Equity Method of Accounting for Investments Flashcards
(14 cards)
What are the two main reasons firms invest in other firms’ equity shares?
- Seek returns through dividends and stock value appreciation
- Influence decisions by electing board members
What are the four different approaches to financial reporting of investments in corporate securities recognized by GAAP?
- Fair-value method
- Cost method
- Consolidation
- Equity method
When is the Fair-Value method used and how are they recorded on the Balance Sheet?
The Fair-Value method is used when an investor possesses only a small percentage of an investee’s company’s outstanding stock, perhaps only a few shares. Initial investment in equity securities are recorded at cost.
How are changes in the fair values of equity securities recognized and how are dividends declared recognized?
The changes in fair values and declared dividends during a reporting period are recognized as income.
What is the Fair Value Hierarchy?
Level 1: Quoted prices in active markets for identical assets or liabilities.
Level 2: Observable inputs other than quoted prices, such as quoted prices for similar assets or liabilities in active markets.
Level 3: Unobservable inputs, such as internal data or assumptions
When is the cost method used?
When the investor has minimal influence over the investee, typically defined as owning less than 20% of the investee’s voting shares
When is consolidation of financial statements used?
When the investor has control over an investee’s operations by owning more than 50% of the investee’s voting shares. At this point, the two corporations are seen as a single entity for reporting purposes.
When is the equity method used?
When the investor is able to exercise a significant influence over the investee by owning between 20% - 50% of the voting stock of this investee.
When applying the equity method, how should the investor account for the following investee events?
1. Income is recognized
2. Dividends are declared
- Proportionate share of income is recognized
- Investor’s share of investee dividends reduce the investment account
What journal entry is made to account for investee earnings using the equity method?
Investment in Investee Company
Equity in Investee Income
What journal entry is made to account for investee declaring dividends using the equity method?
Dividend Receivable
Investment in Investee Company
What journal entry is made to account for collection of cash dividend issued by investee using the equity method?
Cash
Dividend Receivable
What is goodwill?
Goodwill is an intangible assets that represents the excess amount paid over the fair value of the identifiable net assets of the acquired company.
What journal entry is made to record amortization of excess amount paid for identifiable net assets?
Equity in Investee Income
Investment in Acquired Company
