Deck 2: Intercorporate Equity Investments: an Introduction

Question 1

On January 1,20X1,Belle Ltd.purchased 100% of the common shares of Dominique Corporation for $700,000.Dominique's net income was $30,000 for 20X1 and $50,000 for 20X2.DA paid dividends of $20,000 on its common shares during 20X1 and $100,000 during 20X2.As such,total dividends paid by Dominique exceeded income earned by Dominique since it was acquired by Belle.What is the balance in the investment in Dominique's account at the end of 20X2 under the cost and equity methods?

A)
B)
C)
D)

Answer 1

C

Question 2

Forest Ltd.reports its investment in Leeds Co.using the cost method.During the year,Forest received $10,000 in dividends from Leeds.How should Forest report these dividends?

A)As an increase to the "Investment in Leeds Co." account on its statement of financial position
B)As a decrease to the "Investment in Leeds Co." account on its statement of financial position
C)As dividend income on its statement of changes in equity-retained earnings section
D)As dividend income in its statement of comprehensive income

Answer 2

D

Question 3

Which of the following statements about the direct approach to consolidation is true?

A)It can be used for both simple and complex consolidations.
B)It is a more methodical and less intuitive approach than the worksheet approach.
C)The starting point for preparing the consolidated financial statements is the financial statements for each of the parent and subsidiary companies.
D)The starting point for preparing the consolidated financial statements is the trial balance for each of the parent and subsidiary companies.

Answer 3

C

Question 4

At the beginning of 20X1,Anwar Ltd.acquired 15% of the voting shares of Cruz Co.for $150,000.Anwar does not have any significant influence over Cruz.Anwar reports the investment using the cost method.In 20X1,Cruz earned net income of $70,000 and paid dividends of $40,000.In 20X2,Cruz earned net income of $80,000 and paid dividends of $100,000.At the end of 20X2,what journal entry should Anwar make to record its share of Cruz's net income?

A)
B)
C)
D)No entry is required

Question 5

Passive investments can be classified as fair value through profit or loss (FVTPL)or as fair value through other comprehensive income (FVTOCI).Which of the following statements is true?

A)Under both FVTPL and FVTOCI,changes in the fair value of the investment are reported as other comprehensive income on the statement of comprehensive income.
B)Under both FVTPL and FVTOCI,changes in the fair value of the investment are reported under the net income section on the statement of comprehensive income.
C)Under both FVTPL and FVTOCI,dividends received from the investee are reported under the net income section on the statement of comprehensive income.
D)Under both FVTPL and FVTOCI,dividends received from the investee are reported as other comprehensive income on the statement of comprehensive income.

Question 6

What is securitization?

A)It is the process of issuing long-term debt for financing.
B)It is the process of issuing preferred and common shares for financing.
C)It is the process of transferring long-term liabilities to a special purpose entity.
D)It is the process of transferring receivables to a special purpose entity and issuing bonds to finance those receivables.

Question 7

How do joint ventures differ from private corporations?

A)The joint venturers must share the risks and profits of the joint venture equally.
B)There can only be two parties in a joint venture.
C)A joint venture does not have a board of directors.
D)Venturers cannot make unilateral decisions.

Question 8

Bela Ltd.has invested in several domestic manufacturing corporations.Which of the following investments would most likely be accounted for under the equity method on Bela's financial statements?

A)A holding of 15,000 of the 50,000 outstanding common shares of Earthwise Co.
B)A holding of 3,000 of the 10,000 outstanding preferred shares of Earthbent Co.
C)A holding of 5,000 of the 60,000 outstanding common shares of Earth-Kind Co.
D)A holding of 20,000 of the 25,000 outstanding common shares of Earth-Clean Co.

Question 9

At the beginning of 20X1,Anwar Ltd.acquired 15% of the voting shares of Cruz Co.for $150,000.Anwar does not have any significant influence over Cruz.Anwar reports the investment using the cost method.In 20X1,Cruz earned net income of $70,000 and paid dividends of $40,000.In 20X2,Cruz earned net income of $80,000 and paid dividends of $100,000.At the end of 20X2,what journal entry should Anwar make to record the dividends from Cruz?

