far 3-3 Cost Method (External Reporting)

Question 1

Cost method

Answer 1

< 20% / does not exercise significant influence

Do not consolidate

Question 2

Balance Sheet – Investment in Investee

Answer 2

The carrying amount of the investments account on the investor’s (parent’s) books is “original cost,” measured by the FV of the consideration given, including legal fees.

Question 3

Balance Sheet:

Record at Cost

Answer 3

Journal entry to record all costs of acquisition (FV of consideration plus legal fees):

Dr Investment in investee
Cr Cash

Question 4

Balance Sheet:

Marketable Securities-Adjust to FV

Answer 4

Journal entry to record unrealized loss and adjust to FV at year-end:
Dr Unrealized holding losses
Cr Investment in investee (or valuation account)

Journal entry to record unrealized gain and adjust to FV at year-end.
Dr Investment In Investee (or valuation account)
Cr Unrealized holding gains

Question 5

Balance Sheet:

“COST” ALSO CALLED

Answer 5

1. AVAILABLE FOR SALE

2. FAIR VALUE METHOD

Question 6

Balance Sheet:

Reduce Investment in Investee for Return of Capital Distributions

Answer 6

Journal entry to record a return of capital distribution or liquidating dividend is a DIVIDEND IN EXCESS of investor’s share of retained earnings.
Dr Cash
Cr Investment in investee

Question 7

Income Statement

Answer 7

Record cash dividends from the investee’s retained earnings. DO NOT RECOGNIZE STOCK DIVIDENDS (MEMO ENTRY ONLY).

Question 8

Income Statement:

1. Dividends to the Investor/Parent (from Investee) are Income (Earnings) to the Investor/Parent

Answer 8

Journal entry to record the cost method does not recognize a prorated shore of the investee’s
earnings as income to the investor/parent:
Dr Cash
Cr Dividend income

Question 9

Income Statement:
2. Distribution that Exceeds Investor’s Share of the Investee’s Retained Earnings (reduce basis/return of capital distribution)

Answer 9

Journal entry to record distribution:
Dr Cash
Cr Investment In investee

Question 10

The following three issues are the most frequently tested “cost” concepts:

Answer 10

• The “Investment in Investee” is NOT adjusted for Investee earnings.
• The “Investment In lnvestee” is adjusted to FV.
• Cash dividends from the investee are reported as income by the Investor (parent).