ACCT 402 Exam 2

Why does the Coca-Cola company use the equity method to account for investments?

"We use the equity method to account for investments in companies, if our investment provides us with the ability to exercise significant influence over operating and financial policies of the investee. Our consolidated net income includes our Company's proportionate share of the net income or loss of these companies. Our judgment regarding the level of influence over each equity method investment includes considering key factors such as our ownership interest, representation on the board of directors, participation in policy-making decisions and material intercompany transactions."

Consolidation of financial statements

- investor has acquired enough shares to gain some degree of actual control - more than 50% of voting stock - viewed as a single entity for reporting purposes - FASB ASC Section 810-10-05 expands the use of consolidated financial statements to include entities that are financially controlled through special contractual arrangements rather than through voting stock interest

GAAP recognizes four different approaches to the financial reporting of investments in corporate equity securities:

1. Fair value method 2. Cost method for securities without readily determinable fair values 3. Consolidation of financial statements 4. Equity method

In applying the equity method, the cause of such an excess payment can be divided into two general categories:

1. Specifically identifiable investee assets and liabilities can have fair values that differ from their present book values. The excess payment can be identified directly with individual accounts such as inventory, equipment, franchise rights, and so on 2. The investor may pay an extra amount because it expects future benefits to accrue from the investment. Such benefits could be anticipated as the result of factors such as the estimated profitability of the investee or the expected relationship between the two companies

In applying the equity method, the accounting objective is to report the investment and investment income to reflect the close relationship between the investor and investee. After recording the cost of the acquisition, two equity method entries periodically record the investment's impact:

1. The investor's investment account increases as the investee recognizes and reports income 2. The investor decreases the investment account upon receiving dividends

Equity method accounting requires that the investor record its share of investee OCI which then is included in its balance sheet as:

Accumulated Other Comprehensive Income (AOCI) includes items such as accumulated derivative net gains and losses, foreign currency translation adjustments, and certain pension adjustments.

Statutory merger through capital stock acquisition

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

Equity Method

An accounting method in which the investment in common stock is initially recorded at cost, and the investment account is then adjusted annually to show the investor's equity in the investee. the ownership indicates the investor has significant influence over the investee - FASB ASC Topic 323 - employs the accrual basis for recognizing the investor's share of investee income - investor records its share of investee dividends as a decrease in the investment account

Cost Method

An accounting method in which the investment in common stock is recorded at cost, and revenue is recognized only when cash dividends are received. First, cost method equity investments periodically must be assessed for impairment to determine if the fair value of the investment is less than its carrying amount. The ASC allows a qualitative assessment to determine if impairment is likely.4 Because the fair value of a cost method equity investment is not readily available (by definition), if impairment is deemed likely, an entity must estimate a fair value for the investment to measure the amount (if any) of the impairment loss. Second, ASC (321-10-35-2) allows for recognition of "observable price changes in orderly transactions for the identical or a similar investment of the same issuer." Any unrealized holding gains (or losses) from these observable price changes are included in earnings with a corresponding adjustment to the investment account. So even if equity shares are only infrequently traded (and thus fair value is not readily determinable), such trades can provide a basis for financial statement recognition under the cost method for equity investments.

When is the degree of ownership null when determining significant influence?

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.

Which of the following are included in the first two columns of the consolidated worksheets as of the acquisition date?

An investment account in the parent's financial statement column any contingent performance liability that may have accompanied the combination

Statutory Merger

Any business combination in which only one of the original companies continues to exist is referred to in legal terms

assume that Grande Company is negotiating the acquisition of 30 percent of the outstanding shares of Chico Company. Chico's balance sheet reports assets of $500,000 and liabilities of $300,000 for a net book value of $200,000. After investigation, Grande determines that Chico's equipment is undervalued in the company's financial records by $60,000. One of its patents is also undervalued, but only by $40,000. By adding these valuation adjustments to Chico's book value, Grande arrives at an estimated $300,000 worth for the company's net assets. Based on this computation, Grande offers $90,000 for a 30 percent share of the investee's outstanding stock.

