ADVANCED ACCOUNTING (15th Edition) –
EXAMINATION Authors: Joe Ben Hoyle,
Thomas Schaefer, Timothy Doupnik
Prepared for Academic Study
Question 1
Under the equity method of accounting for investments, the investor
recognizes income when:
A) The investee declares a dividend
B) The investee reports earnings in its financial statements
C) The investor receives cash from the investee
D) The fair value of the investment increases
Answer: B
Rationale: Under the equity method, the investor accrues investee income
when it is reported in the investee's financial statements. The investor adjusts
the investment account to reflect all changes in the equity of the investee
company. Dividends declared by the investee create a reduction in the
carrying amount of the Investment account, not income recognition. The fair
value method, not the equity method, recognizes changes in fair value as
income.
Question 2
GAAP guidelines presume the equity method is applicable when an investor
holds what percentage of the outstanding voting stock of the investee?
A) Less than 20%
B) 20% to 50%
,C) More than 50%
D) Exactly 51%
Answer: B
Rationale: GAAP guidelines presume the equity method is applicable if 20 to
50 percent of the outstanding voting stock of the investee is held by the
investor. When an investor holds less than 20%, the fair value method (or cost
method) is typically applied. When an investor holds more than 50%,
consolidation is generally required.
Question 3
When an investor applies the equity method, how are dividends received from
the investee treated?
A) As dividend income on the income statement
B) As a reduction in the investment account
C) As an increase in the investment account
D) As a liability on the balance sheet
Answer: B
Rationale: Dividends declared by the investee create a reduction in the
carrying amount of the Investment account under the equity method. This is
because dividends represent a distribution of the investee's earnings that
have already been recognized as income by the investor. The investment
account is reduced rather than recognizing dividend income, which would
result in double-counting the earnings.
Question 4
Which of the following factors indicates an investor's ability to exercise
significant influence over an investee?
,A) Holding 15% of the investee's voting stock
B) Representation on the investee's board of directors
C) The investee operating in a different industry
D) The investor having no business transactions with the investee
Answer: B
Rationale: Ability to significantly influence investee is indicated by several
factors including representation on the board of directors, participation in
policy-making, and other similar factors. Holding 15% of voting stock is below
the 20% guideline presumption for significant influence. Operating in a
different industry or having no business transactions would not indicate
significant influence.
Question 5
When an investor achieves the ability to exercise significant influence through
a series of stock purchases, how should the change to the equity method be
applied?
A) Retrospectively, restating all prior periods
B) Prospectively from the date significant influence is attained
C) Only when the investee declares dividends
D) Immediately upon the first purchase
Answer: B
Rationale: When the ability to exercise significant influence occurs following
a series of stock purchases, the investor applies the equity method
prospectively. The initial purchase(s) are accounted for by means of the fair
value method (or at cost) until the ability to significantly influence is attained.
The total fair value at the date significant influence is achieved serves as the
basis for prospective application.
Question 6
, Under the equity method, the investor's Investment account is increased by:
A) Dividends received from the investee
B) The investee's reported net income × the investor's ownership percentage
C) The fair value appreciation of the investee's stock
D) The investee's total assets
Answer: B
Rationale: Under the equity method, the investor adjusts the investment
account to reflect all changes in the equity of the investee company. The
investment account is increased by the investor's share of the investee's
reported net income. Dividends received reduce the investment account. Fair
value changes are not recognized under the equity method unless an
impairment occurs.
Question 7
An investor purchased 30% of Investee Company's voting stock for $500,000.
During the year, Investee reported net income of $100,000 and declared
dividends of $40,000. What is the balance in the Investment account at year-
end under the equity method?
A) $500,000
B) $518,000
C) $530,000
D) $488,000
Answer: B ($518,000)
Rationale: Under the equity method, the investment account increases by the
investor's share of investee income ($100,000 × 30% = $30,000) and
decreases by dividends received ($40,000 × 30% = $12,000). Ending balance
= $500,000 + $30,000 − $12,000 = $518,000. The income is recognized when
reported by the investee, and dividends reduce the investment account.