A)
B)
C)
D)No entry is required

Question 10

At the beginning of 20X1,Anwar Ltd.acquired 15% of the voting shares of Cruz Co.for $150,000.Anwar does not have any significant influence over Cruz.Anwar reports the investment using the cost method.In 20X1,Cruz earned net income of $70,000 and paid dividends of $40,000.In 20X2,Cruz earned net income of $80,000 and paid dividends of $100,000.At the end of 20X2,what is the balance of Anwar's "Investment in Cruz" account?

A)$150,000
B)$150,150
C)$154,500
D)$172,500

Question 11

Townsend Ltd.has the following shareholders:
Palermo Co.- 60%
Nix Ltd.- 30%
Riley Ltd.- 10%
Nix has two seats on Townsend's five-person board of directors.Which of the following statements is true?

A)Nix has significant influence over Townsend.
B)Nix has control over Townsend.
C)Townsend is a special purpose entity to Nix.
D)Nix should treat Townsend as a passive investment.

Question 12

How are most significant influence investments in equity securities actually recorded on the investors books?

A)Using the cost method
B)Using the equity method
C)Using proportionate consolidation
D)On a fully consolidated basis

Question 13

Which of the following is not an indicator of significant influence?

A)The investor has representation on the investee's board of directors.
B)There are material transactions between the investor and the investee.
C)The investor and the investee share office space and use the same accounting firm.
D)The investor provides computing services to the investee.

Question 14

O'Reilly Ltd.incorporated O'Reilly R&D Co.to conduct research and development activities.O'Reilly R&D is a(n)________.

A)associated company
B)joint venture
C)special purpose entity
D)passive investment

Question 15

Rudd Ltd.has a passive investment in Burke Ltd.Rudd has elected to treat Burke as a fair value through other comprehensive income (FVTOCI)investment under IFRS 9 Financial Instruments.Which of the following statements is true?

A)Dividends from Burke are reported as other comprehensive income in Rudd's Statement of Comprehensive Income (SCI)
B)Dividends from Burke are reported as a separate component of Rudd's shareholders' equity.
C)Year to year changes in the fair value of the Investment in Burke are reported as net income in Rudd's SCI.
D)Fair value accumulated gains and losses in the Investment in Burke should be reported as a separate component in Rudd's shareholders' equity.

Question 16

Townsend Ltd.has the following shareholders:
Palermo Co.- 60%
Nix Ltd.- 30%
Riley Ltd.- 10%
Nix does not conduct any business with Townsend,nor has it been able to secure a seat on the Board of Directors.Which of the following statements is true?

A)Nix has significant influence over Townsend.
B)Nix should consider Townsend to be a special purpose entity.
C)Nix should consider Townsend to be an associated company.
D)Nix should treat Townsend as a non-strategic investment.

Question 17

In Canada,what subsidiaries must be included in consolidated financial statements?

A)All subsidiaries
B)All subsidiaries,except for ones in unrelated industries
C)All domestic subsidiaries
D)All subsidiaries,except for ones where control is impaired

Question 18

On January 1,20X1,Best Décor Ltd.started Chic Styles Ltd.by contributing $500,000 and received 100% of the common shares of Chic Styles.Chic Styles reported net income of $50,000 in 20X1 and $75,000 in 20X2 and paid out 40% of its net income as dividends in each year.Under the equity method,what amount should be reported as Investment in Chic Styles on Best Décor's separate-entity 20X2 financial statements?

A)
B)
C)
D)

Question 19

On whose books are the consolidating adjusting entries recorded?

A)In the general journal of both the parent and subsidiary companies
B)In the general journal of both the parent company and on the consolidated worksheet
C)In the general journal of both the parent and subsidiary companies and on the consolidated worksheet
D)Only on the consolidated worksheet

Question 20

Carr Co.owns 100% of the common shares of Ice Tops Ltd.Carr records its investment in Ice Tops using the cost method.Carr and Ice Tops have transactions with each other.In preparing Carr's consolidated financial statements,which of the following should be done?

