Section 3 - Cost and Equity Method Flashcards
What are the percentage used for Cost and Equity Method?
0 - 20% Cost method or Marketable securities
- no influence
- if security isn’t marketable, use the cost method
20 - 50% Equity method
-investor has significant voting influence over investee
50% + Consolidation (Section 31)
-investor has CONTROL over the investee
What are some factors to consider when an entity should apply the Equity Method?
20 - 50% SIGNIFICANT INFLUENCE
- Significant intercompany transactions, or technological dependency
- Officers of the investor serving as officers or board members of the investee
- investor is a major customer or supplier of investee
- investors owns at least 20% of voting stock of investee
- investor has definite plans to acquire additional stock in future to bring interest to at least 20%
Equity Method points
- investment recorded at Cost
- investee earns money, this is recorded as an increase in investor’s books based on % investor owns. “equity in earnings” in I/S as component of continuing operations
- dividends received are reduction of investment account and do NOT show up on the I/S
- Differences paid b/w purchase price paid for the investee and the book value of investee’s net assets must be accounted for (FMV, PPE, inventory, land & goodwill)
Equity Method - differences b/w purchase price and b/v
- FMV: write up of assets (FMV increment)
- PPE: depreciated
- Inventory: written off when sold
- Land: not depreciated but written off when sold
- Goodwill: not amortized but impairment losses recognized
How is Preferred Stock recorded under the equity method?
- cannot by itself give an investor significant influence
- under equity method is equal to dividends allocated
What are the Equity Method J/Es?
1) Buy
Investment
Cash
2) Investee earns money
Investment
Equity in earning (I/S)
3) Investee pay dividend
Cash
Investment
4) Amortize/Depreciation/Impairment of excess
Equity in earnings
Investment
When should you not use the Cost Method?
If market value exists:
-use marketable securities rules (trading, avail-for-sale, held to maturity)
If NO market value exists:
-use Cost Method
Cost Method points
- original investment recorded at cost
- investee earns money, NO J/E
- dividend is receive, it is recorded as Dividend Income on I/S (not a reduction of the Investment)
- no difference between BV and purchase price taken into consideration
What is Cost Method - Return of Capital?
Investee declares dividends which exceed the cumulative income it has earned, excess distribution is “return of capital”
Example: investee declares $450 dividend, income earned since investment date is only $400, J/E recorded by a 10% investor would be:
Dividends receivable 45
Dividend income 40
Investment 5
What are Cost Method J/Es?
1) Buy
Investment
Cash
2) Investee pay dividend
Cash
Dividend income
- *Investee earns money - NO J/E
- *Amortize/Depreciation/Impairment of excess - NO J/E
How to record Changes in ownership percentages?
- Equity to Cost - use Cost Method going forward (prospectively)
- Cost to Equity - Retrospectively apply the Equity Method only for the % you previously owned. This requires a prior period adjustment to reported income
Cost to Equity - Retrospectively J/E
(Net income - Dividends) * % of ownership in previous year = Adjustment amount
Investment XX
Retained earnings XX
***Net income and dividends are from year of Cost Method
What are IFRS 3 Method to Equity Investment?
1) Amortized Cost
2) Fair value through other comprehensive income (FVTOCI)
3) Fair value through profit or loss method (FVTPL)
- impairment including in adjustment to fair value and reported in INCOME
What method is used under IFRS - Significant influence?
- use Equity Method
- ‘significant influence” means that investor has authority and power to participate in policy decisions
**if investor has control, must consolidate f/s
What method is used under IFRS - Joint venture?
- use Equity Method
- joint arrangement, those who share control also have rights to net assets
