The Equity Method of Accounting for Investments Practice Exam

The Equity Method of Accounting for Investments Practice Exam

 

Question 1:

What is the equity method of accounting for investments?

A) A method used when the investor owns less than 20% of the investee’s stock
B) A method used when the investor has significant influence over the investee
C) A method used for consolidation of financial statements
D) A method used only for debt securities

Answer:

Question 2:

Under the equity method, how are dividends received from the investee recorded by the investor?

A) As dividend income
B) As a reduction in the investment account
C) As a liability
D) As an increase in retained earnings

 

Question 3:

How is the investor’s share of the investee’s net income recognized under the equity method?

A) As an increase in dividend income
B) As an increase in the investment account and investment income
C) As an expense in the income statement
D) It is not recognized by the investor

 

Question 4:

When would an investor stop using the equity method for an investment?

A) When the ownership percentage falls below 50%
B) When the investor no longer has significant influence over the investee
C) When the investee stops paying dividends
D) When the investee’s stock price declines significantly

 

Question 5:

What is “significant influence,” and how is it typically determined in the context of the equity method?

A) Ownership of more than 10% of the investee’s stock
B) The ability to participate in the policy-making process of the investee, typically with ownership of 20-50%
C) Ownership of the majority of the voting stock
D) Any ownership interest in the investee

 

Question 6:

If an investor applies the equity method, what happens to unrealized gains and losses from transactions with the investee?

A) They are fully recognized in the income statement.
B) They are deferred and amortized over time.
C) They are eliminated to the extent of the investor’s ownership percentage.
D) They are ignored completely.

 

Question 7:

How are impairments in the value of the investee accounted for under the equity method?

A) They are not recognized.
B) The investment is written down to its fair value, and the loss is recognized in income.
C) They are recorded as a reduction in retained earnings.
D) The impairment is amortized over time.

 

Question 8:

Which of the following indicates significant influence under the equity method?

A) Representation on the board of directors
B) Material transactions between the investor and investee
C) Technological dependence of the investee on the investor
D) All of the above

 

Question 9:

What is the primary financial statement impact of using the equity method?

A) The investment is recorded as a liability.
B) The investment is adjusted for the investor’s share of the investee’s income or loss.
C) Dividends are recognized as income.
D) Unrealized gains and losses are recognized in other comprehensive income.

 

Question 10:

Under the equity method, how is goodwill arising from the purchase of an investee treated?

A) It is amortized over a 10-year period.
B) It is tested for impairment annually.
C) It is ignored entirely.
D) It is included in the investment account and not separately recognized.

 

Question 11:

How are losses from the investee recorded under the equity method if they exceed the investor’s investment?

A) Losses continue to be recognized in full.
B) Losses are limited to the investor’s investment in the investee.
C) Losses are deferred to future periods.
D) Losses are ignored entirely.

 

Question 12:

What type of account is used to record the investment under the equity method?

A) Revenue account
B) Liability account
C) Asset account
D) Equity account

 

Question 13:

How are differences between the investor’s purchase price and their share of the investee’s net book value treated?

A) Amortized over the useful life of the underlying assets
B) Immediately expensed
C) Added to the investment account without further action
D) Allocated to goodwill

 

Question 14:

When dividends exceed the investor’s share of the investee’s net income, how is the excess treated?

A) As income
B) As a reduction in the investment account
C) As a liability
D) As a gain on investment

 

Question 15:

Under the equity method, how does an investor handle investee adjustments for prior-period errors?

A) Adjust their investment account retroactively.
B) Ignore prior-period errors.
C) Recognize the adjustment in the current period.
D) Record them as an equity adjustment.

 

Question 16:

When should the investor switch from the equity method to the fair value method?

A) When significant influence is lost.
B) When ownership falls below 50%.
C) When the investment is held for trading.
D) When the investee reports continuous losses.

Question 17:

What happens to the equity investment account when an investee declares and pays dividends?

A) It increases.
B) It decreases.
C) It remains unchanged.
D) It is transferred to retained earnings.

Question 18:

What financial statement contains the line item “Investment Income” under the equity method?

A) Statement of Cash Flows
B) Income Statement
C) Balance Sheet
D) Statement of Retained Earnings

Question 19:

How does the equity method impact the Statement of Cash Flows?
A) Investment income is reported in operating activities.
B) Dividends received are reported in operating activities.
C) Both are correct.
D) Neither is correct.

Question 20:

What is the impact of investee losses on the investor’s equity method accounting?

