F5 - M2 - Equity Method

Question 1

When would you want to use the equity method for equity securities?

Answer 1

When you have 20-50% ownership or there is significant influence exercised by the investor to the investee.

Also if you own more than 50% of a subsidiary but you do not consolidate, then you would use the equity method of accounting.

Question 2

What do you have to own 20 to 50 percent of?

Answer 2

Voting stock

Question 3

Under the equity method, what do you do with dividends?

Answer 3

Dividends on common stock are not income, and do not mark to FMV.

Question 4

When is the equity method not applicable?

Answer 4

Bankruptcy, investment is temp, lawsuits, standstill agreement, investor cannot obtain the financial statement, etc.

Question 5

What are the three things with equity method to remember?

Answer 5

No FMV to FMV adjustment

Dividends are not income

Significant influence

Question 6

For the equity method, how do you record the price that is paid

Answer 6

Purchase price + Debt Issued + FMV of stock

Question 7

How would you record dividend income or net income from another company under the equity method?

Answer 7

So let’s say that you own 30% of another company, that would be significant influence, so you would want to use the equity method.

For net income, let’s say the investee has 1,000,000 in net income, you would want to increase your investment by 300,000 which is 30% of that net income. So you would debit the investment, and increase revenue for the amount you got.

For dividends, you would want to reduce your investment by the dividend amount you got. So lets say you got 300,000 per the facts above, since they issued a 1,000,000 dividend. You debit cash, and credit he investment balance.

This would apply if they had income, if they have a loss, then you reduce your investment but you cannot have negative equity from this.

Question 8

What are the main journal entries under the equity method?

Answer 8

Journal Entry to record investment at cost (FV of consideration plus legal fees):

DR: Investment in investee -xxx
CR: Cash -xxx

Journal entry to increase investment through investee’s earnings:

DR: Investment in investee
CR: Equity in earnings/investee income - both reported on income statement

Journal entry to record the decrease in the investments

DR: Cash - No journal entry for stock dividends
CR: Investment in investee

Question 9

What do you report when you have investments from the investee for both common and preferred stock?

Answer 9

Significant influence is normally met by how much common stock is owned. Voting stock

You need to take net income - preferred dividends * ownership to get your equity earnings.

Question 10

Under the equity method what is the difference between the price you paid for the asset and the book value of the investee’s books?

Answer 10

Goodwill

Question 11

For goodwill how is that calculated?

Answer 11

The purchase price over the book value of the equity is goodwill. You have to be able to identify what amount of the extra payment is justified and what is goodwill where you do not know why you spent extra.

Question 12

What is the accounting method for goodwill?

Answer 12

You do not amortize the amount, and it is not subject to a separate impairment test.

Goodwill adds to the carrying value so at least annually you have to test for impairment.

Question 13

So you do not need to amortize the goodwill. Let’s say that you paid 50,000 more than the book value for an investment, but 20,000 you can identify, but 30,000 you cannot because it is goodwill. What do you do with that 20,000?

Answer 13

So you do not need to amortize the goodwill, but you have to amortize the 20,000 based on it’s useful life. That will reduce the investment and the equity.

DR - Equity in investee income -xxx
CR - Investment in Small Co. -xxx

Question 14

Give an example of the BASE acronym for the equity method purchase of investments.

Answer 14

BASE:

Beginning investment - What you paid for the investment

+ Net Income - Your portion of the net income from the investee

• Excess depreciation - The amount of goodwill you can identify
• Dividends - This will reduce your investment

= Ending CV on the investment balance sheet (FMV)

Question 15

What conditions need to be met to record an impairment under the equity method?

Answer 15

The fair value of the investment falls below the carrying value of the investment.

The entity believes the decline in value is other than temporary.

You then record the loss on the income statement.

Question 16

What is the journal entry for an impairment loss?

Answer 16

Journal entry for impairment loss

DR Impairment Loss
CR Investment