Question 1

Rainbow Company acquired 100 percent of the outstanding common stock of Ribbon Company.At the date of acquisition,no goodwill was involved and the book value of the assets and liabilities of Ribbon Company equal their fair values.Immediately after the acquisition,an elimination entry is prepared in order to prepare consolidated financial statements.Which of the following accounts are affected by the elimination entry?

Accepted Answer

The elimination entry eliminates the Investment account in Ribbon Company and transfers it to the Stockholders' Equity account in Ribbon Company. Therefore, the affected accounts are Investment in Ribbon Company and Stockholders' Equity of Ribbon Company. Investment Revenue is not affected by the elimination entry. Fixed Assets are not specifically mentioned in the question and therefore are not relevant to the elimination entry.

Question 2

Investments acquired with the intent to resell them in the near future are called trading securities.

Accepted Answer

Trading securities are investments that are intended to be sold in the near future and are reported on the balance sheet at fair value.

Question 3

An investor that has effective control over an investee usually owns ________ of the investee's stock.

Accepted Answer

An investor that has effective control over an investee usually owns more than 50% of the investee's stock. This means that the investor has a majority stake in the investee and can make key decisions that affect the investee's operations and strategy.

Question 4

Under the equity method of accounting for investments,the investor recognizes income for ________.

Accepted Answer

Under the equity method of accounting, the investor recognizes its share of income earned by the investee company as income. This is because the investor is seen as having a significant influence over the investee company and is therefore deemed to share in the investee's profits and losses. Dividends received from the investee company are not recognized as income under the equity method, but are instead treated as a reduction in the investment carrying amount. The change in market value of the investee company's stock does not affect the recognition of income for the investor. Goodwill associated with the investee company is also not recognized as income under the equity method, but is instead subject to periodic impairment testing.

Question 5

Accountants require investors with significant influence,but not control,over the decisions of an investee firm to use the ________ method.

Accepted Answer

The equity method is used when the investor has significant influence over the investee but does not have control. This method requires the investor to report its share of the investee's net income or loss on the investor's income statement. The other options, such as cost method, market value method or lower of cost or market method, are not suitable for situations where the investor has significant influence over the investee.

Question 6

A parent company purchases 100 percent of the outstanding common stock in a subsidiary.What happens to the subsidiary the day after the purchase? Which of the following statements is FALSE?

Accepted Answer

When a parent company purchases 100 percent of the outstanding common stock in a subsidiary, the subsidiary does not cease to exist. It continues as a separate legal entity and maintains its own set of books, although it is fully owned by the parent company. The transaction primarily affects the parent company's books, particularly in how it consolidates the subsidiary's financial statements.

Question 7

On January 1,2014,Jonathon Company purchased common stock in Garcia Company for $1,000,000.Jonathon Company treats the investment as trading securities.During 2014,Garcia Company earned $4,000,000 and paid dividends of $1,000,000.Assume that Jonathon Company owns 10% of the outstanding shares of Garcia Company.The market value of the investment at December 31,2014 is $1,100,000.What is the balance in the Investment account at December 31,2014?

Accepted Answer

Since Jonathon Company treats the investment as trading securities, it must be reported at fair value, which is given as $1,100,000 at December 31,2014. The dividends earned by Jonathon Company during the year are not relevant since it's a trading security. Therefore, the balance in the Investment account at December 31, 2014, would be $1,100,000, which is the market value of the investment at that date.

Question 8

Accountants require investors without significant influence over the decisions of an investee firm to use the ________ method.

Accepted Answer

The market value method is used to account for investments in which the investor has no significant influence over the decisions of the investee firm.

Question 9

An investor in securities accounted for by the equity method has the following information available at December 31,2012:
Market value of securities $\quad \$10,000$
Acquisition cost of securities $\quad \$8,000$
How does the investor report the change in market value on the securities at December 31,2012?

Accepted Answer

Under the equity method, the investor recognizes their share of the investee's earnings or losses, which affects the carrying amount of the investment on the balance sheet. Changes in the market value of the securities are not recognized in the financial statements.

Question 10

When a company owns less than 20 percent of the common stock of another company,the market value method of accounting for investments in equity securities is used.

Accepted Answer

When a company owns less than 20% of the common stock of another company, it typically does not have significant influence over that company. Therefore, the market value method (also known as the fair value method) is used for accounting for investments in equity securities, where the investment is recorded at fair value with changes in fair value recognized in earnings.

Question 11

On January 1,2014,Jeff Company purchased common stock in Garcia Company for $1,000,000.Jeff Company treats the investment as available-for-sale securities.During 2014,Garcia Company earned $4,000,000 and paid dividends of $1,000,000.Assume that Jeff Company owns 10% of the outstanding shares of Garcia Company.The market value of the investment at December 31,2014 is $1,100,000.What is the balance in the Investment account at December 31,2014?

