Equity Securities and Associates Reviewer
Equity Securities and Associates Reviewer
Equity Securities and Associates Reviewer
1. Under the cost model of accounting for an investment, changes to the carrying amount of the investment occur if:
A. the investee earns post-acquisition profits or losses;
B. goodwill included in the investment is amortized;
C. the investment is impaired;
D. dividends are received from the investee.
2. The method of accounting that applies to an investor and associate relationship is the:
A. cost method;
B. fair value method;
C. consolidation method;
D. equity method.
A Incorrect. The equity method is used for an investor and associate relationship.
B Incorrect. The equity method is used.
C Incorrect. The consolidation method is used for an investor and its subsidiaries.
D Correct. The method deemed most suitable to reflect the special relationship between an investor and
its associated investments, is the equity method of accounting.
Section 19.3
4. For the purposes of equity accounting, significant influence is regarded as the power of an investor to:
A. control the financial and operating policies of an associate;
B. participate in the financial and operating policy decisions of an investee;
C. participate in the day-to-day management of a joint venture interest;
D. dominate the financing decisions of an entity.
A Incorrect. Participation, not control, is the condition that characterises significant influence.
B Correct. Participation in financing and operating policy decisions characterises significant influence.
C Incorrect. Joint ventures interests are not equity accounted.
D Incorrect. Dominance is regarded as control not significant influence.
Section 19.2
5. The application of the equity accounting method of accounting is based on the investor owning:
A. more than 50% of the voting power in an associate;
B. more than 20% of the voting power in an associate;
C. less than 20% of the voting power in an associate;
D. part of the share capital of an associate whether or not there are voting rights attached.
A Incorrect. More than 50% of the voting power indicates the existence of a parent/subsidiary relationship.
B Correct. It is presumed that if an investor holds more than 20% of the voting shares of another entity
then an investor/associate relationship exists.
C Incorrect. It is presumed that where less than 20% of the voting rights are held that an investor/associate
relationship does not exist.
D Incorrect. The level of ownership must be more than 20% and the shares must have voting rights.
Section 19.1
6. The equity method of accounting need not be applied where the investment:
A. represents more than 20% of the voting shares of an associate;
B. does not provide the investor with significant influence;
C. is held exclusively with a view to its disposal within 12 months;
D. is made by an investor who has no subsidiaries.
A Incorrect. Where the investment is more than 20% of the voting shares of the associate equity accounting must
be applied.
B Incorrect. Where the investment provides the investor with significant influence the equity method must be
applied.
C Correct. If the investment is held with a view to disposing of it within 12 months, equity accounting
need not be applied.
D Incorrect. If the investor has no subsidiaries the equity method is applied directly in the accounting records of
the investor.
Section 19.2
7. Where all of the following conditions apply an investor need not apply the equity method of accounting:
I. The investor is a wholly owned subsidiary or a partly owned subsidiary and its owners do not object to the
method not being used.
II. The investor's debt or equity securities are not traded in a public market.
III. The investor has not filed financial statements with a regulatory organisation for the purpose of issuing any
class of securities in a public market.
IV. The ultimate parent of the investor publishes consolidated financial statements that comply with IFRS.
A. I and IV only;
B. II and III only;
C. I, II and III only;
D. I, II, III and IV.
8. In respect to the equity method of accounting, where an investor has no subsidiaries the investor must apply the:
A. cost method of accounting for investments in associates;
B. consolidated financial reporting
C. equity method in its own accounting records;
D. net present value method to measuring the expected cash flows from an associate.
A Incorrect. The equity method must be applied in the accounting records of the investor.
B Incorrect. The equity method is used not the consolidated financial reporting method.
C Correct. The equity method must be used but instead of making adjustments on a worksheet the
method is applied directly in the accounting records of the investor.
D Incorrect. The equity method is applied in the accounting records of the investor.
Section 19.2
9. The 'one-line' equity accounting method is used when accounting for an investment in:
A. a subsidiary;
B. a unit trust;
C. a joint venture;
D. an associate.
A Incorrect. The line-by-line method is used when accounting for an investment in a subsidiary.
B Incorrect. The one-line method is a term used when referring to the equity method of accounting for an
investment in an associate.
C Incorrect. The one-line equity accounting method does not apply to a joint venture.
D Correct. The equity method of accounting for an investment in an associate is referred to as a one-line
method.
