Ch. 1 the Equity Method of Accounting for Investments Solutions

8173 words 33 pages
Chapter 1 the equity method of accounting for investments

Answers to Questions

1. The equity method should be applied if the ability to exercise significant influence over the operating and financial policies of the investee has been achieved by the investor. However, if actual control has been established, consolidating the financial information of the two companies will normally be the appropriate method for reporting the investment.

2. According to Paragraph 17 of APB Opinion 18, "Ability to exercise that influence may be indicated in several ways, such as representation on the board of directors, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological
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For this reason, financial figures from all previous years are restated as if the equity method had been applied consistently since the date of initial acquisition.

8. In reporting equity earnings for the current year, Riggins must separate its accrual into two income components: (1) operating income and (2) extraordinary gain. This handling enables the reader of the investor's financial statements to assess the nature of the earnings that are being reported. As a prerequisite, any unusual and infrequent item recognized by the investee must also be judged as material to the operations of Riggins for separate disclosure by the investor to be necessary.

9. Under the equity method, losses are recognized by an investor at the time that they are reported by the investee. However, because of the conservatism inherent in accounting, any permanent losses in value should also be recorded immediately. Since the investee's stock has suffered a permanent impairment in this question, the investor must recognize the loss applicable to its investment.

10. Following the guidelines established by the Accounting Principles Board, Wilson would be expected to recognize an equity loss of $120,000 (40 percent) stemming from Andrews' reported loss. However, since the book value of this investment is only $100,000, Wilson's loss is limited to that amount with the remaining


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