Chapter 3 - Cost and Equity Method

Question 1

Cost Method/Marketable Securities - Equity Method - Consolidation Chart

Answer 1

Cost Method/Marketable Securities = 0 -20%

• The implications is that no influence over the investee company exists
• If the security isn’t marketable, use the cost method

Equity Method (one-line consolidation) = 20-50%
- The implication is that the investor has significant voting influence over the investee

Consolidation (Section 31) = + 50%

• The implication is that the investor has control over the investee
• Members of the investor company constitute a majority of the board of directors of the investee

Question 2

Equity Method

Answer 2

Used when the investor has significant influence over the operating and financial policies of the investee

This is the method used when an investor owns more than 20% but less 50% of voting shares in an entity:

1. You can own 21-49% and still not have significant influence
   if the investee opposed investor, another investor owns more
   and “blocks” your interests, you don’t have representation on
   the board
2. Also, you can own less than 20% and HAVE significant
   influence if you own the highest % of stock, if you have
   representation on the board, or are technologically interdependent with the investee

Question 3

Cost Method

Answer 3

• Applies only to equity securities with no significant influence
  and when the fair value cannot be easily determined
• The investment is recorded on the balance sheet at cost
• Dividends are recognized

Question 4

If a market value exists, use ___

Answer 4

Market securities rules (trading, available-for-sale, held to maturity)

Question 5

If no market value exists, use___

Answer 5

Cost method

Question 6

Journal entry: Equity Method: Buy - Acquisition of investment at cost

Answer 6

Investment Dr

Cash Cr

Question 7

Journal entry: Equity Method: Investee Earns Money - Investor records % of earnings

Answer 7

Investment Dr

Equity in Earnings Cr

Question 8

Journal entry: Equity Method: Pay a Dividend - % of Cash dividend

Answer 8

Cash Dr

Investment Cr

Question 9

Journal entry: Equity Method: To record Amortization/Depreciation/Impairment of excess between BV and purchase price

Answer 9

Equity in earnings Dr

Investment Cr

Question 10

Journal entry: Cost Method: Buy - Record at Cost

Answer 10

Investment Dr

Cash Cr

Question 11

Journal entry: Cost Method: Record of Earnings -Investee Earns Money

Answer 11

No Entry

Question 12

Journal entry: Cost Method: Record % or earnings

Answer 12

Cash Dr

Dividend Income Cr

Question 13

Journal entry: Cost Method: Amortization/Depreciation of excess

Answer 13

No Entry

Question 14

Equity to Cost

Answer 14

(ownership changes from 40% to 10%) use the cost method going forward (prospective)

Question 15

Cost to Equity

Answer 15

(ownership changes from 10% to 40%) Retrospectively apply the equity method, but only for the % you previously owned. (10%), this requires a prior period adjustment to reported income.

Question 16

Amortized Cost

Answer 16

Any difference between the original cost and the face amount is treated as a discount or premium and the effective interest method of amortization is applied