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The Equity
Method of
Accounting for
Investments
McGraw-Hill/Irwin
LO 1
Fair-Value Method
Consolidation
Equity Method
The method selected depends upon the degree
of influence the investor has over the investee.
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significantly affect
investees operations
Investment
is made in anticipation
of dividends or market appreciation.
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Cash
Income from Investment
Debit
XXXX
Credit
XXXX
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Credit
XXXX
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Consolidation of
Financial Statements
Required when:
Investors ownership exceeds 50% of
investee
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LO 2
Equity Method
Use when:
Investor has the ability to exercise
significant influence on the
investee operations (whether influence is
applied or not)
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International Standard 28
Investment in Associates
The International Accounting Standards Board (IASB), similar
to FASB, defines significant influence as the power to
participate in the financial and operating policy decisions of the
investee, but it is not control or joint control over those policies.
If investor has 20% or more ownership, it is presumed to have
significant influence, unless it is demonstrated not to be the case.
If investor holds less than 20% ownership, it is presumed it does
not have significant influence, unless influence can be clearly
demonstrated.
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process
Material
intra-entity transactions
Interchange
of managerial personnel
Technological
dependency
percentages
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Equity
Method
20%
Usually lack
of control
or
significant
influence.
Consolidated Financial
Statements
50%
Significant
influence
generally assumed
(20% to 50%
ownership).
100%
Financial
statements of all
related
companies must
be consolidated.
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LO 3
Equity
Method
1. Investor
records
investment at
cost.
1: Same as Fair
Value
2: Investor recognizes
its share (% of
owner-ship)
of investees net
income (net loss)
as an increase
(decrease) in the
investment
account and
3. Records dividends
as a decrease.
2. Investor
recognizes cash
dividends from
investee as
income.
Consolidated
Financial
Statements
One set of
financial
statements are
prepared to
combine accounts
of the investor and
all of its investees
AS A SINGLE
ENTITY.
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XXXX
XXXX
Step 2
Debit Credit
Investment in Investee
Equity in Investee Income
XXXX
If net loss:
Equity in Investee Income
Investment in Investee
Debit Credit
XXXX
XXXX
XXXX
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XXXX
XXXX
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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.
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Reporting a Change
to the Equity Method
Report a change to the equity method if:
An investment that was recorded using the fairvalue method reaches the point where
significant influence is established.
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Equity in Investee
Income (10%)
Retrospective
Adjustment
2012
$7,000
$2,000
$5,000
2013
11,000
4,000
7,000
Total Adjustment to
Retained Earnings:
$12,000
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Examples include:
Discontinued operations
Extraordinary items
Other comprehensive income
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Debit
Credit
Investment in Tiny Company . . . . . . . . . . . 80,000
Extraordinary Loss of Investee. . . . . . . . . . .20,000
Equity in Investee Income . . . . . . . . . . . . . . . . . . . . . . .100,000
To accrue operating income and extraordinary loss from equity
investment.
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LO 4
2.The
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GOODWILL
Equity method goodwill accounts are not
separable from the investment, and are not
separately tested for impairment.
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LO 5
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LO 6
Downstream
Sale
Upstream
Sale
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LO 7
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Summary
Accounting methods used for investments in other
companies depend on percentage of ownership and level
of influence investors can exercise over investees.
If an investor pays more than book value of the investee,
the excess payment is assigned to specific assets,
liabilities, and goodwill.
Intercompany profits on transferred assets are deferred
until the items are consumed or sold to outside parties.
Since 2008, firms may irrevocably elect to report
significant influence investments at fair value instead of
using the equity method.
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