Topic 3 and Topic 4 (FINAL) Flashcards
(82 cards)
1
Q
GAAP-reported four methods to report investments in other companies (B2B):
A
Fair-value method.
Cost method for equity securities without readily determinable fair values.
Consolidation of financial statements.
Equity method
2
Q
What is the GAAP method selection dependent on?
A
the degree of influence the investor (stockholder) has over the investee
3
Q
When do you use the fair-value method?
A
Investor holds a small percentage of equity securities of investee. (usually less than 20%)
4
Q
Initial investments in equity securities when significant influence and control are not present are:
A
Recorded at cost.
Adjusted to fair value if fair value is determinable.
If fair value not determinable, remains at cost
Changes in fair values are recognized as income.
Dividends declared on the securities are recognized as income
5
Q
journal entry for an investor recording investment in the investee at cost
A
Dr. Investment in securities
Cr. Cash (or other
assets/stock)
6
Q
journal entry for an investor recognizing dividend income for cash dividends received from investee
A
Dr. Cash
Cr. Income from investment
7
Q
journal entry for the investor adjustment to the investment account at fair-market value (FMV) if readily determinable at reporting date
If FMV>Cost
A
Dr. Investment
Cr. Unrealized gain on
investment
8
Q
Company X owns 10% of the common stock of Super X corporation and used the fair value method to account for this investment. Super X reported a net income $100,000 for 2020 and paid total dividends of $40,000 on September 1, 2020. How much income should Company X recognize on this investment in 2020?
$6,000
$4,000
$10,000
$60,000
$40,000
A
$4,000
9
Q
What is required when investor’s ownership exceeds 50 percent of an organization’s outstanding voting stock?
A
consolidation of financial statements
10
Q
What happens when a majority of voting stock is held?
A
investor-investee relationship is so closely connected that the two corporations are viewed as a single entity
11
Q
When is the equity method used?
A
Investor has the ability to exercise significant influence on investee operations (whether applied or not). Operating and financial decisions
12
Q
What is the ownership for the equity method?
A
20-50%
13
Q
How are the investor’s share of investee dividends declared recorded under the equity method?
A
as decreases in the investment account, not income.
14
Q
significant influence
A
Representation on the investee’s board of directors.
Participation in the investee’s policy-making process.
Material intra-entity transactions.
Interchange of managerial personnel.
Technological dependency.
Other investee ownership percentages
15
Q
What is the stock ownership level for the fair value or cost method?
A
0-20%
16
Q
What is the stock ownership level for the equity method or fair value?
A
20-50%
17
Q
What is the stock ownership level for consolidated financial statements?
A
50-100%
18
Q
fair value or cost method level of significant influence
A
inability to significantly influence
19
Q
equity method or fair value level of significant influence
A
ability to significantly influence
20
Q
consolidated financial statements level of significant influence
A
control through voting interests: financial statements of all related companies must be consolidated
21
Q
journal entry to record investment for equity method
A
Dr. Investment in investee
Cr. Cash (or other
assets/stock)
22
Q
journal entry to record net income % for equity method
A
Dr. Investment in investee
Cr. Equity in investee income
23
Q
journal entry to record net loss % for equity method
A
Dr. Equity in investee income
Cr. Investment in investee
24
Q
journal entry for the investor to reduce the investment account by the amount of cash dividends received from the investee for the equity method
A
Dr. Cash
Cr. Investment in investee
25
what should be amortized
payment relating to each asset (except land, goodwill, and other indefinite life intangibles)
26
how is goodwill measured for equity method investments
tested for declines in value and impairment
27
journal entry for amortization
Dr. Equity in investee income
Cr. Investment in subsidiary
28
when do you report a change to the equity method
An investment that was recorded using the cost or fair-value method reaches the point where significant influence is established.
When an investment qualifies for use of the equity method, the investor adds the cost of acquiring additional interest in the investee to the current basis and adopts the equity method of accounting [(FASB ASC (para. 323-10-35-33)].
This prospective approach avoids the complexity of restating prior period amounts
29
how does a decline in investment value result
a loss of major customers, changes in economic conditions, loss of a significant patent or other legal right, damage to the company’s reputation, etc.
A temporary drop in the fair value of an investment is simply ignored
30
how is a permanent decline in the investee's fair market value recorded
as an impairment loss and the investment account is reduced to the fair value
31
if part of an investment is sold during the period,
The equity method is applied up to the transaction date.
At the transaction date, the Investment account balance is reduced by the percentage of shares sold.
