Consolidated Statements (Exam 1)

Partial equity method

Accrual accounting without equity adjustments—usually gives balances approximating consolidation figures but easier to apply than equity method.

Three additional categories of costs are incurred in business combinations, regardless of whether dissolution takes place:

Attorneys, accountants, investment bankers, and other professionals engaged for combination-related services. These service fees are expensed in the period incurred. An acquiring firm's internal costs (secretarial and management time allocated to the acquisition activity). Such indirect costs are reported as current year expenses, too. Amounts incurred to register and issue securities in connection with a business combination simply reduce the otherwise determinable fair value of those securities.

Goodwill Impairment Test: Is the Carrying Amount of a Reporting Unit More Than Its Fair Value?

Calculate fair values for each reporting unit with allocated goodwill. Fair value (with allocated goodwill) is compared to the carrying value (including goodwill) of the consolidated entity's reporting unit. Does fair value of the reporting unit exceed carrying value? If yes, goodwill is NOT impaired and remains at its current carrying amount. If no, goodwill impairment is the excess of carrying amount over the fair value of the reporting unit and a loss is recorded.

Initial value method

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

Future Performance

Contingency agreements, consideration based on future performance, often accompany business combinations. The acquiring firm estimates the fair value of the contingency and records a liability equal to the present value of the future payment if appropriate. The liability continues to be measured at fair value with corresponding recognition of gains or losses from the revaluation.

External Reporting

Does not require pushdown accounting when the acquired firm maintains separate incorporation. Provides an option to apply pushdown accounting following a business combination in which the acquirer obtains control of an acquired entity and the acquired entity maintains separate incorporation. If pushdown accounting is used, the parent's acquisition date valuations are "pushed down" to the subsidiary's financial statements.

Three prominent methods used to account for investments are:

Equity method Initial value method Partial equity method

Equity method

Full accrual accounting—creates a total income figure reflective of the entire combined business entity.

Separately identified assets acquired and liabilities assumed

GAAP requires that fair value of assets acquired and liabilities assumed in a business combination be determined at the acquisition date. There are three approaches.

Preexisting goodwill recorded in the acquired company's accounts is ignored in the acquisition-date fair value.

Goodwill is recognized only if excess remains after recognizing fair values of net identified assets.

To explain the process of preparing consolidated financial statements for a business combination, we address three questions:

How is a business combination formed? What constitutes a controlling financial interest? How is the consolidation process carried out?

A private company may elect this alternative only if it also elects the goodwill alternative.

However, they do not have to elect the intangible assets alternative if they elect the goodwill alternative.

External Reporting Option for Private Company Goodwill Accounting.

If a triggering event occurs, then the unamortized balance of goodwill must be assessed for impairment. There is no requirement to remeasure each of the entity's separate assets and liabilities at current fair value to compute a residual implied value for goodwill. The measurement of the goodwill impairment loss equals the excess of the fair value of the acquired entity over its total carrying amount. The amount of impairment loss is limited to the remaining unamortized balance in the goodwill account. They have the option to designate and test goodwill for impairment either at the entity level or the reporting unit level. They may skip the qualitative assessment and go directly to a single-step quantitative impairment test.

Equity Method

Investor has the ability to exercise significant influence on investee operations. Ownership is between 20 and 50 percent. Investor's share of investee dividends declared are recorded as decreases in the investment account, not income.

Pushdown accounting has several advantages for internal reporting:

It simplifies the consolidation process. Amortizations of the excess fair value allocation would be incorporated in subsequent periods as well. Pushdown accounting does not address the many issues in preparing consolidated financial statements.

Private companies can now elect to:

Limit the customer related intangibles it recognizes separately to those capable of being sold or licensed independently from the other assets of the business. Avoid separate recognition of noncompetition agreements.

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 and a business combination, for the most part, is measured in the same manner. Except business combinations are tested for declines in value and impairment. Equity method investments are tested in their entirety for permanent declines in value.

