I2CH 17 13ed Fall 09

I2CH 17 13ed Fall 09 - Chapter 17, Page 1 of 9 CHAPTER 17...

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Chapter 17, Page 1 of 9 CHAPTER 17 NOTES Temporary and Long-Term Investments APB# 18--Use of the Equity Method of accounting for investments in C.S. When there is less than 50% ownership, 1. An Investor must use the equity method of accounting when a significant influence is exercised over the Investee. Also, any company that is the primary beneficiary of a variable interest entity (VIE) must consolidate with that entity. Various disclosures are also necessary for a VIE. We will not further consider this topic in Ch. 17 of Intermediate II. The topic is covered in Acct. 5140, Advanced Accounting II. 2. An Investor must use the cost method or cost with market valuation per FASB #115 when the Investor does not exercise a significant influence over Investee. Note: Investments over 50% are usually consolidated, but on the parent company s books, the equity method is normally used. Companies must consolidate majority-owned subsidiaries unless control is likely to be temporary, or if control does not rest with the majority owner. Also excluded would be subsidiaries in legal reorganization, in bankruptcy, or operating under foreign exchange restrictions so severe as to cast significant doubt on the parent s ability to control the subsidiary. When there is less than 50% ownership (and investee is not consolidated with the investee), the equity method of accounting for the investment is used if the investor has a significant influence over the investee. The general rule for determining whether or not there is a significant influence is: Ownership > 20% = Significant Influence (use equity method)—Unless there is evidence to the contrary Ownership < 20% = No Significant Influence (use cost or Mkt. Val.)—Unless there is evidence to the contrary An Investor may have ownership of 20% or more and have no significant influence because: 1. No voting influence because other shares are closely held. 2. Hostile takeover--court injunction or agreement not to vote stock. 3. Tries to elect member to board and not successful. 4. Tries to get detailed accounting information, but not successful. An Investor may own less than 20% and have a significant influence over investee because no one shareholder owns a large percentage share, and other shareholders do not organize and vote as a block. This may allow the investor to elect a member to the Board of Directors with an investment of less than 20%.
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Chapter 17, Page 2 of 9 EXAMPLE: Assume R Co. purchases 25% of the outstanding common stock of E Co. in January, 20x6, when the stockholders’ equity of E Co. is: Common Stock (par $25)--------------------$500,000 Additional Paid-in Capital-------------------- 120,000 Retained Earnings----------------------------- 150,000 Total Stockholders Equity---------- 770,000 (x .25 = 192,500) The purchase price of the 5,000 shares was $220,000. During 20x6, E Co. declared and paid cash dividends of $50,000 and reported earnings of $120,000. Assume that R Co. was willing to pay the excess of cost over book value for their interest in E Co. because some of E Co.’s
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This note was uploaded on 09/08/2010 for the course ACCT 3600 taught by Professor Stone during the Spring '10 term at UCM.

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I2CH 17 13ed Fall 09 - Chapter 17, Page 1 of 9 CHAPTER 17...

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