Significant Influence - Equity Method

Question 1

When an investor has significant influence over the operating and financial policies of an investee, what method must be used to account for the investment in the investee?

Answer 1

The investment has to be carried on the investor’s books and reported in the investor’s financial stmts using the full equity method of accounting

Question 2

Identify the three major equity items recognized each period by the investor.

Answer 2

1. Recognize investor’s share of investee’s net income/loss
2. Recognize investor’s share of investee’s dividends declared
3. Recognize the effects of any difference between the cost of the investment assignable to the fair value of investor’s amortizable assets and the book value of those assets

Question 3

At the time the investor makes an investment that gives it significant influence over an investee, what information must the investor determine in order to use the equity method of accounting?

Answer 3

At the time of the investment, the investor must determine:

1. BV of assets and liabilities of investee
2. FV of assets and liabilities of the investee
3. Allocation of any difference between cost of investment and FV of investee’s assets and liabilities

Question 4

What is the required accounting if a change in an investor’s level of ownership results in a loss of significant influence, but the entire investment is not disposed of?

Answer 4

The investor must stop using the equity method, and use the fair value instead (either as AFS or trading). The investment is adjusted to FV at the date the significant influence is lost and any difference between FV and the prior equity-based carrying amount will be recognized as a gain or loss in current income

Question 5

At the time an investment gives the investor significant influence, but not control, over an investee, how will any difference between the cost of the investment and the book value of the investee’s assets and liabilities be allocated?

Answer 5

To adjust an investee’s assets and liabilities to FV, then

1. If cost > FV of investee’s net assets, to goodwill; OR
2. If cost

Question 6

What are the elements that enter into the determination of revenue recognized from an equity method investment?

Answer 6

Investor’s share of investee’s reported net income/loss +/- depreciation/amortization on excess of cost of investment over BV = net revenue

Dividends received do NOT enter determination of the investor’s revenue recognized; they reduce the investment account

Question 7

Do dividends received enter into the determination of net revenue under the equity method of accounting?

Answer 7

No, dividends received reduce the investment account because the investor has a significant influence on the investor, dividends declared decreases earnings which affects the investor

Question 8

Under what conditions will an investment give the investor significant influence, but not control over the investee?

Answer 8

When and investor owns 20-50% of the voting equity securities of an investee and there are no impediments to the investor exercising its voting rights to influence the investee’s operating and financial policies. Investments in non-voting equity securities or in debt securities does not convey influence

Question 9

What indicators of significant influence are there when ownership is <20%?

Answer 9

• Has representation on board of directors
• Participates in investee policy making
• Has material intercompany transactions
• Is technologically interdependent with investee
• No other single investor has material voting ownership of the investee

Question 10

What indicators of no significant influence are there when ownership is >20%?

Answer 10

• Investee opposes investment
• Standstill agreement between investor-investee
• Significant influence or control is exercised by others
• Investor lacks information to use the equity method (rare)
• Investor cannot obtain representation on the board of directors

Question 11

What are the entries to record investee’s net income/loss?

Answer 11

Net income:
Dr. Investment in Investee
Cr. Investment Income

Net loss:
Dr. Investment loss
Cr. Investment in Investee

Question 12

What are the items of OCI that might change equity?

Answer 12

• Unrealized G/L on AFS securities
• Foreign currency items
• Pension and post retirement benefit items not recognized in period cost

Question 13

In an investor switches from fair value to equity method, what happens to net income?

Answer 13

The net income of prior periods must be adjusted

Question 14

What is the entry to record cash dividend paid out by investee?

Answer 14

Dr. Dividends receivable

Cr. Investment in Investee

Question 15

How is a gain/loss on a sale of investment under the equity method accounted for?

Answer 15

Gain/loss on sale is the difference between selling price and book value

If SP>BV = Realize gain
If SP<BV = Realize loss

Question 16

In its financial statements, Pulham Corp. uses the equity method of accounting for its 30% ownership of Angles Corp. At December 31, 2005, Pulham has a receivable from Angles.
How should the receivable be reported in Pulham’s 2005 financial statements?

Answer 16

The total receivable should be disclosed separately.

Although the equity method is often called a “one-line” consolidation, intercompany receivables remain separate from the investment account. Intercompany profit or loss is eliminated but that affects the income recognized by Pulham, not the receivable.

Question 17

What’s the difference between U.S. GAAP and IFRS in terms of how an investee is referred to?

Answer 17

U.S. GAAP - no special term

IFRS - referred to as “associates”

Question 18

Who can apply fair value option to equity investees under IFRS?

Answer 18

Only certain investors - venture capital orgs, mutual funds, unit trusts