The document discusses three methods for reporting investments in other companies: the fair value method, consolidation, and the equity method. The equity method is used when the investor has significant influence over the investee, usually through 20-50% ownership. Under the equity method, the investment is initially recorded at cost and adjusted to recognize the investor's share of earnings or losses. Special procedures address changes in accounting method, investee losses, and sale of the investment.

1. Chapter One The Equity Method of Accounting for Investments McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

9. Size (of the Investment) Matters!!! { In some cases, influence or control may exist with less than 20% ownership. 0% 20% 50% 100% Fair Value Equity Method Consolidated Financial Statements 1- Investor Ownership of the Investee’s Shares Outstanding

10. The Significance of the Size of the Investment { Significant influence is generally assumed with 20% to 50% ownership. 0% 20% 50% 100% Fair Value Equity Method Consolidated Financial Statements 1- Investor Ownership of the Investee’s Shares Outstanding

11. The Significance of the Size of the Investment { Financial Statements of all related companies must be consolidated. 0% 20% 50% 100% Fair Value Equity Method Consolidated Financial Statements 1- Investor Ownership of the Investee’s Shares Outstanding

14. Fair-Value Method – Applied (continued…) Step 2: Investor recognizes dividend income for the amount of cash dividends received from investee Journal entry: Debit – Cash Credit – Income from Investment 1-

15. Fair-Value Method – Applied (continued…) Step 3: Investor adjusts the investment account to fair-market value (if readily determinable at report date) If FMV is higher than current carrying balance in account… Journal entry: Debit – Investment Credit – Unrealized Gain on Investment** ** This will appear on the income statement for Trading Securities, or in Other Comprehensive Income for those classified as Available-for-Sale.

16. Equity Method - Applied Step 1: Investor records investment in the investee at “cost”. Journal entry: Debit – Investment in Investee Credit – Cash (or other Assets/Stock) Cost can be defined as cash paid or the Fair Market Value of other assets given up. 1-

20. Special Procedures for Special Situations Reporting a change to the equity method. Reporting investee income from sources other than continuing operations. Reporting investee losses. Reporting the sale of an equity investment. 1-

23. Reporting a Change to the Equity Method (Retroactive Adjustment) 1- The income restatement for these earlier years can be computed as follows: Would have reported under the equity method Did report under the fair-market value method Year Equity in Investee Income (10%) Income Reported from Dividends Retrospective Adjustment 2010 $7,000 $2,000 $5,000 2011 11,000 4,000 7,000 Total Adjustment to Retained Earnings: $12,000

26. Reporting Investee Losses A permanent decline in the investee’s fair market value is recorded as an impairment loss and the investment account is reduced to the fair value. A temporary decline is ignored !!! 1-

31. Excess of Cost Over BV Acquired (Continued…) The amortization of the difference associated with the undervalued assets is recorded as a reduction of both the Investment account and the Equity in Investee Income account. 1-

34. Excess of Cost Over BV – Example Amortization Payment by investor . . . . . . . . . . . . . . . . . . . $90,000 Percentage of book value acquired ($200,000 30%) . . . . . . . . . . . . . . 60,000 Payment in excess of book value . . . . . . . . . . . 30,000 Excess payment identified with specific assets: Equipment (30% of $60,000 undervalued). . .$18,000 Patent (30% of $40,000 undervalued) . . . . . . . 12,000 30,000 Excess payment not identified with specific assets—goodwill . . . . . . . . . . . . . . –0– 1-

35. Amortization of Cost Over BV Example Amortization (Continued) 1-

36. Amortization of Cost Over BV Example Amortization (Continued) 1- Note, that any ADDITIONAL amount paid in excess of the book value of $90,000 would be the cost of the goodwill purchased – and would not be amortized like the other assets.

39. Unrealized Gains in Inventory Example (Continued…) INVESTEE buys inventory and pays a total of $1,250 to investor. INVESTOR sells 200 units of inventory with original cost of $1,000 . If 60 of the original 200 units ( 30% ) remain “ unsold ” to an “outside” party, we must defer our share ( 20% ) of the original $250 of intercompany profit that is unrealized ( 30% ). 1- Outside Party