F5 M2

Question 1

when is the equity method used?

Answer 1

1) investor has significant influence that can be exercised
OR
2) owns 20 to 50% of voting stock (common stock)

Question 2

when investor has more than 50% ownership?

Answer 2

-consolidation method used and consolidated statements presented
-if parent does not consolidate, use equity method

Question 3

when equity method not appropriate? (BILS FROM)

Answer 3

1) Bankruptcy of subsidiary
2) Investment in subsidiary temporary
3) Lawsuit/complaint filed
4) Standstill agreement (investor surrenders significant rights as shareholder)
5) Majority Ownership of another group
6) no Financial info for investor to apply method
7) no Representation on board of directors

Question 4

investment balance under equity method calculation

Answer 4

beginning investment balance
+ % of net income of investee
- % of dividends of investee
= carrying value of investment balance

Question 5

what happens when an investor’s share of investee’s losses reduces investor’s investment to a zero balance?

Answer 5

the equity method is suspended but then is applied again when investee is making income again and the income is able to offset the investor’s share of net losses

Question 6

journal entry to record initial investment (fair value + legal fees)

Answer 6

Dr. Investment in investee
Cr. Cash

Question 7

journal entry to record increase in investment through share of investee’s net income

Answer 7

Dr. Investment in Investee
Cr. Equity in earnings/investee income

*equity in earnings reported as income on I/S

Question 8

journal entry to record decrease in investment for investor’s share in investee’s cash dividends

Answer 8

Dr. Cash
Cr. Investment in Investee

Question 9

treatment of dividends between common stock and preferred dividends

Answer 9

-% share of common stock where there is either 20-50% ownership or significant influence, dividends treated as return of capital and not income

-% share of preferred dividends is treated as income because there is no voting rights for PS and uses fair value through net income method

Question 10

why might the price paid for the investment differ from the book value of investee’s net assets?

Answer 10

1) differences between fair value of net assets acquired versus book value
OR
2) the difference is goodwill

Question 11

when is purchased goodwill tested for impairment?

Answer 11

-in an acquisition of a controlling interest in another company

Question 12

goodwill

Answer 12

an intangible asset associated with purchasing another company

Question 13

goodwill calculation

Answer 13

=purchase price of investment - fair value of equity acquired * % investment

Question 14

asset fair value difference calculation

Answer 14

=fair value of equity acquired - book value of equity acquired

Question 15

fair value of equity

Answer 15

=fair value of net assets * % of investor ownership

Question 16

net book value of equity

Answer 16

= net book value of net assets * % of investor ownership

Question 17

how do we account for fair value asset differences? Include journal entry

Answer 17

-excess of fair value over net book value is amortized over life of asset (NOT LAND)
-additional amortization causes investors share of investee’s net income to decrease

Dr. Equity in investment income
Cr. Investment in investee

Question 18

goodwill under the equity method

Answer 18

is not tested for impairment and not amortized
-however, total investment should be tested annually for impairment

Question 19

when does an equity method investment impairment occur?

Answer 19

1) fair value of investment < carrying value of investment
2) decline in value is NOT temporary

-both conditions must be met to report impairment loss on I/S
-carry value of investment reduced to lower fair value amt on B/S

Question 20

can an impairment loss be reversed?

Answer 20

Under U.S. GAAP, impairment loss CANNOT be reversed if fair value of investment increases in next periods

Question 21

what are liquidating dividends and how are they accounted for under fair value method? (journal entry)

Answer 21

-a dividend distributed in excess of RE and not treated as dividend income

Dr. Cash
Cr. Investment
Cr. Dividend income

Question 22

how are liquidating dividends treated under the equity method?

Answer 22

-treated as return of capital and not treated as dividend income
-reduce investment balance

Question 23

how to account for the transition to the equity method? (from one method to the other)

Answer 23

1) add cost of additional interest in investee to carrying value of previously held investment
2) adopt equity method as of date and onward. No need for retroactive adjustments

Question 24

what if you have equity securities without readily determinable fair values in transitioning to equity method?

Answer 24

-investment should be remeasured immediately BEFORE the transition

Question 25

what if you have equity securities without readily determinable fair values in transitioning from the equity method?

Answer 25

-investment should be remeasured immediately AFTER the transition

Question 26

how are stock dividends treated for an equity method?

Answer 26

-stock dividends increase number of shares but reduce the unit cost, which has no effect on the investment

-a memorandum entry is recorded that reduced unit cost of investor’s investment

Question 27

retained earnings to calculate a liquidating dividend

Answer 27

=dividend income/% of ownership

Question 28

dividends in calculating a liquidating dividend

Answer 28

=cash received from dividend/% of ownership

Question 29

beg. net book value of equity formula

Answer 29

ending net book value
+ dividends paid
- net income
=net book value of equity in the beginning

Question 30

are stock dividends dividend revenue?

Answer 30

No, only a memo entry is made