Initial investments in equity securities when significant influence and control are not present are:

Recorded at cost. Changes in fair values are recognized as income. Dividends declared on the securities are recognized as income

Explain the reasons as to why a firm would want to invest in another business in order to gain significant influence.

Temporary investment to earn a return on idle cash. Gain voting privileges to influence how a firm operates in ways that align with its own operating and financial interests.

Cost Approach

estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility.

Market Approach

estimates fair values using other market transactions involving similar assets or liabilities.

Entry P

intra-entity payable. Debit: Common stock the amount of the liability payable. Credit: Current Assets the amount of the liability payable.

When to Test Goodwill for Impairment?

requires an entity to assess its goodwill for impairment annually for each reporting unit where goodwill resides. More frequent impairment assessment is required if events or circumstances change that make it more likely than not that reporting unit's fair value has fallen below its carrying amount.

By limiting the separate recognition of customer-related intangibles and non-competition agreements,

the value of these intangible assets it recognizes is effectively subsumed into goodwill.

Three approaches:

§ Market Approach § Income Approach § Cost Approach

Characteristics of the Pooling of Interests Method (Prior to 2002)

Accounting incorporated a continuation of previous book values and ignored fair values exchanged in a business combination. Previously unrecognized (typically internally developed) intangibles continue to be reported at a zero-value post combination. Values an acquired firm at its previously recorded book value, so no new amount for goodwill was ever recorded in a pooling.

Statutory Merger (through asset acquisitions)

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

Statutory Merger (through asset acquisitions).

Acquiring company acquires assets and often liabilities. Acquired company dissolves and goes out of business.

Acquisition of more than 50% if the voting stock.

Acquiring company acquires stock that it recorded as an investment; controls decision making of acquired company. Acquired company remains in existence as legal corporation, although now a subsidiary of the acquiring company.

Amortization and Impairment of Other Intangibles

All identified intangible assets with finite lives should be amortized over their economic useful life that reflects the pattern of decline in the economic usefulness of the asset. Intangible assets with indefinite lives are tested for impairment on an annual basis. An entity has the option to first perform qualitative assessments to determine whether "it is more likely than not" that the asset is impaired. If so, a quantitative test must be performed. The asset's carrying value is compared to its fair value. If fair value is less than carrying value, the intangible asset is considered impaired and an impairment loss is recognized. The asset's carrying value is reduced accordingly.

Allowing off-balance-sheet financing.

Allows easier manipulation of assets and liabilities to companies' advantage. Thus, higher rates of return for its assets and sales, as well as lower debt-to-equity ratios.

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

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. If an entity can exercise control over investee, regardless of ownership level, consolidation is required.

Fair-Value Reporting for Equity Method Investments

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. The fair-value option improves financial reporting. It provides entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair-value option matches asset valuation with fair-value reporting requirements for many liabilities.

Report a change to the equity method if:

An investment that was recorded using the cost or fair-value method reaches the point where significant influence is established. When an investment qualifies for 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 [(FASB ASC (para. 323-10-35-33)]. This prospective approach avoids the complexity of restating prior period amounts.

In determining whether to recognize an intangible asset in a business combination, two specific criteria are essential. Intangible assets:

Arise from contractual or other legal rights (most intangibles in business combinations meet the contractual-legal criterion). Are capable of being sold or otherwise separated from the acquired enterprise.

Since the ACQUISITION METHOD is applied to business combinations occurring in 2009 and after, the two prior methods are still in use.

Characteristics of the Purchase Method (Prior to 2002 - 2008) Characteristics of the Pooling of Interests Method (Prior to 2002)

Emphasizing the 20-50 percent voting stock in determining significant influence versus control.

Companies can have contractual control through debt arrangements, long-term sales and purchase agreements, and agreements concerning board membership while having less than 50% of ownership. Thus, leading an opening for this company to continue using the equity method despite having control.

Significant differences are evident in combinations in which each company remains a legally incorporated separate entity.