A) Losses reduce the investment account but not below zero.
B) Losses reduce the investment account without limitation.
C) Losses are not recognized at all.
D) Losses are deferred.

 

Question 21:

Can the equity method be applied retroactively if the investor acquires significant influence mid-year?

A) Yes, it must be applied retroactively.
B) No, it applies only prospectively.
C) Only if approved by auditors.
D) Only if it provides a more accurate representation.

Question 22:

What is the threshold for determining “significant influence” in terms of ownership percentage?

A) Less than 10%
B) 20% to 50%
C) More than 50%
D) Any percentage

 

Question 23:

Under the equity method, how is the investor’s share of investee net income calculated?

A) Based on the percentage of dividends received.
B) Based on the percentage of stock ownership.
C) Based on the fair value of the investment.
D) None of the above.

 

Question 24:

What happens to the equity method if the investor gains control over the investee?

A) It continues unchanged.
B) The equity method transitions to consolidation accounting.
C) The investment is written off.
D) The equity method is replaced by the cost method.

 

Question 25:

Which of the following is true about the investment account under the equity method?

A) It is reported at cost.
B) It is reported at fair value.
C) It is adjusted for the investor’s share of the investee’s earnings and losses.
D) It only changes when dividends are paid.

 

Question 26:

Under the equity method, how should an investor record its share of investee’s other comprehensive income?

A) As part of the investment account, directly impacting net income.
B) As a separate line item in the income statement.
C) As part of the investment account but not affecting net income.
D) As a reduction in the investment account.

 

Question 27:

What happens when the investee declares a stock split?

A) It is ignored by the investor.
B) The investment account is adjusted proportionally.
C) It is treated as a dividend.
D) The investor’s share of income changes.

 

Question 28:

Which method is used to account for an investment if the investor has no significant influence over the investee?

A) Equity method
B) Cost method
C) Consolidation method
D) Fair value method

Question 29:

If an investor has an investment that is not publicly traded, how should it be reported under the equity method?

A) At fair value, determined by market prices.
B) At the investor’s share of the investee’s book value.
C) At cost, adjusted for dividends and income recognition.
D) Using the cost method and not adjusted for market value.

Question 30:

What disclosure is required in the financial statements for investments accounted for under the equity method?

A) The investee’s financial statements must be included in the investor’s report.
B) The proportion of ownership and method of accounting must be disclosed.
C) Only the total dividend income is disclosed.
D) No disclosure is needed for investments under the equity method.

 

Question 31:

How does the investor report intercompany transactions with the investee under the equity method?

A) All intercompany transactions are reported in full.
B) Intercompany transactions are not reported.
C) Intercompany transactions are eliminated to the extent of the investor’s ownership.
D) Intercompany transactions are included as income.

Answer:
C) Intercompany transactions are eliminated to the extent of the investor’s ownership.

Question 32:

If an investee’s net assets are undervalued at the time of purchase, how is the investor’s investment affected under the equity method?

A) The investment is adjusted to reflect the undervalued assets.
B) The investor’s share of net income includes the fair value adjustment.
C) No adjustment is needed.
D) The investment is recorded at historical cost only.

Question 33:

Which of the following would not be included in the investment account under the equity method?

A) The investor’s share of the investee’s net income.
B) The investor’s share of the investee’s other comprehensive income.
C) Dividends paid to the investor by the investee.
D) Unrealized gains from transactions with the investee.

Question 34:

What is the treatment of losses from an investee when the investment account reaches zero?

A) The investor must recognize additional losses beyond the investment balance.
B) The investor does not recognize any further losses.
C) The investor records a liability for the additional losses.
D) The losses are deferred until the investment account becomes positive.

Question 35:

When an investor has significant influence over an investee, which of the following is true?

A) The investor should consolidate the financial statements of the investee.
B) The investor should apply the cost method.
C) The investor should use the equity method to account for the investment.
D) The investor should record the investment at its fair value.

Question 36:

What should an investor do when there is an impairment in the value of an equity method investment?

A) Write off the entire investment as an expense.
B) Adjust the carrying amount of the investment to fair value and recognize a loss.
C) Defer the impairment until the next period.
D) Ignore the impairment until it becomes significant.

Question 37:

Under the equity method, how is a change in the fair value of an investment recognized?

A) It is immediately reported as a gain or loss in the income statement.
B) It is recognized in the other comprehensive income.
C) It is not recognized until the investment is sold.
D) It is recorded as an adjustment to the investment account.

