FAR 19 - Significant Influence - Equity Method Flashcards Preview

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Flashcards in FAR 19 - Significant Influence - Equity Method Deck (28):
1

When an investor acquires sufficient voting common stock of an investee so that it has significant influence, which, if any, of the following kinds of investee data must the investor "capture" at the time the investment is made?
Book values of assets & liabilities
Fair values of assets & liabilities

Both. At the time an investor acquires sufficient voting stock of an investee to give it significant influence over the investee, it must "capture" both the book values and fair values of the investee's assets and liabilities in order to apply the equity method of accounting to the investment.

2

In which one of the following cases is an investor most likely to use the equity method to carry and report an investment in an investee?
A. Investor owns 15% of the voting stock of the investee and has no other affiliation with the investee.
B. Investor owns 40% of the voting stock of the investee, and the investee is in bankruptcy.
C. Investor is a manufacturing firm that owns 25% of the voting stock of a consulting firm.
D. Investor owns 30% of the voting stock of the investee but is unable to obtain representation on the investee's Board of Directors or obtain significant information from the investee.

C. An investor that owns 25% of the voting stock of an investee, in the absence of evidence to the contrary, is presumed to be able to exercise significant influence over the investee. The fact that the investor and the investee are in different lines of business generally does not mitigate the influence the investor is able to exercise.

3

Green Corp. owns 30% of the outstanding common stock and 100% of the outstanding noncumulative nonvoting preferred stock of Axel Corp. Green's 30% ownership of common stock gives it significant influence over Axel.
In 2004, Axel declared dividends of $100,000 on its common stock and $60,000 on its preferred stock. Green exercises significant influence over Axel's operations.
What amount of dividend revenue should Green report in its Income Statement for the year ended December 31, 2004?

$60,000
Only the dividends received on the preferred stock are recognized as revenue: $60,000 = 100% x ($60,000). The common stock investment is accounted for under the equity method, which treats all dividends received as a return of capital. Dividends reduce the investment account under this method.

4

Lee, Inc. acquired 30% of Polk Corp.'s voting stock on January 1, 2004 for $100,000. During 2004, Polk earned $40,000 and paid dividends of $25,000. Lee's 30% interest in Polk gives Lee the ability to exercise significant influence over Polk's operating and financial policies.
During 2005, Polk earned $50,000 and paid dividends of $15,000 on April 1 and $15,000 on October 1. On July 1, 2005, Lee sold half of its stock in Polk for $66,000 cash.

What should the gain on sale of this investment in Lee's 2005 Income Statement be?

$12,250, the correct gain amount, and the amount equals the proceeds of $66,000 less the carrying value of the 1/2 of the investment sold.

Lee uses the equity method because it has significant influence over the investee. The equity method requires that the investor recognize its share of undistributed earnings of the investee in its own income.
The carrying value of the portion of the investment sold reflects 1/2 of the entire income of the investee for 2005, but only the first dividend. The second dividend was declared after the sale and thus could not have affected the investment carrying value on the date of sale.

The carrying value of the entire investment at the date of sale equals:
$100,000 + .30[$40,000-$25,000 + .5($50,000)-$15,000] = $107,500.

The gain, therefore, equals: $66,000-.5($107,500) = $12,250

5

Pal Corp.'s 2004 dividend income included only part of the dividend received from its Ima Corp. investment. The balance of the dividend reduced Pal's carrying amount for its Ima investment. This reflects that Pal accounts for its Ima investment by the:
A. Fair Value method, and only a portion of Ima's 2004 dividends represent earnings after Pal's acquisition.
B. Fair Value method, and its carrying amount, exceeded the proportionate share of Ima's market value.
C. Equity method, and Ima incurred a loss in 2004.
D. Equity method, and its carrying amount exceeded the proportionate share of Ima's market value.

A. The portion of the dividend reducing the investment carrying value is a liquidating dividend. A liquidating dividend occurs when the investee pays more income than was earned during the period the investor owned the shares of the investee.
For example, assume that Pal held 1% of Ima's outstanding stock from January 1-December 31 of 2004 only. Ima earned $40,000 during 2004 but paid $50,000 in dividends ($10,000 coming from earnings before 2004). Pal would receive $500 dividends in total (1%), but only $400 are attributable to earnings during the period Pal was a shareholder. Thus, $100 of the dividend is attributable to income earned by Ima before Pal became an investor. From Pal's viewpoint, this is a return of a portion of Pal's investment, a liquidating dividend.

