Chapter 1
In employing the accrual basis, the equity method recognizes income for the investor
as earnings are reported by the investee.
Select all that apply Under the equity method, after the initial investment is recorded,
an objective is to reflect the close relationship between the investor and investee. the investment account increases as the investee earns and reports net income. the investor recognizes investment income using the accrual method.
The accounting objective underlying the equity method for investments is to
report the investment and related income reflecting the close relationship between the investor and investee.
Because certain intangible assets are considered to have indefinite lives, they are not subject to (1).
1. amortization
In the absence of any significant influence, which of the following investment accounting methods might be appropriate?
Fair-value method.
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 equity in investee income is reduced by the depreciation associated with the excess cost attributable to the limited-lived tangible asset.
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.
When an investor established control over an investee, financial reporting requires the (1) of the investor's and investee's financial statements. (Enter only one word per blank.)
1. consolidation
An investor that accounts for an equity investment under the cost method records income from the investment based on its share of (1) declared from the investee.
1. dividends
According to International Accounting Standards, when an investor has significant influence over an investee, the investor must account for its investment using the (1) method.
1. equity
The ability to exercise significant influence over the operating and financial policies of an investee company is the sole criterion for application of the (1) method.
1. 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 (1) value.
1. fair
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 (1) recognized by the investor company over time.
1. income
The term used to describe inventory sales between an investor company and its equity-method investee is (1) - (2) sales.
1. intra 2. entity
Under the equity method, the investor records a credit to the investment account if a net (1) is reported on the investee's income statement.
1. loss
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 (1) declines in value.
1. permanent
When financial control occurs though contractual relationships rather that voting stock ownership, the controlled firm is called special purpose or (1) (2) (3).
1. variable 2. interest 3. entity
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?
40% of the investor's sale is effectively with itself.
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 basis of its previous 5% investment.
Which of the following describes a circumstance when the equity method is appropriate for financial reporting?
An investor has the ability to exercise significant influence over an investee's decisions and operations.
How does an investor record income from its investment in an equity-method investee?
As a credit to "Equity in Investee Income"
When an equity method investee declares a dividend, how should the investor company record the event?
As a credit to the Investment account.
Select all that apply What are some general criticisms of the equity method for investments in the ownership shares of another firm?
By not including the investee's assets and liabilities in the investor's financial statement amounts, performance metric may be biased. Significant influence and control may not be properly defined by existing quantitative guidelines.
Select all that apply What are some common economic consequences of financial reporting on the reporting firm?
Certain financial statement performance metrics may affect the ability of a firm to raise capital in debt or equity markets. Managerial compensation may depend on reported net income. Failure to maintain certain financial statement ratios may cause a firm to violate debt covenants.
Which of the following are included in net income for an investment in equity shares accounted for under the fair-value method?
Dividends from the investee.
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.
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.
Select all that apply Which of the following represent potential conditions where one firm has the ability to control the operations of another?
One firms owns more than 50% of the voting stock of another firm. One firm has contractual arrangements that provide decision-making power over another firm.
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
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.
Select all that apply Which of the following procedures are followed in applying the fair-value method of accounting for an investment in another firm's equity securities?
The initial investment in equity securities is recorded at cost. Changes in the fair value of equity securities owned during a period are reported as income.
Select all that apply 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 investor's proportionate ownership of the investee. The seller's gross profit percentage. The amount of the intra-entity sale remaining in ending inventory.
Select all that apply Which of the following procedures are followed in applying the cost method of accounting for an investment in another firm's equity securities?
The investor's share of the investee's dividend declarations is recorded as income. In limited circumstances, a cost method investment may be increased when similar securities experience price increases. The investment must be periodically assessed for impairment.
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.
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
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.
When is an investor firm required to prepare consolidated financial statements?
When the investor firm controls an investee's operations.
Under the equity method, the investor records its share of investee dividends as
a decrease to the investment account.
Select all that apply The fair-value option for reporting investments that would otherwise be accounted for under the equity method requires
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.
When one firm can significantly influence the decisions of another firm through its ownership of voting shares, transactions between the two firms
do not provide an objective basis for financial reporting.
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at a measurement date is known as
fair value.
Select all that apply When one firm controls the entire decision making process of another firm,
for reporting purposes the two companies are considered to be a single economic entity. such control may result from majority voting stock ownership or contracts with a variable interest entity. one set of financial statements are created for the combined assets, liabilities, revenues and expenses of both firms.
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
is decreased for the investor's ownership percentage of the gross profit on intra-entity inventories that have not been resold to outside entities.
Select all that apply 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
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.
Select all that apply The IASB and FASB standards on equity method accounting are similar in that they both
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.
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.
Under the equity method, the investment account increases when
the investee recognizes and reports net income.
Select all that apply When an investor sells a portion of an equity-method investment,
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.