Question 38:

Which financial statement will show the investor’s share of the investee’s income?

A) Balance Sheet
B) Income Statement
C) Statement of Cash Flows
D) Statement of Financial Position

Question 39:

What happens when an investor purchases additional shares in the investee and its ownership percentage increases?

A) The investor switches from the equity method to the consolidation method.
B) The investment account remains unchanged.
C) The investor continues to apply the equity method but updates the investment account.
D) The investor must adjust the fair value of the investment.

 

Question 40:

How is an investor’s share of investee’s profits or losses adjusted if the investee is involved in a significant transaction with a third party?

A) The share of profits or losses is adjusted proportionally.
B) The transaction is ignored.
C) The profit or loss is eliminated in the calculation of share.
D) The transaction is recorded as income.

 

Question 41:

What is the impact on the investment account when the investee incurs a loss that exceeds the investor’s share of equity?

A) The investment account is written off entirely.
B) The excess loss is recognized as a liability by the investor.
C) The investment account is reduced to zero, and no additional loss is recognized.
D) The excess loss is deferred until future periods.

 

Question 42:

Under the equity method, when the investor’s share of the investee’s income is recorded, which account is affected?

A) Investment in Investee account and Dividend Income account
B) Cash account and Investment Income account
C) Investment in Investee account and Investment Income account
D) Revenue account and Retained Earnings account

 

Question 43:

How should the investor account for a change in the investee’s ownership structure if it does not affect significant influence?

A) The investor must use the consolidation method.
B) The equity method should continue, and the investment is adjusted proportionally.
C) The investment should be revalued to fair market value.
D) The change is ignored until significant influence is lost.

 

Question 44:

What is the effect on the investment account when an investee distributes a stock dividend?

A) The investment account increases proportionally.
B) The investment account decreases.
C) The investment account remains the same, but the shares held increase.
D) The investment is reported at fair market value.

 

Question 45:

Under the equity method, what happens if an investor fails to account for their share of the investee’s income?

A) There is no impact on the financial statements.
B) The investor must retroactively adjust prior periods.
C) The investment account is unchanged, and income is not recognized.
D) The investor’s financial statements must be restated.

 

Question 46:

Which of the following is true about the presentation of an equity method investment on the investor’s balance sheet?

A) It is presented as a liability.
B) It is recorded as a non-current asset.
C) It is reported as part of cash and cash equivalents.
D) It is reported as a current asset.

 

Question 47:

When an investee issues new shares, how does this affect the investor’s equity share under the equity method?

A) The investor’s share decreases proportionally.
B) The investor’s share increases proportionally.
C) The investor’s share remains the same.
D) The investment is revalued at fair market value.

 

Question 48:

What type of gain or loss should the investor recognize when selling an equity investment to an investee?

A) Full recognition of the gain or loss in the income statement.
B) The gain or loss is deferred until the investee sells the asset to a third party.
C) The gain or loss is recognized in proportion to the investor’s ownership percentage.
D) The gain or loss is ignored for equity method accounting.

 

Question 49:

How should the investor report an impairment loss if the fair value of an equity method investment declines below its carrying amount?

A) The investor should ignore the decline in value.
B) The investor should report the loss as an expense in the income statement.
C) The investment should be written down to fair value, and the loss recognized in the income statement.
D) The investor should apply the cost method.

 

Question 50:

If the investor has joint control over an investee, which method should they apply for accounting purposes?

A) Cost method
B) Fair value method
C) Equity method
D) Consolidation method

 

Question 51:

When an investor switches from the equity method to the cost method due to a loss of significant influence, what is the carrying amount of the investment?

A) The fair value of the investment at the date of the change.
B) The original cost of the investment.
C) The carrying amount under the equity method at the date of change.
D) The investment’s book value at acquisition.

 

Question 52:

What type of adjustments are made when an investee’s financial statements are not aligned with the investor’s reporting period?

A) No adjustments are needed.
B) The investor must align the investee’s financial statements with their own reporting period by applying pro-rata adjustments.
C) The investor adjusts the financials based on the most recent period available.
D) The investor only uses annual reports and ignores interim periods.

 

Question 53:

How should a company record its share of investee’s earnings if the investee reports a prior-period correction?

A) As an adjustment to the current period’s income statement.
B) Retroactively adjust the investment account for the prior period.
C) No adjustment is needed.
D) Report it as an extraordinary item.

 

Question 54:

What is the investor’s share of an investee’s income or loss based on?

