concepts of equity method. - 1 accounting for various investments classification investment in debt...

Concepts of Equity Method. - 1

ACCOUNTING FOR VARIOUS INVESTMENTS

Classification Investment inDebt Securities

Investment inEquity Securities

Control-greater than 50%ownership of voting stock

Not applicable Consolidation

Significant influence - 20% to50% ownership of voting stock

Not applicable Equity method

Debt securities classified as heldto maturity, and equity securitiesfor which fair value is not readilydeterminable

Amortized cost method Cost method

Debt and equity securitiesclassified as trading securities

Fair value method, with unrealized holding gain or lossincluded in earnings

Debt and equity securitiesclassified as available for sale

Fair value method, with unrealized holding gain or lossincluded as a component of comprehensive income/stockholders’ equity


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In some cases, influence or control may exist with less than 20% ownership.

In some cases, influence or control may exist with less than 20% ownership.

Investor Ownership of the Investee’s Shares

Outstanding

0% 20% 50% 100%

Fair Value

Equity Method

Consolidated Financial Statements

Size (of the Investment) Matters!!!

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{Significant influence is generally

assumed with 20% to 50% ownership.

Significant influence is generally assumed with 20% to 50%

ownership.


Outstanding

The Significance of the Size of the Investment

0% 20% 50% 100%

Fair Value

Equity Method


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{Financial Statements of all related Financial Statements of all related companies must be consolidated.companies must be consolidated.

Financial Statements of all related Financial Statements of all related companies must be consolidated.companies must be consolidated.


Outstanding

The Significance of the Size of the Investment

0% 20% 50% 100%

Fair Value

Equity Method


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Criteria for Determining Whether There is “Significant” Influence

(APB Opinion 18)

Representation on the investee’s Board of Directors

Representation on the investee’s Board of Directors

Participation in the investee’s policy-making process

Participation in the investee’s policy-making process

Material intercompany transactions.Material intercompany transactions.

Interchange of managerial personnel.Interchange of managerial personnel.

Technological dependency.Technological dependency.

Extent of ownership in relationship to other investor ownership percentages. Extent of ownership in relationship to other investor ownership percentages.

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Equity Method

Requires that the investor has the potential for “significant” influence.

Generally used when ownership is between 20% and 50%.– Significant Influence might be

present with much smaller ownership percentages. (The accountant must consider the particulars!!!)

Requires that the investor has the potential for “significant” influence.

Generally used when ownership is between 20% and 50%.– Significant Influence might be

present with much smaller ownership percentages. (The accountant must consider the particulars!!!)

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Remember: The ability to exert significant

influence is the determining factor in applying the equity method

No actual influence need have been applied!!

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EQUITY METHODEvidence against Significant

Influence

Investee opposition Investor/investee agreement Closely held majority stockholder Lack of information Lack of board representation


Equity Method

Step 1: The investor records its investment in the investee at cost.

Journal entry:Debit – Investment in Investee

Credit – Cash (or other Assets/Stock)

Cost can be defined by cash paid or the Fair Cost can be defined by cash paid or the Fair Market Value of Stock or Assets given up.Market Value of Stock or Assets given up.

Cost can be defined by cash paid or the Fair Cost can be defined by cash paid or the Fair Market Value of Stock or Assets given up.Market Value of Stock or Assets given up.

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Equity Method

Step 2: The investor recognizes its proportionate (pro rata) share of the investee’s net income (or net

loss) for the period.

Journal entry at end of period:Debit – Investment in Investee

Credit – Equity in Investee Income

This will appear as a separate line-item on the investor’s

income statement.

This will appear as a separate line-item on the investor’s

income statement.

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Equity Method

Step 3: The investor reduces the investment account by the amount

of cash dividends received from the investee.

Journal entry when cash dividends received:Debit – Cash

Credit – Investment in Investee

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Excess of Cost Over BV Acquired

When Cost > BV acquired, the difference must be identified and accounted for.

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When Cost > BV acquired, the difference must be identified and

accounted for.


Excess of Cost Over BV Acquired

The amortization of the difference associated with the undervalued assets is recorded as a

reduction of both the Investment account and the Equity in Investee Income account.

The amortization of the difference associated with the undervalued assets is recorded as a

reduction of both the Investment account and the Equity in Investee Income account.

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Special Procedures for Special Situations

Reporting a change to the equity method.

Reporting a change to the equity method.

Reporting investee income from sources other than continuing

operations.

Reporting investee income from sources other than continuing

operations.

Reporting investee losses.

Reporting investee losses.

Reporting the sale of an equity

investment.

Reporting the sale of an equity

investment.

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?

Reporting a Change to the Equity Method. (Retroactive

Adjustment) An investment that is too small to have

significant influence is accounted for using the fair-value method.

When ownership grows to the point where significant influence is established . . .

. . . all accounts are restated so that the investor’s financial statements appear as if the equity method had been applied from the date

of the first [original] acquisition. - - APB Opinion 18

. . . all accounts are restated so that the investor’s financial statements appear as if the equity method had been applied from the date

of the first [original] acquisition. - - APB Opinion 18

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Reporting Investee Losses

A permanent decline in the investee’s fair market value is recorded as an impairment loss

and the reduction of the investment account to the fair

value.

A permanent decline in the investee’s fair market value is recorded as an impairment loss

and the reduction of the investment account to the fair

value.

A temporary decline is ignored!!!

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Possible Criticisms:

Over-emphasis on possession of 20-50% voting stock in deciding on “significant influence” vs. “control”

Possibility of “off-balance sheet financing”

Potential manipulation of performance ratios

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concepts of equity method. - 1 accounting for various investments classification investment in debt...

Documents

concepts of equity method

equity method evidence

equity method step

fair value equity method

sale fair value method

investor ownership percentages

extent of ownership

debt securities investment