Advanced Accounting Ch. 2 - Reporting Intercorporate...

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Reporting Intercorporate Interests 2 Accounting for Investments in Common Stock 0. The method used to account for investments in common stock depends: 0. On the level of influence or control that the investor is able to exercise over the investee 1. On choices made by the investor because of options available Financial Reporting Basis by Level of Common Stock Ownership 0. Consolidation involves combining for financial reporting the individual assets, liabilities, revenues, and expenses of two or more related companies as if they were part of a single company 0. Consolidation normally is appropriate when one company, referred to as the parent, controls another company, referred to as a subsidiary 1. A subsidiary that is not consolidated with the parent is referred to as an unconsolidated subsidiary and is shown as an investment on the parent’s balance sheet 1. The equity method is used when the investor exercises significant influence over the operating and financial policies of the investee and consolidation is not appropriate 2. May not be used in place of consolidation if consolidation is appropriate 3. Its primary use is in reporting nonsubsidiary investments 2. The cost method is used for reporting investments in equity securities when both consolidation and equity-method reporting are inappropriate The Cost Method 1. Used when the investor lacks the ability either to control or to exercise significant influence over the investee 2. Accounting Procedures 2. The cost method is consistent with the treatment normally accorded noncurrent assets 3. At the time of purchase, the investor records its investment in common stock at the total cost incurred in making the purchase 4. The investment continues to be carried at its original cost until the time of sale 5. Income from the investment is recognized as dividends are declared by the investee 6. Recognition of investment income before a dividend declaration is inappropriate
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The Cost Method - Illustration The Cost Method 3. Declaration of dividends in excess of earnings since acquisition 4. Liquidating dividends - Dividends declared by the investee in excess of its earnings since acquisition by the investor from the investor’s viewpoint 5. The investor’s share of these liquidating dividends is treated as a return of capital, and the investment account balance is reduced by that amount 6. These dividends usually are not liquidating dividends from the investee’s point of view 4. Acquisition at interim date 7. Does not create any major problems when the cost method is used 8. Potential difficulty - liquidating dividend determination 5. Changes in the number of shares held 9. Changes resulting from stock dividends, stock splits, or reverse splits receive no formal recognition in the accounts of the investor 6. Purchases of additional shares 10.Recorded at cost similar to initial purchase 11.New percentage ownership is calculated to determine whether switch to the equity method is required
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