A) The percentage of shares held in the investee.
B) The investor’s vote on the investee’s board.
C) The fair value of the investee’s assets.
D) The proportion of dividends received.

 

Question 55:

Under the equity method, how is the investor’s share of the investee’s income recorded when the investee pays no dividends?

A) It is recorded as revenue in the income statement.
B) It is recorded as an increase in the investment account.
C) It is recorded as a loan payable.
D) It is recorded as a reduction in the investment account.

 

Question 56:

What is true about the investor’s accounting treatment if the investee has a significant amount of unrealized intercompany profits?

A) The investor recognizes the profit immediately.
B) The investor eliminates the unrealized profit to the extent of their ownership share.
C) The investor defers the profit indefinitely.
D) The profit is ignored.

 

Question 57:

Which of the following statements is correct about the use of the equity method?

A) It can be used when the investor has less than 10% ownership.
B) It is used only when the investor has full control over the investee.
C) It is used when the investor can exert significant influence, typically through 20-50% ownership.
D) It is used for investments classified as trading securities.

 

Question 58:

If an investor owns 30% of an investee and receives a dividend that exceeds its share of the investee’s retained earnings, how is this excess handled?

A) The excess is recognized as income.
B) The excess is treated as a reduction to the investment account.
C) The excess is reported as a gain on the income statement.
D) The excess is deferred until the next period.

 

Question 59:

When an investor gains control over an investee, what change in accounting method should be applied?

A) The investor should continue using the equity method.
B) The investor should switch to the cost method.
C) The investor should consolidate the investee’s financial statements.
D) The investor should cease recognizing any share of the investee’s earnings.

 

Question 60:

If an equity investment is sold, how should the investor record the transaction?

A) The entire sale is recognized as income.
B) The gain or loss is recognized as the difference between sale proceeds and the carrying amount of the investment.
C) The gain or loss is ignored until audited.
D) The sale proceeds are reported as cash inflow only.

 

Question 61:

Under the equity method, when an investee issues new shares and the investor does not buy any of them, what happens to the investor’s ownership percentage?

A) The ownership percentage increases.
B) The ownership percentage decreases.
C) The ownership percentage stays the same.
D) The ownership percentage is disregarded.

Question 62:

What type of income does an investor recognize when the investee records a gain on the sale of an asset?

A) Only the gain is recognized in the income statement.
B) The investor recognizes their share of the gain, adjusted for any unrealized profit elimination.
C) The investor does not recognize any income from the sale.
D) The investor recognizes the gain as revenue.

Question 63:

Which of the following is a common reason an investor may choose to apply the equity method instead of the cost method?

A) The investor wants to report the investment at market value.
B) The investor has significant influence over the investee.
C) The investor owns less than 10% of the investee’s stock.
D) The investee is a subsidiary.

Question 64:

How is the initial investment recorded on the balance sheet when using the equity method?

A) At the fair value of the investee’s shares.
B) At the amount paid for the shares, adjusted for subsequent earnings and dividends.
C) At cost, without any subsequent adjustments.
D) At the investee’s book value at the acquisition date.

 

Question 65:

What must an investor do if an investee incurs significant losses and the investor’s share of those losses exceeds the carrying amount of the investment?

A) The investor must continue to recognize the excess losses as an expense.
B) The investor must suspend recognition of additional losses until future periods.
C) The investor must write off the entire investment and stop recognizing losses.
D) The investor must recognize the losses as a liability on the balance sheet.

Question 66:

Which type of transaction between an investor and an investee should be eliminated for equity method accounting purposes?

A) Transactions that do not involve cash.
B) Intercompany sales of goods and services.
C) Transactions with third parties.
D) Dividends paid by the investee to the investor.

Question 67:

When an investor recognizes its share of an investee’s loss, how does it affect the investment account?

A) It increases the investment account.
B) It decreases the investment account.
C) It has no effect on the investment account.
D) It reclassifies the investment as a liability.

 

Question 68:

What is the treatment of dividends received from an investee under the equity method?

A) The dividends are recorded as income.
B) The dividends are recorded as a reduction in the investment account.
C) The dividends are reported as an increase in cash.
D) The dividends are ignored in the accounting records.

 

Question 69:

If an investor loses significant influence over an investee, what happens to the investment previously recorded under the equity method?

A) The investment is reclassified as an investment held for trading.
B) The investment is transferred to the cost method.
C) The investment continues to be accounted for under the equity method.
D) The investment must be written off.

