College

of
Business
Administration

Advanced Accounting
ACC 311
Chapter One - 5

Lecture Leader: Dr Mohamed Z. Yassin

Email: myassin@uob.edu.bh
 Chapter One

The Equity
Method of
Accounting for
Investments
Summary of Accounting Methods

1-3
Accounting for an Investment - Equity Method

1 The investor increases the investment account as the

investee earns and reports income.

2 The investor decreases its investment account’s

carrying value for its share of investee cash dividends.

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 Excess of Cost Over Book Value
of Acquired Investment

When Purchase Price > Book Value of an investment

acquired, the difference must be identified.

Assets may be undervalued on the investee’s books because:

1. The fair values (FV) of some assets and liabilities are
different than their book values (BV).
2. The investor may be willing to pay extra because future
benefits are expected to accrue from the investment due
to goodwill.

1-5
 The Amortization Process

When an investor buy investment in investee

company, The Excess Payment associated with
the differences between assets and liabilities
fair value and book value should be:
amortized over an appropriate time period.

(except land, goodwill, and other indefinite life

intangibles)

1-6
 The Amortization Process

Very Important Note:

The investor's share of investee income should be
decreased by the annual amortization expenses.

So,
Investor Income =
(Investee’s Income x Ownership Percentage) –
Annual Amortization

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 Understand the financial reporting
consequences for:

a. A change to the equity method.

b. Sales of equity method investments.

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 Reporting a Change to the Equity
Method
Report a change to the equity method if:
➢ An investment that was recorded using the cost or
fair-value method reaches the point where
significant influence is established.
➢ When an investment qualifies for use of the equity
method, the investor adds the cost of acquiring
additional interest in the investee to the current
basis and adopts the equity method of accounting.
➢ This prospective approach avoids the complexity
of restating prior period amounts.

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 Reporting a Change to the
Equity Method Example
➢ Alpha Company acquires a 10 % ownership
in Bailey Company on January 1, 2020, for
$84,000.
➢ Alpha company does not have the ability to
exert significant influence over Bailey.
➢ Alpha properly records the investment
using the fair-value method and recognizes
in net income its 10 % ownership share of
changes in Bailey’s fair value.
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 Reporting a Change to the
Equity Method Example
➢ Alpha Company recognizes increase in its 10 %
ownership in Bailey Company at the end of 2020
and increases its investment account to $89,000
according to fair value.
➢ On January 1, 2021, Alpha purchases an
additional 30 % of Bailey’s outstanding voting
stock for $267,000.
➢ Alpha achieves the ability to exercise significant
influence over Bailey and will now apply the
equity method to account for its investment in
Bailey. 1-11
 Reporting a Change to the
Equity Method Example
➢ On January 1, 2021, Bailey’s carrying amounts for its
assets and liabilities equaled their fair values except for
a patent, which was undervalued by $175,000 and had
a 10-year remaining useful life.

➢ The fair value of Alpha’s total (40 %) investment

serves as the valuation basis.

➢ On January 1, 2020 Bailey’s common stock book value

$670,000 increased to be $715,000 on January 1, 2021.
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 Reporting a Change to the
Equity Method Example

Alpha prepares the following journal entry on

January 1, 2021, to bring about prospective
change to the equity method (recording the 30%
“$267,000” new purchase of investment):

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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Reporting a Change to the
Equity Method Example

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 Recording a Change to the Equity
Method (continued)
Bailey reports net income of $130,000 and declares and pays a
$50,000 dividend at the end of 2021. Alpha records the
following journal entries:

1-22
 Recording a Change to the Equity
Method (continued)
Bailey reports net income of $130,000 and declares and pays a
$50,000 dividend at the end of 2021. Alpha records the
following journal entries:

1-23
 Recording a Change to the Equity
Method (continued)
Bailey reports net income of $130,000 and declares and pays a
$50,000 dividend at the end of 2021. Alpha records the
following journal entries:

1-24
 Recording a Change to the Equity
Method (continued)
Bailey reports net income of $130,000 and declares and pays a
$50,000 dividend at the end of 2021. Alpha records the
following journal entries:

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Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-26
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-27
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-28
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-29
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-30
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-31
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-32
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-33
Cost 10% 2020 $190,000 Land $120,000 Income 2021 $300,000
Cost 30% 2021 $600,000 Undervalued

Net Assets BV 2021 $1,850,000 Extra Excess Trademark Dividends 2021 $110,000
Net Assets FV 2021 $2,000,000 (8 Years) 1-34
1-35
1-36
1-37
1-38
 Understand the financial reporting
consequences for:

a. A change to the equity method.

b. Sales of equity method investments.

1-39
 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 (CR) 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.

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Example:
Top Co. owns (40% = 40,000 shares) of 100,000
outstanding shares of Bottom Co. The cost was $200,000
some years ago however the investment balance on
1/1/2015 increased to be $320,000.
On 1/7/2015 Top sold 10,000 shares (25% from total
investment 40,000 and %10 from total Bottom’s shares
100,000) for $110,000 in cash.
Bottom Co. reports net income $70,000 and dividends
$30,000 during the first 6 months of 2015.
Prepare the required journal entries during 2015 for Top
Co. to record the net income, dividends and any gain or
loss from the selling transaction of Bottom Co. shares.
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Example: Journal entries 1/7/2015

Investment in Bottom 28,000

Equity in investee income 28,000
70,000 x %40

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Example: Journal entries 1/7/2015

Investment in Bottom 28,000

Equity in investee income 28,000
70,000 x %40
Dividend receivable 12,000
Investment in Bottom 12,000
30,000 x %40

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Example: Journal entries 1/7/2015

Investment in Bottom 28,000

Equity in investee income 28,000
70,000 x %40
Dividend receivable 12,000
Investment in Bottom 12,000
30,000 x %40
Cash 12,000
Dividend receivable 12,000
Cash collection

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Example: Journal entries 1/7/2015
Reminder:
Gain or Loss = difference between selling price and the
book value (carrying amount).

Investment in Bottom book value on 1/7/2015 =

Investment Balance 1/1/2015 320,000

+ Share of income 70,000 x 40% 28,000
– Share of dividends 30,000 x40% (12,000)
= Investment Balance 1/7/2015 336,000
Book value of sold shares = 336,000 x %25 = 84,000

Selling price $110,000 > $84,000 Sold Shares BV

So, gain on sale of investment $26,000

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Example: Journal entries 1/7/2015
Investment in Bottom 28,000
Equity in investee income 28,000
70,000 x %40
Dividend receivable 12,000
Investment in Bottom 12,000
30,000 x %40
Cash 12,000
Dividend receivable 12,000
Cash collection
Cash 110,000
Investment in Bottom 84,000
Gain on sale of investment 26,000

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1-47
 End of Today’s Lecture

Thank you ☺