Adjusted Cost Method and Equity Method

Question 1

When should a company elect the Adjusted Cost Method for the accounting treatment of an investment?

Answer 1

• 0-20% ownership
• no significant influence over the investee
• You can’t determine FMV such as if the investment is shares of stock in a non publicly traded company
• requires election

Question 2

When should a company elect the Equity Method for the accounting treatment of an investment?

Answer 2

• 20-50% ownership
• significant influence over the entity
• investor DOES NOT have a controlling interest in the entity

Question 3

When should a company elect the Consolidation Method for the accounting treatment of an investment?

Answer 3

• The investor has a controlling interest in the Acquiree

Question 4

How should you determine if an investment as a significant influence over an entity?

Answer 4

• Significant intercompany transactions or technological dependcy
• Officers of the investor serving as officers or board members of the investee
• The investor is a major customer or supplier of the investee
• The investor owns at least 20% of the voting stock of the investee provided: no other investor holds a larger voting block, or a small group of investors own a majority of the equity and exercises total control
• The investor has definite plans to acquire additional stock in the future to bring their interest up to at least 20%

Question 5

How is the equity method more consistent with accrual accounting?

Answer 5

The investor recognizes its share of the investee’s income in the period earned, regardless of if or when the income is distributed to equity holders.

Question 6

True or False, a stock dividend is recognized as dividend income?

Answer 6

FALSE

Question 7

What is the equity method accounting approach used for join operations under IFRS known as?

Answer 7

The proportionate consolidation approach.

Question 8

OK Co. uses the equity method to account for its January 1, 20X4 purchase of FDL Inc.’s common stock. On January 1, 20X4, the fair values of FDL’s FIFO inventory and plant exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect OK’s reported equity in FDL’s 20X4 earnings

Answer 8

Inventory - Decrease
Plant - Decrease

Under the equity method, the investor adjusts the portion of the investee’s income recognized to account for differences between the book values of the investee’s assets and liabilities and their fair values. Under FIFO, it is assumed that inventory on hand is sold first and, if the fair value is greater than the carrying value, the difference increases cost of sales, decreasing the investee’s income. Likewise, if the fair value of plant assets is greater than the carrying value, the difference will be allocated over the asset’s depreciable life, increasing depreciation expense and further reducing the investee’s income. The investor will then recognize a proportionate amount of the investee’s adjusted income.

Question 9

How should stock dividends be accounted for?

Answer 9

A stock dividend is the distribution of additional shares of stock, not a payment of cash, and is recognized by spreading the existing basis over the increased number of shares. Not recognized as dividend income.

Question 10

When an entity accounts for investments in common stock under the equity method, it is required by ASC 323 to disclose the following:

Answer 10

• The name of each investee (not investor) and percentage of the entity’s ownership of each investee’s common stock
• The entity’s accounting policies for investments in common stock
• The difference, in any, between the carrying amount of the investment and the amount of the entity’s underlying equity in the investee’s net assets and the entity’s accounting treatment of the difference

Question 11

When applying the equity method, how do you determine significant influence for IFRS?

Answer 11

When the investor has the power to participate in the decisions of the investee.

Question 12

What is Implied goodwill?

Answer 12

In an acquisition accounted for under the equity method, such as a 30% interest in another entity, there is implied goodwill if the cost exceeds a proportionate amount of the fair value of the underlying net assets.

Question 13

Under the equity method, how are dividends on common stock recognized?

Answer 13

As a reduction of the investment NOT dividend income

Question 14

How are dividends on preferred stock recognized ?

Answer 14

Recognized as dividend income