Question

Summarize concepts from the first 3 chapters. What have you learned? I would like to see summary of:

1. Chapter 1: Equity method (new account titles, how account balances change for each)

2. Chapter 2: List the 3 types of business combinations and define them. Define acquisition method Also list the first 2 consolidation entries for acquisitions.

3. Chapter 3: What are the 3 methods parents can use to record investment in subsidiary? What are the consolidation entries for each method?

Answer 1

Equity Method

The equity method is an accounting techniqueused by firms to assess the profits earned by their investments in other companies. The firm reports the income earned on the investment on its income statement, and the reported value is based on the firm's share of the company assets.

BREAKING DOWN 'Equity Method'

The equity method is the standard technique used when one company has a significant investment in another. When a company holds approximately 20% or more of another company's stock, it is considered to have significant control, which signifies the power one company can exert over another. This power includes representation on the board of directors, partaking in policy development and the interchanging of managerial personnel. If a firm owns 25% of a company with a $1 million net income, the firm reports earnings under the equity method of $250,000.

When the equity method is used to account for ownership in a company, the investor records the initial investment in the stock at cost and that value is periodically adjusted to reflect the changes in value due to the investor's share in the company's income or losses.

Equity Method Earnings Adjustment

The equity method acknowledges the substantive economic relationship between two entities. When a company, the investor, has a significant influence on the operating and financial results of another company, the investee, it can directly affect the value of the investor's investment. With an investment holding above 20%, the investor usually records its share of the investee's earnings as revenue from investment, which increases the carrying value of the investment.

Equity Method Loss Adjustment

When the investee company reports a net loss, the investor company records its share of the loss as loss on investment, which decreases the carrying value of the investment. Using the equity method, a company reports the carrying value of its investment independent of any fair value change in the market. With a significant influence over another company's operating and financial policies, the investor is basing its investment value on changes in the value of that company's net assets from operating and financial activities and the resulting performances, including earnings and losses.

Equity Method Dividend Adjustment

When the investee company pays a cash dividend, it decreases the value of its net assets. Using the equity method, the investor company receiving the dividend records an increase to its cash balance but, meanwhile, reports a decrease to the carrying value of its investment. Other financial activities that affect the value of the investee's net assets should have the same impact on the value of the investor's share of investment. The equity method ensures proper reporting on the business situations for the investor and the investee, given the substantive economic relationship they have.

Business Combination And Its Types

Business combination is a voluntary association of firms for the achievement of a common objective. The combination among the firms may be temporary or permanent. The combination may be formed by a written agreement among the firms, or there may be an oral understanding among them to unite for enjoying the advantages of a monopoly.

division of business combination.

1. Horizontal combination
2. Vertical combination
3. Circular combination
4. Diagonal combination

Horizontal Combination:

It is a voluntary association of two or more than two business units activity at the same distribution level and serving the same geographical market.

Vertical combination:

The vertical combination is another type of business combination. the combination of a firm engaged in successive phases of the process of manufacture or sale under an effective control of top management

Diagonal Combination:

Another type is Diagonal combination is also named as service combination. it is brought about by combining two or more than two business units providing auxiliary (helping) services in the main line of production .

Acquisition method

When an acquiree buys another company and the acquirer uses GAAP, the acquirer must record the event using the acquisition method. This approach mandates a series of steps to record the acquisitions, which are:

1. Measure any tangible assets and liabilities that were acquired
2. Measure any intangible assets and liabilities that were acquired
3. Measure the amount of any noncontrolling interest in the acquired business
4. Measure the amount of consideration paid to the seller
5. Measure any goodwill or gain on the transaction