05 Equity Method Intro

Question 1

At the time an investment gives the investor significant influence, but not control, over an investee, how will any difference between the cost of the investment and the book value of the investee’s assets and liabilities be allocated?

Answer 1

To adjust an investee’s assets and liabilities to fair value, then

1 If cost of investment > fair value of investee’s net assets, to Goodwill;

OR 2 If cost of investment

Question 2

When an investor has significant influence over the operating and financial policies of an investee, what method must be used to account for the investment in the investee?

Answer 2

The investment must be carried on the investor’s books and reported in the investor’s financial statements using the full equity method of accounting.

Question 3

At the time an investor makes an investment that gives it significant influence over an investee, what information must the investor determine in order to use the equity method of accounting?

Answer 3

At the time of investment, the investor must determine:

1 Book value of assets and liabilities of investee;

2 Fair value of assets and liabilities of investee;

3 Allocation of any difference between cost of investment and fair value of investee’s assets and liabilities.

Question 4

Under what conditions will an investment give the investor significant influence, but not control, over the investee?

Answer 4

When an investor owns 20% to 50% of the voting equity securities of an investee and there are no impediments to the investor exercising its voting rights to influence the investee’s operating and financial policies. Investments in non-voting equity securities (e.g., preferred stock) or in debt securities does not convey influence.

Question 5

What is the required accounting if a change in an investor’s level of ownership results in a loss of significant influence, but the entire investment is not disposed of?

Answer 5

The investor must cease using the equity method of accounting and begin accounting for the investment at fair value (either as AFS or held-for-trading). The investment will be adjusted to fair value at the date significant influence is lost and any difference between fair value and the prior equity-based carrying amount will be recognized as a gain or loss in current income.

Question 6

Identify the three major equity method items recognized each period by an investor.

Answer 6

1 Recognize investor’s share of investee’s net income/loss;

2 Recognize investor’s share of investee’s dividends declared;

3 Recognize adjustment to share of investee’s net income/loss for “depreciation/amortization” of amount allocated to excess of fair value over book value.

Question 7

What are the elements that enter into the determination of revenue recognized from an equity method investment?

Answer 7

Investor’s share of investee’s reported net income/loss - “depreciation/amortization” on excess of cost of investment over book value (OR + “depreciation/amortization” on excess of book value over cost of investment) = net revenue recognized for equity method investment. Dividends received do not enter into the determination of the investor’s revenue recognized; they reduce the investment account.