M2 Equity Method

Differences between Purchase Price and Book Value of the Investee's Net Assets: Attributable to

Assets Fair Value Differences: differences between the book value and fair value of the net assets acquired Goodwill: any remaining difference is goodwill

GAAP accounting rules for the equity method: BASE account analysis

B = Beginning Balance A = Add: Investor's share of investee's earnings S = Subtract: Investor's share of investee's dividends E = Ending Balance

Equity Method not Approrpriate

Bankruptcy of subsidiary; investment in subsidiary is temporary; lawsuit or complaint is filled; A "standstill agreement" is signed (investor surrenders significant rights as a shareholder); Another small group has majority ownership and operates the company without regard to investor; investor cannot obtain the fin. info. neccessary to apply the equity method; investor cannot obtain representation on the board in order to exercise significant influence

Equity Method Accounting: Investment Account Increase

by the investor's share of the investee's net income with a corresponding credit to the investor's income statement account, Equity in Sub./Investee Income; distribution of dividends by the investee reduces the investment balance; continuing losses may result in a decrease of the investment account to a zero bal.

Significant Influence

company that owns 20% to 50% of voting stock of another "investee" company is presumed to be able to exercise significant influence over the operating and financial polices and therefore must use the equity method when presenting the investment in the investee

Transitioning to Equity method: Securities w/o determinable fair values:

investment must be remeasured immediately before the transaction; If transitioning FROM, investment must be remeasured immediately after the transaction

Equity Method Accounting

investment originally recorded at the price paid to acquire the investment

Equity Method Impairment

recognized when following two occur: 1. Fair value of the investment falls below the carrying value of the investment; 2. The entity believes the decline in value is other than temporary

Equity Method Impairment: If both conditions are met

reports impairment loss on the IS and the carrying value of the investment is reduced to the lower fair value on the BS

When to use Equity Method

used to account for investments if significant influence can be exercised by the investor over the investee

Consolidated Financial Statements should be presented:

when ownership is greater than 50% and there is control over investee

Transition to Equity Method

when significant influence is acquired, necessary to record a change from the fair value method to the equity method

Equity Method still Correct when:

when the ownership percentage is less that 20% but the "ability to exercise significant influence" exists

Investment in Investee Common Stock and Preferred Stock

"significant influence" test is generally met by the amt. of common stock owned; calculation of the income from sub. to be reported on the IS include: Preferred Stock Dividends & Shares of earnings available to common shareholders (net income reduced by preferred dividends)

Recording change from FV method to Equity method

1. Add the cost of acquiring the additional interest in the investee to the carrying value of the previously held investment; 2. Adopt the equity method as of that date and going forward; retroactive adjustments not required

JE to record decrease in the investment by the investor's share of the cash dividend from the investee:

DR. Cash CR. Investment in Investee

JE to record the acquisition of the additional interest in a Co.

DR. Investment in Co. CR. Cash

JE to record Investment @ Cost (FV of consideration plus legal fees)

DR. Investment in Investee CR. Cash

JE to record increase in the investment by the investor's share of the earnings of the investee:

DR. Investment in Investee CR. Equity in earnings/investee income (reported as income on IS)

Equity Method: Asset Premium =

Fair Value of Equity Acquired - Book Value of Equity Acquired

Equity Method: Goodwill =

Purchase price of Investment - Fair Value of Equity Acquired

Differences between Purchase Price and Book Value of the Investee's Net Assets:

additional adjustments to the investment account under the equity method result from differences between the price paid for the investment and the book value of the investee's net assets

Equity Method Accounting: Investment Account

adjusted as the net asset of investee changes through the earning of income and payment of dividend

Accounting for Asset Fair Value Differences

excess of fair value over its book value is amortized over the life of the asset (excess caused by land is not amortized); additional amortization causes the investor's share of the investee's net income to decrease DR. Equity in Investee Income CR. Investment in Investee

Accounting for Equity Method Goodwill:

fair value excess attributable to goodwill is not amortized and is not subject to a separate impairment test; however the total equity method investment (including goodwill) must be tested annually for impairment

US GAAP Impairment Loss Reversal

not permitted if the fair value of the investment increases in subsequent periods