Ch 1 The Equity Method of Accounting for Investments

Question 1

When Investee sells (inventory) to investor, is this upstream or downstream?

Answer 1

upstream

Question 2

When is it appropriate to use the FV method for an investment in equity shares of another company?

Answer 2

• When the investor holds a small percentage (usually less than 20%) of equity securities of the investee
• When the investor cannot significantly affect investee’s operations
• When the investment is made in anticipation of dividends or market appreciation

Question 3

What are three methods of accounting for investments in corporate equity securities?

Answer 3

1) Fair Value Method
2) Equity Method
3) Consolidation

Question 4

What is the criteria for using the equity method?

Answer 4

-must have ‘ability’ to exercise significant influence over operating and financial policies of an investee.

Question 5

What are conditions that indicate significant influence?

Answer 5

• investor representation on the board of directors of the investee
• investor participation in the policymaking process of the investee
• Material intra-entity transactions
• interchange of managerial personnel
• technological dependency
• extent of ownership by the investor in relation to the size and concentration of other ownership interests in the investee

Question 6

What happens if the method of accounting for investments in equity security changes due to a change in significant influence?

Answer 6

all accounts are restated so that the investor’s financial statements appear as if the equity method had been applied from the date of first acquisition.

Question 7

What is a downstream transfer?

Answer 7

When the investor sells an item to the investee.

Question 8

What is an upstream transfer?

Answer 8

When the investee sells to an investor.

Question 9

Under the fair-value option, changes in the fair value of the elected financial items are included in _________.

Answer 9

earnings

Question 10

How do firms report the investment’s fair value and changes in fair value?

Answer 10

firms report the investment’s fair value as an asset and changes in fair value as earnings.

Question 11

Under the fair value option, how are dividends recorded?

Answer 11

in earnings

Question 12

What is the objective of the fair value option as according to FASB ASC 825?

Answer 12

to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.