Section 19.1
10. The equity method of accounting for an investment in an associate includes the following steps:
I II III IV
Recognise the initial investment at Yes Yes No No
cost
Recognise the initial investment at Yes No Yes No
fair value
Reduce the carrying amout by any No Yes No Yes
distributions
Adjust the carrying amount by the No Yes Yes No
investor's share of the associate's
profit or loss
A. I;
B. II;
C. III;
D. IV.
A Incorrect. The carrying amount is reduced by any distributions from the associate.
B Correct. The initial investment is recognised at cost not fair value.
C Incorrect. The initial investment is recognised at cost not fair value.
D Incorrect. The Initial investment is recognised at cost.
Section 19.2
11. Mandy Limited acquired a 30% share in Sandy Limited for $27 000. Mandy Limited has no other investments. At
the date on which it became an associate, Sandy Limited had the following equity items: Share capital $50 000,
Retained earnings $40 000. At the end of the financial year following acquisition, Sandy Limited generated a
profit of $6 000. The carrying amount of the investment in Sandy Limited at the end of the financial year is:
A. $25 200;
B. $27 000;
C. $28 800;
D. $33 000.
12. Codger Limited acquired a 40% investment in Lodger Limited for $50 000. Lodger declared and paid a dividend
of $10 000. Codger Limited does not prepare consolidated financial statements. The appropriate entry for the
investor to record this dividend is:
A. DR Cash $4 000
CR Investment in associate $4 000;
B. DR Dividends payable $4 000
CR Cash $4 000;
C. DR Cash $4 000
CR Dividend revenue $4 000;
D. DR Investment in associate $4 000
CR Dividend revenue $4 000.
A Correct. The investment in associate is reduced when the investor receives a distribution from the
associate.
B Incorrect. This entry would be recorded by the associate not the investor.
C Incorrect. The distribution from the associate is recognised as a reduction of the investment.
D Incorrect. The investment in the associate should be reduced not increased.
Section 19.2
13. Investor Limited acquired a 25% interest in Investee Limited for $15 000. Investor holds other equity investments
but does not prepare consolidated financial statements. Investee Limited revalued its buildings class of assets by
$50 000 during the current financial period. The balance of the investment in associate account at the end of the
current financial period is:
A. $12 500;
B. $15 000;
C. $16 250;
D. $27 500.
A Incorrect. This is the investor's share of the revaluation reserve of the associate which must be added to the
carrying amount of the investment.
B Incorrect. This is the initial amount of the investment. The investor's share of the revaluation reserve must be
added.
C Incorrect. This is 25% of the initial investment plus the share of the revaluation reserve.
D Correct. The initial investment of $15 000 is increased by the investor's shares of the revaluation
reserve.
Section 19.2
14. Tea Limited acquired a 35% investment in Cup Limited for $20 000. Tea Limited also owns two subsidiaries and
prepares consolidated financial statements. Cup Limited declared and paid a dividend of $5 000 during the
current financial year. The appropriate consolidation adjustment to record this transaction will include the
following entry:
A. DR Investment in associate;
B. DR Cash;
C. DR Dividend revenue;
D. DR Share of profit of associate.
A Incorrect. The investment is also adjusted to reflect the share of the profit and the dividend.
B Correct. The calculation is as follows: Initial investment ($25 000) + share of revaluation (30% x $4 000)
+ share of profit (30% x $10 000) – share of dividend (30% x $1 500).
C Incorrect. The investment is also adjusted to reflect the share of the revaluation and the dividend.
D Incorrect. The investment is reduced by the 30% share of the dividend.
Section 19.2
17. When an associate declares and pays a dividend out of pre-acquisition profits the application of the equity
method results in the investor making the following adjustment:
A. DR Investment in associate;
B. Cr Cash;
C. CR Dividend revenue;
D. No adjustment.
A Incorrect. The losses are recognised until the carrying amount of the investment is zero.
B Incorrect. The losses are recognised until the carrying amount of the investment is zero.
C Correct. The losses are recognised against the investment until it is reduced to zero.
D Incorrect. The investment remains classified as a non-current asset even if it is incurring losses.
