Question 1

Consolidated financial statements provide more helpful information than does the equity method, because

Accepted Answer

Consolidated financial statements provide a more helpful picture of the operations and financial position of the single economic entity since they include all the assets, liabilities, revenues, and expenses of the controlled subsidiaries, not just the investment account that represents the parent's investment in the subsidiary's common shareholders' equity and not just the parent's share of the subsidiary's net income. Furthermore, the parent, because of its voting interest, can control the use of all of the subsidiary's assets even if it doesn't have 100% ownership. Therefore, all of the options are correct.

Question 2

InvestCo purchases 30% of NewCo's stock on January 1, Year 1, for $100,000.In Year 1, NewCo paid total dividends of $30,000 and had a net income of $70,000.In Year 2, NewCo suffered a loss of $20,000 and paid no dividends.On January 1, Year 3, InvestCo sells its investment in NewCo for $105,000.How is the sale recorded?

Accepted Answer

The initial investment was $100,000. In Year 1, InvestCo's share of NewCo's net income was $21,000 (30% of $70,000), increasing the investment to $121,000. Dividends received were $9,000 (30% of $30,000), reducing the investment to $112,000. In Year 2, InvestCo's share of the loss was $6,000 (30% of $20,000), reducing the investment to $106,000. Selling for $105,000 results in a $1,000 loss.

Question 3

If Barton Company purchases a minority active interest in Laramie Company for $150,000, Barton will make which of the following entries to record the purchase using the equity method?

Accepted Answer

When using the equity method, the initial cost of purchasing the investment is recorded as an increase in the Investment in Laramie Company account and a decrease in the Cash account. Therefore, the correct entry would be Investment in Laramie Company 150,000 Cash 150,000. Choice A is incorrect because Equity in Laramie Company is not a valid account. Choice C is incorrect because Deferred Revenue does not relate to the purchase of an investment. Choices D and E are incorrect because they relate to the issuance of stock, which does not apply in this situation.

Question 4

Park Inc.owns 35 percent of Exeter Corporation.During the calendar year 2013, Exeter had net earnings of $300,000 and paid dividends of $36,000.Park mistakenly accounted for the investment in Exeter using the cost method rather than the equity method of accounting.What effect would this have on the investment account and net income, respectively?

Accepted Answer

Using the cost method, dividends received from Exeter would be recorded as a reduction in the investment account rather than as income. Therefore, the investment account would be understated and net income would also be understated.

Question 5

When an investor uses the equity method to account for investments in common stock, cash dividends received by the investor from the investee should be recorded as

Accepted Answer

When using the equity method, dividends received are recorded as a deduction from the investment account because they decrease the investor's share of the investee's retained earnings. This is in contrast to the treatment of dividends received under the cost method, which are recorded as dividend revenue.

Question 6

A minority, active investment is generally

Accepted Answer

A minority, active investment is generally considered to be an investment in another company's stock of between 20% and 50%. This typically means that the investor has significant influence over the investee, but not enough to control it outright. The specific percentage range may vary depending on the jurisdiction and accounting standards used.

Question 7

Minority, passive investments are initially recorded at the

Accepted Answer

Minority, passive investments are initially recorded at the acquisition cost according to the cost method of accounting. This cost includes the purchase price paid by the investor and any additional costs incurred to acquire the investment, such as brokerage fees or legal expenses. The fair market value of the net assets or the present/future value of cash flows may be considered in certain situations, such as goodwill impairment testing or valuation of certain securities, but it is not the initial recording basis for minority, passive investments.

Question 8

The equity method of accounting for an investment in the common stock of another company should be used when the investment

Accepted Answer

The equity method of accounting is used when the investor has significant influence over the investee, typically indicated by ownership of 20-50% of the investee's voting stock. This influence can be achieved through board representation or other means of influence. Options A, B, and D are not relevant to determining whether to use the equity method.

Question 9

Which of the following is/are true?

Accepted Answer

All statements are true. Owning more than 50% of the voting stock allows firm P to control broad policy making and potentially day-to-day operations of company S, making P the parent and S the subsidiary. Both U.S. GAAP and IFRS require consolidation of financial statements in such cases.

Question 10

For various reasons, a single economic entity may exist in the form of a parent and several legally separate subsidiaries, often referred to as an affiliated group. Which of the following is/are true?

Accepted Answer

A) This statement is true. The consolidated financial statements give a complete picture of the financial performance and position of the affiliated group.
B) This statement is also true. While each subsidiary is a separate legal entity, they operate as one entity under the control of the parent company.
C) This statement is also true. The consolidated financial statements provide a more comprehensive view of the financial performance of the affiliated group, making it easier for shareholders to evaluate the group's overall financial health.

Question 11

Which of the following is/are true regarding the acquisition method for a business combination?

