Lesson 7

Question 1

When an investor has an investment of 20% or more, the investor must account for the investment using what method of accounting?

Answer 1

Equity Method

Question 2

What is the equity method?

Answer 2

The investor and the investee acknowledge a substantive economic relationship.

Question 3

How does the equity method work?

Answer 3

The investor’s proportionate share o the earnings (losses) of the investee periodically increases (decreases) the investment’s carrying amount. Cash dividends received by the investor from the investee also decrease the investment’s carrying amount.

It recognizes that investee’s earnings increase investee’s net assets, and that investee’s losses and dividend decrease these net assets.

Question 4

Koehn Corporation accounts for its investment in the common stock of Sells Company under the equity method.

How should Koehn Corporation ordinarily record a cash dividend received from Sells as?

Answer 4

A reduction of the carrying value of the investment

Question 5

When a company holds between 20% and 50% of the outstanding stock of an investee, what criteria must be met to account with the equity method?

Answer 5

The investor should use the equity method to account for its investment unless circumstances indicate that it is unable to exercise “significant influence” over the investee.

Question 6

Under the equity method of accounting for investments, when should an investor recognizes its share of the earnings?

Answer 6

When earnings are reported by the investee in its financial statements

Question 7

Foucault Company owns 40,000 of the 100,000 outstanding shares of Mango Inc. common stock. During 2020, Mango earns $640,000 and pays cash dividends of $480,000. If the beginning balance in Foucault’s investment account was $430,000, what is the balance at December 31, 2020?

Answer 7

$494,000

The balance of investment account is the following: $430,000 (Beginning Investment Balance) + ($640,000 (Net Income) x (40,000 /100,000)) - ($480,000 (Dividends) x 40,000 / 100,000) = $494,000.

Question 8

Under the equity method, if an investee company generates net income, what transaction should the investor company make?

Answer 8

Records its proportionate share as an increase in its investment account