Section 19.6
19. Where an investor has discontinued the use of the equity method because the associate has incurred losses it
must disclose the:
A. unrecognised share of current period and cumulative losses of the associate;
B. reason why it has discontinued the method;
C. accounting policy it has adopted in place of the equity method;
D. effect on the statement of changes in equity if it had continued to use the method.
A Correct. The unrecognised share of both current period and cumulative losses must be disclosed if
the equity method is discontinued.
B Incorrect. This is not a required disclosure.
C Incorrect. This is not a required disclosure.
D Incorrect. This effect is not required to be disclosed.
Section 19.6
20. Investments in associates accounted for using the equity method are presented in the statement of financial
position amongst:
A. equity;
B. non-current liabilities;
C. current assets;
D. non-current assets.
2. Which of the following statements best describes the term “significant influence”?
a. The holding of a significant proportion of the share capital in another entity.
b. The contractually agreed sharing of control over an economic entity.
c. The power to participate in the financial and operating policy decisions of an entity.
d. The mutual sharing in the risks and benefits of a combined entity.
3. Which statement is incorrect concerning the equity method?
a. The investment in associate is initially recorded at cost.
b. The investment in associate is increased or decreased by the investor’s share of the profit or loss of the investee
after the date of acquisition.
c. The investor’s share of the profit or loss of the investee is not recognized in the investor’s profit or loss.
d. Distributions received from the investee reduce the carrying amount of the investment.
Identification of Associates
• A holding of 20% or more of the voting power (directly or through subsidiaries) will indicate significant influence unless it
can be clearly demonstrated otherwise.
• If the holding is less than 20%, the investor will be presumed not to have significant influence unless such influence
can be clearly demonstrated.
d.
4. Which statement is incorrect concerning significant influence?
I. If an investor holds directly or indirectly, less than 20% of the voting power of the investee, it is presumed that the
investor does not have significant influence, unless such influence can be clearly demonstrated.
II. If an investor holds, directly or indirectly, 20% or more of the voting power of the investee, it is presumed that the
investor does not have significant influence, unless it can be clearly demonstrated that this is not the case.
III. A substantial or majority ownership by another entity does not necessarily preclude an
investor from having significant influence. a. I, II and III
b. I and II only
c. III only
d. II only
Accounting for Associates
In its consolidated financial statements, an investor should use the equity method of accounting for investments in
associates, unless:
• An investment in an associate that is acquired and held exclusively with a view to its disposal within 12 months from
acquisition should be accounted for as held for trading under PFRS 9 (FVPL).
• A parent that is exempted from preparing consolidated financial statements by PAS 27 may prepare separate financial
statements as its primary financial statements. Use cost method or PFRS 9.
Accounting for Associates
• An investor need not use the equity method if all of the following four conditions are met:
1. The investor is itself a wholly owned subsidiary, or is a partially-owned subsidiary of another entity and its
other owners, including those not otherwise entitled to vote, have been informed about, and do not object to,
the investor not applying the equity method;
2. The investor's debt or equity instruments are not traded in a public market;
3. The investor did not file, nor is it in the process of filing, its financial statements with a securities commission
or other regulatory organization for the purpose of issuing any class of instruments in a public market; and
4. The ultimate or any intermediate parent of the investor produces consolidated financial statements available
for public use that comply with PFRS.
Applying the Equity Method of Accounting
1. Basic principle – The equity investment is initially recorded at cost and is subsequently adjusted to reflect the
investor's share of the net profit or loss of the associate.
2. Distributions and other adjustments to carrying amount Distributions received from the investee reduce the
carrying amount of the investment. Adjustments to the carrying amount may also be required arising from
OTHER changes in the investee's equity (revaluation surplus and translation gains and losses.)
3. An associate with outstanding preference shares
a. The investor computes its share of profits or losses after adjusting for the dividends on such shares, whether
or not the dividends have been declared on cumulative preference shares.
b. However if the preference shares is non-cumulative, adjustments for dividends are made only if there is a
declaration.
5. An investor uses the equity method to account for an investment in ordinary shares. After the date of acquisition, the
investment account of the investor would.
a. Not be affected by its share of the earnings or losses of the investee
b. Not be affected by its share of earnings of the investee, but be decreased by its share of the losses of the
investee
c. Be increased by its share of the earnings of the investee, but not be affected by its share of the losses of the
investee.
d. Be increased by its share of the earnings of the investee, and decreased by its share of the losses of the
investee
6. If an associate has outstanding cumulative preference share, held by outside interests, the investor computes its share of
profits or losses
a. After adjusting for preference dividends which were actually paid during the year.
b. Without regard for preference dividends.
c. After adjusting for the preference dividends only when declared.
d. After adjusting for the preference dividends, whether or not the dividends have been declared.