Accepted Answer

All of the options presented are true regarding the acquisition method for a business combination. The identifiable tangible and intangible assets and liabilities of the acquired company must be measured at their fair values. The acquirer should compare the fair value of the cash, common stock, or other consideration given with the fair value of the identifiable assets less liabilities acquired. The excess of the fair value of the consideration over the fair value of the acquired firm's identifiable assets net of identifiable liabilities is goodwill. If the fair value of the identifiable assets less liabilities exceeds the fair value of the consideration, the excess is a gain from a bargain purchase, which the purchaser immediately includes in net income.

Question 12

For which type of investments would unrealized increases and decreases be recorded directly in an owners' equity account?

Accepted Answer

Available-for-sale securities are the type of investments for which unrealized gains and losses are recorded directly in an owner's equity account, specifically in other comprehensive income, until they are sold or result in a realized gain or loss.

Question 13

U.S.GAAP and IFRS require firms to account for business combinations using the _____ method.

Accepted Answer

Both U.S.GAAP and IFRS require firms to account for business combinations using the purchase method. This involves recognizing and measuring the fair value of assets and liabilities acquired in the transaction, and any goodwill resulting from the combination. The pooling-of-interests and uniting-of-interests methods were used in the past but are no longer allowed under current accounting standards. The equity method is used for investments in associates or joint ventures, and the cost method is used for investments in some securities.

Question 14

Dividends and interest from Minority, Passive Investments become income when the

Accepted Answer

The answer of Dividends and interest from Minority, Passive Investments...

Question 15

Pareto Corporation owns 40% of Spring Corporation.During Year 3, Spring has net income of $60,000.What entry should Pareto record related to its investment in Spring during Year 3?

Accepted Answer

Since Pareto owns 40% of Spring Corporation, it has an equity method investment in Spring. Under the equity method, Pareto records its share of Spring's net income as an increase in its investment account. Therefore, the entry should be Investment in Spring Corp. 24,000 and Equity in Earnings of Affiliate 24,000 to reflect Pareto's share of Spring's net income. The other options do not reflect the equity method of accounting.

Question 16

U.S.GAAP view investments of between 20 and 50 percent of the voting stock of another company (unless evidence indicates that significant influence cannot be exercised) as

Accepted Answer

According to U.S. GAAP, investments of between 20 and 50 percent of the voting stock of another company are considered minority investments. However, if evidence indicates that significant influence can be exercised, they are considered active investments. Since the question states that there is no evidence to suggest significant influence cannot be exercised, the best choice is minority, active investments, which is option B.

Question 17

Business firms have several reasons for preferring to operate as a group of legally separate corporations, rather than as a single entity.From the standpoint of the parent company, the more important reasons for maintaining legally separate subsidiary companies include which of the following?

Accepted Answer

All of the reasons mentioned - reducing risk, dealing with jurisdiction-specific laws and tax rules, expanding/diversifying, and reducing costs of divestment - are valid reasons for maintaining legally separate subsidiary companies.

Question 18

If Wabasso Company pays $55,000 in dividends to its corporate investor Lament Corporation (Lament owns 35% of The Wabasso Company), what entry should Lament Corporation record when it receives the dividends?

Accepted Answer

Lament Corporation should debit Cash and credit Investment in Wabasso Company because it owns 35% of Wabasso, indicating significant influence, and uses the equity method.

Question 19

Pense Co.purchased 40% of the stock of Stretch Co.in Year 1 for $100,000.Stretch had net income in Year 1 of $50,000 and net income in Year 2 of $30,000.Stretch also paid total dividends of $20,000 in Year 2.On January 1, Year 3, Pense Co.sold its investment in Stretch Co.to GE Capital Corporation (GE) for $130,000.What entry would Pense Co.make to record the sale of Stretch Co.?

Accepted Answer

To record the sale of Stretch Co., Pense Co. should debit Cash for $130,000 as they received cash from GE Capital Corporation for the sale of their investment. Pense Co. should also credit Investment in Stretch for its original cost of $100,000 and credit Gain on Sale for the difference between the sale price of $130,000 and the investment's carrying amount of $124,000. Therefore, the entry would be:
Cash  $130,000
Gain on Sale     $6,000
Investment in Stretch  $124,000

Question 20

In Year 2, ABC Corp.acquired a 15% interest in XYZ, Inc., for $50,000.During the year, XYZ paid dividends of $10,000 and had net income of $30,000.ABC sold the shares of XYZ for $65,000 cash.What entry will ABC make to record the sale?

Accepted Answer

To record the sale of the investment in XYZ, ABC Corp. would debit Cash for $65,000, credit Investment in XYZ for $50,000 (to remove the investment from the books), and credit Gain on Sale for $15,000 (which is the difference between the selling price and the carrying amount of the investment). Therefore, the correct entry is:
Cash 65,000 
Gain on Sale 15,000
Investment in XYZ 50,000

Quiz 14: Intercorporate Investments in Common Stock