CPA Financial Accounting and Reporting (FAR) : Business Combinations
Study concepts, example questions & explanations for CPA Financial Accounting and Reporting (FAR)
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Example Questions
Example Question #5 : Equity Method
ABC Inc is currently using the equity method to account for its 25% investment in DEF Inc. In the acquisition last year of DEF stock, ABC calculated $750,000 of goodwill. The correct accounting for this goodwill during the current year is:
No accounting necessary
Test for impairment at year end
Amortization over the anticipated holding period of the DEF stock
Amortization over 50 years
No accounting necessary
Any goodwill created in an investment accounted for under the equity method is ignored. It is neither amortized nor tested for impairment. The entire investment is subject to the impairment test.
Example Question #1 : Equity Method
Gerald Company purchased 30% of Randy Company's outstanding nonvoting preferred stock. How should this investment be recorded?
None of the answer choices are correct
Fair value method
Consolidation method
Equity method
Fair value method
There is not significant influence in this situation so the fair value method is utilized. If there was more than 50% ownership, consolidation would be used and the equity method would only be used if there is significant influence.
Example Question #1 : Fair Value Method
Which of the following is correct regarding the fair value method?
The investment account is adjusted for investee earnings
The investment account is reduce for impairment at the balance sheet date
The investment account is adjusted to fair value at the balance sheet date
The investment account will always be reported at historical cost
The investment account is adjusted to fair value at the balance sheet date
When using the fair value method, an investment is originally accounted for at cost, then adjusted to fair value each year and the balance sheet date.
Example Question #2 : Fair Value Method
Blue Corp purchased marketable securities in Purple Corp during Year 1. At the end of Year 1, the fair value of Purple Corp had dropped below cost. Blue Corp considered the decline in value to be temporary and the security is classified as available-for-sale. What should be the effect on Blue's financial statements in Year 1?
Decrease in available-for-sale securities and decrease in net income
Decrease in available-for-sale securities and decrease in other comprehensive income
Decrease in available-for-sale securities and no effect on net income
No effect on available-for-sale securities and decrease in net income
Decrease in available-for-sale securities and decrease in other comprehensive income
Unrealized holding gains/losses on securities classified as available-for-sale are recognized as part of other comprehensive income. Therefore, in this scenario, the investment account is decreased and a loss is recognized in OCI.
Example Question #3 : Fair Value Method
A marketable debt security is moved from available-for-sale to held-to-maturity securities. At the transfer date, the security’s market value has fallen below its cost. What amount is used at the transfer date to record the security in the held-to-maturity portfolio?
Market value, only if the decline in market value below cost is considered permanent
Cost, regardless of whether the decline in market value below cost is considered permanent or temporary
Market value, regardless of whether the decline in market value below cost is considered permanent or temporary
Cost, if the decline in market value below cost is temporary
Market value, regardless of whether the decline in market value below cost is considered permanent or temporary
The security will be recorded at market value regardless of whether the decline in value is permanent or temporary.
Example Question #4 : Fair Value Method
ABC Company acquired 40% of the outstanding non voting preferred stock of DEF Co. Which method of recording an investment should ABC use?
Equity method if no other investor has more than a 40% interest
The equity method because of ABC's significant influence can be assumed
Equity method if it can acquire an additional 11% by year end
Fair value method
Fair value method
Significant influence cannot be exercised by holding non voting stock. Fair value must be used.
Example Question #5 : Fair Value Method
ABC Company received a cash dividend from a common stock investment. Should ABC report an increase in the investment account if it uses the fair value method or the equity method of accounting?
Equity method
Both
Fair value method
Neither
Neither
Under fair value, receipt of a dividend does not affect the investment account whereas under equity method it is a decrease in the investment account.
Example Question #1 : Fair Value Method
When a dividend is paid from a majority owned subsidiary to its parent company, what effect is demonstrated?
No effect on NCI
No effect on retained earnings
Effect on retained earnings
None of the answer choices are correct
No effect on retained earnings
In this circumstance, the dividend is treated as a return of capital from one company to its parent. Retained earnings remains stagnant and the NCI is decreased as it has its capital returned to it.
Example Question #1 : Cost Method
Carmen, Inc purchased 15% of Loman's 60,000 outstanding shares of common stock on January 1, Year 2, for $80,000. On December 31, Year 2, Carmen purchased an additional 12,000 shares of common stock for $150,000. Loman reported $75,000 in earnings for Year 2. There was no goodwill as a result of either transaction, and Loman didn't issue any additional shares of stock in Year 2. There was no unrealized holding gain or loss reported in other comprehensive income for this investment. What amount should Carmen report in its investment account at the end of Year 2?
$310,000
$242,000
$258,000
$230,000
$230,000
Carmen will use the cost method to account for this investment in Year 1, meaning that the ending balance in the investment account will just be the cost of the stock purchases ($80K + $150K). Because the second purchase brought Carmen's ownership percentage up from 15% to 35%, they will use the equity method beginning in Year 3, but Year 2 will still be accounted for using the cost method.
Example Question #2 : Cost Method
Which of the following is not true regarding the cost method for investments?
An investment accounted for using the cost method could be recorded as a marketable security or as an available-for-sale securities
An investor able to exercise significant influence over an investee will not use the cost method, regardless of the percentage owned
An investor would use the cost method to account for a short-term investment
An investor owning 15% of an investee's outstanding stock, with the ability to exercise significant influence, would use the cost method to report its investment
An investor owning 15% of an investee's outstanding stock, with the ability to exercise significant influence, would use the cost method to report its investment
If the investor has the ability to exercise significant influence over an investee, it should account for its investment using the equity method, regardless of the percentage of ownership.
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