An increase in income affects long-term assets, not current assets or current liabilities, so it would have no effect on the current ratio. The assets would be higher so asset turnover would decrease. No other turnover ratios would be affected. Dividends usually decrease the investment account under the equity method so there would be an effect.
Since these are liquidating dividends they would decrease the investment account under the cost method so there would be an effect. There would be at least some dividend recorded. Since these are liquidating dividends a portion of the dividends will go to reduce the investment account thus not all of the dividends received will be income. The portion of dividends received in excess of the share of earnings would cause a reduction in the investment account.
Voting shares can be obtained without gaining significant influence i. Purchasing goods and services would not constitute significant influence over the company, and thus does not result in the equity method being applied. This would result in a write-down of the investment, and does not correlate to the use of the equity method. This simply represents the historical cost of the investment.
It must be adjusted for the income and dividends declared by the investee. Dividends declared by the investee cause a reduction to the investment, not an increase. Net income reported by the investee causes an increase to the investment, not a decrease. Thus, both net earnings and retained earnings would be understated. The cost method does not record any increase to the investment account, thus its balance would be understated when compared to the equity method.
The cost method causes and understatement to the investment account, net earnings and retained earnings. By wrongly classifying this entry, the investment is overstated, and retained earnings are also overstated. Because the dividend entry was recorded incorrectly, the financial position will not be correctly stated. Because the dividends were recorded as dividend revenue, retained earnings would be overstated.
Currently, the investment is overstated because the dividends declared should have resulted in a reduction to the investment account. E Cost versus Equity Reporting a. E Investment Income a. E Fair Value Method a. E Fair Value Recognition a. Stock Cash Record purchase of Montgomery Co. Stock 6, Record dividend from Montgomery Co. Stock 31, Income from Montgomery Co. Stock Cash Record purchase of Thinbill Company. Stock 18, Income from Thinbill Co. E Balance Sheet Worksheet a. Since the buildings and equipment are reported net of accumulated depreciation on the balance sheet, this entry will not affect the worksheet.
However, if sufficient information had been given, this entry would have made a difference in the worksheet balances for Buildings and Equipment and Accumulated Depreciation. Additionally, this entry would impact any footnote disclosure of the details of Buildings and Equipment. Equity Method Entries on Trim Corp. Equity Method Entries on Purple Co. Computation of other comprehensive income reported by Jimm Co. Proportion of ownership held by Dewey Other comprehensive income reported by Jimm Co.
Computation of market value of securities held by Jimm Co. Amount paid by Jimm Co. Equity Method Entries on Peanut Co. Record Peanut Co. The difference must be what was in accumulated depreciation at the date of the acquisition. Note that this assumes there were no sales or other disposals of Building and equipment during the year.
Investment in. Net Income. Note that this entry is carried forward from the previous year see solution to P again assuming that no sales or other disposals of Building and equipment took place during the year. Investment in Income from Snoopy Co. Equity Method Entries on Paper Co. Record Paper Co.
Cost Method Entries on Peanut Co. Investment in Snoopy Co. Acquisition Price Ending Balance. Book Value Calculations: Total. Chapter 3 explains how the basic consolidation process changes when the parent company owns less than percent of the subsidiary. In order to facilitate this new approach, we emphasize that this edition includes elimination entries used in consolidation to facilitate the elimination of the investment in a subsidiary in two steps: 1 first the book value portion of the investment and income from the subsidiary are eliminated and 2 then the differential portion of the investment and income from subsidiary are eliminated with separate entries.
We believe that this approach is more intuitive for students. It presents the criteria used in determining when equity method reporting must be applied, and it fully illustrates and compares both the cost method and equity method. While coverage of this topic may seem to replicate materials presented in the typical intermediate accounting sequence, many students do not have an adequate understanding of the entries recorded on the parent company's books and experience problems with the elimination entries needed in the consolidation process as a result.
The discussion of the cost method includes purchases and sales of additional shares subsequent to the initial investment. The discussion of the equity method significantly extends beyond the cost method coverage to include changes in the number of shares held and retroactive application of the equity method when sufficient additional shares of the investee are acquired to attain significant influence.
Chapter 2 also illustrates the use of fair value option. This chapter briefly discusses interests other than investments in common stock e. Additional Considerations portion of the chapter discusses how to determine significant influence and accounting for investments in subsidiaries.
