Chap 1 the equity method of accounting for investment

8/2/2019 Chap 1 the equity method of accounting for investment

1/14

Chapter One

The EquityMethod of

Accountingfor

Investments

McGraw-Hill/Irwin Copyright 2011 by The McGraw-Hill Companies, Inc. All rights reserved.


2/14

Reporting Investments inCorporate Equity Securities

GAAP recognizes 3 ways to reportinvestments in other companies:

Fair-Value MethodConsolidation

Equity Method

1-2

The method is selected based uponthe degree of influence the investor

has over the investee.


3/14

Fair Value Method1-3

Used when the investor holds a smallpercentage of the investees outstanding

stock, and is not able to significantly

affect the investees operations.Investment is made in anticipation

of dividends and/or

market appreciation.Investments will be classified

as eitherTrading Securities or

Available-for-Sale Securities.


4/14

Fair Value Method(Trading vs Available-for-Sale)

1-4

Trading SecuritiesHeld for sale in the short term.

Unrealized holding gains and losses are

included in earnings (net income).

Available-for-Sale SecuritiesAny 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).


5/14

Consolidation of FinancialStatements

Required when the investorsownership exceeds 50% of investee,except where control does not actuallyrest with the majority investor

Contractual agreementsBankruptcies

Government restrictions One set of financial statements

is prepared which consolidatesall accounts of the parent company andall of its controlled subsidiarycompanies, as though they were asingle entity.

1-5


6/14

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 bepresent with much lower ownershippercentages. (The accountant mustconsider the particulars!!!)

1-6


7/14

What is Significant Influence??(FASB ASC Section 323)

Representation on theinvestees Board of Directors

Participation in the investees

policy-making processMaterial intercompany transactions

Interchange of managerialpersonnel

Technological dependencyExtent of ownership in

relation to other investorownership percentages

1-7


8/14

Special Proceduresfor Special Situations

Reporting achange tothe equitymethod. Reporting investee

income from sourcesother than continuing

operations.Reportinginvestee

losses.Reporting the

sale of an equityinvestment.

1-8


9/14

?

Reporting a Changeto the Equity Method

An investment that is too small tohave significant influence is recordedusing the fair-value method, but

When ownership grows to the point

where significant influence isestablished . . .

. . . all accounts are restated so that the

investors financial statements appearas if theequity method had been applied from the date

of the first [original] acquisition. - - APB

FASB ASC (para. 323-10-35-33)

1-9


10/14

Reporting Investee Income fromSources other than Operations

When net income includeselements other thanOperating Income, theseelements should be

presented separately on theinvestors income statement.

Examples include:

Discontinued operations Extraordinary items

Prior period adjustments

1-10


11/14

Reporting Investee Losses

A permanentdecline in theinvestees fair

market value isrecorded as an

impairment loss andthe investment

account is reducedto the fair value.

A temporarydecline isignored!!!

1-11


12/14

Reporting the Sale ofan Equity Investment

If part of an investment issold during the period . . .

The equity method continues to be

applied up to the date of thetransaction.At the transaction date, a proportionate

amount of the Investmentaccount isremoved.

If significant influence is lost, NORETROACTIVE ADJUSTMENT isrecorded, but the equity method is nolonger applied.

1-12


13/14


14/14

INVESTOR

INVESTEE

INVESTOR

INVESTEE

DownstreamSale

UpstreamSale

Unrealized Gains in Inventory

Sometimes affiliated companies sell orbuy inventory from each other.

1-14

Documents

Chap 1 the equity method of accounting for investment