EXAMINATION Authors: Joe Ben Hoyle,
Thomas Schaefer, Timothy Doupnik
Prepared for Academic Study
Question 1
Under the equity method of accounting for investments, the investor
recognizes income when:
A) The investee declares a dividend
B) The investee reports earnings in its financial statements
C) The investor receives cash from the investee
D) The fair value of the investment increases
Answer: B
Rationale: Under the equity method, the investor accrues investee income
when it is reported in the investee's financial statements. The investor adjusts
the investment account to reflect all changes in the equity of the investee
company. Dividends declared by the investee create a reduction in the
carrying amount of the Investment account, not income recognition. The fair
value method, not the equity method, recognizes changes in fair value as
income.
Question 2
GAAP guidelines presume the equity method is applicable when an investor
holds what percentage of the outstanding voting stock of the investee?
A) Less than 20%
B) 20% to 50%
,C) More than 50%
D) Exactly 51%
Answer: B
Rationale: GAAP guidelines presume the equity method is applicable if 20 to
50 percent of the outstanding voting stock of the investee is held by the
investor. When an investor holds less than 20%, the fair value method (or cost
method) is typically applied. When an investor holds more than 50%,
consolidation is generally required.
Question 3
When an investor applies the equity method, how are dividends received from
the investee treated?
A) As dividend income on the income statement
B) As a reduction in the investment account
C) As an increase in the investment account
D) As a liability on the balance sheet
Answer: B
Rationale: Dividends declared by the investee create a reduction in the
carrying amount of the Investment account under the equity method. This is
because dividends represent a distribution of the investee's earnings that
have already been recognized as income by the investor. The investment
account is reduced rather than recognizing dividend income, which would
result in double-counting the earnings.
Question 4
Which of the following factors indicates an investor's ability to exercise
significant influence over an investee?
,A) Holding 15% of the investee's voting stock
B) Representation on the investee's board of directors
C) The investee operating in a different industry
D) The investor having no business transactions with the investee
Answer: B
Rationale: Ability to significantly influence investee is indicated by several
factors including representation on the board of directors, participation in
policy-making, and other similar factors. Holding 15% of voting stock is below
the 20% guideline presumption for significant influence. Operating in a
different industry or having no business transactions would not indicate
significant influence.
Question 5
When an investor achieves the ability to exercise significant influence through
a series of stock purchases, how should the change to the equity method be
applied?
A) Retrospectively, restating all prior periods
B) Prospectively from the date significant influence is attained
C) Only when the investee declares dividends
D) Immediately upon the first purchase
Answer: B
Rationale: When the ability to exercise significant influence occurs following
a series of stock purchases, the investor applies the equity method
prospectively. The initial purchase(s) are accounted for by means of the fair
value method (or at cost) until the ability to significantly influence is attained.
The total fair value at the date significant influence is achieved serves as the
basis for prospective application.
Question 6
, Under the equity method, the investor's Investment account is increased by:
A) Dividends received from the investee
B) The investee's reported net income × the investor's ownership percentage
C) The fair value appreciation of the investee's stock
D) The investee's total assets
Answer: B
Rationale: Under the equity method, the investor adjusts the investment
account to reflect all changes in the equity of the investee company. The
investment account is increased by the investor's share of the investee's
reported net income. Dividends received reduce the investment account. Fair
value changes are not recognized under the equity method unless an
impairment occurs.
Question 7
An investor purchased 30% of Investee Company's voting stock for $500,000.
During the year, Investee reported net income of $100,000 and declared
dividends of $40,000. What is the balance in the Investment account at year-
end under the equity method?
A) $500,000
B) $518,000
C) $530,000
D) $488,000
Answer: B ($518,000)
Rationale: Under the equity method, the investment account increases by the
investor's share of investee income ($100,000 × 30% = $30,000) and
decreases by dividends received ($40,000 × 30% = $12,000). Ending balance
= $500,000 + $30,000 − $12,000 = $518,000. The income is recognized when
reported by the investee, and dividends reduce the investment account.
