far 3-4 Equity Method and Joint Ventrures (External Reporting)

Question 1

Equity Method

Answer 1

Do not consolidate, we don’t control
(20%-50%, exercises significant influence)

The equity method is used to account for investments if significant influence can be exercised by the investor over the investee.

Question 2

What are 2 equity method criteria?

Answer 2

1. Significant influence

2. Between 20% and 50% ownerhip

Question 3

Exercises Significant Influence

Answer 3

• Largest shareholder

- Majority of board

Question 4

The Examination frequently presents questions where the ownership percentage is below 20%, but the “ability to exercise significant influence” exists. The _________ is the correct method of accounting for these investments.

Answer 4

equity method

If you own 10, 12, 14%, but you’re the largest shareholder & you have a majority of the board. That means you do exercise influence, so it could be below 20%, but then you would look for additioanal facts to suggest that you do exercise significant influence.

Question 5

Balance Sheet-“Investment in Investee “ using Equity

Journal entry to record at cost (FV of consideration plus legal fees);

Answer 5

Dr Investment in investee
Cr Cash

If your stock instead of cash,
Cr Common stock - parent
Cr APIC - parent

Question 6

Balance Sheet-“Investment in Investee “ using Equity

Journal entry to record increase by the investor’s/parent’s ownership percentage of earnings of
investee

Answer 6

Dr Investment in investee

Cr Equity in earnings / investee income

Question 7

Balance Sheet-“Investment in Investee “ using Equity

Journal entry to record decrease by the investor’s/parent’s ownership percentage of cash dividends from investee (stock dividends reduce unit cost of stock owned in investee):

Answer 7

Dr Cash

Cr Investment in investee

Question 8

Income Statement - Record the investor’s parent’s ownership percentage of earnings as
income (dividends are not income, treat as bank withdrawals).

Journal entry to record investee earnings (investor’s / parent’s PERCENTAGE OWNERSHIP OF EARNINGS OF INVESTEE):

Answer 8

Dr Investment in investee

Cr Equity in earnings / investee income

Question 9

Pass key

An easy way to remember all the GAAP accounting rules for the equity method” is to think of it like a bank
account and use your base account analysis:

Answer 9

[BASE}
B - Beginning balance

A - Add: Investor’s share of investee’s earning (like bank Interest; it is Income when eamed, not when taken out).

S - Subtract: Investor’s share of investee’s dividends (like bank withdrawals; and it is not Income)

E - Ending balance

Question 10

If stock dividend

Answer 10

If stock dividend = memo entry only

Question 11

Investments in Investee Common Stock and Preferred Stock

Answer 11

1. The “significant influence” test is generally met by the amount of common stock (which is usually the only voting stock).
2. The calculation of the income from subsidiary
   a. Preferred stock dividends, and
   b. Share of earnings

Question 12

Differences between the Purchase Price and Book Value (NBV) of the Investee’s Net Assets

Answer 12

1. Asset Fair Value Differences
   Differences between the book value and fair value of the net assets acquired.
2. Goodwill
   Any remaining difference is goodwill.
3. Amortize Asset Fair Value Difference (Premium) Over Related Asset Life
   Dr Equity in investee income
   Cr Investment in investee
4. Goodwill Difference-Not Amortized and No Impairment Test

Question 13

Pass key

To better understand the journal entry and its impact, think of the amortization of excess purchase price (premium) as a bank service charge. The___________ which we treat like a bank account,will have the account balance (balance sheet asset) reduced by this “bank service charge” and also will have the net earnings from the account reduced by this (service) charge.

Answer 13

“equity method,”

Question 14

Joint Venture Accounting

Answer 14

Under both U.S. GAAP and IFRS, investors generally account for joint venture investments using
the equity method.

Question 15

STEP-BY-STEP ACQUISITION (still not consolidating)

A. Change from Cost Method to Equity Method

Answer 15

When significant influence is acquired, it is necessary to record a change from the cost / available-for-sale classification to the equity method. The investment account and the retained earnings account are adjusted retrospectively for the difference between the available for-sale classification/cost method to the equity method.

Question 16

A. Change from Cost Method to Equity Method:

1. To Equity from Cost

Answer 16

The equity method should be used and the periods during which the cost method (fair value) was used are retrospectively adjusted.

Question 17

A. Change from Cost Method to Equity Method:
2. Equity in Investee Income Calculation

pass key

Answer 17

The key to answering questions relating to this issue correctly Is to:
• Apply the new method (equity) to the PRIOR PERIOD’S OLD PERCENTAGE (1 = < 20%).
• Do not apply the new percentage to the prior period (you did not own that percentage
back then!).