ch1 - CHAPTER 1 THE EQUITY METHOD OF ACCOUNTING FOR...

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CHAPTER 1 THE EQUITY METHOD OF ACCOUNTING FOR INVESTMENTS A. Three methods are principally used for external financial reporting of an investment in corporate equity securities. 1. Fair value (FASB 115) a. investor owns less than 20% of the voting stock b. neither significant influence nor control are present c. income recognized when dividends are declared d. portfolios reported at market value; if unavailable, report at cost e. classification - trading or available for sale 1. trading securities a. held for the short term b. adjustment to unrealized gains or losses included in earnings 2. available for sale securities a. securities not classified as trading b. adjustment to unrealized gains or losses reported in stockholders’ equity under other comprehensive income 2. Equity method a. Investor owns 20-50% of the voting stock. b. investor must have the ability to significantly influence investee c. Conditions that indicate presence of degree of influence: 1. Representation on the Board of Directors 2. Participation in policy-making process 3. Material intercompany transactions 4. Interchange of managerial personnel 5. Technological dependency 6. Investor relationship in relation to the size and concentration of other owners d. SFAS 159 “The Fair value Option for Financial Assets and Financial Liabilities (2008) allows firms to elect the use of the fair value e. investment account adjusted to reflect all changes in the equity of investee company f. income accrued as soon as it is earned g. dividends reduce the carrying value of the investment account. 3. Consolidation a. Investor controls another company’s voting stock (owns more than 50%) b. control through variable interest (FIN 46R) c. financial statements are consolidated and reported for the combined entity d. consolidated statements must be presented using the equity method B. Accounting for an investment - the Equity Method Chapter 1: Study Notes 1
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1. Two accounts are maintained by the investor: a. Investment in S Company (balance sheet) b. Equity in Investee Income (income statement) 2. The investment account is adjusted by the investor to reflect all changes in the equity of the investee company a. Accrue its percentage share of investee’s income with the following entry: Investment in S Company xxx Equity in Investee Income xxx b. Reduce the carrying amount of the investment account by the percentage share of dividends Cash xxx Investment in S Company Example: On January 1, 2007, Pepper, Inc. purchased a 40% interest in Salt Company for $500,000. Prepare the following entries: 1 . Record the investment 2. Entries for 2007 assuming Salt Co.’s income was $200,000 and dividends paid were $40,000 3 . Entries for 2008 assuming Salt Co.’s income was $180,000 and dividends paid were $40,000. C.
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ch1 - CHAPTER 1 THE EQUITY METHOD OF ACCOUNTING FOR...

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