Book value of Chico Company [assets minus liabilities (or stockholders' equity)] $200,000 Undervaluation of equipment 60,000 Undervaluation of patent 40,000 Value of net assets $300,000 Percentage acquired 30% Purchase price $ 90,000

Special Purpose Entities (SPEs)

Corporations, trusts, or partnerships created for a single specified purpose. Usually have no substantive operations and are used only for financing purposes. vehicle for firms to keep large amounts of assets and liabilities off their consolidated financial statements

Little Company reported a net income of 200,000 during 2017 and declared and paid cash dividends of 50,000. These figures indicate that little's net assets have increased by 150,000 during the year. How does Big Company record this? (It owns 20% interest) Use the equity method

Investment in Little Company 40,000 Equity in investee income 40,000 (To accrue earnings of a 20% owned investee (200,000*20%)) Dividend receivable 10,000 Investment in little company 10,000 (to record a dividend declaration (50,000*20%)) Cash 10,000 Dividend receivable 10,000 Record collection of dividend

Conditions guiding degree of influence according to FASB ASC Topic 323

Investor representation on the board of directors of the investee. Investor participation in the policy-making process of the investee. Material intra-entity transactions. Interchange of managerial personnel.Page 6 Technological dependency. Extent of ownership by the investor in relation to the size and concentration of other ownership interests in the investee.

Statutory merger through asset acquisition

One company obtains the assets, and often the liabilities, of another company in exchange for cash, other assets, liabilities, stock, or a combination of these. The second organization normally dissolves itself as a legal corporation. Only the acquiring company remains in existence, having absorbed the acquired net assets directly into its own operations.

In consolidation entry S

S stands for subsidiary stockholders' equity

Why does Consolidation Entry S remove the subsidiary's stockholders' equity accounts?

Subsidiary ownership accounts are not relevant because consolidated statements are prepared for the parent company owners

The fair value of the consideration transferred to acquire a business from its former owners is the starting point in valuing the recording a business combination. In describing the acquisition method, the FASB ASC states:

The consideration transferred in a business combination shall be measured at fair value, which shall be calculated as the sum of the acquisition-date fair values of the assets transferred by the acquirer, the liabilities incurred by the acquirer to former owners of the acquiree, and the equity interests issued by the acquirer. (ASC 805-30-30-7)

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

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

Before preparation of a consolidated worksheet, an acquisition-date fair value allocation schedule is typically prepared. What is the purpose of the acquisition-date fair value allocation schedule?

The schedule provides supporting calculations that identify fair value adjustments required in consolidation the schedule computes the allocated value assigned to goodwill or bargain purchase gain the schedule allocates the consideration transferred among the individual assets acquired and liabilities assumed in the business combination

Which of the following is an attribute of a statutory merger? one company directly acquires another company's assets and assumes its liabilities two or more existing companies are untied under the ownership of a newly created company

a

Included in the accounts of the parent and subsidiary combined for consolidated financial reporting are: revenues and expenses common stock dividends declared assets and liabilities

a and d

Which of the following intangibles are often recognized in a business combination? patents customer relationships franchise agreements assembled workforce

a b and c

Which of the following may be included in the calculation of the consideration transferred for a newly acquired firm? A. Sum of the acquisition-date fair values of the assets transferred by the acquirer B. Th liabilities incurred by the acquirer to former owners of the acquiree C. The stockholder equity account balances of the acquired firm D. The equity interests issued by the acquirer in the combination

a b and d

When the consideration transferred in a 100% acquisition is less than total net fair value of the identifiable net assets received, the excess is recognized as:

a gain on bargain purhcase

the equity method is often referred to as

a single-line consolidation

When an equity-method investment account balance is reduced to zero due to a current year loss, the investor should:

accrue no additional losses leave the investment account at zero until subsequent investee profits eliminate all unrecognized losses discontinue use of the equity method and not establish a negative balance

A fundamental principle of the acquisition method is that an:

acquirer must identify the assets acquired and the liabilities assumed in the business combination once these assets have been identified, the acquirer measures the assets acquired and the liabilities assumed at their acquisition-date fair values, with only a few exceptions.

