ACCT 450 Ch 1
LO-01-01 International Standard 28 Investment in Associates
If investor has 20% or more ownership, it is presumed to have significant influence, unless it is demonstrated not to be the case. If investor holds less than 20% ownership, it is presumed it does not have significant influence, unless influence can be clearly demonstrated.
LO-01-07 Fair Value Reporting Option
An entity may irrevocably elect fair value as the initial and subsequent measurement for certain financial assets and financial liabilities including investments accounted for under the equity method. Under the fair-value option, changes in the fair value of the elected financial items are included in earnings.
LO-01-04 Excess of Investment Cost Over Book Value Acquired
Fair values of specific investee assets and liabilities can differ from their book values. Excess payment can be identified directly with those accounts. If purchase price exceeds fair value, future benefits are expected to accrue from the investment due to estimated profitability of the investee or the relationship established between the two companies. The additional payment is attributed to an intangible asset referred to as goodwill rather than to any specific investee asset or liability.
LO-01-01 GAAP Reporting
Fair-Value Method Consolidation of Financial Statements Equity Method
LO-01-02 Extensions of Equity Method Applicability
For some investments that either fall short of or exceed 20 to 50 percent ownership, the equity method is appropriately used for financial reporting. Conditions can exist where the equity method is appropriate despite a majority ownership interest. If the non-controlling rights are so restrictive as to call into question whether control rests with the majority owner, the equity method is employed for financial reporting rather than consolidation.
LO-01-05d Reporting Sale of Equity Investment
If part of an investment is sold during the period: The equity method continues to be applied up to the date of the transaction. At the transaction date, the Investment account balance is reduced by the percentage of shares sold. If significant influence is lost, NO RETROACTIVE ADJUSTMENT is recorded, but the equity method is no longer applied.
LO-01-01 FASB ASC section 810-10-05, Variable Interest Entities
Includes entities controlled through special contractual arrangements (not through voting stock interests) Intended to combat misuse of SPE's (Special Purpose Entities) to keep large amounts of assets and liabilities off the balance sheet known as "off balance sheet financing"
LO-01-01 Fair-Value Method
Investor holds less than 20% Cannot significantly affect investee's operations Investment made in anticipation of dividends or market appreciation Recorded at cost and adjusted to fair value if determinable Trade Security examples: -Held for sale in the short term -Unrealized holding gains and losses are included in earnings Equity securities not classified as trading securities are classified as available-for-sale securities and reported at fair value. Unrealized holding gains and losses are excluded from earnings and reported in a separate component of shareholders' equity as part of other comprehensive income. Dividends received are recognized as income for both trading and available-for-sale securities. Although the balance sheet amounts for the investments remain at fair value under this option, changes in fair values over time are recognized in the income statement (as opposed to other comprehensive income) as they occur.
LO-01-01 Consolidation of Financial Statements
Investor's ownership exceeds 50% of an organization's outstanding voting stock except when control does not rest with the majority investor One set of financial statements prepared to consolidate all accounts of the parent company and all of its controlled subsidiaries as a single entity.
LO-01-06 Deferral of Unrealized Profits in Inventory
Many equity acquisitions establish ties between companies to facilitate the direct purchase and sale of inventory items. Such intra-entity transactions can occur either on a regular basis or only sporadically.
LO-01-06 Financial Reporting Effects
Measurements of financial performance often affect the following: -The firm's ability to raise capital. -Managerial compensation. -The ability to meet debt covenants and future interest rates. -Managers' reputations.
LO-01-05b Investee Other Comprehensive
OCI is defined as revenues, expenses, gains, and losses that under GAAP are included in comprehensive income but excluded from net income. Accumulated Other Comprehensive Income (AOCI) includes unrealized holding gains and losses on available-for-sale securities, foreign currency translation adjustments, and certain pension adjustments. OCI is accumulated and reported in stockholders' equity and represents a source of change in investee company net assets that is recognized under the equity method.
LO-01-05b Reporting Investee Other Comprehensive Income and Irregular Items
Other equity method recognition issues arise for irregular items traditionally included within net income. An investor must report its share of the following items reported in investee's current income: Discontinued operations Extraordinary items Other comprehensive income
LO-01-06 Criticisms of the Equity Method
Over-emphasis on possession of 20-50% voting stock in deciding on significant influence vs. control Allowing off-balance sheet financing Potential manipulation of performance ratios
LO-01-04 The Amortization Process
Payment relating to each asset (except land, goodwill, and other indefinite life intangibles) should be amortized over an appropriate time period. Goodwill associated with equity method investments, for the most part, is measured in the same manner as goodwill arising from a business combination, tested for declines in value and impairment. Goodwill, implicit in equity investments, is not.
LO-01-05a Reporting a Change to the Equity Method
Report a change to the equity method if: An investment that was recorded using the fair-value method reaches the point where significant influence is established. All accounts are restated retroactively so the investor's financial statements appear as if the equity method had been applied from the date of the first acquisition. (FASB ASC para. 323-10-35-33)
LO-01-02 Sole Criterion for Utilizing the Equity Method
Significant Influence (FASB ASC Topic 323) -Representation on 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
LO-01-02 Limitations of Equity Method Applicability
The equity method is not appropriate for investments that demonstrate any of the following characteristics regardless of the investor's degree of ownership: • An agreement exists between investor and investee by which the investor surrenders significant rights as a shareholder. • A concentration of ownership operates the investee without regard for the views of the investor. • The investor attempts but fails to obtain representation on the investee's board of directors.
LO-01-02 Accounting for an Investment - Equity Method
The investor increases the investment account as the investee earns and reports income. The investor uses the accrual method to record investment income —recognizing it in the same time period as the investee earns it. The investor decreases its investment account's carrying value for its share of investee cash dividends. When the investee declares a cash dividend, its owners' equity decreases.
LO-01-06 Deferral of Unrealized Profits in Inventory (2)
The seller of the goods retains a partial stake in the inventory for as long as the buyer holds it. The earning process is not considered complete at the time of the original sale. Reporting the profit is delayed until the inventory is consumed within operations or resold to an unrelated party. At the disposition of the inventory, the original sale is culminated and gross profit is recognized.
LO-01-01 Equity Method
Use when: Investor has the ability to exercise significant influence on investee operations (whether influence is applied or not) Generally used when ownership is between 20% and 50%. Significant Influence might be present with much lower ownership percentages. Under the equity method, investor's share of investee dividends declared are recorded as decreases in the investment account, not income
LO-01-04 Excess of Cost Over Book Value of Acquired Investment
When Purchase Price > Book Value of an investment acquired, the difference must be identified. Assets may be undervalued on the investee's books because: The fair values (FV) of some assets and liabilities are different than their book values (BV). The investor may be willing to pay extra because future benefits are expected to accrue from the investment.
LO-01-05b Reporting Investee Income from Sources other than Operations
When net income includes elements other than Operating Income, these elements should be presented separately on the investor's income statement. Examples include: Discontinued operations Extraordinary items Other comprehensive income