7. Under the equity method of accounting for investments, an investor recognizes its share of the earnings in the period in
which the
a. Investor sells the investment
(a) Goodwill relating to an associate is included in the carrying amount of the investment. However,
amortization of that goodwill is not permitted and is therefore not included in the determination of the
investor’s share of the associate’s profits or losses.
(b) Any excess of the investor’s share of the net fair value of the associate’s identifiable assets, liabilities and
contingent liabilities over the cost of the investment
Theory 10
The difference between the selling price and carrying amount of the investment sold shall be recognized in profit or loss.
The “retained investment” shall be accounted for under PFRS 9 and shall be remeasured to fair value on the date
significant influence ceases and recognized in profit or loss.
13. When the investor discontinues the use of the equity method because significant influence is lost, the investment in
associate retained by the investor shall be measured at
a.Fair value
b.Carrying amount’
c. Amortized cost
d.Original cost
8. Application of the equity method achieved in stages
The previously held interest that was accounted for under the cost or fair value method shall be remeasured to fair
value on the date the investor gains significant influence.
The difference between the fair value and the carrying amount of the previously held investment shall be recognized in
profit or loss.
The total of the fair value of the previously held investment and the new acquisition cost shall be regarded as the total
cost of the investment classified as “associate”.
If the FVOCI was used to account for the previously held investment, any cumulative unrealized gain or loss as OCI
shall be reclassified to retained earnings.
9. Losses in excess of investment
The investor’s share in the associates losses cannot exceed the “interest in the associate” and shall discontinue the
application of the equity method is this is the case.
After the investor's interest is reduced to zero, additional losses are recognized by a provision (liability) only to the
extent that the investor has incurred legal or constructive obligations or made payments on behalf of the associate.
If the associate subsequently reports profits, the investor resumes recognizing its share of those profits only after its
share of the profits equals the share of losses not recognized.
14. If under the equity method, an investor’s share of losses of an associate equals or exceeds the carrying amount of an
investment, which of the following is not correct?
b. Additional losses are provided for, or a liability is recognized, to the extent that the investor has incurred legal or
constructive obligations or made payments on behalf of the associate.
c. If the associate subsequently reports profits, the investor resumes its share of those profits without regard to the
share of net losses not previously recognized.
1. Prepare journal entries for the relating to the investment for the current year.
2. Compute for the investment income for the current year.
3. Compute for the carrying amount of the investment at year end.
Problem 1 (answer)
The excess is fully “expensed” because all the inventory was already sold during the year.
Required:
1. Compute the goodwill on January 1,2018.
Problem 2 (answer)
7. To reclassify the retained investment as financial asset at fair value through profit or loss:
Financial asset – FVPL 5,000,000
Investment in associate 5,000,000
Financial Assets at Amortized Cost
• Nominal rate is the coupon rate or stated rate appearing on the face of the bond.
• Effective rate is the yield rate or market rate which is the actual rate or true interest rate which the bondholder earns
on bond investment. It is the rate that exactly discounts estimated future payments through the expected life of the
bonds.
• Effective rate and nominal rate are the same if the cost of the bond investments is equal to the face value.
• Effective rate is lower than the nominal when the bonds are acquired at a premium.
• Effective rate is higher than the nominal when the bonds are acquired at a discount.
Effective interest method
• Requires the comparison between interest earned and interest or interest income and interest received. The
difference between the two represents the premium or discount amortization.
• Interest earned is computed by multiplying the effective rate and the carrying amount.
• Interest received is computed by multiplying the nominal rate by the face value of the bond.
• The carrying amount of the bond investment is the initial cost plus the amortization of discount or less periodic
amortization of premium.
1.The contractual agreement between an investor and the bond issuer is contained in a formal document known as.
a.Contract of debt
b. Bond indenture
c. Bond certificate
d.Bond agreement
b.Coupon rate
c. Stated rate
4. If the 5 year bond matures on October 1, 2017 and interest is payable semiannually, the interest dates are
a.April 1 and October 1
d.Not determinable
Schedule of Amortization
Date Interest Interest Discount Carrying
b. Investors are willing to invest in the bonds at rates that are lower than the stated interest rate.
c. Investors are willing to invest in the bonds at rates that are higher than the stated interest rate.
d.A capital gain is expected.
b.When the stated rate of interest on the bonds is greater than the market rate of interest.
c. When the price of the bonds is greater than their maturity value.
