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Flashcards in Equity Method of Accounting for Investments Deck (8)
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1
Q

When is the equity method used to account for investments in stocks?

A

when the shareholder has the ability to apply significant influence over an investee.

usually between 20% and 50% ownership

2
Q

What criteria should be examined to determine if an entity has the ability to significantly influence another entity so that the equity method of accounting is used appropriately?

A

investor representation on the board of directors

% of ownership compared to other owners

amount of intra-entity transactions

exchange of management personnel

investor participation in policy making

entity technological dependency on the investor

3
Q

On Jan 1, year 1, B buys 30% of L for $400,000. During year 1, L reports net income of $100,000 and pays cash dividends of $40,000. The entity method is to be applied to this investment.

What does B report as its income from ownership of L?

What is the balance in the investment account within the records of B?

A

B will recognize 30% of L’s reported income (100,000 x .3 = 30,000)

the investment balance is 400,000 to start and is increased by 30,000 income and reduced by the dividends paid 12,000 (40,000 x .3) the investment account balance is 418,000.

4
Q

Assume A buys 30% of Z on Jan 1, year 1, when the book value of Z is $500,000. A pays $170,000.

How much goodwill is in this purchase price? What happens to this goodwill?

A

the book value of Z is 500,000 so 30% of that would be 150,000 since A paid 170,000 the 20,000 over book value is considered goodwill.

goodwill remains in the investment account and under the equity method it is not separately subjected to impairment testing

5
Q

In applying the equity method, how is income from the investee recognized?

In applying the equity method, how are dividends received from the investee recognized?

A

the investor recognizes its portion of income as soon as its earned by the investee

dividends received are not reported as income when the equity method is applied and instead reduces the investment account

6
Q

Assume B buys 40% of Y on Jan 1, year 1, when the book value of Y is $600,000. B pays $300,000. Y has a building that is on its books at $450,000, but it is really worth $500,000.

How much goodwill is included in the purchase price?

A

the book value of Y is 600,000 so 40% of that would be 240,000 since B paid 300,000 the 60,000 over book value must be assigned.

Y has an undervalued building on its books by 50,000 so 40% of that or 20,000 is assigned to the building

60,000 - 20,000 = 40,000 goodwill

7
Q

Assume C buys 40% of X on Jan 1, year 1, when the book value of X is $700,000. C pays $360,000. Y has a building with a 4 year that is on its books at $450,000, but it is really worth $500,000. Any unexplained excess amount is assigned to a databases assumed to have a 20-year life owned by X.

What amount of amortization expense should C recognize in year 1 when applying the equity method?

A

the book value of X is 700,000 so 40% of that would be 280,000 since C paid 360,000 the 80,000 over book value must be assigned.

Y has an undervalued building on its books by 50,000 so 40% of that or 20,000 is assigned to the building

80,000 - 20,000 = 60,000 database

20,000/4 = 5,000 amortization for building

60,000/20 = 3,000 amortization for database

8,000 total amortization expense

8
Q

An entity that owns 30% of another entity applies the equity method. During the current year the investee reported a net income of $200,000 and paid a dividend of $40,000. Amortization relating to the purchase price paid by the investor was $25,000.

How much income should the investor recognizes for this year?

A

the investor recognizes 30% of 200,000 or 60,000 and the income is reduced by the amortization of 25,000 so 35,000 income is recognized

dividends received decrease the investment account but don’t impact its income