Question 70:

What is the impact on the investor’s income statement when an investee reports a net income?

A) The investor reports the full net income of the investee as revenue.
B) The investor recognizes their share of the investee’s net income as a separate line item.
C) The net income of the investee does not affect the investor’s income statement.
D) The net income is reported as an adjustment to cash.

 

Question 71:

How is the investment account adjusted when the investee declares and pays a cash dividend?

A) The investment account is increased by the amount of the dividend.
B) The investment account is decreased by the amount of the dividend.
C) The dividend is recognized as revenue in the income statement.
D) The investment account remains unchanged.

Question 72:

What is the accounting treatment for an impairment of an equity method investment?

A) The impairment is ignored until the investment is sold.
B) The impairment loss is recognized in the income statement, and the investment is written down.
C) The impairment is recorded as an adjustment to equity.
D) The impairment affects the investee’s financials only, not the investor’s..

Question 73:

If an investor owns 40% of an investee and the investee reports a profit, how should the profit be reported in the investor’s financial statements?

A) The investor should report 40% of the profit as equity income.
B) The investor should report the full profit of the investee.
C) The profit is not reported until the investor sells the investment.
D) The profit should be deferred and reported in the next period.

Answer:
A) The investor should report 40% of the profit as equity income.

Question 74:

Which of the following is not a reason to use the equity method?

A) The investor has the ability to influence the investee’s financial and operating policies.
B) The investor owns a majority of the voting shares.
C) The investor owns 20% or more of the investee’s voting stock.
D) The investor has no significant influence over the investee.

 

Question 75:

When an equity investment is sold, which of the following must be calculated?

A) The investee’s fair value at the time of sale.
B) The total dividends paid by the investee.
C) The gain or loss on the sale, which is the difference between the sale proceeds and the carrying amount of the investment.
D) The profit earned by the investee.

 

Question 76:

Under the equity method, what should an investor do if the investee reports a loss that exceeds the carrying amount of the investment?

A) Record the loss as an expense on the income statement.
B) Write off the entire investment and stop recording further losses.
C) Suspend the recognition of losses until the investment recovers.
D) Continue to recognize losses proportionally until the investment balance is zero.

 

Question 77:

Which of the following is true regarding dividends paid to an investor from an investee under the equity method?

A) They are treated as revenue on the investor’s income statement.
B) They are recorded as a reduction in the investment account.
C) They are treated as a gain on the investor’s income statement.
D) They are reported as an asset on the balance sheet.

 

Question 78:

How does an investor recognize its share of an investee’s income when using the equity method?

A) By increasing its share of cash and recognizing the income on the income statement.
B) By increasing the investment account and recognizing income on the income statement.
C) By decreasing the investment account and recognizing income as an expense.
D) By recording the income in a separate account and not affecting the investment account.

 

Question 79:

If an investor invests in an entity and initially has significant influence but later loses it, what must be done to the investment?

A) The investment is reclassified as an investment in a subsidiary.
B) The equity method is discontinued, and the investment is revalued at fair value.
C) The investment is still accounted for using the equity method until the loss of influence is verified.
D) The investment is transferred to a trading account.

 

Question 80:

Under the equity method, what happens if the investor purchases additional shares in an investee, increasing their ownership percentage?

A) The investment is transferred to the cost method.
B) The investor must reapply the equity method to reflect the new ownership percentage.
C) The ownership percentage remains unchanged; the investor only adjusts for dividends.
D) The investor should apply consolidation for the investee.

 

Question 81:

What is the purpose of adjusting the carrying amount of the investment under the equity method?

A) To align with fair market value.
B) To reflect the investor’s share of the investee’s profits, losses, and dividends.
C) To maintain consistency with the cost method.
D) To calculate potential future gains or losses.

 

Question 82:

How should an investor account for an investee that is not fully owned but controlled by the investor (i.e., the investor owns more than 50% of the voting shares)?

A) Using the equity method.
B) Using the cost method.
C) Using the consolidation method.
D) Ignoring the investee in financial statements.

 

Question 83:

When using the equity method, how is an investee’s net income reported on the investor’s income statement?

A) As a separate line item called “Equity in Investee’s Income.”
B) As a part of “Other Income” without any specific line item.
C) As an adjustment to revenue.
D) It is not reported; only dividends are reported.

 

Question 84:

Which of the following should be included when calculating an investor’s share of investee’s net income under the equity method?

