The equity Method of Accounting for Investments

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What indicates an investor's ABILITY to significantly influence the decision-making process?

* What is the Investor representation on the board of directors of the investee? * What is Investor participation in the policymaking process of the investee? * Are the Material intra-entity transaction significant? *What interchange of managerial personnel exists? * Is there Technological dependency? * What is the extent of ownership by the investor in relation to the size and concentration of other ownership interests in the investee. If an investor holds between 20 and 50% of the voting stock of the investee, significant influence is normally assumed and the equity method is applied unless there is evidence to the contrary.

Davis made a significant portion of its sales to one customer who recently announced its decision to make no further purchases from Davis Company, an action that led to the loss of market value in common stock - a permanent drop in market value. Hawkins, Inc owns 35 percent of the outstanding shares of Davis, an investment recorded using the equity method. How would the loss in value affect this investor's financial reporting?

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How are intra-entity transfers reported in an investee's separate financial statements if the investor is using the equity method?

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How is the unrealized gross profit on intra-entity sales calculated? What effect does an unrealized gross profit have on the recording on an investment if the equity method is applied?

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If an investor chooses to change from the fair-value method to the equity method, which procedures are applied to effect this accounting change?

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In a stock acquisition accounted for by the equity method, a portion of the purchase price often is attributed to goodwill or to specific assets or liabilities. How are these amounts determined at acquisition? How are these amounts accounted for in subsequent periods?

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Princeton Co olds a 40% interest in the outstanding voting stock of Yale Company. On June 19 of the current year, Princeton sells part of this investment. What accounting should Princeton make on June 19 What accounting will Princeton make for the remainder of the current year?

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Riggins company accounts for its investment in Bostic Company using the equity method. During the past fiscal year, Bostic reported an extraordinary gain on its income statement. How would this extraordinary item affect the investor's financial records?

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What is the difference between downstream and upstream sales? How does this difference impact application of the equity method?

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What is the fair-value option for reporting equity method investments? How do the equity method and the fair-value option differ in recognizing income from an investor?

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What managerial incentives exist that could influence a firm's percentage ownership interest in another firm?

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Wilson Co. acquired 40% of Andrews Co. for $100,000 because of losses expected to result from Andrew's failure in marketing several new products. Andrews corresponding book value was much higher. In the first year after acquisition, Andrews lost $300,000. In applying the equity method, how would Wilson account for this loss?

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After recording the cost of the acquisition, what transactions or events create changes in the investment account of the investor?

An investor's investment account increases as the investee earns and reports income or decreases when losses occur. The investor's investment account is creased whenever a dividend is collected..

What theoretical problems can opponents of the equity method identify?

Emphasizing the 20-50% of voting stock in determining significant influence versus control. Can one firm exert "control" over another firm absent an interest an interest of more than 50%? In addition, contracts can limit one firm's ability to act without permission of the other. Allowing off balance sheet financing - Firms can avoid balance sheet disclosure of debts by maintaining investments at less than 50% ownership. Potentially biasing performance ratios. By keeping its ownership of voting shares below 50% a company can technically meet the rules for applying the equity method and at the same time report investee assets and liabilities "off balance sheet. As a result it will report smaller values for assets and liabilities. Consequently, higher rates of return for its assets and sales, as well as lower debt-to-equity ratios.

Why does the equity method record dividends received from an investee as a reduction in the investment account and not as dividend income?

In applying the equity method, the accounting objective is to report the investor's investment and income reflecting the close relationship between the companies. An investor's investment account is decreased whenever a dividend is collected because distribution of cash dividends reduces the carrying value of the investee company, the investor mirrors this change by recording the receipt as a decrease in the carrying value of the investment rather than as revenue. A parallel is established between the investment account and the underlying activities of the investee

A company acquires a rather large investment in another corporation. What criteria determine whether the investor should apply the equity method of accounting to this investment?

Use the EQUITY METHOD if the investment indicates the ABILITY for the investor to exercise SIGNIFICANT INFLUENCE over the investee. * What is the Investor representation on the board of directors of the investee? * What is Investor participation in the policymaking process of the investee? * Are the Material intra-entity transaction significant? *What interchange of managerial personnel exists? * Is there Technological dependency? * What is the extent of ownership by the investor in relation to the size and concentration of other ownership interests in the investee.


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