In this most simple scenario, there is no differential and there is no need to account for a noncontrolling interest. It allows students to become familiar with the consolidation process in the easiest possible scenario. Appendix 2B repeats the consolidation example from the chapter when the parent company uses the cost method instead of the equity method. Understand and explain how ownership and control can influence the accounting for investments in common stock.
Prepare journal entries using the cost method for accounting for investments. Prepare journal entries using the equity method for accounting for investments. Understand and explain differences between the cost and equity methods. Prepare journal entries using the fair value option. Make calculations and prepare basic elimination entries for a simple consolidation. Prepare a consolidation worksheet. Accounting for Investments in Common Stock.
Comparison of the Cost and Equity Methods. Overview of the Consolidation Process. Since instructors often have different styles and preferences, we have attempted to include slides that will accommodate different approaches and that can be adapted to classes with different levels of preparation.
For example, some instructors prefer to introduce the material before students have read the chapter. We have tried to facilitate these types of introductory discussions by including slides that replicate key points from the chapter. Other instructors expect students to have read the chapter and attempted homework problems before coming to class. As a result, they may not find it useful to review all of the topics in the chapter or to include slides that simply review many of the details they expect students to study before class.
However, instructors following. If instructors elect to spend two class periods on the same subject, they might find a combination of both styles to be useful by first introducing foundational material before students have read the chapter and studied the topic, followed by an extended discussion the next class period after students have read the chapter and attempted homework problems. We have tried to develop slides that can facilitate a flexible approach to allow instructors to select the slides that best match their objectives and style for class discussions.
This is the reason we are including over slides for some chapters in the text. We do not expect all instructors to use all slides, but the slide files should help support different teaching approaches and allow instructors to select the subset of slides that best matches their specific discussion objectives. The slides are organized by learning objective. We have included a slide at the beginning of each learning objective to show where the new material begins. Instructors may or may not want to use these learning objective slides in class. We provide them primarily as a way of organizing the material.
We also include short multiple choice questions at the end of most learning objectives.
Finally, we provide longer exercises and problems that many instructors find useful in assessing understanding and encouraging group learning. LO Slides summarize basic concepts related to LO While slide 4 repeats the diagram from the chapter, slide 5 provides a more interactive view of the same concept. Instructors should choose slides from this LO that they deem most important to emphasize to their students Prepare journal entries using the cost method for accounting for investments. Slides summarize basic concepts related to LO related to the cost method.
The simple example in slide 19 allows students to practice cost method journal entries. Instructors should choose slides from this LO that they deem most important to emphasize to their students Prepare journal entries using the equity method for accounting for investments. Slides summarize basic concepts related to LO related to the equity method. The simple example in slides allows students to practice equity method journal entries. Instructors should choose slides from this LO that they deem most important to emphasize to their students. Slides summarize basic concepts related to LO comparing the cost and equity methods.
The example in slides allows students to practice making journal entries under both methods and to easily compare them. Slide 49 summarizes the fair value option and slide 50 provides an example to allow students to practice the fair value option. Slides provide a summary of the consolidation process.
Slide 54 allows the instructor to explain how the worksheet is used to calculate the numbers used in consolidated financial statements. Slides introduce the concept of elimination entries. Slide 57 introduces a comprehensive example to be used to illustrate the consolidation process under the equity method. Slide 58 explain the basic elimination entry and slides show how to make basic book value calculations used in the basic elimination entry. This series of slides provides the foundation for helping students begin to learn how to prepare consolidated financial statements.
Instructors should spend enough time here to ensure that students understand these basic concepts. Slides show students how to set up the worksheet. In slide 63 instructors should explain that the first step in preparing a consolidation worksheet is to enter the numbers from trail balances of the parent and subsidiary into the first two columns of the worksheet. In slide 64, we emphasize that the same line items that are subtotaled in the actual financial statements of the companies need to subtotaled in the elimination entry columns. This is a critical point.
In slide 65 we ask students to introduce the numbers from the basic elimination entry for the Pea Soup example from the previous section into the worksheet. We emphasize that debits and credits in each sub-section need to be sub-totaled. However, it is critical to help students understand that the articulation in the financial statements also applies to the adjustment columns. Since net income carries down to the statement of retained earnings, the sub totals in the elimination entry adjustment columns must be carried down with the net income number. Likewise, since the ending balance in retained earnings carries down from the statement of retained earnings to the balance sheet, the sub totals in the elimination entry columns must be carried down with the retained earnings ending balances.
Emphasize that taking time to pay attention to these details will save students a significant amount of time and headaches in the long run. Slides walk students through the consolidation worksheet one line item at a time. We only do this once in chapter 2. Once students have practiced adding across each row, we assume they can do it on future worksheets.