Consolidation of the financial information is only simulated. Acquiring company does not physically record the acquired assets and liabilities. Dissolution does not occur; each company maintains independent record-keeping. To facilitate the preparation of consolidated financial statements, a worksheet and consolidation entries are employed using data gathered from these separate companies although neither company ever records consolidation worksheet entries in its journals.

Equity Obligations

Contingent obligations classified as equity are reported as a component of stockholders' equity. Equity contingencies are not remeasured at fair value. Whether contingent obligations are a liability or equity, the initial value recognized in the combination does not change regardless of whether the contingency is eventually paid or not. A loss from revaluation of a contingent performance obligation is reported in the consolidated income statement as a component of ordinary income.

Impairments of Equity Method Investments

Declines in investment value can result due to a loss of major customers, changes in economic conditions, loss of a significant patent or other legal right, damage to the company's reputation, etc. A temporary drop in the fair value of an investment is simply ignored. FASB ASC (para. 323-10-35-32) requires that a loss in value of an investment which is other than a temporary decline shall be recognized. A permanent decline in the investee's fair market value is recorded as an impairment loss and the investment account is reduced to the fair value.

Excess of Investment Cost over Book Value Acquired

Differences may exist between a company's book value and fair value. When purchase price exceeds book value of an investment acquired, the difference must be identified. Assets may be undervalued on the investee's books.

Consolidation Entry D

Eliminates the subsidiary Dividends removes the intra-entity transfer of cash for the dividends distributed to Parrot from Sun.

Consolidation Entry I

Eliminates the subsidiary Income accrued by the parent. Removes Sun's income recognized by Parrot during the year so Sun's revenue and expense accounts (and current amortization expense) can be brought into the consolidated totals.

Criticisms of the Equity Method

Emphasizing the 20-50 percent voting stock in determining significant influence versus control. Allowing off-balance-sheet financing.

Partial Equity Method (Acquisition Made During the Current Year)

Equity in Subsidiary Earnings account and Investment account amounts will differ from equity method. Consolidation Entry S, A, I (Debit - Equity in Subsidiary Earnings, Credit - Investment), D, E.

Partial Equity Method (Consolidation Subsequent to Year of Acquisition)

Equity in Subsidiary Earnings, Investment, and Beginning Retained earnings for parent company account amounts differ from equity method. Consolidation Entry S, A, I (Debit - Equity in Subsidiary Earnings, Credit - Investment), E, P (if necessary), C (Debit - Beginning Retained Earnings for parent company, Credit - Investment)

Equity Method Accounting Procedures

Excess of Investment Cost over Book Value Acquired The Amortization Process

Pushdown Accounting

External Reporting Other Issues Internal Reporting

Record-keeping if parent can exert control over subsidiary:

External financial reporting: Consolidation is required. Internal record-keeping: Parent selects an investment accounting method to monitor activities of subsidiary

Differences may exist between 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 costs rather than current value. Reported figures are affected by the accounting methods selected and lead to different book values, for example: Inventory costing methods (LIFO and FIFO) and Acceptable depreciation methods (straight-line, units of production).

Equity Method (Acquisition Made during the Current Year)

First, identify the book values and fair values and the difference. Second, allocate the excess fair value. Third, calculate the amortization of eligible assets. Fourth, record the acquisition on the date acquired, the dividend declaration from subsidiary on the date declared, and the receipt of subsidiary cash dividend on the date received. Fifth, record the income earned by subsidiary and the annual amortization expense of eligible assets at fiscal year-end. Sixth, prepare the financial statements. (consolidation worksheet)

Reporting the sale of an equity investment.

If part of an investment is sold during the period: The equity method is applied up to the transaction date. 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 if the investor is required to change FROM the equity method to the fair-value method. Note: A change TO the equity method is also treated prospectively

Goodwill, or a gain from a bargain purchase.

If the consideration transferred exceeds the net amount of the assets acquired and liabilities assumed, the difference is attributed to the asset goodwill by the acquiring company. If the fair value of the assets acquired and liabilities assumed exceeds the consideration transferred, a "gain on bargain purchase" is recognized by the acquiring business.