Acquisition of more than 50 percent of the voting stock

acquiring company - acquires stock that is recorded as an investment; control decision making of acquired company acquired company - remains in existence as legal corporation, although now a subsidiary of the acquiring company

Control through ownership of variable interest. 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

statutory consolidation through capital stock or asset acquisition

acquiring company - newly created entity receives assets or capital stock of original companies acquired company - original companies may dissolve while remaining as separate divisions of newly created company

An investor purchased 5% of a company, and later purchased sufficient shares to qualify for the equity method. How is it accounted for?

add the cost of the shares to the current basis of its previous 5% investment

The purpose of consolidation entry A is to:

adjust the subsidiary asset and liability accounts to their acquisition-date fair value

Consolidation Entry A

adjusts the subsidiary balances from their book values to their fair values beginning of the current reporting period

To complete a consolidation acquisition-date worksheet:

all account balances, after adjusting for consolidation entries, are extended across to the consolidated total column the investment in subsidiary account balance is eliminated entirely in consolidation

Entry S

always refers to the removal of the subsidiary's beginning stockholders' equity balances for the year against the book value portion of the investment account

Why do some criticeze the recognition of bargain purchase gains in business combinations?

an unrealized gain is recognized despite the lack of any selling activity by the acquirer

How does the acquisition method treat contingent consideration when present in a business combination?

as a negotiated component of the fair value of the consideration transferred

Which f the following are legacy methods of accounting for business combinations? acquisition method pooling of interests method purchase method ownership combination method

b and c

Which of the following best describes control through majority voting stock ownership?

by exercising majority voting power, one firm can dictate the operating and financing of another firm

A company's fair value at any time is based on a multitude of factors such as:

company profitability, the introduction of a new product, expected dividend payments, projected operating results, and general economic conditions.

In a business combination when each combining firm maintains its separate incorporation:

consolidation worksheets are employed to generate financial reports for the combined economic entity the acquiring firm utilizes an investment account to record the acquisition each company maintains independent record keeping

There has been a fundamental change in the way we account for and report business combinations from a _________-based to a _______-value model

cost; fair

How should an investor record the event of a dividend (equity method)?

credit to the investment account

Consolidation Entry D

designed to offset the impact of the dividends transaction by removing the Dividends declared account

When an investment account is reduced to zero, the investor should:

discontinue using the equity method rather than establish a negative balance. The investment retains a zero balance until subsequent investee profits eliminate all unrecognized losses. Once the original cost of the investment has been eliminated, no additional losses can accrue to the investor (since the entire cost has been written off).

A parent company, over time, will routinely make which of the following adjustments in applying the equity method to its investment in subsidiary account?

dividends form subsidiary excess acquisition date fair value over book value amortization income as it is earned and reported by the subsidiary

What income statement account should an investor use to defer its proportional share of intra-entity gross profits remaining in ending inventory from sales to an investee?

equity investment income

In its recent annual report, the CocaCola company describes its 28% investment in CocaCola FEMSA, a Mexican bottling company with operations throughout much of Latin America. The CocaCola Company uses the ____________________ to account for several of its bottling company investments, including FEMSA.

equity method

Three methods of monitoring the activities of subsidiaries have become the most prevalent:

equity method initial value method partial equity method

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

fair market values

What is the measurement attribute employed in determining the consideration transferred in a business combination

fair value

Under the FVM of accounting for an investment, the investor recognizes income when

fair value of the investor's shares increase the investee pays a dividends

The acquisition method embraces a ____________ measurement attribute

fair-value - reflects the FASB's increasing emphasis on fair value for measuring and reporting the financial effects of business combinations

Even though measurement of an intangible asset may lack precision, recognition of the identified intangible asset may result in greater

faithful representation

consolidated financial statements

financial statements that present the assets and liabilities controlled by the parent company and the total revenues and expenses of the subsidiary companies

Acquisition agreements often contain provisions to pay:

former owners upon achievement of a specified future performance measure

What are examples of subsidiaries of PepsiCo?