A)Ice Tops' retained earnings should be deducted from Carr's retained earnings.
B)Ice Tops' share capital should be added to Carr's share capital.
C)Dividends received by Carr from Ice Tops should be deducted from Carr's dividend income.
D)Carr's receivable from Ice Tops should be netted with Carr's accounts receivable.

Question 21

Under which method does the Statement of Comprehensive Income show "Equity in earnings of Subsidiary"?

A)Cost method
B)Equity method
C)Modified equity
D)Consolidation

Question 22

At the beginning of 20X1,Rally Ltd.acquired 18% of Neily Co.for $90,000.Rally has significant influence over Neily.Rally records the investment in Neily using the cost method.Rally's share of Neily's income was $29,000 for 20X1 and $33,000 for 20X2.Rally received dividends from Neily of $25,000 for 20X1 and $35,000 in 20X2.For reporting purposes in 20X2,what adjustment must be made to recognize Rally's share of Neily's 20X2 income?

A)
B)
C)
D)No entry is required

Question 23

Bud Ltd.owns 100% of Calla Co.Calla owns 55% of Daisy Ltd.and Daisy owns 90% of Fern Ltd.Which of the following statements is true?

A)Only Bud has to prepare consolidated financial statements.
B)Only Bud and Calla have to prepare consolidated financial statements.
C)Only Bud and Daisy have to prepare consolidated financial statements.
D)Bud,Calla,Daisy,and Fern have to prepare non-consolidated financial statements.

Question 24

On January 1,20X2,Soho Co.purchased 4,000 shares,representing 12%,of Rico Inc.for $78,000.Soho is a publicly traded company.During the next two years,the following information was available for Rico.

Required:
a.Assuming Soho classifies this investment as FVTPL,prepare the journal entries for the next two years related to this investment,and the carrying value of the investment at the end of 20X2 and 20X3.
b.Assuming Soho classifies this investment as FVTOCI,prepare the journal entries for the next two years related to this investment,and the carrying value of the investment at the end of 20X2 and 20X3.

Question 25

On January 1,20X8,XZ Co.purchased 3,000 shares,representing 30% of AR Limited,for $390,000.XZ is a publicly traded company.AR's total net income was $86,000 for the year ended December 31,20X8.AR also paid dividends in total of $25,000 during 20X8.At the year end,each share of AR was trading at $150 per share.
Required:
a.Based on the information above,show the journal entries that XZ would have used to report its original purchase and any related investment income for AR for 20X8 assuming that XZ reports its investment in AR using FVTPL.What is the investment account balance at the end of December 31,20X8?
b.Based on the information above,show the journal entries that XZ would have used to report its original purchase and any related investment income for AR for 20X8 assuming that XZ reports its investment in AR as a significantly influenced investment.What is the investment account balance at the end of December 31,20X8?

Question 26

Jonas Co.owned 60% of Kara Co.'s voting shares and 25% of Lynn Ltd.'s voting shares.Kara owns 30% of Lynn's voting shares.Which of the following statements is true?

A)Kara is the only subsidiary of Jonas.
B)Both Kara and Lynn are subsidiaries of Jonas.
C)Lynn is a subsidiary of both Kara and Jonas.
D)Lynn is the only subsidiary of Kara.

Question 27

At the beginning of 20X1,Rally Ltd.acquired 18% of Neily Co.for $90,000.Rally has significant influence over Neily.Rally records the investment in Neily using the cost method.Rally's share of Neily's income was $29,000 for 20X1 and $33,000 for 20X2.Rally received dividends from Neily of $25,000 for 20X1 and $35,000 in 20X2.For reporting purposes in 20X2,what adjustment must be made to recognize unremitted earnings from 20X1?

