CPA Financial Accounting and Reporting (FAR) : Equity Method
Study concepts, example questions & explanations for CPA Financial Accounting and Reporting (FAR)
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Example Questions
Example Question #1 : Equity Method
On January 1, Year 1, Parent Company buys 15% of Son Company for $300,000. Parent has the ability to assert significant influence over Son and does not elect the fair value method. During Year 1, Son reported net income of $160,000 and paid cash dividends of $25,000. What is the book value of Parent's investment in Son at the end of Year 1?
$324,000
$327,750
$320,250
$300,000
$320,250
Parent must use the equity method to account for its investment in Son because it has the ability to exert significant influence over Son. Under the equity method, the balance in the investment account at the end of the year will be the beginning balance of $300K (equal to cost) + Parent's portion of Son's net income equal to $24K ($160K x 15% ownership) - Parent's portion of dividends paid of $3,750 ($25K x 15% ownership).
Example Question #2 : Equity Method
Greg Company owns 75% of George Company's common stock. During the 3rd quarter of the current year, George sold inventory to Greg for $100,000. At the end of the current year, half of this purchase remains in Greg's inventory. For the current year, Greg's gross profit margin was 25% and George's gross profit margin was 40%. How much unrealized profit should be eliminated from ending inventory at year-end?
$12,500
$50,000
$20,000
$25,000
$20,000
George must eliminate any gross profit recognized on sold inventory that still remains in Greg's possession. Thus the elimination would be calculated as $100K x 50% remaining in inventory x 40% GP margin.
Example Question #3 : Equity Method
Which of the following, if received from an investee, will effect income reported by an investor using the equity method?
Cash dividend
Stock split
Stock dividend
None of the above
None of the above
Under the equity method, dividends are not reported as income. Even a cash dividend would reduce the investment account rather than increasing income.
Example Question #4 : Equity Method
ABC Company uses the equity method to account for its investment in DEF Co common stock. How should ABC record a 3% stock dividend received from DEF?
As dividend revenue at DEF's carrying value of the stock
As a memorandum entry reducing the unit cost of all DEF stock owned
As dividend revenue at the market value of the stock
As a reduction in the total cost of DEF stock owned
As a memorandum entry reducing the unit cost of all DEF stock owned
ABC should record the stock dividend received from DEF with a memorandum entry that reduces the unit cost of all DEF stock owned.
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
Equity method
Consolidation method
Fair value 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.
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