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

Includes entities controlled through special contractual arrangements. Intended to combat misuse of special purpose entities to keep large amounts of assets and liabilities off the balance sheet, known as "off-balance-sheet financing.

Reporting Investee's OCI and Irregular Items

OCI is defined as revenues, expenses, gains, and losses that under GAAP are included in comprehensive income but excluded from net income. Items included in AOCI (Accumulated Other Comprehensive Income) on the balance sheet are accumulated derivative net gains and losses, foreign currency translation adjustments, and certain pension adjustments. Equity method accounting requires that the investor record its share of investee OCI and irregular items traditionally found in net income. AOCI is reported in stockholders' equity (Balance Sheet) and represents a source of change in investee company net assets that is recognized under the equity method.

Consolidation Entry E

Recognizes excess amortization Expenses for the current period on the allocations from the original adjustments to fair value. Recognizes current year excess amortization expenses relating to the adjustments of Sun's assets to acquisition-date fair values. It adjusts depreciation expense for the tangible asset equipment and adjusts amortization expense for the intangible asset patented technology.

Consolidation Entry A

Recognizes the unamortized Allocations as of the beginning of the current year associated with the adjustments to fair value. adjusts subsidiary balances from their book values to acquisition-date fair values and includes goodwill created by the acquisition. It represents the Allocations made in connection with the excess of the subsidiary's fair values over its book values.

Business Combinations

Refers to a transaction or other event in which an acquirer obtains control over one or more businesses. Is formed by a wide variety of transactions or events with various formats. Can differ widely in legal form. Unites two or more enterprises into a single economic entity that requires consolidated financial statements.

Entry A

Remove the excess payment in the investment account at acquisition date and assign it to the specific accounts indicated by the fair-value allocation schedule

Entry S

Remove the sub's equity account balances and remove the Investment in Sub balance.

Consolidation Entry S

Removes investment in Sun Company account and adds each asset and liability book values to the consolidated figures. Removes Sun's stockholders' equity accounts as of the beginning of the year. Eliminates the subsidiary's Stockholders' equity account beginning balances and the book value component within the parent's investment account.

Significant Influence

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

The Acquisition Method

Required to account for a business combination. It embraces the fair value in measuring the acquirer's interest in the acquired business.

Consolidation of financial statements

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

Control through ownership of variable interests.

Risks and rewards often flow to a sponsoring firm that may or may not hold equity shares. Acquiring company establishes contractual control over a variable interest entity to engage in a specific activity. Acquired company remains in existence as a separate legal entity - often a trust or partnership.

Criteria for Utilizing the Equity Method

Significant Influence (FASB ASC Topic 323)

The differences in the equity method between IAS 28 and FASB ASC:

The FASB allows a fair-value method reporting option for investments that otherwise are accounted for under the equity method, IAS 28 does not. If the investee employs accounting policies that differ from those of the investor, IAS 28 requires the financial statements of the investee to be adjusted to reflect the investor's accounting policies for the purpose of apply the equity method, GAAP does not.

Equity Method Reporting Potential Effects

The ability to raise capital. Managerial Compensation. The ability to meet debt covenants and future interest rates. Manager's reputations. Consequently, prior to making investment decisions, firms will study and assess the prospective effects of applying the equity method in the income reported in financial statements.

Fair value

The price that would be received from selling an asset or paid for transferring a liability in an orderly transaction between market participants at the measurement date.

Characteristics of the acquisition method:

Valuation basis is fair value of consideration transferred and includes the contingent consideration but excludes direct combination costs. Assets acquired and liabilities assumed are recorded at their individual fair values. Goodwill is the excess of the consideration transferred over the fair values of the net assets acquired. Acquired in-process research and development is recognized as an asset. Professional service fees to help accomplish the acquisition are expensed.

No two business combinations are exactly alike, but they share one or more of the following characteristics that potentially 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 expansion.

