LS Ch. 1

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.

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

Because certain intangible assets are considered to have indefinite lives, they are not subject to

amortization

An upstream sale refers to a situation where

an investor company purchases inventory from its investee

WOTF are included in net income for an investment in equity shares accounted for under the fair-value method?

dividends from the investee

When one firm can 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; cannot be considered independent

The term used to describe inventory sales between an 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

The equity method of accounting for investments is appropriate when the investor has the ability to exercise ___________ ___________ over the investee.

significant influence

When one firm controls the entire decision making process of another firm,

such control may result from majority voting stock ownership or contracts with a variable interest entity; for reporting purposes the two companies are considered to be a single economic entity; one set of financial statements are created for the combined assets, liabilities, revenue and expenses of both firms

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

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

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

How does an investor record income from its investment in an equity-method investee?

as a credit to "equity in investee income"

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; the liabilities of equity-method investees do not appear in the body of the investor's financial statements; significant influence and control may not be properly defined by existing quantitative guidelines

What are some common economic consequences of financial statements 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.

When an investor established control over an investee, financial reporting requires the ________ of the investor's and investee's financial statments.

consolidation

Rather than recording dividend revenue, under the equity method an investor records an investee dividend declaration as a reduction in its _______ account.

investment

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

investor representation on the investee's board of directors; technological dependency between the investor and investee; investor participation in the policy making process of the investee

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 OCI on its financial records.

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

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

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

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

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

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

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

through a credit to equity in investee income

When an investee sells inventory to its investor company, such intra-entity sales are commonly referred to as __________ sales.

upstream

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

Why does the equity method consider investee dividends as an inappropriate measure of investment income to an investor?

Through its significant influence, an investor can influence the timing of investee dividends and thus manipulate income; investee dividends provide for a cash basis of income recognition, not an accrual basis.

As of the date the equity method become applicable for an investment, the investor allocates its purchase price to its share of the investee's assets and liabilities based on their individual ________ values.

fair

As of the date the equity method become applicable for an investment, the investor allocates its purchases price to its share of the investee's assets and liabilities based on their individual ____ values

fair

When a company invests in the actively-traded equity shares of another company, but cannot influence the decisions of the investee, the investor company accounts for its investment using the _______ value method.

fair

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 owners 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

WOTF represent potential conditions where one firm has the ability to control the operations of another?

one firm owns greater than 50% of the voting stock of another firm; one firm has contractual arrangements that provided decision-making power over another firm.

To provide consistency in application, what is the FASB's general quantitative guideline for application of the equity method?

ownership of 20-50% of the voting stock of an investee

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.

percentage

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 ___________ declines in value.

permanent

Under the equity method, the investment account increases when

the investee recognizes and reports net income

Under the equity method, after the initial investment is recorded,

the investment account increases as the investee earns and reports net income; the investor recognizes investment income using the accrual method; an objective is to reflect the close relationship between the investor and investee

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 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.

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

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

the investor is unable to exercise significant influence over the investee; after several tries, the investor is unable to gain a seat on the investee's board of directors; the 75% owners of the investee make decisions without consulting the investor

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

the investor purchases shares of the investee; the fair value of the investee's share increase

In applying the equity method

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

An intra-entity inventory sale occurs between an investor and its equity-method investee. What factors determine the amount of gross profit from the dale to be deferred as of the end of the year?

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

Determining factors in judging whether to apply the equity method in accounting for an equity investment include

the level of ownership interest in the investee's voting shares; representation on the investee's board of directors; participating in policy-making decisions of the investee