Cost & equity method

Question 1

What are 3 ways an investor may invest in other companies?

Answer 1

1. Equity securities (common or preferred stock)
2. Debt securities (bonds)
3. Derivatives (stock rights)

Question 2

What percentage of ownership is related to the cost method & marketable securities?

Answer 2

0% - 20%

No influence

Question 3

What percentage of ownership is the equity method of accounting?

Answer 3

20% - 50%

“One line consolidation” into one investment account instead of breaking it out to assets & liabilities

Has significant voting influence

Question 4

What percentage of ownership represents a consolidation?

Answer 4

50%+

Has control

Question 5

What is the difference between cost method of accounting and marketable securities?

(0-20%)

Answer 5

Cost method is used for non-publicly traded companies. It doesn’t have market value.

Marketable securities are investments in publicly traded companies (trading, held to maturity, held for sale).

Question 6

Under the equity method, the investment is initially recorded at what?

Answer 6

At cost (purchase price)

DR Investment
CR Cash

Question 7

Under the equity method, when the invested earns money, how does the investee recognize it?

Answer 7

Record income when it’s earned because you will get the money eventually through dividends & if not, you can vote them out.

Dr investment (B/S)
    Cr Equity in Investment (I/S)

IS, non operating, non cash

Question 8

Under the equity method, how does the investee recognize dividends?

Answer 8

You already recognized the revenue when income was earned.

The Company issuing the dividend is decreasing their equity, so you need to do so too.

DR Cash
CR Investment

Question 9

Under the equity method, how do recognize the following:

Difference between purchase price & book value (goodwill-amortization)

Difference between fair value & book value (PPE–depreciation)

Answer 9

DR Equity in earnings (IS)
CR Investment

Goodwill: impairment

PPE (depreciation): (FV-BV)/years

Land: written off when sold

Inventory: written off when sold

Question 10

Can the cost method be used when the owner owns 30%?

Answer 10

Yes! If the one other investor owns a majority of the company (70%), you don’t significant influence & the equity method isn’t reasonable.

Use the cost method!

Question 11

Under the cost method, how do you record the purchase of the Investment?

Answer 11

Dr Investment
CR Cash

@ the purchase price

Question 12

Under the cost method, how do record the company’s income?

Answer 12

Trick question! You don’t–only under the equity method.

Question 13

Under the cost method, how do you record dividends?

Answer 13

DR Cash

CR Dividend income

Question 14

Under the cost method, how do you record the dep, amort, & impairment?

Answer 14

Trick question! You don’t-only under the equity method.

Question 15

What are 3 General approaches applied to investments under IFRS?

Answer 15

1. Amortized cost approach (differences in cost & face value is amortized) - scheduled payments & hold to maturity
2. Fair value through OCI (FVTOCI) - may either hold it until maturity or dispose of it
3. Equity investment - significant influence indicates that the investor has the power to participate in policy decisions
   (4. Control is still consolidations)

NO PERCENTAGES LIKE GAAP!