Accepted Answer

Since Jeff Company treats the investment as available-for-sale securities, the increase in market value of the investment is recorded as an unrealized gain in other comprehensive income. Therefore, the Investment account will remain at its initial cost of $1,000,000 plus any dividend income received during the year, which is $100,000 ($1,000,000 x 10% x 10%). Thus, the balance in the Investment account at December 31, 2014 is $1,100,000.

Question 12

Accountants require investors that have control over the decisions of an investee firm to use the ________ method.

Accepted Answer

Consolidated financial statements are required when an investor has control over an investee firm. This method combines the financial statements of both the investor and the investee, providing a complete picture of the financial status of the group. The other methods listed, such as cost, market value, and lower of cost or market, are used for different purposes and do not apply specifically to situations where an investor has control over an investee firm.

Question 13

If an investor uses the equity method to account for a long-term equity investment,then the investor records income when the investee pays a dividend.

Accepted Answer

The equity method requires the investor to record its share of the investee's earnings as income, regardless of whether or not a dividend is paid. Dividends paid by the investee are accounted for separately as a reduction of the investment account balance.

Question 14

If an investor uses the equity method to account for a long-term equity investment,then the investor records income when the investee reports net income.

Accepted Answer

When using the equity method, the investor's share of the investee's net income is recorded as income on the investor's income statement.

Question 15

The company that owns 100 percent of another company's stock is called the ________.The company that is controlled by another company is called the ________.

Accepted Answer

The company that owns 100 percent of another company's stock is commonly referred to as the parent company while the company that is controlled by another company is called its subsidiary. These terms are commonly used in business and finance to describe the relationship between two companies. Choice A and B are not accurate descriptions of the relationship between a parent and subsidiary company. Choice D is a term used to describe a smaller segment within a larger company, and not necessarily a company that is controlled by another.

Question 16

Brankov Company purchased common stock in Ramona Company for $400,000.In the current year,Ramona Company reported net income of $50,000 and paid a dividend of $32,000.At the end of the year,the market value of the investment in Ramona Company was $410,000.
Required:
A) Assume Brankov Company owns 10% of the shares of Ramona Company. Brankov Company considers the investment to be available-for-sale securities. Show the effects of the transactions above on the accounts of Brankov Company using the balance sheet equation.
B) Assume Brankov Company owns 25% of the shares of Ramona Company. Show the effects of the transactions above on the accounts of Brankov Company using the balance sheet equation.

Accepted Answer

The answer of Brankov Company purchased common stock in Ramona...

Question 17

Under the equity method of accounting for investments,the acquisition cost of an investment is adjusted for ________.

Accepted Answer

The equity method of accounting involves adjusting the acquisition cost of an investment for both dividends received and the investor's share of earnings or losses of the investee after the investment date. This is because the investor has a significant influence over the investee and is therefore entitled to a share of its profits and losses. Changes in the market value of the investment are not relevant under the equity method, as the investor's level of influence over the investee remains the same regardless of changes in the investment's market value.

Question 18

Ramon Company acquired 40% of the voting stock of Boulder Company for $40 million.At the end of Year 1,Boulder Company reports net income of $15 million and pays cash dividends of $5 million.At the end of Year 1,the market value of Ramon Company's investment in Boulder Company is $44 million.What accounts will be affected on Ramon Company's books to account for the increase in market value of the investment at the end of Year 1?

Accepted Answer

Under the equity method of accounting, which is likely used here given the significant influence implied by a 40% ownership, the increase in market value of the investment does not affect the accounting records. Only the share of Boulder's net income and dividends paid would be recorded, not changes in market value.

Question 19

For trading securities,changes in the market value of the securities are included in ________.For available-for-sale securities,changes in the market value of the securities are included in ________.

Accepted Answer

For trading securities, changes in market value are included in retained earnings as they affect net income. For available-for-sale securities, changes are included in other comprehensive income.

Question 20

On January 1,2014,Liberty Company purchased common stock in Garcia Company for $1,000,000.During 2014,Garcia Company earned $4,000,000 and paid dividends of $1,000,000.Assume that Liberty Company owns 30% of the outstanding shares of Garcia Company.The market value of the investment at December 31,2014 is $1,100,000.What is the balance in the Investment account at December 31,2014?

Accepted Answer

Liberty Company owns 30% of Garcia Company, so it should use the equity method. The initial investment is $1,000,000. Liberty's share of Garcia's earnings is 30% of $4,000,000, which is $1,200,000. Liberty's share of the dividends is 30% of $1,000,000, which is $300,000. The investment account is increased by the share of earnings and decreased by the share of dividends: $1,000,000 + $1,200,000 - $300,000 = $1,900,000.

Quiz 17: Understanding and Analyzing Consolidated Financial Statements