A) Only the dividends paid to the investor.
B) The investee’s total revenue and expenses, excluding intercompany transactions.
C) The investee’s profit after eliminating intercompany profits and unrealized gains.
D) Only the investee’s operating income.

 

Question 85:

If an investor’s share of an investee’s losses exceeds the investment’s carrying amount, how should the investor report the loss?

A) As a liability in the balance sheet.
B) By stopping further recognition of the losses until the investment recovers.
C) As an expense in the income statement.
D) As an adjustment to the retained earnings of the investor.

 

Question 86:

What happens to the investor’s equity income when the investee’s fair value of identifiable assets and liabilities is adjusted during the acquisition?

A) The investor recognizes a gain on the fair value adjustment.
B) The investor must adjust its equity income to reflect the fair value allocation.
C) The fair value adjustment is not recognized by the investor.
D) The fair value adjustment is reported as an intangible asset.

 

Question 87:

What should be done if the investee’s financial statements are not prepared according to the same accounting principles as the investor?

A) The investor should use the cost method instead of the equity method.
B) The investor must adjust the investee’s financials to align with their own principles before applying the equity method.
C) The investor should only use the investee’s reported net income without any adjustments.
D) The investor can ignore the discrepancy and proceed with the equity method.

 

Question 88:

What is the main reason for an investor to apply the equity method?

A) To report the investment at fair value.
B) To report the investment as an asset on the balance sheet without changes.
C) To recognize income based on the investor’s share of the investee’s net income.
D) To treat the investment as a subsidiary.

 

Question 89:

When an investor increases its ownership interest in an investee from 10% to 30%, what change in accounting is required?

A) The investment must be transferred to the cost method.
B) The investment should continue to be recorded at cost.
C) The equity method should be applied, starting from the date of significant influence.
D) The investment is reclassified as a financial asset held for trading.

 

Question 90:

How should an investor account for unrealized intercompany profits from transactions with an investee?

A) Recognize them immediately in the investor’s income statement.
B) Eliminate them to the extent of the investor’s ownership share before recognizing equity income.
C) Report them as revenue on the income statement.
D) Ignore them as they do not affect financial reporting.

 

Set 2 Practice Exam

 

1. Gaw Company owns 15% of the common stock of Trace Corporation and used the fair-value method to account for this investment. Trace reported net income of $110,000 for 2018 and paid dividends of $60,000 on October 1, 2018. How much income should Gaw recognize on this investment in 2018?

 

1. A) $16,500.
2. B) $9,000.
3. C) $25,500.
4. D) $7,500.
5. E) $50,000.

 

2. Yaro Company owns 30% of the common stock of Dew Co. and uses the equity method to account for the investment. During 2018, Dew reported income of $250,000 and paid dividends of $80,000. There is no amortization associated with the investment. During 2018, how much income should Yaro recognize related to this investment?

 

2. A) $24,000.
3. B) $75,000.
4. C) $99,000.
5. D) $51,000.
6. E) $80,000.

 

3. On January 1, 2018, Pacer Company paid $1,920,000 for 60,000 shares of Lennon Co.’s voting common stock which represents a 45% investment. No allocation to goodwill or other specific account was necessary. Significant influence over Lennon was achieved by this acquisition. Lennon distributed a dividend of $2.50 per share during 2018 and reported net income of $670,000. What was the balance in the Investment in Lennon Co. account found in the financial records of Pacer as of December 31, 2018?

 

3. A) $2,040,500.
4. B) $2,212,500.
5. C) $2,260,500.
6. D) $2,171,500.
7. E) $2,071,500.

 

4. An investor should always use the equity method to account for an investment if:

 

4. A) It has the ability to exercise significant influence over the operating policies of the investee.
5. B) It owns 30% of an investee’s stock.
6. C) It has a controlling interest (more than 50%) of an investee’s stock.
7. D) The investment was made primarily to earn a return on excess cash.
8. E) It does not have the ability to exercise significant influence over the operating policies of the investee.

 

On January 1, 2016, Dermot Company purchased 15% of the voting common stock of Horne Corp. On January 1, 2018, Dermot purchased 28% of Horne’s voting common stock. If Dermot achieves significant influence with this new investment, how must Dermot account for the change to the equity method?

 

• A) It must use the equity method for 2018 but should make no changes in its financial statements for 2017 and 2016.
• B) It should prepare consolidated financial statements for 2018.
• C) It must restate the financial statements for 2017 and 2016 as if the equity method had been used for those two years.
• D) It should record a prior period adjustment at the beginning of 2018 but should not restate the financial statements for 2017 and 2016.
• E) It must restate the financial statements for 2017 as if the equity method had been used then.

