Rogers Section 3 Cost & Equity Method

Question 1

When do you use the Cost method or Marketable Securities?

Answer 1

0-20% ownership; no influence over the investee company exists; if security is not marketable then use the cost method

Question 2

When is the Equity method used?

Answer 2

20-50%; when the investor has significant voting influence over the investee

Question 3

When is the consolidation method used?

Answer 3

50% or more; when the investor has control over the investee; when members of the investor company constitute a majority of the board of directors of the investee

Question 4

In the equity method, what is equity in earnings?

Answer 4

equity in earnings is an income statement account and appears under continuing operations; when the investee earns money this is considered a increase in the investor’s books and recorded as “equity in earnings”

Question 5

in the equity methods, how are dividends recorded and where are they recorded?

Answer 5

dividends are a reduction in the investor’s investment account; it is not on the income statement

Question 6

any difference between purchase price paid by the investee and the book value of the investee’s net assets must be accounted for. What is usually the source of this difference?

Answer 6

goodwill, ppe, land, inventory

Question 7

where is the excess of cost of the investment over book value reported?

Answer 7

it is included in the investement and not reported separately

Question 8

What will happen if the difference between cost and purchase is due to depreciable and amortizable assets under the equity method?

Answer 8

differences will be amortized against the reported equity in investee income based on the appropriate life of the asset

Question 9

what will happen if the difference between cost and purchase is due to goodwill, under the equity method?

Answer 9

amount initially recorded will later reduce reported income in periods that impairment losses are recognized

Question 10

what will happen if the differences between cost and purchase is due to other assets, under the equity method?

Answer 10

outstanding differences will be written off against reported income at the time the asset is sold

Question 11

Cost Method

Answer 11

1. ) original investment recorded at cost
2. ) when the investee earns money, NO journal entry is recorded
3. ) when a dividend is received it is recorded as Dividend Income on the income statement NOT a reduction to investment
4. ) no difference in BV and purchase price is taken into consideration

Question 12

Equity Method calculation

Answer 12

FMV-Purchase Price= Goodwill

BV-FMV= changes in PPE or anything else

Question 13

what happens when dividends received under the cost method are greater than the cumulative income earned since the date of investment?

Answer 13

the excess distribution is a return of capital to the investor and is accounted for as a reduction in the carrying value of the investment

Question 14

what happens when an investee declares a stock dividend or issues stock rights or other classes of stock to existing shareholders

Answer 14

no income is reported; the CV of the investment is allocated over the increased quantity of securities- if securities are all of the same class then no entry is needed; if they are part of different classes then an entry is made to transfer part of the CV, using the relative FMV approach

Question 15

cash surrender value

Answer 15

life insurance investment; the portion of the premium that increases the cash value is accumulated as an asset (non-current) on the balance sheet and the rest of the premium is recognized as life insurance expense

Question 16

Equity to Cost

Answer 16

40 to 10%; use the cost method going forward- PROSPECTIVE

Question 17

Cost to Equity

Answer 17

10 to 40%; RETROSPECTIVELY apply the equity method but only for the % you previously owned- this requires a prior period adjustment to reported income

How to calculate: previous net income less previous year dividends= what to increase investment and retained earnings by

Question 18

Under IFRS, when an investment is made in an entity over which it has significant influence…

Answer 18

it is considered an investment in an associate (affiliate) and the equity method is used

1. ) if the investor has control, consolidated financial statements are appropriate
2. ) if the investor shares control in a joint arrangement, the investment will be considered either a joint operation or a joint venture, which will determine the accounting

Question 19

Under IFRS, when an investment is made in an entity over which has an active market

Answer 19

use FVTPL, fair value through profit or loss method; must have an active market to determine its FV

Question 20

Under IFRS joint ventures use

Answer 20

equity method if they share control and have rights to the net assets of the arrangement

proportionate consolidation is joint control do not have rights to the net assets

Question 21

Equity in earnings is an …

Answer 21

income statement account

-debit equity and earnings and credit investments for depreciation and inventory

Question 22

how does an excess of fair values over carrying amounts affect equity in earnings and investments for inventory, PPE, and Land?

Answer 22

Land- no effect
Sale of Inventory- decrease both
Inventory no sale- no change
PPE- decrease
Goodwill impaired- decrease

Question 23

Significant influence is indicated by

Answer 23

having the power to participate in the decisions of the investee

Question 24

AFS (Available for Sale) method of accounting….

Answer 24

purchase- Dr. Investments Cr. Cash
unrealized gain/loss- Dr. Market Adjustment AFS Security (B/S item) Cr. Unrealized gain/loss (B/S item)
Dividends- Dr. Cash Cr. Dividend Income (I/S item)

• initial investment recorded at cost
• DO NOT RECOGNIZE any portion of net income as an increase in investment
• recognize dividend income not decrease in investment
• recognize unrealized gain or loss and report after net income as a component of other comprehensive income
• report the investment amount on balance sheet at FMV (cost plus or minus unrealized gain or loss)

Question 25

what is goodwill?

Answer 25

Asset Value (FMV) less Cost of Asset (Purchase Price)