Philippine School of Business

826 R. Papa St. Sampaloc, Manila

Administration
CPA REVIEW
THEORY OF ACCOUNTS Gutierrez/Ocampo
HAND OUT NO. 05-40 May 2006

INVESTMENT IN EQUITY

Applying PHILIPPINE ACCOUNTING STANDARD (PAS) 39 Financial

Instruments: Recognition and Measurement under investment.; (PAS) 28
Investment in Associates

MULTIPLE CHOICE:

1. When a company holds between 20% and 50% of the outstanding stock of an
investee, which of the following statements applies?
a. The investor should always use the equity method to account for its investment.
b. The investor should use the equity method to account for its investment unless
circum-stances indicate that it is unable to exercise "significant influence" over
the investee.
c. The investor must use the fair value method unless it can clearly demonstrate
the ability to exercise "significant influence" over the investee.
d. The investor should always use the fair value method to account for its
investment.
B
2. If the parent company owns 90% of the subsidiary company's outstanding common
stock, the company should generally account for the income of the subsidiary under
the
a. cost method.
b. fair value method.
c. divesture method.
d. equity method.
D
3. Byner Corporation accounts for its investment in the common stock of Yount Company
under the equity method. Byner Corporation should ordinarily record a cash
dividend received from Yount as
a. a reduction of the carrying value of the investment.
b. additional paid-in capital.
c. an addition to the carrying value of the investment.
d. dividend income.
A
4. Under the equity method of accounting for investments, an investor recognizes its share
of the earnings in the period in which the
a. investor sells the investment.
b. investee declares a dividend.
c. investee pays a dividend.
d. earnings are reported by the investee in its financial statements.
D
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5. Dane, Inc., owns 35% of Marin Corporation. During the calendar year 2004,
Marin had net earnings of P300,000 and paid dividends of P30,000. Dane
mistakenly recorded these transactions using the fair value method rather
than the equity method of accounting. What effect would this have on the
investment account, net income, and retained earnings, respectively?
a. Understate, overstate, overstate
b. Overstate, understate, understate
c. Overstate, overstate, overstate
d. Understate, understate, understate
D
6. PAS 28 generally applies cost method when the level of ownership of another
company is at what percentage?
a. Less than 20%
b. 20%-30%
c. 30%-50%
d. More than 50%
A

7. When an investor uses the cost method to account for investments in

common stock, cash dividends received by the investor from the investee should
normally be recorded as
a. a deduction from the investment account.
b. dividend revenue.
c. an addition to the investor's share of the investee's profit.
d. a deduction from the investor's share of the investee's profit.
B
8. Under the cost method of accounting for unconsolidated investments in
common stock, goodwill amortization
a. reduces the investment account.
b. increases the investment account.
c. reduces both investment income and the investment account.
d. is not recorded.
D
9. From the following, select the most appropriate basis for the valuation of a
new investment when properties or services are exchanged for stock.
a. The par or stated value of the stock received
b. The book value of the property or services exchanged
c. The fair market value of the stock received
d. Either b or c, whichever is more clearly determinable
C

10. For which type of investments would unrealized increases and decreases
be recorded directly in an owners' equity account?
a. Equity method securities
b. Available-for-sale securities
c. Trading securities
d. Held-to-maturity securities

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11. The equity method of accounting for an investment in the common stock of
another company should be used when the investment
a. is composed of common stock and it is the investor's intent to vote the
common stock.
b. ensures a source of supply such as raw materials.
c. enables the investor to exercise significant influence over the investee.
d. gives the investor voting control over the investee.
C
12. When an investor uses the equity method to account for investments in common
stock, the investment account will be increased when the investor recognizes
a. a proportionate share of the net income of the investee.
b. a cash dividend received from the investee.
c. periodic amortization of an intangible arising from contractual rights
acquired in the purchase.
d. depreciation related to the excess of market value over book value of the
investee's depreciable assets at the date of purchase by the investor.
A

13. When an investor uses the equity method to account for investments in
common stock, cash dividends received by the investor from the investee should
be recorded as
a. an increase in the investment account.
b. a deduction from the investment account.
c. dividend revenue.
d. a deduction from the investor's share of the investee's profits.
B
14. Consolidated financial statements are typically prepared when one
company has
a. accounted for its investment in another company by the equity method.
b. significant influence over the operating and financial policies of another
company.
c. the controlling financial interest in another company.
d. a substantial equity interest in the net assets of another company.
C
15. Poster Inc. owns 35 percent of Elliott Corporation. During the calendar year
2005, Elliott had net earnings of P300,000 and paid dividends of P36,000. Poster
mistakenly accounted for the investment in Elliott using the cost method rather
than the equity method of accounting. What effect would this have on the
investment account and net income, respectively?
a. Understate, overstate
b. Overstate, understate
c. Overstate, overstate
d. Understate, understate

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TRUE OR FALSE

T 16. Control is the power to govern the financial and operating policies of an
entity so as to obtain
benefits from its activities.
T 17. An associate is an entity, including an unincorporated entity over which
the investor has
significant influence.
18. Equity method can be use for investment classified as held for sale in
accordance with PFRS 5.
T 19. Investment in associates accounted for using the equity method shall
be classified as non-
current assets.
T 20. Profits and losses resulting from upstream and downstream
transactions between an investor and an associate must be eliminated to the
extent of the investor’s interest in the associate.

21.An investment in stock is initially recorded at cost and all commissions,

taxes, and other fees are expensed as incurred, under both the cost and equity
methods.

22.Under some circumstances, consolidated financial statements are

appropriate even though the parent company owns less than 50 percent of the
voting stock of the subsidiary.

23.Accounting practice allows companies not to consolidate certain

majority-owned subsidiaries if these subsidiaries have "nonhomogeneous"
operations, a large minority interest, or a foreign location.

T 24.The cost method of accounting should always be used when the investor
does not exercise significant influence over the investee.

T 25.The equity method may not be appropriate in some cases even though
the investor owns more than 20 percent of the voting stock of the investee.

26.As a general rule, consolidated financial statements should be prepared

only when the parent corporation owns 80 percent or more of the outstanding
common stock of the subsidiary.

27.Under the cost method, the investment account is periodically adjusted

to reflect changes in the underlying net assets of the investee.

28.When an investment in equity securities has been accounted for under

the equity method, but circumstances dictate a change to the cost method,
retroactive application of the cost method is required.

T 29.When the purchase price of stock is greater than the underlying book
value of the investee's net assets as a result of a difference between the fair
values and book values of depreciable assets, an adjustment is made by the
investor to the income reported by the investee in applying the equity method.

T 30.No adjustment is made to the investment account when changing from

the equity method to the cost method.

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