Cost and Equity Method

Question 1

Define: Cost Method

Answer 1

Method of accounting for investment in nonmarketable equity securities involving recognizing the investment at cost and income as dividends are declares, applied when the investor has no significant influence over the investee, typically when ownership is under 20%

Question 2

Define: Equity Method

Answer 2

Method of accounting for investment in nonmarketable equity securities involving recognizing a proportionate share of the investee’s earnings in the period earned, applied when the investor can exercise significant influence over the investee but does not have control, typically when ownership is between 20% and 50%.

Question 3

Define: Consolidation

Answer 3

Preparation of financial statements for two or more entities as if they were a single entity, applied when one entity has a controlling financial interest in another, typically when ownerships exceeds 50%.

Question 4

Define: Applied Prospectively

Answer 4

Applied in the current and future periods requiring no adjustment to prior periods (ex. Change in estimate).

Question 5

Define: Applied Retrospectively

Answer 5

Applied to prior periods requiring adjustment to reflect how financial statements would have appeard if the method had been used originally (ex. Change in accounting principle).

Question 6

Define: Equity to Cost

Answer 6

A loss of significant influence requiring the dicontinuation of the equity method and the prospective application of the cost method.

Question 7

Define: Cost to Equity

Answer 7

A gain of significant influence requiring that the equity method be applied retrospectively to reflect results as if it had been applied from the date the investment was acquired.