Advanced Accounting Modules

Advanced Accounting Modules - MODULE 1: CHAPTER 1 The...

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MODULE 1: CHAPTER 1 The Equity Method of Accounting for Investments Applicability of Alternative Methods If one entity owns less than 20 percent of the common stock of another, the cost method is used. If one entity owns 20 percent to 50 percent of the common stock of another, the equity method is used, since it is considered that the investor can exercise considerable influence on the investee. If over 50 percent of the investee’s voting stock is owned by the investor, consolidation is generally required. (This is covered in Module 2.) The fair value method is used when influence is negligible, which is presumed when ownership interest is less than 20 percent. When using the fair value method, the initial investment is recorded at cost. Income is only realized to the extent of dividends received. Both Trading Securities and Available-for-Sale Securities are carried at market value. Statement of Financial Accounting Standards (SFAS) No. 15 provides more details. Other Things You Should Know about the Equity Method Temporary differences in pretax accounting income and taxable income will occur because the investor shows the investee’s profits for book reporting but dividends for tax reporting. This results in a deferred income tax credit account. The Equity Method of Accounting for Investments If the ownership goes below 20 percent, or if the investor is unable to influence the investee, the equity method is discontinued, but the balance in the investment account is maintained. The fair value method should then be applied. If the investor increases his ownership in the investee to 20 percent or more, the equity method should be used for current and future years MODULE 2: CHAPTER 2 Fundamentals of Consolidation of Financial Information Historically, business combinations have been accounted for as “Purchases” or “Pooling of Interests.” In its SFAS 141, “Business Combinations,” the FASB states that all business combinations should be accounted for using the purchase method. The purchase method is not to be applied retroactively, leaving intact prior poolings of interests. Therefore, it is important to understand how to account for past poolings. In a pooling, one company obtained essentially “all” of the other company’s stock. The
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transaction involved the exchange of common stock. No exchange of cash was allowed. The ownership interests of two or more companies were combined into one new company. No single company was dominant. Precise cost figures were difficult to obtain. To use pooling of interests, strict criteria had to be met. The book values of the two combining companies were joined. No goodwill was recorded. Revenues and expenses were combined retroactively for the two companies. Both companies continued to exist. An Investment in Subsidiary account was recorded on the larger of the companies’ books.
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Advanced Accounting Modules - MODULE 1: CHAPTER 1 The...

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