C2-4 - C2-4 Use of the Cost or Equity Method [AICPA...

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Unformatted text preview: C2-4 Use of the Cost or Equity Method [AICPA Adapted] a. Under the cost method, the investor recognizes income as dividends are received from the investee. Under the equity method, an investor recognizes as income its share of an investee's earnings or losses in the periods in which they are reported by the investee. The amount recognized as income under the equity method is adjusted for any change in the remaining amount of the difference between original investment cost and the investor's equity in net assets of the investee at the investment date. One could argue that the equity method is more consistent with accrual accounting than is the cost method because the equity method recognizes income when earned rather than when dividends are received. On the other hand, one could argue that the cost method is more consistent with the realization concept because the income is not recognized by the investor until actually realized by the investor as it is distributed by the investee. b. Madison should have assessed whether it could have exerted significant influence over Boomer's operating and financial policies. Madison did not own 20 percent or more of Boomer's voting stock (which would have led to the refutable presumption that it could exercise significant influence); however, the ability to exercise significant influence may be indicated by other factors such as Madison's provision of three key management personnel and purchase of 25 percent of Boomer's output. c. On becoming a 30 percent owner of Boomer, Madison should use the equity method to account for its investment. As of January 2, 20X8, Madison's investment and retained earnings accounts must be adjusted retroactively to show balances as if the equity method had been used from the initial purchase date. Both accounts should be increased by 18 percent of Boomer's undistributed income since formation. ...
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