The Equity Method of Accounting for Investments

11471 Words May 25th, 2011 46 Pages
Chapter 1 the equity method of accounting for investments

Chapter Outline

I. Three methods are principally used to account for an investment in equity securities. A. Fair-value method: applied by an investor when only a small percentage of a company’s voting stock is held. 1. Income is recognized when dividends are declared. 2. Portfolios are reported at market value. If market values are unavailable, investment is reported at cost.

B. Consolidation: when one firm controls another (e.g., when a parent has a majority interest in the voting stock of a subsidiary or control through variable interests (FIN 46R), their financial statements are consolidated and reported for the combined entity.
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B. Payments made in excess of underlying book value can sometimes be identified with specific investee accounts such as inventory or equipment. C. An extra acquisition price can also be assigned to anticipated benefits that are expected to be derived from the investment. For accounting purposes, these amounts are presumed to reflect an intangible asset referred to as goodwill. Goodwill is calculated as any excess payment that is not attributable to specific accounts. For the year 2002 and beyond, goodwill is no longer amortized.

V. Deferral of unrealized gains in inventory A. Gains derived from intercompany transactions are not considered completely earned until the transferred goods are either consumed or resold to unrelated parties. B. Downstream sales of inventory 1. “Downstream” refers to transfers made by the investor to the investee. 2. Intercompany gains from sales are initially deferred under the equity method and then recognized as income at the time of the inventory’s eventual disposal. 3. The amount of gain to be deferred is the investor’s ownership percentage multiplied by the markup on the merchandise remaining at the end of the year. C. Upstream sales of inventory 1. “Upstream” refers to transfers made by the investee to the investor. 2. Under the equity method, the deferral process for unrealized gains is identical for upstream
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