor sells a portion of an equity-method investment, the investor recognizes a gain or loss on the sale. the investor continues to apply the equity method if the investor continues to have the ability to exercise significant influence over the investee. no gain or loss is recognized if the investor continues to have the ability to exercise significant influence over the investee. the investment account should reflect a balance current as of the date of sale.

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

When an investor sells a portion of an equity-method investment, Multiple select question. the investor recognizes a gain or loss on the sale. no gain or loss is recognized if the investor continues to have the ability to exercise significant influence over the investee. the investment account should reflect a balance current as of the date of sale. 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. the investor continues to apply the equity method if the investor continues to have the ability to exercise significant influence over the investee.