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Advanced Accouting Exam 1 Outline

Advanced Accouting Exam 1 Outline - Chapter One The Equity...

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Chapter One – The Equity Method of Accounting for Investments Fair-Value Method An investor cannot expect to significantly affect the investee’s operations or decision making Investments are recorded at cost and periodically adjusted to fair value SFAS 115 principles: o Initial investments in equity securities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable; otherwise, the investment remains at cost o Equity securities held for sale in the short term are classified as trading securities and reported at fair value, with unrealized gains and losses included in earnings o Equity securities not classified as trading securities are classified as available-for-sale securities and reported at fair value with unrealized gains and losses excluded from earnings and reported in a separate component of shareholders’ equity as part of other comprehensive income. o Dividends received are recognized as income for both trading and available-for-sale securities. Equity Method Investor is able to influence the amount and timing of dividend distributions Reporting investment income, the equity method requires that the investor recognize income as the investee earns it, not when the investor receives dividends If an investor holds between 20 and 50 percent of the voting stock of the investee, significant influence is normally assumed and the equity method applied ACCOUNTING FOR AN INVESTMENT – THE EQUITY METHOD After recording the cost of the acquisition, two equity method entries periodically record the investment’s impact: o The investor’s investment account increases as the investee earns and reports income The investor recognizes investment income using the accrual method—that is, in the same time period as the investee earns it. EX: If an investee reports income of $100,000, a 30 percent owner should immediately increase its own income by $30,000 o The investor’s investment account is decreased whenever a dividend is collected In contrast, the fair-value method reports investments at fair value if it is readily determinable, and income is recognized only recognized only on receipt of dividends ACCOUNTING PROECEDURES USED IN APPLYING THE EQUITY METHOD Facts: Little Company reported a net income of $200,000 during 2008 and paid cash dividends of $50,000. Big Company records the following journal entries to apply the equity method: (Accrue 20 percent owned investee) Investment in Little Company 40,000 Equity in Investee Income 40,000 (Record receipt of cash dividend) Cash 10,000
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Investment in Little Company 10,000 Reporting a Change to the Equity Method All accounts are restarted so that the investor’s financial statements appear as if the equity method had been applied from the date of the first acquisition Facts: Giant Company acquires a 10 percent ownership in Small Company on Jan 1, 2008. Subsequently on Jan 1, 2010, Giant purchases an additional 30 percent of the Small’s outstanding voting stock.
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