Section 3 - Cost and Equity Method

Question 1

What are the percentage used for Cost and Equity Method?

Answer 1

0 - 20% Cost method or Marketable securities

• no influence
• if security isn’t marketable, use the cost method

20 - 50% Equity method
-investor has significant voting influence over investee

50% + Consolidation (Section 31)
-investor has CONTROL over the investee

Question 2

What are some factors to consider when an entity should apply the Equity Method?

Answer 2

20 - 50% SIGNIFICANT INFLUENCE

• Significant intercompany transactions, or technological dependency
• Officers of the investor serving as officers or board members of the investee
• investor is a major customer or supplier of investee
• investors owns at least 20% of voting stock of investee
• investor has definite plans to acquire additional stock in future to bring interest to at least 20%

Question 3

Equity Method points

Answer 3

• investment recorded at Cost
• investee earns money, this is recorded as an increase in investor’s books based on % investor owns. “equity in earnings” in I/S as component of continuing operations
• dividends received are reduction of investment account and do NOT show up on the I/S
• Differences paid b/w purchase price paid for the investee and the book value of investee’s net assets must be accounted for (FMV, PPE, inventory, land & goodwill)

Question 4

Equity Method - differences b/w purchase price and b/v

Answer 4

• FMV: write up of assets (FMV increment)
• PPE: depreciated
• Inventory: written off when sold
• Land: not depreciated but written off when sold
• Goodwill: not amortized but impairment losses recognized

Question 5

How is Preferred Stock recorded under the equity method?

Answer 5

• cannot by itself give an investor significant influence

- under equity method is equal to dividends allocated

Question 6

What are the Equity Method J/Es?

Answer 6

1) Buy
Investment
Cash

2) Investee earns money
Investment
Equity in earning (I/S)

3) Investee pay dividend
Cash
Investment

4) Amortize/Depreciation/Impairment of excess
Equity in earnings
Investment

Question 7

When should you not use the Cost Method?

Answer 7

If market value exists:
-use marketable securities rules (trading, avail-for-sale, held to maturity)

If NO market value exists:
-use Cost Method

Question 8

Cost Method points

Answer 8

• original investment recorded at cost
• investee earns money, NO J/E
• dividend is receive, it is recorded as Dividend Income on I/S (not a reduction of the Investment)
• no difference between BV and purchase price taken into consideration

Question 9

What is Cost Method - Return of Capital?

Answer 9

Investee declares dividends which exceed the cumulative income it has earned, excess distribution is “return of capital”

Example: investee declares $450 dividend, income earned since investment date is only $400, J/E recorded by a 10% investor would be:

Dividends receivable 45
Dividend income 40
Investment 5

Question 10

What are Cost Method J/Es?

Answer 10

1) Buy
Investment
Cash

2) Investee pay dividend
Cash
Dividend income

• *Investee earns money - NO J/E
• *Amortize/Depreciation/Impairment of excess - NO J/E

Question 11

How to record Changes in ownership percentages?

Answer 11

• Equity to Cost - use Cost Method going forward (prospectively)
• Cost to Equity - Retrospectively apply the Equity Method only for the % you previously owned. This requires a prior period adjustment to reported income

Question 12

Cost to Equity - Retrospectively J/E

Answer 12

(Net income - Dividends) * % of ownership in previous year = Adjustment amount

Investment XX
Retained earnings XX

***Net income and dividends are from year of Cost Method

Question 13

What are IFRS 3 Method to Equity Investment?

Answer 13

1) Amortized Cost
2) Fair value through other comprehensive income (FVTOCI)

3) Fair value through profit or loss method (FVTPL)
- impairment including in adjustment to fair value and reported in INCOME

Question 14

What method is used under IFRS - Significant influence?

Answer 14

• use Equity Method
• ‘significant influence” means that investor has authority and power to participate in policy decisions

**if investor has control, must consolidate f/s

Question 15

What method is used under IFRS - Joint venture?

Answer 15

• use Equity Method

- joint arrangement, those who share control also have rights to net assets

Question 16

What method is used under IFRS - Joint operation?

Answer 16

• use proportionate consolidation approach
• joint arrangement, those with joint control do not have rights to net assets

**investor measures and recognizes proportionate amount of operation’s assets, liabilities, revenues and expenses on f/s