A)
B)
C)
D)No entry is required

Question 28

On February 1,20X5,Peter Co.purchased 20% of the outstanding shares of Mary Inc.at a cost of $275,000.During the next two fiscal years,Mary Inc.reported the following:

Required:
a.If Peter uses the cost method for recording its investment in Mary,what would the balance in the investment account be at January 31,20X7? What would be reported on the statement of comprehensive income with respect to this investment for 20X6 and 20X7?
b.If Peter uses the equity method for recording its investment in Mary,what would the balance in the investment account be at January 31,20X7? What would be reported on the statement of comprehensive income with respect to this investment?

Question 29

Hattrick Corp.is a wholly owned,parent-founded subsidiary of Bobby Inc.The unconsolidated statements of income and the statement of changes of retained earnings for the two companies for the year ended December 31,20X6,are as follows (in 000s):
Additional information:
• Bobby sells some of its output to Hattrick.During 20X6,intercompany sales amounted to $25,000,000.Hattrick has accounts payable owing to Bobby for $200,000 at December 31,20X6.
• Bobby owns the land on which Hattrick's building is located.Bobby leases the land to Hattrick for $30,000 per month.
Bobby accounts for its investment in Hattrick under the cost method
Assume that Bobby is a private corporation that reports under ASPE.Prepare the statement of income and retained earnings for Bobby for the year 20X6 using the equity method.

Question 30

Jarrett Corporation uses the equity method to account for its 25% investment in Polo Corporation and receives $15,000 in dividends.How should Jarrett account for these dividends?

A)An increase in assets
B)A decrease in the investment
C)An increase in income
D)A decrease in income

Question 31

Ying Corporation formed a new subsidiary,Zang Limited,in 20X2.Ying is mainly involved in the manufacturing,distributing and retailing of dog food and Zang manufacturers and distributes cat food.At that time,Ying provided all of the start up capital to Zang in the form of equity,purchasing all of Zang's shares for $1.5 million.The unconsolidated statements for the two companies as at December 31,20X7 are shown below:


During 20X7,the following transactions took place (all dollars are in thousands):
• Ying provided a loan to Zang and charged interest totalling $80.
• Zang sold merchandise to Ying totalling $3,270,which was all subsequently sold to outside third parties by the end of the year.
• Included in Zang's receivables is $270 still owed by Ying for these sales.
• Ying charged management fees of $900 during the year to Zang.
Required:
Using the direct approach,prepare the consolidated statements of comprehensive income;statement of changes in equity-retained earnings section;and statement of financial position as at December 31,20X7.Show details of all of your work to arrive at the consolidated balances.Provide the consolidating journal entries required.

Question 32

Gunnar Ltd.owns 100% of the common shares of Ivy Ltd.During the year,Gunnar reported net income of $108,000 including its income from its investment in Ivy accounted for under the cost method.Ivy reported net income of $20,000 and paid dividends of $8,000 during the year.What net income will be reported by Gunnar on its separate-entity financial statements under the equity method and on its consolidated financial statements?

A)
B)
C)
D)

Question 33

Ritva Co purchased a 38% interest in Saron Ltd on October 1,20X9 for $765,000.The management of Ritva is now preparing the first set of financial statements since the acquisition and is unsure of how to report the investment.
a.If Ritva is a publicly traded company following IFRS,can the investment be reported on an equity basis? On the cost basis? At fair market value through profit or loss? Under what circumstances would each of these be appropriate for reporting purposes? What would be the impact on net earnings under each method? What is the impact on the investment account under each method?
b.If Ritva is a privately held corporation following ASPE,can the investment be reported on an equity basis? Or on the cost basis? Or at fair market value through profit or loss? Under what circumstances would each of these be appropriate for reporting purposes?

Question 34

Hattrick Corp.is a wholly owned,parent-founded subsidiary of Bobby Inc.Both Bobby and Hattrick report under IFRS.The unconsolidated statements of comprehensive income and part of the statement of changes in equity-retained earnings for the two companies for the year ended December 31,20X6,are as follows (in 000s):
Additional information:
• Bobby sells some of its output to Hattrick.During 20X6,intercompany sales amounted to $25,000,000.Hattrick has accounts payable owing to Bobby for $200,000 at December 31,20X6.
• Bobby owns the land on which Hattrick's building is located.Bobby leases the land to Hattrick for $30,000 per month.
• Bobby accounts for its investment in Hattrick under the cost method.
Required:
Prepare a consolidated statement of comprehensive income and consolidated statement of changes in equity - retained earnings section for Bobby Inc.for the year ended December 31,20X6.

