Equity Method and Joint Ventures (External Reporting) Flashcards
When is the equity method used to account for investments?
If significant influence can be exercised by the investor over the investee
What is the critical criterion for using the equity method?
The investor exerts significant influence over the operating and financial policies of the investee
When is it presumed that the investor exercises significant influence over the investee?
Investor owns 20%-50% voting stock
“Largest shareholder”
“Majority of board”
When is the equity method not appropriate?
- Bankruptcy of sub
- Investment is temporary
- Lawsuit/complaint filed
- “Standstill agreement” is signed (investor surrenders significant rights)
- Another small group has majority ownership and they operate the company w/out regard to the investor
- Investor cannot obtain the financial info necessary to apply the equity method
- Investor cannot obtain representation on the BoD
How is the investment accounted for under the equity method?
Investment in investee = Cost + Earnings - Dividends
J/E to record initial investment at cost (FV of consideration plus legal fees)
Dr. Investment in investee
Cr. Cash (or C/S & APIC)
J/E to record increase by investor’s ownership % of earnings of investee
Dr. Investment in investee
Cr. Equity in earnings/investee incom
J/E to record decrease by investor’s ownership % of cash dividends from investee
Dr. Cash
Cr. Investment in investee
How are stock dividends accounted for under the equity method?
Memo entry only
If an investor company owns both common and preferred stock of an investee company, how is the “significant influence” test met?
Generally met by the amount of C/S owned
If an investor company owns both common and preferred stock of an investee company, how is income from the investee calculated?
Includes:
- Preferred stock dividends, and
- Share of earnings available to common shareholders (reduced by preferred dividends)
How is a difference between the purchase price and book value of the investee’s net assets accounted for?
The difference is first allocated to the asset fair value (amortized over asset life) and then to goodwill
J/E to record amortization of “premium” over related asset life
Dr. Equity in investee income
Cr. Investment in investee
Reduces income from investee
What method must be used if a parent company does not consolidate a 50%+ owned sub (b/c lack of control)?
Equity method
What method is used to account for joint venture investments?
Equity method
When a investment changes from the cost method to the equity method due to significant influence being acquired, how are the investment account and RE account adjusted for the difference?
Retrospectively
When applying the new method (equity) to the prior period, what percentage of ownership should be used?
The prior period’s old percentage (not the new percentage)
When a investment changes from the cost method to the equity method due to significant influence being acquired, how are the investment account and RE account adjusted for the difference under IFRS?
Prospectively
BASE
Beginning balance
Add
Subtract
Ending balance
J/E to record the retrospective adjustment to the investment and RE account and write off the unrealized loss on AFS securities
Dr. Investment in investee
Cr. RE
Cr. Unrealized loss on AFS securities
Under the equity method, what is recorded as investment income?
The investor’s share of the investee’s earnings
If an investor owns preferred stock in an investee, how is the investment accounted for?
Cost method
Dividends = revenue
What is the correct accounting for goodwill created in an investment under the equity method?
It is ignored (neither amortized nor tested for impairment)
The entire investment (using equity method) is subject to impairment test
When changing from equity to cost method, is retroactive adjustment required?
No
In a business combination, what is the valuation of goodwill?
A calculation of the residual paid above the FV of identifiable net assets