Under the cost method, liquidating dividends are treated as a reduction in the investment account whereas normal dividends are treated as income. The wording of the question implies that dividends are otherwise treated as income. Thus, the equity method could not be the method used by the firm.

Under the equity method, all dividends are treated as a reduction in the investment account. No dividends received are treated as income under the equity method.

6

Larkin Co. has owned 25% of the common stock of Devon Co. for a number of years, and has the ability to exercise significant influence over Devon. The following information relates to Larkin's investment in Devon during the most recent year:
Carrying amount of Larkin's investment in Devon at the beginning of the year $200,000
Net income of Devon for the year 600,000
Total dividends paid to Devon's stockholders during the year 400,000

What is the carrying amount of Larkin's investment in Devon at year end?
A. $100,000
B. $200,000
C. $250,000
D. $350,000

C. Larkin's investment in Devon at year end would be computed as the carrying amount of the investment at the beginning of the year ($200,000) + Larkin's share of Devon's reported net income for the year ($600,000 x .25 = $150,000)-Larkin's share of Devon's dividends paid during the year ($400,000 x .25 = $100,000), or $200,000 + $150,000 = $350,000-$100,000 = $250,000, the correct answer.

7

When the equity method is used to account for investments in common stock, which of the following affects the investor's reported investment income?
Goodwill amortization related to purchase
Cash dividends from investee

Neither. Under the equity method of accounting for an investment, neither amortization of goodwill nor dividends from the investee affect the investor's investment income. Goodwill resulting from an investment in another entity (i.e., the excess of the cost of the investment over the investor's share of the fair value of the investee's identifiable assets) is not amortized. Dividends from the investee are not recognized as income; rather, they reduce the investment account.

8

Lee, Inc. acquired 30% of Polk Corp.'s voting stock on January 1, 2004 for $100,000.
During 2004, Polk earned $40,000 and paid dividends of $25,000. Lee's 30% interest in Polk gives Lee the ability to exercise significant influence over Polk's operating and financial policies. During 2005, Polk earned $50,000 and paid dividends of $15,000 on April 1 and $15,000 on October 1.
On July 1, 2005, Lee sold half of its stock in Polk for $66,000 cash.

The carrying amount of this investment in Lee's December 31, 2004 Balance Sheet should be:

A. $100,000
B. $104,500
C. $112,000
D. $115,000

B. $104,500 = $100,000 + .30[$40,000-$25,000] because the equity method is used by Lee, who has significant influence over Polk.
Under the equity method, the investor recognizes its share of undistributed earnings in the investee, since acquiring the investment, in its income.

9

When the equity method is used to account for investments in common stock, which one of the following affect(s) the investor's reported investment income?
A change in market value of investee's common stock
Cash dividends from investee

Neither. Under the equity method of accounting, changes in the market value of the investee's common stock are ignored. Further, cash dividends received by the investor from the investee are not recognized as investment income; rather they are recognized as a debit to cash and a reduction in (credit to) the investor's investment in investee account.

10

Grant, Inc. acquired 30% of South Co.'s voting stock for $200,000 on January 2, 2004.
Grant's 30% interest in South gave Grant the ability to exercise significant influence over South's operating and financial policies. During 2004, South earned $80,000 and paid dividends of $50,000. South reported earnings of $100,000 for the six months ended June 30, 2005, and $200,000 for the year ended December 31, 2005. On July 1, 2005, Grant sold half of its stock in South for $150,000 cash. South paid dividends of $60,000 on October 1, 2005.

In Grant's December 31, 2004 Balance Sheet, what should the carrying amount of this investment be?

$209,000
Grant uses the equity method because it has significant influence over South. Under the equity method, the investor recognizes its share of the undistributed earnings of the investee as an increase in the investment carrying value. Thus, at the end of 2004, the carrying value of the investment is $200,000 + .30($80,000-$50,000) = $209,000.

11

Pare, Inc. purchased 10% of Tot Co.'s 100,000 outstanding shares of common stock on January 2, 2004, for $50,000.
On December 31, 2004, Pare purchased an additional 20,000 shares of Tot for $150,000. There was no goodwill as a result of either acquisition, and Tot had not issued any additional stock during 2004. Tot reported earnings of $300,000 for 2004.

What amount should Pare report in its December 31, 2004, Balance Sheet as investment in Tot?

