Question

1. Which of the following results in a decrease in the investment account when applying the equity method?

a. Net income of the investor

b. Net income of the investee

c. Unrealized gain on intercompany inventory transfers for the current year

d. Dividends paid by the investor

e. Purchase of additional common stock by the investor during the current year

2. Which of the following is a characteristic of a business combination that should be accounted for as a purchase?

a. The combination must involve the exchange of equity securities only.

b The acquired subsidiary must be smaller in size than the acquiring parent.

c The two companies may be about the same size, and it is difficult to determine the acquired company and the acquiring company.

d The transaction may be considered to be the uniting of the ownership interests of the companies involved.

e The transaction clearly establishes an acquisition price for the company being acquired.

3. Under the partial equity method, the parent recognizes income when

a dividends are received from the investee.

b dividends are declared by the investee.

c it is earned by the subsidiary.

d the related contract is signed by the subsidiary.

e the related expense has been incurred.

Answer 1

1.c.Unrealized gain on intercompany inventory transfers for the current year

Under the equity method, the transfers between the holding and subsidiary company shall be eliminated. This includes transaction like transfer of stocks to parent by the subsidiary company and vice versa. The profit component in such sale shall be eliminated and hence the investment income of parent decline in such case. So, the correct option is ( c)

2.e. The transaction clearly establishes an acquisition price for the company being acquired.

GAAP requires that when a company acquires another company resulting in a business combination, it shall be recorded at the fair value of the purchased company. Hence, the correct option is e. as the fair value is to be clearly established before such acquisition.

3.c it is earned by the subsidiary.

The partial equity method is a method where the income of the subsidiary is to be recognized by parent in the consolidated financial statements. GAAP states that it shall be recognized when the income is earned by subsidiary i.e. on the accrual basis.