Download Advanced Accounting by Hoyle et al, 6th Edition

Chapter One
The Equity
Method of
Accounting
for
Investments
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.
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Reporting Investments in
Corporate Equity Securities
GAAP recognizes 3 ways to report
investments in other companies:
 Fair-Value Method
Consolidation
Equity Method
The method is selected based upon
the degree of influence the investor
has over the investee.
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Fair Value Method
Used when the investor holds a small
percentage of the investee’s outstanding
stock, and is not able to significantly
affect the investee’s operations.
Investment is made in anticipation
of dividends and/or
market appreciation.
Investments will be classified
as either Trading Securities or
Available-for-Sale Securities.
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Fair Value Method
(Trading vs Available-for-Sale)
Trading Securities
Held for sale in the short term.
Unrealized holding gains and losses are
included in earnings (net income).
Available-for-Sale Securities
Any Securities not classified as
Trading.
Unrealized holding gains and losses
are reported in shareholders’ equity
as other comprehensive income (ie,
not included in net income).
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Consolidation of Financial
Statements
Required when the investor’s
ownership exceeds 50% of investee,
except where control does not actually
rest with the majority investor
 Contractual agreements
 Bankruptcies
 Government restrictions
 One set of financial statements
is prepared which consolidates
all accounts of the parent company and
all of its controlled subsidiary
companies, as though they were a
single entity.

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Equity Method

Used when the investor has
the ability to exercise
significant influence on the
investee operations
 Generally used when
ownership is between 20% and 50%.
 Significant Influence might be
present with much lower ownership
percentages. (The accountant must
consider the particulars!!!)
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What is “Significant” Influence??
(FASB ASC Section 323)
Representation on the
investee’s Board of Directors
Participation in the investee’s
policy-making process
Material intercompany transactions
Interchange of managerial
personnel
Technological dependency
Extent of ownership in
relation to other investor
ownership percentages
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Special Procedures
for Special Situations
Reporting a
change to
the equity
method.
Reporting
investee
losses.
Reporting investee
income from sources
other than continuing
operations.
Reporting the
sale of an equity
investment.
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Reporting a Change
to the Equity Method

An investment that is too small to
have significant influence is recorded
using the fair-value method, but…
 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
FASB ASC (para. 323-10-35-33)
?
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Reporting Investee Income from
Sources other than Operations

When net income includes
elements other than
Operating Income, these
elements should be
presented separately on the
investor’s income statement.

Examples include:
 Discontinued operations
 Extraordinary items
 Prior period adjustments
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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 investment
account is reduced
to the fair value.
A temporary
decline is
ignored!!!
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Reporting the Sale of
an Equity Investment
If part of an investment is
sold during the period . . .
 The equity method continues to be
applied up to the date of the
transaction.
 At the transaction date, a proportionate
amount of the Investment account is
removed.
 If significant influence is lost, NO
RETROACTIVE ADJUSTMENT is
recorded, but the equity method is no
longer applied.
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Excess of Cost Over BV Acquired
When Cost > BV acquired,
the difference must be identified.
Source of the Difference
Accounting
Assets that are
undervalued on the
investee's books
Goodwill
Amortize the difference over the
remaining useful life of the
associated asset.
For fiscal years beginning on or
after Dec. 15, 2001, Goodwill will
be carried forward without
adjustment until the investment is
sold or a permanent decline in
value occurs.
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Unrealized Gains in Inventory
Sometimes affiliated companies sell or
buy inventory from each other.
INVESTOR
Downstream
Sale
INVESTEE
INVESTOR
Upstream
Sale
INVESTEE