Lecture 3: Cost and Equity Method Flashcards
Equity Method (ASC 323) is used when?
Investor owns 20-50% of equity in another business. Investor has significant influence over the operating and financial policies of the investee. Even if ownership is less than 20%, one must consider how much influence exists.
Factors to consider whether or not the equity security can apply the Equity Method?
Does the investor have:
- significant intercompany transactions or technology dependency
- officers of the investor serving as officers or BOD of investee
- investor is major supplier to investee
- investor owns at least 20% of voting stock of investee, but not if another SH or voting block owns a majority and exercises total control.
- investor has definite plans to acquire more stock to bring their ownership up to at least 20%
Under the equity method, the investment is originally recorded at:
cost
Under the equity method, as the investee earns income it is recorded:
as an increase to the investor’s investment account on the books based on the % owned. This is considered “equity in earnings” and is reported on the IS under continuing operations.
Under the equity method, dividends received are recorded as:
a reduction to the investment account on the investor’s books and increase to cash, does not show on IS
Under the equity method, any differences between purchase price and the book value of the investee’s net assets are recorded as:
a reduction to the investment account and a reduction to “equity in earnings”. These include FMV write up of assets: PPE (Depreciation) Inventory (Written off when sold), Land (not depreciated, written off when sold) and Goodwill (not amortized but impairment losses recognized)
Cost Method (ASC 325) is used when?
no significant influence exists and no market value exists (if did have market value then account for by HFT, AFS, HTM)
Under the Cost Method, the original investment is recorded at:
cost
Under the cost method, when the investee earns money:
the investor records no entry
Under the cost method, when a dividend is received, it is recorded as:
Dividend income on the IS and not a reduction of the investment
dr. cash
cr. dividend income
Under the cost method, when there is a difference between cost and book value:
no entry recorded for excess GW, amortization or depreciation
Under Cost Method, if an investee declares a stock dividend or issues stock rights to existing SH, it is recorded as:
no income reported, the CV of the investment is simply allocated over the increased quantity of securities.
exg. assume client bought 100 shares of stock @ $22/share = $2,200
dr. investment 2200
cr. cash 2200
If investee declares a 10% stock dividend, the the number of shares held by the investor will increase to 110 but no entry is made. The cost basis for each year becomes $20/share. (2200/110)
Cash Surrender Value with purchase of Life insurance
the purchase of life insurance is a form of an investment if it builds up a cash value. if you pay $25 a month but only $15 goes to the expense the $5 goes to investment.
Changes in Ownership % Equity to Cost ( 40% to 10%)
use the cost method moving forward, prospectively.
Changes in ownership % Cost to Equity (10% to 40%)
Retrospectively apply the equity method, but only for the % you previously owned. (10%) This requires a prior period adjustment to reported income.
exg. If bought shares on Jan X1 with 10% ownership and then on May X1 bought an additional 30% bringing ownership up to 40%. From Jan to April you will do a prior period adjustment for NI less any dividends X 10% and then from May to Dec you will use 40%.