If significant influence is lost, NO RETROACTIVE ADJUSTMENT is recorded if the investor is required to change FROM the equity method to the fair-value method.
Note: A change TO the equity method is also treated prospectively
32
downstream sales of inventory - investor sales to investee
Profit recognition is delayed until buyer disposes of the goods. *to defer gross profit on sale of inventory to investee
Investor decreases current equity income to reflect the deferred portion of the intra-entity profit.
When this inventory is eventually consumed or sold to unrelated parties, the deferral is no longer needed and the deferral entry is reversed.
33
upstream sales of inventory - investee sales to investor
reported in the same manner as downstream sales.
Profit recognition is delayed until buyer disposes of the goods. *to defer recognition of gross profit until inventory is used or sold to outside parties
Investor decreases current equity income to reflect the deferred portion of the intra-entity profit.
When this inventory is eventually consumed or sold to unrelated parties, the deferral is reversed
34
Perez, Inc. applies the equity method for its 25% investment in Senior, Inc. During 2021, Perez sold goods with a 40% gross profit to Senior. Senior sold all of these goods in 2021. How should Perez report the effect of the intra-entity sale on its 2021 income statement?
Sales and cost of goods sold should be reduced by the amount of intra-entity sales.
Sales and cost of goods sold should be reduced by 25% of the amount of intra-entity sales.
Investment income should be reduced by 25% of the gross profit on the amount of intra-entity sales.
No adjustment is necessary
No adjustment is necessary
35
3 criticisms of the equity method
Emphasizing the 20–50 percent of voting stock in determining significant influence versus control.
Allowing off-balance-sheet financing.
Potentially biasing performance ratios
36
7 reasons or motives for firms to combine
Vertical integration.
Cost savings.
Quick entry for products into markets.
Economies of scale.
More attractive financing opportunities.
Diversification of business risk.
Business expansion
37
why consolidated financial reporting
these financial statements provide more meaningful information than separate statements.
these financial statements more fairly present the activities of the these companies.
these companies may retain their legal identities as separate corporations
38
business combination
Refers to a transaction or other event in which an acquirer obtains control over one or more businesses.
Is formed by a wide variety of transactions or events with various formats.
Can differ widely in legal form.
Unites two or more enterprises into a single economic entity that requires consolidated financial statements
39
statutory merger
Any business combination in which only one of the original companies continues to exist
40
two types of statutory mergers
a. A business combination in which one company obtains all of the assets, and often the liabilities, of another company.
b. A business combination in which one company obtains all of the capital stock of another company. The acquiring company must gain 100 percent control of all shares of stock before legally dissolving the company
41
statutory consolidation
A specific type of business combination that unites two or more companies under the ownership of a newly created company. Two or more companies transfer either their assets or their capital stock to a newly formed corporation
42
control without dissolution
When one company achieves legal control over another by acquiring a majority of voting stock, although control is present, no dissolution takes place. Each company remains in existence as an incorporated operation
43
if dissolution occurs
Dissolved company’s records are closed out. Surviving company’s accounts are adjusted to include appropriate balances of the dissolved company
44
if separate incorporation is maintained
Each company continues to retain its own records. Worksheets facilitate the periodic consolidation process without disturbing individual accounting systems
45
steps if dissolution occurred
1. All account balances are physically consolidated in the financial records of the survivor.
2. Permanent consolidation occurs at the combination date.
3. Dissolved company’s records are closed out.
4. Surviving company’s accounts are adjusted to include appropriate balances of the dissolved company.
46
steps if separate incorporation is maintained
1. Only the financial statement information (on work papers, not the actual records) is consolidated.
2. The consolidation process is carried out at regular intervals whenever F/S are prepared.
3. Each company continues to retain its own records.
4. Worksheets facilitate the periodic consolidation process without disturbing individual accounting systems
47
acquisition method
Required to account for a business combination. It embraces the fair value in measuring the acquirer’s interest in the acquired business
48
Applying the acquisition method involves using fair value to recognize and measure:
The consideration transferred for the acquired business and any noncontrolling interest.
Separately identified assets acquired and liabilities assumed.
Goodwill, or a gain from a bargain purchase.
49
when should fair value of the assets acquired and liabilities assumed in a business combination be determined?
at the acquisition date
50
fair value
The price that would be received from selling an asset or paid for transferring a liability in an orderly transaction between market participants at the measurement date
51
3 valuation techniques
The market approach estimates fair values using other market transactions involving similar assets or liabilities.
