ACCT 404 Exam 1

What are the four recognized approaches to financial reporting of investments in corporate equity securities?

1. Fair-value method
2. Cost method for equity securities without readily determinable fair values
3. Consolidation of financial statements
4. Equity method

What fair-value method procedures are followed when the shareholder possesses neither significant influence nor control over the investee?

Initial investments in equity securities are recorded at cost and subsequently adjusted to fair value if fair value is readily determinable. Otherwise, the investment remains at cost.
Changes in the fair values of equity securities during a reporting period are recognized as income.
Dividends declared on the equity securities are recognized as income.

When do we use the fair value method?

Investor holds a small percentage of equity securities of investee.
Investor cannot significantly affect investee's operations.
Investment is made in anticipation of dividends or market appreciation.

What conditions indicate that an investor has significant influence over an investee?

Investor representation on the board of directors of the investee.
Investor participation in the policy-making process of the investee.
Material intra-entity transactions.
Interchange of managerial personnel.
Technological dependency.
Extent of ownership by the investor in relation to the size and concentration of other ownership interests in the investee.

How do we treat excess cost over book value that cannot be attributed to a specific asset or liability?

Assign to the intangible asset goodwill.

What evidence would indicate permanent reductions in the fair value of an investee?

absence of an ability to recover the carrying amount of the investment or inability of the investee to sustain an earnings capacity that would justify the carrying amount of the investment

What are criticisms of the equity method?

Emphasizing the 20-50% of voting stock in determining significant influence versus control
Allowing off-balance-sheet financing
Potentially biasing performance ratios

What is the objective of the equity method?