 

6. During January 2017, Wells, Inc. acquired 30% of the outstanding common stock of Wilton Co. for $1,400,000. This investment gave Wells the ability to exercise significant influence over Wilton. Wilton’s assets on that date were recorded at $6,400,000 with liabilities of $3,000,000. Any excess of cost over book value of Wells’ investment was attributed to unrecorded patents having a remaining useful life of ten years.

In 2017, Wilton reported net income of $600,000. For 2018, Wilton reported net income of $750,000. Dividends of $200,000 were paid in each of these two years. What was the reported balance of Wells’ Investment in Wilson Co. at December 31, 2018?

 

1. A) $1,609,000.
2. B) $1,485,000.
3. C) $1,685,000.
4. D) $1,647,000.
5. E) $1,054,300.

 

• On January 1, 2018, Bangle Company purchased 30% of the voting common stock of Sleat Corp. for $1,000,000. Any excess of cost over book value was assigned to goodwill. During 2018, Sleat paid dividends of $24,000 and reported a net loss of $140,000. What is the balance in the investment account on December 31, 2018?

 

• A) $950,800.
• B) $958,000.
• C) $836,000.
• D) $990,100.
• E) $956,400.

 

On January 1, 2018, Jordan Inc. acquired 30% of Nico Corp. Jordan used the equity method to account for the investment. On January 1, 2019, Jordan sold two-thirds of its investment in Nico. It no longer had the ability to exercise significant influence over the operations of Nico. How should Jordan account for this change?

1. A) Jordan should continue to use the equity method to maintain consistency in its financial statements.
2. B) Jordan should restate the prior years’ financial statements and change the balance in the investment account as if the fair-value method had been used since 2018.
3. C) Jordan has the option of using either the equity method or the fair-value method for 2018 and future years.
4. D) Jordan should report the effect of the change from the equity to the fair-value method as a retrospective change in accounting principle.
5. E) Jordan should use the fair-value method for 2019 and future years, but should not make a retrospective adjustment to the investment account.

 

Tower Inc. owns 30% of Yale Co. and applies the equity method. During the current year, Tower bought inventory costing $66,000 and then sold it to Yale for $120,000. At year-end, only $24,000 of merchandise was still being held by Yale. What amount of intra-entity gross profit must be deferred by Tower?

 

• A) $6,480.
• B) $3,240.
• C) $10,800.
• D) $16,200.
• E) $6,610.

 

10. On January 4, 2018, Watts Co. purchased 40,000 shares (40%) of the common stock of Adams Corp., paying $800,000. There was no goodwill or other cost allocation associated with the investment. Watts has significant influence over Adams. During 2018, Adams reported income of $200,000 and paid dividends of $80,000. On January 2, 2019, Watts sold 5,000 shares for $125,000. What was the balance in the investment account after the shares had been sold?

 

• A) $848,000.
• B) $742,000.
• C) $723,000.
• D) $761,000.
• E) $925,000.

 

On January 3, 2018, Austin Corp. purchased 25% of the voting common stock of Gainsville Co., paying $2,500,000. Austin decided to use the equity method to account for this investment. At the time of the investment, Gainsville’s total stockholders’ equity was $8,000,000. Austin gathered the following information about Gainsville’s assets and liabilities:

 

11. What is the amount of goodwill associated with the investment?

• A) $500,000.
• B) $200,000.
• C) $0.
• D) $300,000.
• E) $400,000.

 

12. For 2018, what is the total amount of excess amortization for Austin’s 25% investment in Gainsville?

 

• A) $27,500.
• B) $20,000.
• C) $30,000.
• D) $120,000.
• E) $70,000.

 

Club Co. appropriately uses the equity method to account for its investment in Chip Corp. As of the end of 2018, Chip’s common stock had suffered a significant decline in fair value, which is expected to recover over the next several months. How should Club account for the decline in value?

 

• A) Club should switch to the fair-value method.
• B) No accounting because the decline in fair value is temporary.
• C) Club should decrease the balance in the investment account to the current value and recognize a loss on the income statement.
• D) Club should not record its share of Chip’s 2018 earnings until the decline in the fair value of the stock has been recovered.
• E) Club should decrease the balance in the investment account to the current value and recognize an unrealized loss on the balance sheet.

 

14. An upstream sale of inventory is a sale:

 

A) Between subsidiaries owned by a common parent.