While this may seem like a tedious exercise and even though this is an advanced financial accounting text , we have found from our experience that students often forget the normal balance in different types of accounts and have trouble remembering whether a debit or credit entry increases or decreases different types of accounts. We find that walking through this exercise one time helps students to remember these basic concepts. Slides provide a detailed comprehensive consolidation example. We have students work this exercise in small groups in class.
Advanced preparation includes either providing students a spreadsheet file or a hard copy similar to slide 73 so that they can work this exercise in class. In slide 74, we ask students to work together to perform the book value calculations. In slide 75, we review the book value calculations and explain which numbers are used in the basic elimination entry. We then ask students to attempt the basic elimination entry in their groups. In slide 76, we show them the answer. Slides allow the instructor to explain the optional accumulated depreciation elimination entry.
In purchasing another company, it is also useful to ensure that the fixed assets of the acquired company appear in the consolidated financial statements as if the acquiring company had acquired those assets on the date of acquisition. This elimination entry nets the accumulated depreciation on the date of acquisition against the cost basis, so that they appear as if they were newly acquired at their net book values on the acquisition date. After having students go through this process with their groups, we show them slide 79 BEFORE having them complete the worksheet. Slide 80 provides the solution.
Appendix 2B Slides repeat the same consolidation example using the cost method. Some instructors like to show students how to perform a consolidation under the cost method. Slides summarize differences between the cost and equity methods. Students could be asked to write a brief memo discussing why companies would be encouraged to invest in the stock of other companies.
A question could be raised as to the trade-off of investing in stock of another company or increasing the capital expenditures of the company for additional fixed assets. What are the economic benefits of investing in another company? Students could be assigned a recent article on investments on the Internet and asked to prepare an executive summary of the article, highlighting its major points for a business executive e. Students could be asked to review the financial statements of a large public company and write a report on their investments.
Students should list the different type of investments, percentage ownership, and method of accounting for the investments. Choice of Accounting Method The criteria used in determining significant influence are reviewed. Students also must specify when investment income will be greater under the cost method and when it will be greater under the equity method.
They should also explain why the use of the equity method becomes more appropriate as the percentage of ownership increases. They should support their findings with citations and quotations from the appropriate literature. Application of the Equity Method Students must review authoritative pronouncements to determine whether the company should utilize the cost or equity method subsequent to the sale of part of its investment. Students must prepare a memorandum to the controller and outline and support their opinion.
Need for Consolidation Process An effective answer to this case requires an understanding of which balances must be eliminated in order to avoid misstating the consolidated balance sheet totals. Account Presentation Students must research authoritative literature to determine the proper way of combining account balances from different subsidiaries. A memorandum that reports findings and provides the necessary supporting references is required. Consolidating an Unprofitable Subsidiary An unprofitable venture is currently consolidated with a profitable entity without separately disclosing the loss.
Students must research the issue to determine if disclosure is necessary, and describe what type of disclosures will be necessary in the financial statement notes or the management discussion. Reference to authoritative literature must be included in a memorandum to the treasurer. Multiple Choice Questions on Intercorporate Investments Two multiple-choice questions deal with conceptual issues related to the cost and equity methods. Acquisition Price Given the net income and dividend payments of an investee for a three-year period and the ending balance in the investment account on the investor's books, the acquisition price paid by the investor is computed under cost and equity method reporting.
Investment Income The investor's income is computed for a four-year period using both the cost and equity methods. Journal entries for the final year are recorded under both methods. Dividends in excess of earnings are paid in the third year. Cost versus Equity Reporting Students must compute the income to be reported for three years under the a cost method and b the equity method. Liquidating dividends exist for the cost method. E 15 min. LO E EA 5 min. LO , LO M. Investment Value Calculation of the investment account balance is required for three consecutive years.
Investee with Preferred Stock Outstanding Journal entries must be given for the investor under the equity method. Preferred stock information is provided. Income Reporting Separate recognition of an extraordinary gain reported by the investee is required on an investor's books. Fair Value Recognition Journal entries are required for all transactions occurring during the year of purchase assuming that the investor utilizes 1 the equity method and 2 the fair value method. Operating income and other comprehensive income reported by the investee is provided.
Other Comprehensive Income Reported by Investee The investee records an operating loss in the first year and a gain in the second year. Dividends are paid in both years. We are now shifting to the analysis of supply decisions.
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