,ACCESSTestBankforAdvancedAccounting15thEditionHoyle
w w w w w w w w
Chapter 01 - The Equity Method of Accounting for Investments –
w w w w w w w w w w
Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e
w w w w w w
CHAPTER 1 T w w
w HE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
w w w w w w
Chapter Outline w
I. Four methods are principally used to account for an investment in equity securities alo
w w w w w w w w w w w w w
ng with a fair value option.
w w w w w w
A. Fair value method: applied by an investor when only a small percentage
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o f a company’s voting stock is held.
w w w w w w w w
1. The investor recognizes income when the investee declares a dividend.
w w w w w w w w w
2. Portfolios are reported at fair value. If fair values are unavailable, investment
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is reported at cost. w w w w
B. Cost Method: applied to investments without a readily determinable fair value. Wh
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en the fair value of an investment in equity securities is not readily determinable, a
w w w w w w w w w w w w w w w
nd the investment provides neither significant influence nor control, the investment
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may be measured at cost. The investment remains at cost unless
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1. A demonstrable impairment occurs for the investment, or
w w w w w w w
2. An observable price change occurs for identical or similar investments of the sa
w w w w w w w w w w w w
me issuer. w w
The investor typically recognizes its share of investee dividends declared as dividend in
w w w w w w w w w w w w
come.
w
C. Consolidation: when one firm controls another (e.g., when a parent has a w w w w w w w w w w w
majorit y interest in the voting stock of a subsidiary or control through variable
w w w w w w w w w w w w w w
interests, their financial statements are consolidated and reported for the
w w w w w w w w w w
combined entity.
w w
D. Equity method: applied when the investor has the ability to exercise signific
w w w w w w w w w w w
ant influence over operating and financial policies of the investee.
w w w w w w w w w w
1. Ability to significantly influence investee is indicated by several factors includi
w w w w w w w w w w
ng representation on the board of directors, participation in policy-
w w w w w w w w w w
making, etc. w
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of
w w w w w w w w w w w w w
the outstanding voting stock of the investee is held by the investor.
w w w w w w w w w w w w
Current financial reporting standards allow firms to elect to use fair value for any new i
w w w w w w w w w w w w w w w
nvestment in equity shares including those where the equity method would otherwise a
w w w w w w w w w w w w w
pply. However, the option, once taken, is irrevocable. The investor recognizes both inv
w w w w w w w w w w w w w
estee dividends and changes in fair value over time as income.
w w w w w w w w w w w
1-1
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
,ACCESSTestBankforAdvancedAccounting15thEditionHoyle
w w w w w w w w
Chapter 01 - The Equity Method of Accounting for Investments –
w w w w w w w w w w
Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e
w w w w w w
II. Accounting for an investment: the equity method w w w w w w
A. The investor adjusts the investment account to reflect all changes in the equity of
w w w w w w w w w w w w w
the investee company.
w w w
B. The investor accrues investee income when it is reported in the investee’s financ
w w w w w w w w w w w w
ial statements.
w w
C. Dividends declared by the investee create a reduction in the carrying amount of
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th e Investment account. This book assumes all investee dividends are declared
w w w w w w w w w w w w
and paid in the same reporting period.
w w w w w w w
III. Special accounting procedures used in the application of the equity method
w w w w w w w w w w
A. Reporting a change to the equity method when the ability to significantly influence
w w w w w w w w w w w w
an investee is achieved through a series of acquisitions.
w w w w w w w w w
1. Initial purchase(s) will be accounted for by means of the fair value method
w w w w w w w w w w w w
(o r at cost) until the ability to significantly influence is attained.
w w w w w w w w w w w w
2. When the ability to exercise significant influence occurs following a series of sto
w w w w w w w w w w w w
ck purchases, the investor applies the equity method prospectively. The total
w w w w w w w w w w w
fa ir value at the date significant influence is attained is compared to the
w w w w w w w w w w w w w w
investee’ s book value to determine future excess fair value amortizations.
w w w w w w w w w w w
B. Investee income from other than continuing operations
w w w w w w
1. The investor recognizes its share of investee reported other comprehensi
w w w w w w w w w
ve income (OCI) through the investment account and the investor’s own
w w w w w w w w w w w
OCI. w
2. Income items such as discontinued operations that are reported separately by t
w w w w w w w w w w w
he investee should be shown in the same manner by the investor. The materia
w w w w w w w w w w w w w w
lity of these other investee income elements (as it affects the investor)
w w w w w w w w w w w w
continue s to be a criterion for separate disclosure.