B) With the transfer of goods scheduled by contract to occur on a specified future date.

C) In which the goods are physically transported by boat from a subsidiary to its parent.

D) Made by the investor to the investee.

E) Made by the investee to the investor.

 

15. What amount of equity income would Atlarge have recognized in 2018 from its ownership interest in Ticker?

 

A) $19,792.

B) $27,640.

C) $22,672.

D) $24,400.

E) $21,748.

 

16. What was the balance in the Investment in Ticker Co. account at the end of 2018?

 

A) $401,136.

B) $413,872.

C) $418,840.

D) $412,432.

E) $410,148.

 

. On Deuce’s December 31, 2019 balance sheet, what balance was reported for the Investment in Wiz Co. account?

 

A) $117,000.

B) $143,400.

C) $152,000.

D) $134,400.

E) $141,200.

 

18. What amount of equity income should Deuce have reported for 2019?

 

A) $30,000.

B) $16,420.

C) $38,340.

D) $18,000.

E) $32,840.

 

19. In a situation where the investor exercises significant influence over the investee, which of the following entries is not actually posted to the books of the investor?

 

(I) Debit to the Investment account, and a Credit to the Equity in Investee Income account.

(II) Debit to Cash (for dividends received from the investee), and a Credit to Investment Income account.

(III) Debit to Cash (for dividends received from the investee), and a Credit to the Dividend Receivable.

 

A) Entries I and II.

B) Entries II and III.

C) Entry I only.

D) Entry II only.

E) Entry III only.

 

All of the following would require use of the equity method for investments except:

 

A) Material intra-entity transactions.

B) Investor participation in the policy-making process of the investee.

C) Valuation at fair value.

D) Technological dependency.

E) Interchange of managerial personnel.

 

All of the following statements regarding the investment account using the equity method are true except:

 

A) The investment is recorded at cost.

B) Dividends received are reported as revenue.

C) Net income of investee increases the investment account.

D) Dividends received reduce the investment account.

E) Amortization of fair value over cost reduces the investment account.

 

A company has been using the fair-value method to account for its investment. The company now has the ability to significantly influence the investee and the equity method has been deemed appropriate. Which of the following statements is true?

 

A) A cumulative effect change in accounting principle must occur.

B) A prospective change in accounting principle must occur.

C) A retrospective change in accounting principle must occur.

D) The investor will not receive future dividends from the investee.

E) Future dividends will continue to be recorded as revenue.

 

A company has been using the equity method to account for its investment. The company sells shares and does not continue to have significant influence. Which of the following statements is true?

 

A) A cumulative effect change in accounting principle must occur.

B) A prospective change in accounting principle must occur.

C) A retrospective change in accounting principle must occur.

D) The investor will not receive future dividends from the investee.

E) Future dividends will continue to reduce the investment account.

 

24. When an investor appropriately applies the equity method, how should it account for any investee Other Comprehensive Income (OCI)?

 

A) Under the equity method, the investor only recognizes its share of investee’s income from continuing operations.

B) The OCI would reduce the investment.

C) The OCI would increase the investment.

D) The OCI would not appear on the investor’s income statement but would be a component of comprehensive income.

E) The OCI would be ignored but shown in the investor’s notes to the financial statements.

 

25. How should a permanent loss in value of an investment using the equity method be treated?

 

A) The equity in investee income is reduced.

B) A loss is reported in the same manner as a loss in value of other long-term assets.

C) The investor’s stockholders’ equity is reduced.

D) No adjustment is necessary.

E) Record an offset to cash.

 

26. Under the equity method, when the company’s share of cumulative losses equals its investment and the company has no obligation or intention to fund such additional losses, which of the following statements is true?

 

A) The investor should change to the fair-value method to account for its investment.

B) The investor should suspend applying the equity method until the investee reports income.

C) The investor should suspend applying the equity method and not record any equity in income of investee until its share of future profits is sufficient to recover losses that have not previously been recorded.

D) The cumulative losses should be reported as a prior period adjustment.

E) The investor should report these as equity method losses in its income statement.

 

27. When an investor sells shares of its investee company, which of the following statements is true?

 

A) A recognized gain or loss is reported as the difference between selling price and original cost.

B) An recognized gain or loss is reported as the difference between selling price and original cost.

C) A recognized gain or loss is reported as the difference between selling price and carrying value.

D) An unrealized gain or loss is reported as the difference between selling price and carrying value.

E) Any gain or loss is reported as part of comprehensive income.

 

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