Examine the reasoning for the goodwill impairment testing method

When accounting for goodwill subsequent to the acquisition date, GAAP requires an impairment approach rather than amortization. FASB reasoned that goodwill can decrease over time. However, it does not do so in a "rational and systematic" manner. Goodwill impairment losses are reported as operating items in the consolidated income statement. FASB provides firms the option to conduct a qualitative analysis to assess whether further testing procedures are appropriate. If circumstances indicate a potential decline in the fair value of a reporting unit below it's carrying amount, further tests are required to see if goodwill is the source of the decline.

Investment Reduced to Zero

When accumulated losses incurred and dividends paid by the investee reduce the investment account to $-0-, no further loss can be accrued. A temporary decline is ignored! Once the original cost of the investment has been eliminated, no additional losses can accrue to the investor. Future equity income will be offset by these losses prior to recording equity income in our results.

The Definition of Control

is ownership of a majority voting interest, and, therefore, as a general rule ownership by one reporting entity, directly or indirectly, of more than 50 percent of the outstanding may also exist with a lesser percentage of ownership, for example, by contract, lease, agreement with other stockholders, or by court decree. The direct or indirect ability to determine the direction of management and policies through ownership, contract, or otherwise.

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. companies may retain their legal identities as separate corporations.

Income Approach

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

Understand the effects from preparing consolidated financial reports that are created by the passing of time.

·The passage of time creates complexities for internal record-keeping and the balance of the investment account varies due to the accounting method used. A worksheet and consolidation entries are used to eliminate the investment account and record the subsidiary's assets and liabilities to create a single set of financial statements for the combined business entity.

Extensions of Equity Method Applicability

For some investments that 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.

Contingent Consideration - Post Combination

Future Performance Equity Obligations

Other Issues

Goodwill: Goodwill recognized in the combination is reported in the acquired entity's separate financial statements. Bargain purchase gains: The acquired entity does not recognize the gain in its income statement but as an adjustment to its additional paid-in capital. Acquisition-related liabilities: Only the debt for which the acquired firm is jointly or severally liable must be recognized. Acquisition-date subsidiary retained earnings: Company is recognized as a new reporting entity. Acquired firm reports zero acquisition-date retained earnings.

How are the accounting record affected?

If dissolution occurs, surviving company's accounts are adjusted to include appropriate balances of the dissolved company. The records are closed out. If separate incorporation is maintained, each company continues to retain its own records. Worksheets facilitate the periodic consolidation process without disturbing individual accounting systems.

Statutory Consolidation (through capital stock or asset acquisition)

Newly created entity receives assets or capital stock of original companies. Original companies may dissolve while remaining as separate divisions of newly created company.

Consideration Transferred Equals Net Fait Values of Identified Assets Acquired and Liabilities Assumed

Identified assets acquired and liabilities assumed are recorded at their fair values.

Consideration Transferred is less than net amount of Fair Values of Identified Assets Acquired and Liabilities Assumed

Identified assets acquired and liabilities assumed are recorded at their fair values. The difference between consideration transferred and acquired companies identifiable net assets is place in gain on bargain purchase.

Consideration Transferred Exceeds Fair Values of Net Assets Acquired and Liabilities Assumed

Identified assets acquired and liabilities assumed are recorded at their fair values. The difference between consideration transferred and acquired companies net identifiable assets will be placed in goodwill.

· What is to be consolidated?

If dissolution occurs, appropriate account balances are physically consolidated in the financial records of the survivor. If separate incorporation is maintained, only the financial statement information (not the actual records) is consolidated.

When does the consolidation take place?

If dissolution occurs, permanent consolidation occurs at the combination date. If separate incorporation is maintained, the consolidation process is carried out at regular intervals whenever financial statements are to be prepared.

Initial Value Method (Acquisition Made During the Current Year)

Investment account will contain different amount than equity method, and Equity in Subsidiary Earnings account is replaced by Dividend Income. Consolidation Entry S, A, I (Debit - Dividend Income, Credit - Dividends Declared), E. There is no entry for D.