w w w w w w w w w
C. Investee losses w
1. Losses reported by the investee create corresponding losses for the investor.
w w w w w w w w w w
2. A permanent decline in the fair value of an investee’s stock should be recogniz
w w w w w w w w w w w w w
ed immediately by the investor as an impairment loss.
w w w w w w w w w
3. Investee losses can possibly reduce the carrying value of the investment accou
w w w w w w w w w w w
nt to a zero balance. AtMthat point, the equity method ceases to be applicable a
w w w w w w w w w w w w w w w
nd the fair-value method is subsequently used.
w w w w w w w
D. Reporting the sale of an equity investment w w w w w w
1. The investor applies the equity method until the disposal date to establish a pro
w w w w w w w w w w w w w
per book value.
w w w
2. Following the sale, the equity method continues to be appropriate if enough shar
w w w w w w w w w w w w
es are still held to maintain the investor’s ability to significantly influence the inv
w w w w w w w w w w w w w w
estee. If that ability has been lost, the fair-value method is subsequently
w w w w w w w w w w w w
used. w
IV. Excess investment cost over book value acquired
w w w w w w
A. The price an investor pays for equity securities often differs significantly from t
w w w w w w w w w w w w
he investee’s underlying book value primarily because the historical cost base
w w w w w w w w w w w
d accounting model does not keep track of changes in a firm’s fair
w w w w w w w w w w w w w
value.
w
B. Payments made in excess of underlying book value can sometimes be identified w
w w w w w w w w w w w w
ith specific investee accounts such as inventory or equipment.
w w w w w w w w w
C. An extra acquisition price can also be assigned to anticipated benefits that are ex
w w w w w w w w w w w w w
1-2
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
, w pected to be derived from the investment. In accounting, these amounts are presu
w w w w w w w w w w w w
w med to reflect an intangible asset referred to as goodwill. Goodwill is calculated
w w w w w w w w w w w w
1-3
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
w w w w w w w w
Chapter 01 - The Equity Method of Accounting for Investments –
w w w w w w w w w w
Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e
w w w w w w
CHAPTER 1 T w w
w HE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS
w w w w w w
Chapter Outline w
I. Four methods are principally used to account for an investment in equity securities alo
w w w w w w w w w w w w w
ng with a fair value option.
w w w w w w
A. Fair value method: applied by an investor when only a small percentage
w w w w w w w w w w w
o f a company’s voting stock is held.
w w w w w w w w
1. The investor recognizes income when the investee declares a dividend.
w w w w w w w w w
2. Portfolios are reported at fair value. If fair values are unavailable, investment
w w w w w w w w w w w
is reported at cost. w w w w
B. Cost Method: applied to investments without a readily determinable fair value. Wh
w w w w w w w w w w w
en the fair value of an investment in equity securities is not readily determinable, a
w w w w w w w w w w w w w w w
nd the investment provides neither significant influence nor control, the investment
w w w w w w w w w w w
may be measured at cost. The investment remains at cost unless
w w w w w w w w w w w
1. A demonstrable impairment occurs for the investment, or
w w w w w w w
2. An observable price change occurs for identical or similar investments of the sa
w w w w w w w w w w w w
me issuer. w w
The investor typically recognizes its share of investee dividends declared as dividend in
w w w w w w w w w w w w
come.
w
C. Consolidation: when one firm controls another (e.g., when a parent has a w w w w w w w w w w w
majorit y interest in the voting stock of a subsidiary or control through variable
w w w w w w w w w w w w w w
interests, their financial statements are consolidated and reported for the
w w w w w w w w w w
combined entity.
w w
D. Equity method: applied when the investor has the ability to exercise signific
w w w w w w w w w w w
ant influence over operating and financial policies of the investee.
w w w w w w w w w w
1. Ability to significantly influence investee is indicated by several factors includi
w w w w w w w w w w
ng representation on the board of directors, participation in policy-
w w w w w w w w w w
making, etc. w
2. GAAP guidelines presume the equity method is applicable if 20 to 50 percent of
w w w w w w w w w w w w w
the outstanding voting stock of the investee is held by the investor.
w w w w w w w w w w w w
Current financial reporting standards allow firms to elect to use fair value for any new i
w w w w w w w w w w w w w w w
nvestment in equity shares including those where the equity method would otherwise a
w w w w w w w w w w w w w
pply. However, the option, once taken, is irrevocable. The investor recognizes both inv
w w w w w w w w w w w w w
estee dividends and changes in fair value over time as income.