2. All of the investments of Doppler are nominal in respect to percentage of ownership (5% or less).
3. Each investment is considered by Doppler’s management to be available-for-sale.
Instructions
(1) Prepare any necessary correcting journal entries related to investments (a) and (b).
(2) Prepare the entry, if necessary, to record the proper valuation of the available-for-sale equity security
portfolio as of December 31, 2013.
Solution 17-131
(1) (a) Harmon — original purchase 4,000 shares stock dividend
400 shares total holding 4,400 shares
Total cost of $220,000 ÷ Total shares of 4,400 = $50 cost per share
Solution 17-131 (cont.)
Sold 100 shares
Correct entry:
Cash (400 × $65) ....................................................................... 26,00
0
Equity Investments......................................................... 20,000
Gain on Sale of Investments .......................................... 6,000
Entry made:
Cash........................................................................................... 26,00
0
Equity Investments......................................................... 26,000
Correction:
Equity Investments..................................................................... 6,00
0
Gain on Sale of Investments .......................................... 6,000
Correct entry:
Cash........................................................................................... 24,00
0
Dividend Revenue.......................................................... 24,000
Entry made:
Cash........................................................................................... 24,00
0
Equity Investments......................................................... 24,000
Correction:
Equity Investments..................................................................... 24,00
0
Dividend Revenue.......................................................... 24,000
(To properly record dividends under fair value
method)
Increase
Quantity Cost Fair Value (Decreas
e)
Harmon 4,000 shares $ 200,000 $296,000 $ 96,000
Taber 20,000 shares 800,000 660,000
(140,000
)
$1,000,000 $956,000 $
( 44,000)
Year-end Adjustment:
Unrealized Holding Gain or Loss—Equity........................................ 44,000
Fair Value Adjustment (available-for-sale) ........................ 44,000
1. 240,000 240,000
———————————————————————————————————————————————
2. 18,000 18,000
9,000 (9,000)
———————————————————————————————————————————————
3. 9,000 9,000
12,000 (12,000)
———————————————————————————————————————————————
4. (3,000) (3,000)
1,500 (1,500)
———————————————————————————————————————————————
All of the investments had been purchased in 2018. In 2019, Korman completed the following investment
transactions:
March 1 Sold 5,000 ordinary shares of Thomas Corp., @ €31 less fees of €1,500.
April 1 Bought 600 ordinary shares of Werth Stores, @ €45 plus fees of €550.
The Korman Company portfolio of trading equity investments appeared as follows on December 31, 2019:
Cost Fair Value
10,000 ordinary shares of Gant €182,000 €195,500
600 ordinary shares of Werth Stores 27,550 25,500
€209,550 €221,000
Instructions
Prepare the general journal entries for Korman Company for:
(a) the 2018 adjusting entry.
(b) the sale of the Thomas Corp. shares.
(c) the purchase of the Werth Stores' shares.
(d) the 2019 adjusting entry.
Solution 17-139
(a) 12-31-18
Unrealized Holding Gain or Loss—Income................................... 8,000
Fair Value Adjustment....................................................... 8,000
(€337,000 – €329,000)
(b) 3-1-19
Cash [(5,000 €31) – €1,500]..................................................... 153,500
Loss on Sale of Investments......................................................... 1,500
Equity Investment............................................................. 155,000
(c) 4-1-19
Equity Investments....................................................................... 27,550
Cash [(600 €45) + €550]............................................... 27,550
(d) 12-31-19
Fair Value Adjustment.................................................................. 19,450
Unrealized Holding Gain or Loss—Income....................... 19,450
[(€221,000 – €209,550) + €8,000]
Pr. 17-140—Trading equity investments.
Perez Company began operations in 2017. Since then, it has reported the following gains and losses for its
investments in trading securities on the income statement:
Cash.......................................................................................... 24,000
Dividend Revenue.......................................................... 24,000
Entry made:
Cash.......................................................................................... 24,000
Equity Investments......................................................... 24,000
Solution 17-141 (cont.)
Correction: