Generally Accepted Accounting Principles
in the United States

 

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Equity Method
(APB Opinion No. 18)
  
U.S. GAAP by Topic
Statements of Financial Accounting Standards (SFAS)
 
Equity Method

Accounting Principles Board (APB) Opinion No. 18
        a.  The Equity Method of Accounting for Investments in Common Stock
        b.  Issued in March 1971

Investments in Equity Securities
        a.  More than 50% ownership of another company
                 --> Consolidated Financial Statements
                 --> Accounting Research Bulletin (ARB) No. 51, August 1959

        b.  At least 20%, but no more than 50% ownership of another company
                 --> Equity Method is used.
                 --> Accounting Principles Board (APB) Opinion No. 18, March 1971
        
        c.  Less than 20% ownership of another company
                 --> No significant influence
                 --> Rules of SFAS No. 115 (May 1993) are applied.         

Investments in Debt Securities
        a.  Rules of SFAS No. 115 (May 1993) are applied. 

Equity Method
        a.  Initial investment in common stock
                 --> recorded at cost

        b.  Investor's share of net income of investee (after the date of acquisition)
                 --> increases the carrying amount of investment.
                 --> in the period when net income is reported by investee

        b.  Investor's share of net loss of investee (after the date of acquisition)
                 --> decreases the carrying amount of investment.
                 --> in the period when net loss is reported by investee

        c.  Dividends received from investee (after the date of acquisition)
                 --> decrease the carrying amount of investment.
                 --> in the period when dividends are declared

        d.  Series of operating losses of investee
                 --> may require an additional decrease
                       in the carrying amount of investment
 
Examples of Equity Method

Example 1
   
On January 1, 2006, Company A purchased 500,000 shares of Company B's common stock at $30 per share.  Company B had 2,000,000 shares of common stock issued and outstanding. 

   Additional information about Company B:
         Net income for 2006 (Jan. 1 - Dec. 31):  $3,000,000
         Dividend declared on December 15, 2006:  $.50 per share
         Dividend was paid on January 20, 2007.

     Company A's share of Company B's common stock
         = 500,000 shares / 2,000,000 shares
         = 25 % 
            --> At least 20%, but no more than 50%
            --> Equity method is used.

     Company A's initial investment in Company B's common stock
         = 500,000 shares x $30
         = $15,000,000

     Company A's share of Company B's net income for 2006
         = $3,000,000 x 25%
         = $750,000

     Company A's share of Company B's dividend declared in 2006
         = $.50 per share x 500,000 shares
         = $250,000

Journal entries by Company A:   

a.  Initial investment (1/1/2006)
  Debit Credit
  Investment in Company B 15,000,000
           Cash 15,000,000

b.  Dividend declared (12/15/2006)
  Debit Credit
  Dividends receivable 250,000
           Investment in Company B 250,000

c.  Net income (12/31/2006)
  Debit Credit
  Investment in Company B 750,000
           Income from investment 750,000

d.  Dividend paid (1/20/2007)
  Debit Credit
  Cash 750,000
           Dividends receivable 750,000

Balance of Investment in Company B as of 12/31/2006:
     $15,000,000 - $250,000 + $750,000 = $15,500,000


Example 2
   
On January 1, 2006, Company A purchased 300,000 shares of Company C's common stock at $20 per share.  Company B had 1,000,000 shares of common stock issued and outstanding. 

   Additional information about Company C:
         Net loss for 2006 (Jan. 1 - Dec. 31):  $500,000
         No dividend was declared during 2006.

   What is the balance of "Investment in Company C" as of December 2006?

     Company A's share of Company C's common stock
         = 300,000 shares / 1,000,000 shares
         = 30 % 
            --> At least 20%, but no more than 50%
            --> Equity method is used.

     Company A's initial investment in Company C's common stock
         = 300,000 shares x $20
         = $6,000,000

     Company A's share of Company C's net loss for 2006
         = $500,000 x 30%
         = $150,000

Balance of Investment in Company C as of 12/31/2006:
     $6,000,000 - $150,000 = $5,850,000


Other Accounting Topics   
 
  Inventory Valuation Methods
  Depreciation Methods
  Revenue Recognition Principle
  Accrual Basis vs. Cash Basis Accounting
  Basics of Journal Entries
  Ratios for Financial Statement Analysis
 
  U.S. GAAP by Topic
  Statements of Financial Accounting Standards (SFAS)


 


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