College

of
Business
Administration

Advanced Accounting
ACC 311
Chapter One - 6

Lecture Leader: Dr Mohamed Z. Yassin

Email: [email protected]
 Chapter One

The Equity
Method of
Accounting for
Investments
 Understand the financial reporting
consequences for:

a. A change to the equity method.

b. Sales of equity method investments.

1-3
 Reporting Sale of Equity Investment

If part of an investment is sold during the period:

The equity method continues to be applied up to the date

of the transaction to record the selling of investment.

At the transaction date, the Investment Account balance is

reduced by the percentage of shares sold. And record gain
(credit) or loss (debit) on sale of investment.
If significant influence is lost, NO ADJUSTMENT is
recorded, but the equity method is no longer applied.

1-4
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-5
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-6
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-7
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-8
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-9
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-10
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-11
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-12
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-13
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-14
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-15
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-16
2021 $600,000 2021 $160,000
1/1/2019 Total Investment $1,480,000 1/7/2021 Sold Investment $300,000
75,000 shares 25% 12,000 shares 4% (12,000 x $25)

Net Income 2019 $340,000 Dividends 2019 $120,000

2020 $480,000 2020 $140,000
1-17
2021 $600,000 2021 $160,000
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-18
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-19
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-20
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-21
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-22
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 No Goodwill Dividends 2020 $70,000

Dividends 2021 $80,000 1-23
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-24
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-25
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-26
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-27
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-28
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-29
1/1/2020 $312,000 All Excess Copyright Income 2020 $180,000
Cost 30% Payment (16 years) Income 2021 $230,000

Net Assets BV 2020 $800,000 1/1/2022 Sold $400,000 Dividends 2020 $70,000
All Investment Dividends 2021 $80,000 1-30
 Understand the financial reporting
consequences for:

Understand the financial reporting

consequences for:
a. A change to the equity method.
b. Sales of equity method investments.
c. Investee other comprehensive income.
d. Investee losses and impairments of
equity.

1-31
 Investee Other Comprehensive Income

➢ OCI is defined as revenues, expenses, gains, and losses

that under GAAP are included in comprehensive income
but excluded from net income.

➢ OCI is accumulated and reported in stockholders’ equity

and represents a source of change in investee company
net assets that is recognized under the equity method.
(Note: it could be loss).

➢ Equity method requires that investor records its share of

investee OCI which then included in the balance sheet as
Accumulated Other Comprehensive Income (AOCI).
1-32
Reporting Investee Other Comprehensive
Income and Irregular Items

➢ Other equity method recognition issues arise for

irregular items traditionally included within
investee’s net income.
An investor must report its share of the following
irregular items reported in investee’s current income:
➢ Discontinued operations
➢ Extraordinary items

1-33
 Reporting Investee Losses and
Impairment of Equity Investments
Investee’s loss should be recorded and reduce
the carrying amount of investment account.

So, By Time:

Equity Investment Could Be Reduced

to ZERO

1-34
 If Equity Investment Reduces to
ZERO
When accumulated losses incurred and
dividends paid by the investee reduce the
investment account to $-0-, no further loss can
be accrued (deducted).

Investor stop using the equity method rather

than record a negative balance. Balance remains
at $-0-, until subsequent profits eliminate all
unrecognized losses.
1-35
 Reporting Investee Losses and
Impairment of Equity Investments
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 in fair value is ignored.

1-36
 Criticisms of the Equity Method

➢ Over-emphasis on possession of 20-50%

voting stock in deciding on significant
influence vs. control.
➢ Allowing off-balance sheet financing.
(Assets and Liabilities hidden in
Investment account).
➢ Potential manipulation of performance
ratios. (Shifting from consolidation to
equity method of vice versa).
1-37
 Fair Value Reporting Option

An entity may irrevocably elect fair value as the

initial and subsequent measurement for certain
financial assets and financial liabilities including
investments otherwise accounted for under the
equity method.

Under the fair-value option, changes in the fair

value of the elected financial items are included in
earnings. 1-38
 Summary of Main Technical Points:
Three methods for Fair value < 20% Equity between 20%-50% Consolidate >
equity investments 50% and control. (Indicator percentages Not MUST)
Fair value method Report dividends as income & adjust the investment
carrying amount (BV) with the fair value (If available).
Equity method Investment carrying amount = acquisition price + share of
reported income (-) share of dividends declared.
Excess payment Attributed to (1) the higher fair value of some asset than BV
(2) Any extra payment attributed to intangibles (goodwill).
Excess payment Should be amortized (expense) over an appropriate time
treatment (BV & FV) period except land, indefinite life intangibles and goodwill.

Earning in investor = Accrual income in investee income – amortization

income statement expenses
Change from fair If significant influence achieved, No adjustments needed
value to equity but the fair value method will not use anymore, and equity
method method will be applied.

1-39
 Summary of Main Technical Points:
Sale of equity - Apply equity method up to selling date.
investment - Reduce investment account (credit).
- Record gain (credit) or loss (debit). (Selling price BV)
Other Investor should record its share of investee OCI as
Comprehensive Accumulated Other Comprehensive Income (AOCI) in
Income (OCI) balance sheet.
Irregular items An investor must report its share of discontinued operations
extraordinary items from investee’s income.

Reducing Due to Loss the investment account will be reduced only

investment account until Zero balance. Then stop applying equity method.
Decline in Fair It there is a permanent decline in fair value, the investment
Value account balance should be adjusted to fair value
(temporary decline ignored).

1-40
 Prepare for Consolidation

Please watch the following short videos before

next session:

https://www.youtube.com/watch?v=PNFEhNaIsVU

https://youtu.be/vUrEkvn5Aok

1-41
 End of Today’s Lecture

Thank you ☺