The income approach relies on multi-period estimates of future cash flows projected to be generated by an asset. (DCF NPV, IRR)
The cost approach estimates fair values by reference to the current cost of replacing an asset with another of comparable economic utility. i.e. PPE
52
What if the amount paid does NOT EQUAL the Fair Value of the Assets acquired?
If the purchase price is MORE than the Fair Value of the Assets acquired, the difference is attributed to GOODWILL
If the purchase price is LESS than the Fair Value of the Assets acquired, we got a BARGAIN!! And we will record a ”GAIN on Bargain Purchase”
53
when does an exception to the general rule of recording business acquisitions at fair value of the consideration transferred occur?
the rare circumstance of a bargain purchase
54
bargain purchase
The fair value of the consideration transferred by the acquirer is less than the fair value received in an acquisition, which is considered more relevant for asset valuation than the consideration transferred.
A gain is recognized
55
Three additional categories of costs are incurred in business combinations, regardless of whether dissolution takes place:
Attorneys, accountants, investment bankers, and other professionals engaged for combination-related services. These service fees are expensed in the period incurred.
An acquiring firm’s internal costs (secretarial and management time allocated to the acquisition activity). Such indirect costs are reported as current year expenses, too.
Amounts incurred to register and issue securities (if any) in connection with a business combination simply reduce the otherwise determinable fair value of those securities.
56
the acquisition method when separate incorporation is maintained
Significant differences are evident in combinations in which each company remains a legally incorporated separate entity.
Consolidation is only simulated Acquiring company does not physically record the acquired assets and liabilities
Dissolution does not occur; each company maintains independent record-keeping
A worksheet and consolidation entries are employed using data gathered from these separate companies although neither company ever records consolidation worksheet entries in its journals
57
what happens with the acquisition method when the subsidiary is not dissolved?
Prepare a worksheet to consolidate the financial statements of two companies that form a business combination in the absence of dissolution
58
3 key points of the acquisition method when the subsidiary is not dissolved
Fair value is the basis for initial consolidation of subsidiary’s net assets.
Consolidation of financial information is simulated.
Neither company physically records the transaction.
59
consolidation worksheet entries
1. Prior to constructing a worksheet, the parent prepares a formal allocation of the acquisition-date fair value similar to the equity method procedures
2. Acquisition-date financial information for parent (after journal entry for the investment and combination costs) and sub is recorded in the first two columns of the worksheet (sub’s prior revenue and expense already closed).
3. Remove the sub’s equity account balances and remove the Investment in Sub balance (Entry S).
4. Remove the excess payment in the investment account at acquisition date and assign it to the specific accounts indicated by the fair-value allocation schedule (Entry A)
5. Combine all account balances and extend into the Consolidated Totals column.
6. Subtract consolidated expenses from revenues to arrive at net income
60
acquisition date fair value allocations additional issues
Preexisting goodwill recorded in the acquired company’s accounts is ignored in the acquisition-date fair value.
Acquired IPR&D (acquired businesses in-process research and development) is measured at acquisition-date fair value, recognized as an asset, and tested for impairment. It is not amortized until its useful life is determined to be no longer indefinite.
61
What is the typical % range of ownership level when using the equity method of accounting for stock investments? (For example, 0-20%)
20-50%
62
When an investor uses the equity method to account for investments in common stock, the investor's share of cash dividends from the investee should be recorded as
A. a deduction from the investor's share of the investee's profits
B. dividend income
C. a deduction from the stockholders' equity account, Dividends to Stockholders
D. a deduction from the investment account
D. a deduction from the investment account
63
The equity method tends to be most appropriate if
A. an investment represents 50 percent or more of the voting stock of an investee
B. an investment enables the investor to influence the operating and financial decisions of the investee
C. majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to the views of the investor
D. the investor is unable to obtain representation on the investee's board of directors
B. an investment enables the investor to influence the operating and financial decisions of the investee
64
Under fair-value accounting for an equity investment, which of the following affects the income the investor recognizes from its ownership of the investee?
A. the investee's reported income adjusted for excess cost over book value amortizations
B. changes in the fair value of the investor's ownership shares of the investee
C. Intra-entity profits from upstream sales
D. Other comprehensive income reported by the investee
B. changes in the fair value of the investor's ownership shares of the investee
65
Pretend you own your company. If your company purchases an equity investment (i.e. stock in another company) at a price in excess of the investee's book value, the difference must be identified and accounted for correctly in your accounting records (TRUE/FALSE)
True
66
If the difference between the purchase price and the investee's book value cannot be attributed to a specific asset or liability, it is assigned as which intangible asset on your books?
Goodwill
67
What is the term used to describe sales between an investor and its equity method investee?
