QUESTIONS

1 Only the investor’s accounts are affected when outstanding stock is acquired from existing
stockholders. The investor records the investment at its cost. Since the investee company is not a
to the transaction, its accounts are not affected. Both investor and investee accounts are affected w
unissued stock is acquired directly from the investee. The investor records the investment at it's
cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previo
unissued stock.

2 Goodwill arising from an equity investment of 20 percent or more is not recorded separately from
investment account. Under the equity method, the investment is presented on one line of the balan
sheet in accordance with the one-line consolidation concept.

3 Dividends received from earnings accumulated before an investment is acquired are treated as
decreases in the investment account balance under the fair value/cost method. Such dividends are
considered a return of a part of the original investment.

4 The equity method of accounting for investments increases the investment account for the investo
share of the investee’s income and decreases it for the investor’s share of the investee’s losses and
dividends received from the investee. In addition, the investment and investment income account
adjusted for amortization of any investment cost-book value differentials related to the interest ac
Adjustments to the investment and investment income accounts are also needed for unrealized pro
and losses from transactions between the investor and investee companies. A fair value adjustmen
optional under SFAS No. 159.

5 The equity method is referred to as a one-line consolidation because the investment account is rep
one line of the investor’s balance sheet and investment income is reported on one line of the inves
statement (except when the investee has extraordinary gains/losses or gains/losses from discontin
In addition, the investment income is computed such that the parent company’s income and stock
equal to the consolidated net income and consolidated stockholders’ equity that would result if th
the investor and investee were consolidated.

6 If the equity method of accounting is applied correctly, the income of the parent company will ge
controlling interest share of consolidated net income. If the subsidiary is 100% owned by the pare
net income under the equity method will equal the consolidated net income of the parent and it’s

7 The difference in the equity method and consolidation lies in the detail reported, but not in the am
reported. The equity method reports investment income on one line of the income statement wher
of revenues and expenses are reported in the consolidated income statement.

8 The investment account balance of the investor will equal underlying book value of the investee i
 method is correctly applied, (b) the investment was acquired at book value which was equal to fa
pooling method was used, or the cost-book value differentials have all been amortized or written
losses, and (c) there have been no intercompany transactions between the affiliated companies tha
investment account-book value differences.

9 The investment account balance must be converted from the cost to the equity method when acqu
the interest held to 20 percent or more. The amount of the adjustment is the difference between th
income reported under the cost method in prior years and the income that would have been report
method of accounting had been used. The offsetting account in the journal entry is retained Earni
from the cost to the equity method of accounting for equity investments are changes in the reporti
require restatement of prior years’ financial statements when the effect is material.

E 2-3

1 Bow's percentage ownership in tre

Bow’s 20,000 shares/(60,000 + 20,000) shares 25%

2 Goodwill

Investment cost $ 500,000

Book value ($1,000,000 + $500,000)*25% $ 375,000
Goodwill $ 125,000

E 2-4

Income from Med for 2011

Share of Med’s income ($200,000*1/2 year*30%) $ 30,000

 red from existing
vestee company is not a party
e accounts are affected when
s the investment at it's
ct the issuance of previously

ecorded separately from the

on one line of the balance

quired are treated as

hod. Such dividends are

t account for the investor’s

the investee’s losses and for
stment income accounts are
related to the interest acquired.
eeded for unrealized profits
. A fair value adjustment is

nvestment account is reported on

on one line of the investor’s income
ns/losses from discontinued operations).
any’s income and stockholders’ equity are
y that would result if the statements of

parent company will generally equal the

100% owned by the parent, the parent’s
me of the parent and it’s subsidiary.

ported, but not in the amount of income

income statement whereas the details
nt.

k value of the investee if (a) the equity

e which was equal to fair value, the
en amortized or written off as impairment
affiliated companies that have created

quity method when acquisitions increase

he difference between the investment
would have been reported if the equity
l entry is retained Earnings. Changes
re changes in the reporting entity that
material.