Acctg 322_Ch1_Financial_Deboskey

Front 1

The equity method of accounting for an investment relfects the close relationship that could exist between an investor and investee. T/F

Back 1

True

Front 2

Use equity method when:

Back 2

Owner achieves significant influence over investee'soperating and financial decisions (20-50%)

Front 3

3 approato approaches to the financial reporting of investments in corporate equity securities.

Back 3

1)Fair-Value Method
2)Consolidation of Financial Statements
3)Equity Method

Front 4

The financial statement reporting fora particular investment depends primarily on the degree of influence that the investor (stockholder) has over the investee, a factor typically indicated by the relative size ownership. T/F

Back 4

True

Front 5

Fair Value Method (SFAS 115)
4 basic principles:

Back 5

1) 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
2)Equity Securities held for sale in the short term are classified as trading securities and reproted at fair value, with unrealized gains & losses included in earnings.
3) Equity securities not classified as trading securities are classified as available-for-sale securities and reported at fair value with unrealized gains & losses excluded from earnings & reported in a separate component of shareholders' equity as part of OCI (other comprehensive income)
4)dividends received are recognized as income for both trading and available-for-sale securities

Front 6

Consolidation of Financial Statements - a single set of financial statements is created for external reporting purposes when stockholder accumulates more than 50% of organizations outstandingvoting stock - with all assets, liabilities, revenues, and expenses being brought together. T/F

Back 6

True. However, owning a majority of the voting shares of an investee does not always lead to consolidate financial statements.

Front 7

SPE (Special Purpose Entities) were firms that avoided consolidation of entites in which they owned little or no voting stock but otherwise were controlled through special contracts. This allowed for firms to keep large amounts of assets and liabilities off their consolidated financial statements. T/F

Back 7

True

Front 8

Equity Method -
Especially important is the investor's ability to influence the amount & timing of dividend distributions. Because of this influence, the receipt of dividend from an investee does not qualify as an objective basis for recording income to the investor firm. T/F

Back 8

.True. To provide an objective basis for reporting investment income, the equity method requires that the investor recognize income as the investee earns it, not when the investor receives dividends.

Front 9

The equity method effectively removes managers' ability to use their influence over the timing and amounts of investee dividend distributions to increase current income (or defer income to future periods). This is becaue under the equity method, the investor recognizes incvestee income as it is earned by the investee, not when dividend received. T/F

Back 9

True

Front 10

(FAS159) The Fair Falue Option for Financial Assets and financial Liabilites allows business entities the option to report many financial assets, including those currently accounted for by the equity method, at their fair values.

Back 10

True

Front 11

6 Criteria that indicate the presence of ddegree of influence to utitlize equity method:

Back 11

1) Investor representation on the board of directors of the investee.
2)Investor participation in the policy-making process of the investee
3)Material intercompany transactions
4)Interchange of managerial personnel
5)technological dependency
6)Extent of ownership by the investor in releation to the size and concentration of ofther ownership interests in the investee
(all are evaluated to determine significant influence)

Front 12

If an entitiy can excercise control over its investee, regardless of ownership level, consilidation (rather than the equity method) is appropriate.

Back 12

true.

This type of control could be achieved through contractual and other arrangements called variable interests

Front 13

3 Limitations of Equity Method applicability:

Back 13

1)if an agreement exists between investor and investe by which the investor surrenders significant rights as a shareholder.
2)a concentration of wonership operates the investee without regard for the views of the investor
3) the investor attempts but fails to obtain representation on the investee's board of directors
(The equity method is not applied in any of these situations!!!)

Front 14

Extensions of Equity Method applicability:

Back 14

1)Corporation having significant control despite only owning 13% stock - by being party to a shareowner's agreement with two owner entities for a combined ownership right over 39%.
2)Instances where approval or veto rights granted to minority shareholders restrict the powers of the majority shareholder. Such minority rights - if they are restrictive enought to question the majority owner's control, the euqity method is applied

Front 15

Criteria: Lack of ability to significantly influence
Ownership level: less than 20%

Back 15

Applicable accounting method -
Fair Value (SFAS 115) or Cost

Front 16

Criteria: Presence of ability to significantly influence
Ownership - 20-50%

Back 16

Applicable accounting method:
Equity Method (APB Opinion 18 and SFAS 142) or fair value (SFAS 159)

Front 17

Criteria: Control thorugh voting interests
Ownership - more than 50%

Back 17

Consolidated financial statements (ARB 51, SFAS 141 and 142)

Front 18

Criteria: Control through variable interests (governace documents, contracts)
Ownershipn- Primary beneficiary status (no ownership requires)

Back 18

consolidated financial Statements (FIN46R)

Front 19

Equity method reporting process is important to users of the investor's financial statements because the equity method affects both the timing of income recognition as well as the carrying value of theinvestment account

Back 19

true

Front 20

Equity method:
The investor's investment account increases as the investee earns and reports income. The investor recognizes investment income usitng the accrual method (in the same time period as the investee earns it)

Back 20

True

Front 21

Under the equity method - the investor's investment account is decreased whenever a dividend is collected. (Because distribution of cash dividends reduces the book value of the investee company, the investor mirrors this change by recording the receipt as a decrease in the carrying value of the investment rather than as revenue.

Back 21

true

Front 22

Investee event (application of equity method):
Income is earned

Back 22

Investor accounting under equity method:
proportionalte share of income is recognized

Front 23

Investee event: (applicaiton of equity method):
Dividends are distributed

Back 23

Investor accounting under equity method:
Dividends received are recorded as a reduction in investment

Front 24

Carrying Value of Investment under Equity method =
Income of Little Co 200,000
+Equity in investee income 40,000
- (dividends paid by Little co. $50,000x20% (big co's investment in Little co.)10,000

Back 24

true