Question 35

In changing from the cost method to consolidation,which of the following is not required?

A)Replacement of the "Investment in Subsidiary" account with the assets and liabilities of the subsidiary
B)Elimination of intercompany transactions and balances
C)Elimination of the subsidiary's share capital account
D)Elimination of the subsidiary's retained earnings since acquisition

Question 36

Chow HK Ltd.acquired 40% of the common shares of Welsh Trading Co.Chow paid a purchase price discrepancy (PPD)and uses the equity method to report the investment.Which of the following adjustment does Chow not have to make in calculating its share of Welsh's earnings?

A)Dividends received from Welsh
B)Amortization of PPD
C)Elimination of PPD
D)Elimination of unrealized gains/losses on intercompany transactions

Question 37

Forest Ltd.reports its investment in Leeds Co.on an equity basis.During the year,Forest received $10,000 in dividends from Leeds.How should Forest report these dividends?

A)As an increase to the "Investment in Leeds Co." account on its statement of financial position
B)As a decrease to the "Investment in Leeds Co." account on its statement of financial position
C)As dividend income on its statement of changes in equity-retained earnings section
D)As dividend income in its statement of comprehensive income

Question 38

Diaz Ltd.acquired 35% of Saturn Ltd.many years ago.At first,Saturn was profitable,but recently,it has been posting losses.Diaz believes that Saturn will be profitable again and has no plans to dispose of it,even though Diaz's share of the losses has exceeded its investment interest.Diaz uses the equity method.Which of the following statements is true?

A)Diaz should continue to decrease its "Investment in Saturn" account.
B)Diaz should put its share of Saturn's losses in a contra-account to its "Investment in Saturn" account,to be reduced by Saturn's future profits.
C)Diaz should reduce its retained earnings directly by its share of Saturn's losses.
D)Diaz should stop recognizing its share of Saturn's losses and not recognize Saturn's future profits until they exceed the unrecognized losses.

Question 39

In 20X5,Bing created a wholly owned subsidiary called Bango Limited.Bing is a private company and reports under ASPE.Bing is currently using the cost method to record its investment in Bango,but is trying to decide if it should report using the equity method or the consolidation method.This is the only subsidiary that Bing has.
Statements of Earnings and Retained Earnings for Bing and Bango
for the year ended December 31,20X5.

Other Information
During the year,the following transactions occurred between the two companies:
1.Bing sold merchandise to Bango for $560,000.At the end of the year,Bango still owed Bing $25,000 for this merchandise.
2.Bango charged rent of $20,000 to Bing for office space.
3.Licensing fees were paid by Bango to Bing in the amount of $150,000.
Required:
(a)Prepare the Statement of Earnings and Retained Earnings for Bing using the equity method of reporting its investment in Bango.
(b)Prepare the Consolidated Statement of Earnings and Retained Earnings for Bing.
(c)Compare the equity method and the consolidation method and discuss any similarities and differences.
(d)If Bing had other subsidiary investments,what other factors would be considered in trying to decide if the consolidation or equity method should be used?

Question 40

Which methods will result in the same income and shareholders' equity?

A)Equity and consolidation
B)Cost and consolidation
C)Cost and equity
D)Each method results in different income and shareholder's equity amounts.

Question 41

Rasor Inc.uses the equity method of reporting its 40% investment in Ivan Co.The balance in the Investment in Ivan was $50,750 at January 1,20X3.During the next three years,Ivan reported the following net earnings (losses)and dividends paid.

Required:
Calculate the balance of the Investment in Ivan account at December,31 20X5.

Question 42

PCo owns 60% of ACo and 20% of BCo and 10% of DCo.ACo owns 45% of DCo.Identify the basis that each company is required to use when reporting its equity investments (if any).