FAR 3 - Cost & Equity Method

Question 1

Equity Method

(20-50%)

Key Points

Answer 1

• Investment originally recorded at Cost
• As investee earns income, Investment account increases and earnings is credited to “Equity in Earnings”
• Dividends are considered as a reduction in Investment
• Difference between purchase price & investees book must be accounted for
  
  • FMV write up of assets
    
    • PPE - Depreciatied
    • Inventory - written off when sold
    • Land - not depreciated, written off when sold
    • Goodwill - not amortized, but impaired losses recognized

Question 2

Cost Method

(0-20%)

Key Points

Answer 2

• Original investment recorded at cost
• NO Journal Entry when investee earns money
• Dividend receive is recorded as Dividend Income (not a reduction in investment)

Question 3

Changes in Ownership Percentages

Equity to Cost

vs.

Cost to Equity

Answer 3

Equity to Cost - (ex 40%-10%) use the cost method going forward (prospectively)

Cost to Equity - (ex 10%>40%) Retrospectively apply the equity method, but only for the % you previously owned, this requires a prior period adjustment to reported net income

Question 4

How to record Investsments under IFRS? 3 Ways

Answer 4

1. Amortized Cost - held to collect interest
2. FVTOCI - Fair Value to OCI - may hold or sell like AVS
3. FVTPL - Fair Value to P&L

Question 5

Fair Value Option for Investment (usually in Equity Method)

Answer 5

Under the fair value option, an entity may report financial instruments, including investments in the stock of another entity, at fair value provided consolidation is not required. With a 30% ownership, Peabody’s investment in Newman would normally require the equity method, but Peabody may, and did, elect the fair value option. Peabody will recognized its $6,000 share of dividends ($20,000 x 30%) as a reduction in the carrying value of the investment, reducing it to $394,000. It is then adjusted to its fair value of $410,000, requiring an increase of $16,000, recognized as income in the period of increase.

NOTE: When electing FV option, calculate income & dividends received/reduction first in investment and THEN write up or down the investment to the FMV amount.

Question 6

Net Income Effect from Equity Investment

Answer 6

Net Income from Investee

• FMV
• Inventory

=NI from Investee * Ownership %

NOTE: Dividends paid out is not subtracted from Investee’s Net Income to get “NI from Investee”

If asking for change in BS include dividends paid out in calculation

If asking for change in IS don’t include dividends paid out but do include FMV write up reductions.