frito-lay gatorade Quaker Oats Sabra Tropicana Products

When the consideration transferred exceeds the acquisition-date net amount of the identified assets acquired and the liabilities assumed, the acquirer recognizes the asset ________ for the excess

goodwill

When the consideration transferred in a 100% acquisition exceeds the total net fair value of the identifiable net assets received, the excess is recognized as

goodwill

any extra payment that cannot be attributed to a specific asset or liability is assigned to the intangible asset:

goodwill

The acquisition method requires the recognition and measurement of which of the following?

goodwill or gain from bargain purchase acquirer's identified assets and liabilities any existing non controlling interest

Consolidation Entry E

increases expenses when excess fair over book value acquisition date allocations are made to depreciable subsidiary assets provides current period amortization expense for the acquisition date fair value adjustements

Many equity acquisitions establish ties between companies to facilitate the direct purchase and sale of

inventory items intra-entity sales

The equity method embraces the full accrual accounting in maintaining the:

investment account and related income over time the acquiring company accrues income when the subsidiary earns it amortization is recognized through periodic adjusting entries (including acquisition date fair value over book value)

Intangible assets:

lack physical substance are common in business combinations are required to meet specific criteria to qualify for recognition in a business combination

Goodwill recognized in a business combination:

may embody synergies the acquirer expects to achieve from the combination is an asset that represents future economic benefits may capture value derived from other intangible assets not otherwise eligible for recognition

A business combination occurs and the acquired firm is legally dissolved. If the consideration transferred by the acquiring firm equals the collective fair value of the acquired firm's net identifiable asset, then:

neither goodwill nor a bargain purchase gain is recorded

Under the Partial equity method, the parent recognizes the reported income accruing from the subsidiary. However:

no other equity adjustments such as amortization are recorded

When an acquired firm continues its separate legal corporate existence, which of the following best describes the procedures to prepare consolidated financial statements

only the financial statement information of the acquired firm and the parent are used to prepare consolidated financial statements

Which of the following describes a fair value exchange price in an orderly transaction between market participants?

price paid to transfer a liability or received from selling an asset

If an increase in an investment now provides an investor with the ability to exercise significant influence over an investee, the change to the equity method of investment accounting is applied on a ____________ basis

prospective

Zell company sells inventory at a 10,00 GP to its equity method investee. Before the end of the year, the investor sells all the inventory to an outsider. Zell should:

recognize the entire 10,000 GP on its IS

In-process research and development acquired in a business combination is:

recognized as an indefinite tangible asset tested periodically for impairment recognized at its acquisition date fair value

When an equity method invested company's activities require recognition of OCI, the investor compan

records its proportionate share of OCI in AOCI

Income approach

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

Consolidation Entry I

removes from the worksheet the subsidiary income during the year brings the equity in subsidiary earnings account to a zero balance

When the parent uses the equity method, Consolidation Entry 1

removes the parent's recorded equity income

When the parent uses the equity method, Consolidation Entry I:

removes the parent's recorded equity income

Special procedures are required in accounting for:

reporting a change to the equity method reporting investee income from sources other than continuing operations reporting investee losses reporting the sale of an equity investment

business combination

separate organizations tied together through common control frequently the case for large corporations

Consolidated net income determination involves first combining the:

separately recorded revenues and expenses of the parent with those of the subsidiary on a consolidated worksheet.

What are some of the reasons firms combine?

size and scale valuable synergies through combined business (production and distribution) - vertical integration elimination of duplicate facilities and staff quick entry for new and existing products into domestic and foreign markets access financing at more attractive rates (larger size = better negotiation leverage) diversify business risks and opportunities

What is the accounting treatment of the acquired subsidiary's equity accounts in a business combination?

subsidiary accounts are excluded from the accounting for the business combination

Under the initial value method, the parent recognizes income from its share of any:

subsidiary dividends when declared reflects the cash basis for income recognition investment balance remains on the parent's financial records at the initial fair value assigned at the acquisition date

worksheet effect of consolidation entry S

subsidiary stockholders' equity account balances are brought to zero in consolidation