w w w w w w w w w w w
1-1
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
,ACCESSTestBankforAdvancedAccounting15thEditionHoyle
w w w w w w w w
Chapter 01 - The Equity Method of Accounting for Investments –
w w w w w w w w w w
Hoyle, Schaefer, Doupnik, Advanced Accounting, 15e
w w w w w w
II. Accounting for an investment: the equity method w w w w w w
A. The investor adjusts the investment account to reflect all changes in the equity of
w w w w w w w w w w w w w
the investee company.
w w w
B. The investor accrues investee income when it is reported in the investee’s financ
w w w w w w w w w w w w
ial statements.
w w
C. Dividends declared by the investee create a reduction in the carrying amount of
w w w w w w w w w w w w
th e Investment account. This book assumes all investee dividends are declared
w w w w w w w w w w w w
and paid in the same reporting period.
w w w w w w w
III. Special accounting procedures used in the application of the equity method
w w w w w w w w w w
A. Reporting a change to the equity method when the ability to significantly influence
w w w w w w w w w w w w
an investee is achieved through a series of acquisitions.
w w w w w w w w w
1. Initial purchase(s) will be accounted for by means of the fair value method
w w w w w w w w w w w w
(o r at cost) until the ability to significantly influence is attained.
w w w w w w w w w w w w
2. When the ability to exercise significant influence occurs following a series of sto
w w w w w w w w w w w w
ck purchases, the investor applies the equity method prospectively. The total
w w w w w w w w w w w
fa ir value at the date significant influence is attained is compared to the
w w w w w w w w w w w w w w
investee’ s book value to determine future excess fair value amortizations.
w w w w w w w w w w w
B. Investee income from other than continuing operations
w w w w w w
1. The investor recognizes its share of investee reported other comprehensi
w w w w w w w w w
ve income (OCI) through the investment account and the investor’s own
w w w w w w w w w w w
OCI. w
2. Income items such as discontinued operations that are reported separately by t
w w w w w w w w w w w
he investee should be shown in the same manner by the investor. The materia
w w w w w w w w w w w w w w
lity of these other investee income elements (as it affects the investor)
w w w w w w w w w w w w
continue s to be a criterion for separate disclosure.
w w w w w w w w w
C. Investee losses w
1. Losses reported by the investee create corresponding losses for the investor.
w w w w w w w w w w
2. A permanent decline in the fair value of an investee’s stock should be recogniz
w w w w w w w w w w w w w
ed immediately by the investor as an impairment loss.
w w w w w w w w w
3. Investee losses can possibly reduce the carrying value of the investment accou
w w w w w w w w w w w
nt to a zero balance. AtMthat point, the equity method ceases to be applicable a
w w w w w w w w w w w w w w w
nd the fair-value method is subsequently used.
w w w w w w w
D. Reporting the sale of an equity investment w w w w w w
1. The investor applies the equity method until the disposal date to establish a pro
w w w w w w w w w w w w w
per book value.
w w w
2. Following the sale, the equity method continues to be appropriate if enough shar
w w w w w w w w w w w w
es are still held to maintain the investor’s ability to significantly influence the inv
w w w w w w w w w w w w w w
estee. If that ability has been lost, the fair-value method is subsequently
w w w w w w w w w w w w
used. w
IV. Excess investment cost over book value acquired
w w w w w w
A. The price an investor pays for equity securities often differs significantly from t
w w w w w w w w w w w w
he investee’s underlying book value primarily because the historical cost base
w w w w w w w w w w w
d accounting model does not keep track of changes in a firm’s fair
w w w w w w w w w w w w w
value.
w
B. Payments made in excess of underlying book value can sometimes be identified w
w w w w w w w w w w w w
ith specific investee accounts such as inventory or equipment.
w w w w w w w w w
C. An extra acquisition price can also be assigned to anticipated benefits that are ex
w w w w w w w w w w w w w
1-2
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
, w pected to be derived from the investment. In accounting, these amounts are presu
w w w w w w w w w w w w
w med to reflect an intangible asset referred to as goodwill. Goodwill is calculated
w w w w w w w w w w w w
1-3
© McGraw Hill LLC. All rights reserved.MNoMreproductionMorMdistribution without the prior written consent of
w w w w w w w w w w w w
McGraw Hill LLC. w w w
