Ch.2_notes_Part I

Ch.2_notes_Part I - Chapter 2 Part I Accounting for Equity...

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Chapter 2 Accounting for Equity Investments Part I Stock Investments - Accounting for Investments in Common Stock. Accounting recognition and valuation depends upon the percentage ownership in the investee. i. If the investor owns less than 20% of the voting stock of the investee, the investor does not have the ability to "exercise significant influence" over the investee, and the fair value/cost method should be used. ii. If the investor owns more than 20% of the voting stock of the investee, investor has the ability to "exercise significant influence" over the investee, and the equity method should be used. iii. If the investor owns more than 50% of the voting stock of the investee, then the investor (the parent company) can control the operations of the investee (the subsidiary), and consolidated financial statements must be prepared (Chapters 3-6). During the year, the parent may account for the subsidiary using either the cost or the equity method because after the consolidating entries, the consolidated financial statements will be the same. However, the consolidation process is easier if the equity method is used. Other advantages in using the equity method are: 1) parent net income will equal consolidated net income, and 2) the symmetry between entries on the books of the parent to account for the subsidiary and the end-of-period working paper entries to consolidate parent and subsidiary. Fair Value/Cost Method Initial investments in common stock are recorded by debiting the "Investment in Investee " account. Dividends earned are recorded by crediting "Dividend Income" or "Dividend
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Ch.2_notes_Part I - Chapter 2 Part I Accounting for Equity...

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