The acquisition method thus embraces the fair value of the consideration transferred in measuring the acquirer's interest in the acquired business. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Thus, the market values are often:

the best source of evidence of the FV of consideration transferred in a business combination

In financial reporting for a bargain purchase business combination

the collective fair value of the identifiable net assets becomes the acquired firm's valuation basis no goodwill is reported as a result of the business combination a gain is reported on the acquiring firm's income statement

When a business combination results in a bargain purchase gain, which of the following best describes the valuation basis of the acquired firm?

the collective fair value of the net identifiable assets acquired

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

Under the equity method, why does the investor not recognize its share of dividends declared by an investee as income?

the equity method embraces the accrual model for income recognition

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 the collective FV of the net identified assets acquired and liabilities assumed exceeds the consideration transferred:

the fair value of the net identifiable assets becomes the valuation basis for the acquired firm the acquirer recognizes a gain on bargain purchase

Which of the following are criteria that are essential to recognizing an intangible asset acquired in a business combination?

the intangible asset is capable of being sold or otherwise separated from the acquired enterprise and/or arises from a contractual or other legal right

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

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

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 gp % the amount of the intra-entity sale remaining in ending inventory

When the fair value of a 100% acquired subsidiary's net identifiable assets exceeds the consideration transferred:

the parent records a bargain purchase gain on its books a bargain purchase gain is reported in the consolidated income statement in the period of the acquisition the identifiable assets of the acquired subsidiary are reported in the acquisition-date consolidated balance sheet at fair-value

IASB definition of significant influence

the power to participate in the financial and operating policy decisions of the investee, but it is not control or join control over those policies If an investor holds, directly or indirectly (e.g., through subsidiaries), 20 per cent or more of the voting power of the investee, it is presumed that the investor has significant influence, unless it can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or indirectly (e.g., through subsidiaries), less than 20 per cent of the voting power of the investee, it is presumed that the investor does not have significant influence, unless such influence can be clearly demonstrated. A substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence. Under the equity method, the investment in an associate is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor's share of the profit or loss of the investee after the date of acquisition. The investor's share of the profit or loss of the investee is recognised in the investor's profit or loss. Distributions received from an investee reduce the carrying amount of the investment.

Fair value asc definition

the price that would be received to sell an asset or paid to transfer a liability in an orderly transactions between market participants on the measurement date

Criteria for utilizing the Equity method

the rationale underlying the equity method is that an investor begins to gain the ability to influence the decision-making process of an investee as the level of ownership rises FASB ASC Topic 323 - ability to exercise significant influence even though the investor holds 50% or less of the stock significant influence is usually assumed when the investor owns between 20-50% interest

Which of the following contribute to the full-accrual income recognition of the subsidiary income on the parent's financial records under the equity method?

the recognition of excess acquisition-date fair value adjustment amortizations to subsidiary income the recognition of subsidiary reported income

A number of possible reasons exist for a difference between the book value of a company and its fair value as reflected by the price of its stock

true

For a statutory merger or a statutory consolidation, when the acquired company (or companies) is (are) legally dissolved, only one accounting consolidation ever occurs.

true

Included in the consolidated totals are the subsidiary's amortized acquisition-date excess fair over book value allocations

true

The selection of a particular method does not affect the totals ultimately reported for the combined companies

true

in a combination when all companies retain incorporation, a different set of consolidation procedures is appropriate. Because the companies preserve their legal identities, each continues to maintain its own independent accounting records. Thus, no permanent consolidation of the account balances is ever made. Rather, the consolidation process must be carried out anew each time the reporting entity prepares financial statements for external reporting purposes.

true

Fair value method

used when the investor uses the shares for dividends or appreciation in value; does not possess a significant level of control FASB accounting standards codification Topic 321 Initial investments in equity securities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable (typically by reference to market value); otherwise, the investment remains at cost. Changes in the fair values of equity securities during a reporting period are recognized as income. Dividends declared on the equity securities are recognized as income.

In conjunction with combining a subsidiary's revenues and expenses with those of the parent company, the income from subsidiary account accrued by a parent is brought to a ______ balance as part of the consolidation process

zero