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Unformatted text preview: App D - Reporting and Interpreting Investments in Other Corporations Appendix D Reporting and Interpreting Investments in Other Corporations ANSWERS TO QUESTIONS 1. The appropriate method of accounting for investments in another corporation depends on the level of involvement the investor has over the investee. When the investor controls the investee, the consolidation method is appropriate. Control is presumed to exist when the investor owns over 50 percent of the outstanding shares of voting common stock. When the investor exerts a significant, but not controlling, influence over the investee, the equity method is appropriate. Significant influence is presumed to exist when the investor owns from 20 to 50 percent of the outstanding shares of voting common stock. When the investor has little involvement with the investee (the investment is passive, usually representing less than 20 percent of the investee’s voting stock), a market value method is appropriate. 2. The accounting methods used for securities available for sale and trading securities differ primarily in how holding gains or losses are recorded and reported. If the passive investment consists of securities available for sale, these holding gains or losses are reported as a component of stockholders’ equity and are not entered into the income statement. If the passive investment consists of trading securities, these holding gains or losses are reported in the income statement just like gains and losses on other assets and, as part of net income, are closed into retained earnings every year. 3. The primary differences between passive investments and equity method investments (i.e., those involving a significant influence) involve the recording and reporting of the investee’s net income and dividends. The investor’s share of the investee’s net income is recorded as investment income for equity method investments because the investor influences the investee’s income-generating process when significant influence exists, but not when the investment is passive. The investor’s share of dividends paid by the investee is recorded as investment income and is reported on the income statement for passive investments. For equity method investments, dividends are not recorded as investment income but instead are recorded as reductions in the investment. The final difference between the two methods is that passive investments are reported at market value whereas equity method investments are reported at cost, adjusted for the investor’s share of net income minus dividends. D-1 App D - Reporting and Interpreting Investments in Other Corporations 4. Investments involving significant influence are accounted for using the equity method whereas those involving control are accounted for using the consolidation method. The primary difference between the equity and consolidation methods is that the equity method reports the investment in a single account whereas the consolidation method involves combining all of the accounts of the investee with...
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