Initial Value Method (Consolidation Subsequent to Year of Acquisition)

Investment has different amount , Equity in Subsidiary Earnings account is replaced by Dividend Income with a different amount, Retained Earnings contains a different amount for parent company. Consolidation Entry S, A, I (Debit - Dividend Income, Credit - Dividends Declared), E, P (if necessary), C (Debit - Investment, Credit - Beginning Retained Earnings for parent company).

Cost Method

Investments in equity securities the employ the ____________ often continue to be reported at their original cost over time. However, GAAP allows for two fair value assessments that may affect cost method amounts reported on the financial statements: Periodic assessment for impairment to determine if the fair value of the investment is less than its cost. Recognition of "observable price changes in orderly transaction for identical or a similar investment of the same issuer" as unrealized holding gains (or losses).

Fair-value Method

Investor holds a small percentage of equity securities of investee. Inventory cannot significantly affect investee's operations. Investment is made in anticipation of dividends or market appreciation.

Acquired IPR&D (in-process research and development) is measured at acquisition-date fair value, recognized as an asset, and tested for impairment.

It is not amortized until its useful life is determined to be no longer indefinite.

Factors to be considered in determining the useful life of an intangible asset include:

Legal, regulatory, or contractual provisions. The effects of obsolescence, demand, competition, industry stability, rate of technological change, and expected changes in distribution channels. The enterprise's expected use of the intangible asset. The level of maintenance expenditure required to obtain the asset's expected future benefits.

Deferral of Intra-Entity Gross 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 sporadically.

Consolidation worksheet entries (adjustments and eliminations) are entered on the worksheet only. Steps in the process:

Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition-date fair value similar to the equity method procedures. Acquisition-date financial information for parent (after journal entry for the investment and combination costs) and sub is recorded in the first two columns of the worksheet (sub's prior revenue and expense already closed). Journal Entries S and A. Combine all account balances and extend into the Consolidated Totals column. Subtract consolidated expenses from revenues to arrive at net income.

Upstream Sales of Inventory

Profit recognition is delayed until buyer disposes of the goods. Investor decreases current equity income to reflect the deferred portion of the intra-entity profit. The investor's own inventory account contains the deferred gross profit. Recognition of profit is deferred by decreasing the investment account rather than the inventory balance. When this inventory is eventually consumed or sold to unrelated parties, the deferral is reversed.

Downstream (Investor to Investee) Sales of Inventory

Profit recognition is delayed until buyer disposes of the goods. Investor decreases current equity income to reflect the deferred portion of the intra-entity profit. When this inventory is eventually consumed or sold to unrelated parties, the deferral is no longer needed. The investor should recognize the deferred intra-entity gross profit. Recognition shifts from the year of inventory transfer to the year in which the sale to unrelated customers occurred. An alternative treatment would be the direct reduction of the investor's inventory balance as a means of accounting for this deferred amount.

Applying The Acquisition Method involves using fair value to recognize and measure:

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.

Assets may be undervalued on the investee's books because:

The fair values (FV) of some assets and liabilities are different from their book values (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.

Accounting for Decreases in an Investment

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. The investor shall 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.

Accounting for Increases in an Investment

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 asset balance is increased as the investee makes a profit. The investor reduces the investment account if the investee reports a loss.

Explain the four methods of accounting for reporting investments in corporate capital stock.

The method selected depends upon the degree of influence the investor (stockholder) has over the investee. GAAP recognizes four methods to report investments in other companies: 1. Fair-value Method 2. Cost Method 3. Equity Method 4. Consolidation of financial statements.

Comparisons Across Internal Investment Accounts

The parent's internal investment method choice has no effect on the resulting consolidated statements.

Characteristics of the Purchase Method (Prior to 2002 - 2008)

Valuation basis is cost and includes direct combination costs but excludes the contingent consideration. Cost is allocated to the assets acquired and liabilities assumed based on their individual fair values (unless a bargain purchase occurs and then the long-term items may be recorded as amounts less than their fair values). Goodwill is the excess of cost over the fair values of the net assets purchased. Acquired in-process research and development is expensed immediately at the purchase date.