$230,000 This question is difficult because it is easy to forget that once the investor has acquired a sufficient percentage of the stock to use the equity method, which is retroactively applied to earlier periods for which the holdings were not sufficient to use the equity method. In these earlier periods, only the actual ownership percentage is applied.
In this question, the equity method becomes the required method only at the very end of the year. So, only the 10% is used in applying the equity method for the purpose of recognizing income, which in turn increases the investment account.
The ending balance of the investment account is then: $50,000 (original investment) + $150,000 (second investment) + $30,000 (.10 x $300,000, which is the equity in earnings of the investee) = $230,000.

12

Lee, Inc. acquired 30% of Polk Corp.'s voting stock on January 1, 2004 for $100,000. During 2004, Polk earned $40,000 and paid dividends of $25,000.
Lee's 30% interest in Polk gives Lee the ability to exercise significant influence over Polk's operating and financial policies. During 2005, Polk earned $50,000 and paid dividends of $15,000 on April 1 and $15,000 on October 1. On July 1, 2005, Lee sold half of its stock in Polk for $66,000 cash.

Before income taxes, what amount should Lee include in its 2004 Income Statement as a result of the investment?
A. $40,000
B. $25,000
C. $12,000
D. $7,500

C. $12,000 = .30($40,000). Under the equity method, the investor recognizes its share of investee earnings in its own income. The equity method is used because Lee has significant influence over Polk.

13

Peel Co. received a cash dividend from a common stock investment. Should Peel report an increase in the investment account if it accounts for the investment as held-for-trading or uses the equity method of accounting?
Held-for-trading
Equity method

Neither. A dividend never increases the investment account under any accounting method.
Under the cost method, the dividend is recorded as revenue. Under the equity method, the dividend is recorded as a decrease in the investment account.

14

T/F: A gain or loss on the sale of an investment accounted for using the equity method would be determined as the difference between the selling price and the original cost of the investment.

False.
would be the difference between the selling price and the book value of the investment at the time of sale.
If SP > BV = realize gain
If SP

15

T/F: An investor's write-off of a portion of an excess payment (cost > book value) will reduce the amount of Investment (Equity) Revenue that would otherwise be recognized by the investor.

True

16

T/F: If the cost of an investment for a portion of the stock of a company is greater than the fair market value of the net assets acquired, the excess payment is for goodwill.

True

17

T/F: An investment that will have to be accounted for using the equity method should be initially recorded at cost.

True

18

T/F: Under the equity method of accounting for investments, the investor does not recognize prior period adjustments recognized by the investee.

False.
They do recognize prior period adjustments recognized by the investee.

19

T/F: An investor's write-off of a portion of a bargain purchase (cost

False.
An investor's write-off of a portion of an excess payment (cost > book value) will reduce the amount of Investment (Equity) Revenue that would otherwise be recognized by the investor.

20

T/F: If an investor properly switches from the fair value method to the equity method of accounting for an investment, the net income of prior periods must be adjusted.

True

21

Which of the following is not required under IFRS with respect to equity method accounting?
A. The accounting policies of the "associate" must conform with the accounting policies of the investor.
B. Any investor can elect to apply the fair value option to the accounting for the "associate."
C. The reporting dates for the investor and "associate" cannot be more than 3 months apart.
D. Any impairment loss on an equity investment is measured as the carrying value less the recoverable amount.

B. Under IFRS, the fair value option can only be applied by certain investors such as venture capitalist, mutual funds or unit trusts.

22

According to IFRS guidance on equity method accounting, under what circumstances would the investor be required to recognize the associate's (investee's) losses that exceed the investor's investment?

I. The associate's return to profitability is imminent and assured.
II. The investor has guaranteed the obligations and commitments of the associate.

II only.
If the investor has obligations or commitments to make payments on behalf of the associate, it may continue to recognize its share of losses to the extent of those obligations.

23

Which of the following methods may a mutual fund investor use to measure and report an equity method investment under IFRS?
Fair Value method
Equity method

Both. Under IFRS, only certain investors can elect to measure the equity investee using the fair value option. Mutual fund investors are allowed to utilize the fair value option.

24

T/F: Under IFRS, significant transactions and events of an investee that occur between the end of an equity method investee's accounting period and the later end of the investor's accounting period must be adjusted in the equity amounts reported by the investor.

True

25

T/F: Under IFRS, investees accounted for using the equity method are identified as "associates."

True

26

T/F: IFRS requires that an investor apply uniform accounting policies in its use of the equity method.

True

27

T/F: U.S. GAAP requires that an investor and its investees accounted for using the equity method must use the same accounting policies.

False.
The investor and investee can use different accounting policies in accounting for using the equity method.

28

T/F: Under both U.S. GAAP and IFRS, any investor may elect to account for an investment in an entity over which it has significant influence using fair value, instead of the equity method.

False

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