Intra-entity
68
Hawkins Company has owned 10 percent of Larker, Inc., for the past several years. This ownership did not allow Hawkins to have significant influence over Larker. Recently, Hawkins acquired an additional 30 percent of Larker and now will use the equity method. How will the investor report change?
a. A cumulative effect of an accounting change is shown in the current income statement
b. A retrospective adjustment is made to restate all prior years presented using the equity method
c. No change is recorded; the equity method is used from the date of the new acquisition
d. Hawkins will report the change as a component of accumulated other comprehensive income
c. No change is recorded; the equity method is used from the date of the new acquisition
69
When an equity method investment account is reduced to a zero balance
a. The investor should establish a negative investment account balance for any future losses reported by the investee
b. The investor should discontinue using the equity method until the investee begins paying dividends
c. Future losses are reported as unusual items in the investor's income statement
d. The investment retains a zero balance until subsequent investee profits eliminate all unrecognized losses
d. The investment retains a zero balance until subsequent investee profits eliminate all unrecognized losses
70
Perez, Inc., applies the equity method for the 25 percent investment in Senior, Inc. During 2021, Perez sold goods with a 40 percent gross profit to Senior, which sold all of these goods in 2021. How should Perez report the effect of the intra-entity sale on its 2021 income statement?
a. Sales and cost of goods sold should be reduced by the amount of the intra-entity sales
b. Sales and cost of goods sold should be reduced by 25 percent of the amount of intra-entity sales
c. Investment income should be reduced by 25 percent of the gross profit on the amount of intra-entity sales
d. No adjustment is necessary
d. No adjustment is necessary
71
Creating a huge organization with a widely diverse group of businesses (i.e. conglomerates) is always a reason and the primary motivator for business combinations (TRUE/FALSE)
False
72
During a statutory merger through an asset acquisition, the acquired company will dissolve and go out of business. (TRUE/FALSE)
True
73
The acquisition method uses which method to measure and assess business activity for a business combination? {book value, fair value, pooling of interests, or purchase method}
Fair value
74
Which of the following does not represent a primary motivation for business combinations?
a. Combinations are often a vehicle to accelerate growth and competitiveness
b. Cost savings can be achieved through elimination of duplicate facilities and staff
c. Synergies may be available through quick entry for new and existing products into markets
d. Larger firms are less likely to fail
d. Larger firms are less likely to fail
75
What is a statutory merger?
a. a merger approved by the Securities and Exchange Commission
b. An acquisition involving the purchase of both stock and assets
c. A takeover completed within one year of official tender offer
d. A business combination in which only one company continues to exist as a legal entity
d. A business combination in which only one company continues to exist as a legal entity
76
What is goodwill?
a. An intangible asset representing the excess of consideration transferred over the collective fair values of the net identifiable assets acquired in a business combination
b. An expense that an acquiring firm recognizes for the excess of consideration transferred over the collective fair values of the net identifiable assets acquired in a business combination
c. A concept representing synergies resulting from a business combination but not recognized for financial reporting purposes
d. An internally developed intangible asset that is recognized on a business firm's balance sheet as the business generates profits in excess of normal rate of return on its identifiable net assets
a. An intangible asset representing the excess of consideration transferred over the collective fair values of the net identifiable assets acquired in a business combination
77
FASB ASC 805, "Business Combinations," provides principles for allocating the fair value of an acquired business. When the collective fair values of the separately identified assets acquired and liabilities assumed exceed the fair value of the consideration transferred, the difference should be
a. Recognized as an ordinary gain from a bargain purchase
b. Treated as negative goodwill to be amortized over the period benefited, not to exceed 40 years
c. Treated as goodwill and tested for impairment on an annual basis
d. Applied pro rata to reduce, but not below zero, the amounts initially assigned to specific non-current assets of the acquired firm
a. Recognized as an ordinary gain from a bargain purchase
78
If fair value of the consideration transferred by the acquirer (for example, cash paid to purchase control of another company) exceeds the net identified asset fair value, what is recognized on the financial records?
Goodwill
79
In the example above, if the difference between the fair value of the purchase price is less than the net asset fair value, a bargain purchase is recognized. These combinations are rather rare and create a "Gain on Bargain Purchase" on the financial records (TRUE/FALSE)
True
80
When separate incorporation is maintained during the acquisition method, consolidation is simulated using worksheet entries that do not adjust or eliminate account balances of either the parent or subsidiary (TRUE/FALSE)
True
81
Acquired in-process research and development (IPR&D) is considered an intangible asset always subject to amortization (TRUE/FALSE)
False
82
