Equity Method and Joint Ventures (External Reporting)

Question 1

When is the equity method used to account for investments?

Answer 1

If significant influence can be exercised by the investor over the investee

Question 2

What is the critical criterion for using the equity method?

Answer 2

The investor exerts significant influence over the operating and financial policies of the investee

Question 3

When is it presumed that the investor exercises significant influence over the investee?

Answer 3

Investor owns 20%-50% voting stock

“Largest shareholder”

“Majority of board”

Question 4

When is the equity method not appropriate?

Answer 4

• 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

Question 5

How is the investment accounted for under the equity method?

Answer 5

Investment in investee = Cost + Earnings - Dividends

Question 6

J/E to record initial investment at cost (FV of consideration plus legal fees)

Answer 6

Dr. Investment in investee

Cr. Cash (or C/S & APIC)

Question 7

J/E to record increase by investor’s ownership % of earnings of investee

Answer 7

Dr. Investment in investee

Cr. Equity in earnings/investee incom

Question 8

J/E to record decrease by investor’s ownership % of cash dividends from investee

Answer 8

Dr. Cash

Cr. Investment in investee

Question 9

How are stock dividends accounted for under the equity method?

Answer 9

Memo entry only

Question 10

If an investor company owns both common and preferred stock of an investee company, how is the “significant influence” test met?

Answer 10

Generally met by the amount of C/S owned

Question 11

If an investor company owns both common and preferred stock of an investee company, how is income from the investee calculated?

Answer 11

Includes:

• Preferred stock dividends, and
• Share of earnings available to common shareholders (reduced by preferred dividends)

Question 12

How is a difference between the purchase price and book value of the investee’s net assets accounted for?

Answer 12

The difference is first allocated to the asset fair value (amortized over asset life) and then to goodwill

Question 13

J/E to record amortization of “premium” over related asset life

Answer 13

Dr. Equity in investee income
Cr. Investment in investee

Reduces income from investee

Question 14

What method must be used if a parent company does not consolidate a 50%+ owned sub (b/c lack of control)?

Answer 14

Equity method

Question 15

What method is used to account for joint venture investments?

Answer 15

Equity method

Question 16

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?

Answer 16

Retrospectively

Question 17

When applying the new method (equity) to the prior period, what percentage of ownership should be used?

Answer 17

The prior period’s old percentage (not the new percentage)

Question 18

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?

Answer 18

Prospectively

Question 19

BASE

Answer 19

Beginning balance
Add
Subtract
Ending balance

Question 20

J/E to record the retrospective adjustment to the investment and RE account and write off the unrealized loss on AFS securities

Answer 20

Dr. Investment in investee
Cr. RE
Cr. Unrealized loss on AFS securities

Question 21

Under the equity method, what is recorded as investment income?

Answer 21

The investor’s share of the investee’s earnings

Question 22

If an investor owns preferred stock in an investee, how is the investment accounted for?

Answer 22

Cost method

Dividends = revenue

Question 23

What is the correct accounting for goodwill created in an investment under the equity method?

Answer 23

It is ignored (neither amortized nor tested for impairment)

The entire investment (using equity method) is subject to impairment test

Question 24

When changing from equity to cost method, is retroactive adjustment required?

Answer 24

No

Question 25

In a business combination, what is the valuation of goodwill?

Answer 25

A calculation of the residual paid above the FV of identifiable net assets