E. INVESTMENTS - 2. FINANCIAL ASSETS Equity Securities, Equity Method Treatment Flashcards
E. INVESTMENTS
3. EQUITY METHOD INVESTMENTS
When to use Equity Method and procedures:
This is the method used when an investor owns more than 20% but less 50% of voting shares in an entity and/or has “significant influence” over the investee (more than 50% ownership would require consolidation).
It’s possible to own 21-49% and still not have significant influence if the investee opposes the investor, another investor owns more and “blocks” the interests of the investor, or if the investor doesn’t have representation on the board. In these cases the fair value option would be used.
Also, you can own less than 20% and HAVE significant influence if you own the highest % of stock, if you have representation on the board, or are technologically interdependent with the investee. In this case the equity method could be used.
If the investment is greater than the proportionate FV of net assets, the excess is goodwill. However, the goodwill from the equity method is not separated on the balance sheet, it is just included in the investment account.
If an entity was accounting for an investment with another method, and then switched to the equity method, that change will be applied prospectively.
Recording the investment:
The cost of the investment is recorded as “Investment in XYZ”.
Example:
ABC corp makes an investment in XYZ corp that equals 30% of the stock of XYZ and gives ABC significant influence.
The cost of the investment was $100,000.
Entry to record investment:
Investment in XYZ $100,000
Cash $100,000
Dividends reduce the investment on your books, and it’s pro-rata:
XYZ pays $10,000 in dividends for the year. ABC would make the following entry:
Cash $3,000
Investment in XYZ $3,000
Dividends received are considered a return of investment and lowers the investment account.
Income is the opposite: If XYZ had net income of $30,000, ABC’s “share” as a 30% owner is $9,000.
The entry would be:
Investment in XYZ $9,000
Investment income $9,000
If XYZ reported a net loss of $30,000 for the period:
Investment loss $9,000
Investment in XYZ $9,000
Impairment
- An equity method investment is evaluated for impairment, and
- If the change in FV is considered other than temporary,
- the investment is written down to FV and
- a loss is recognized in income.
E. INVESTMENTS
3. EQUITY METHOD INVESTMENTS
Other things to know:
Dividend Rules
Other things to know:
The rules for dividends only apply to the common stock of the investee.
If the investor also had preferred stock, dividends received from the preferred stock would be regular dividend income.
E. INVESTMENTS
3. EQUITY METHOD INVESTMENTS
Other things to know:
Intangible Amortization
If an investment made is more than the book value for the proportionate amount due to an undervalued intangible asset, as that asset is amortized it will reduce the investment account:
Example:
ABC purchases 25% of the common stock of XYZ for $500,000. The book value of the shares was $400,000 due to an undervalued intangible asset. ABC determines the useful life of the intangible asset to be 10 years, so each year ABC will amortize $10,000, which will reduce ABC’s “investment in XYZ” account by the $10,000.
