CMA® > CMA® Part 1 > A.2. Investments and Consolidations > Flashcards

A.2. Investments and Consolidations Flashcards

Understand the accounting treatment for debt and equity investments, business combinations, and consolidations. (45 cards)

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1
Q

What are the two main types of securities that organizations hold as investments?

A
  • Equity securities
  • Debt securities
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2
Q

How are marketable debt securities classified for accounting purposes?

A
  • Held-to-maturity
  • Available-for-sale
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3
Q

What method is used to account for held-to-maturity debt securities?

A

Amortized cost

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4
Q

What method is used to account for available-for-sale debt securities?

A

Fair value through Accumulated Other Comprehensive Income

(AOCI)

Any premium or discount on the debt securities is amortized and the securities’ values on the balance sheet are also adjusted to their fair values at the end of each reporting period.

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5
Q

Under what conditions are equity securities accounted for by an investor using the equity method?

A

When the investor has significant influence, usually indicated by ownership of 20% to 50% of the investee’s voting stock.

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6
Q

What is the accounting treatment for trading securities?

A

Fair value through the income statement

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7
Q

What is the classification criterion for a debt security to be held-to-maturity?

A

The company must have both the positive intent and the ability to hold the security to maturity.

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8
Q

How are credit losses on held-to-maturity debt securities measured?

A

Using the current expected credit loss (CECL) model

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9
Q

What is the maximum amount of credit loss for an available-for-sale debt security?

A

The amount by which its fair value is below its amortized cost.

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10
Q

What is the accounting treatment for privately held equity securities when the investor does not have significant influence?

A

Cost less impairment, adjusted for observable price changes.

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11
Q

What is the main purpose of trading debt securities?

A

To generate profits from short-term price changes.

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12
Q

What is the accounting treatment for publicly held equity securities when the investor does not have significant influence?

A

Fair value through the income statement

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13
Q

What factors should be considered when estimating credit losses on debt securities?

A
  • Past events
  • Current conditions
  • Reasonable and supportable forecasts
  • Qualitative factors
  • Quantitative factors
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14
Q

What is the required accounting treatment when an investor controls another company?

A

Consolidation

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15
Q

What factors are considered in determining whether a credit loss exists for a security?

A
  • The extent to which the fair value is less than the amortized cost basis
  • Adverse conditions related to the security, an industry, or geographic area
  • The payment structure of the debt security and the likelihood of the issuer making future payments
  • Failure of the issuer to make scheduled interest or principal payments
  • Changes to the rating of the security by a rating agency
  • Information relevant to the security’s collectability
  • Industry analyst reports and forecasts
  • Credit ratings
  • Other relevant market data and credit enhancements
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16
Q

How is an Allowance for Credit Losses-Available-For-Sale Securities recorded?

A

It is recorded for the amount of the credit loss, limited by the amount by which the security’s fair value is less than its amortized cost basis.

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17
Q

What is the Fair Value Option for Investments in Debt Securities?

A

This allows an investor to report a debt security at fair value through the income statement, with all unrealized gains and losses related to changes in its fair value reported on the income statement.

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18
Q

How are unrealized losses due to factors other than credit losses reported on available-for-sale debt securities?

A

They are reported in accumulated other comprehensive income net of applicable taxes.

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19
Q

What is the accounting treatment for held-to-maturity debt securities if the fair value option has been elected?

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A

If the fair value option has been elected for a held-to-maturity debt security, the debt security is reported at fair value on the balance sheet, and unrealized gains and losses on that security are reported in net income.

When a held-to-maturity debt security is accounted for at fair value, any purchase discount or premium on the debt security must still be amortized. The amortized cost at each reporting date is used to determine the amount of unrealized holding gain or loss.

20
Q

How are dividends received accounted for on equity securities where the investor does not have significant influence?

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A

Dividend income is recognized for any cash dividends declared on common or preferred stock.

21
Q

What is a liquidating dividend?

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A

A dividend paid from a source other than retained earnings, considered a return of the investor’s capital.

22
Q

How is a stock dividend received accounted for?

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A

It does not give rise to any journal entry; only a memorandum entry is used to record the receipt of additional shares and the fact that the investor’s cost per share held is now proportionately less.

23
Q

How is an investment initially recorded under the equity method?

24
Q

When an equity investment is accounted for under the equity method, how does the investor record a profit earned by the investee?

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A

The investor’s investment account is increased by the investor’s share of the investee’s earnings.

25
How are cash dividends received treated by the investor under the equity method of accounting for an equity investment?
They are recorded as a **reduction** of the investor's investment account and an increase to cash or dividends receivable.
26
What is **equity method goodwill**?
For an equity investment accounted for under the equity method, equity method goodwill is the difference between the **price paid for** the investment and the **fair value of the net assets** acquired (based on the percentage of ownership).
27
How is the **disposal** of an **equity investment** accounted for?
A gain or loss is recognized for the difference between the **carrying amount** of the investment and the **selling price**.
28
What is the **fair value option** for equity method investments?
For a specific security that would otherwise be reported using the equity method, an investor may elect to use the fair value option instead, with all **gains and losses** related to changes in its **fair value** reported on the income statement. ## Footnote If the fair value option is used for an equity investment where the investor has significant influence, the investor does not report its proportionate share of the investee’s income or loss, and dividends received by the investor are credited to dividend income and do not reduce the investments account.
29
What is a **business combination**?
This occurs when one company gains a **controlling financial interest** in another company.
30
What accounting method is used for business combinations?
The acquisition method
31
What is **pushdown accounting**?
When one company gains control of another company, the acquirer records its purchase of the acquired assets and liabilities at their fair values, regardless of their valuations on the acquiree’s balance sheet. Use of the **acquirer’s basis of accounting** for the **assets and liabilities** of the acquiree is called “pushdown accounting.”
32
What is the acquisition method in business combinations?
The acquisition method involves: * Measuring and recognizing the fair value of the consideration transferred by the acquirer for the acquired business * Measuring and recognizing the fair value of the assets acquired, liabilities assumed, and any noncontrolling interest * Measuring and recognizing either goodwill or a gain
33
What is **noncontrolling interest**?
It arises when a company acquires **less than a 100% interest** in an acquired company but holds a controlling financial interest and must consolidate the subsidiary’s financial statements with its own.
34
What are the **two models** used for assessing controlling financial interest?
* The voting interest model * The variable interest entity (VIE) model
35
What is a **variable interest entity** (VIE)?
A legal entity financially controlled by one or more companies that do not hold a **majority voting interest**.
36
What is the **purpose** of a consolidation worksheet?
To prepare consolidated financial statements for external publication by recording **adjustments**, **eliminations**, and **adjusted balances**.
37
Why must **intercompany transactions** be eliminated in consolidation?
To prevent overstatement of assets, liabilities, revenues, expenses, and net income on the consolidated financial statements.
38
What happens to intercompany receivables and payables in consolidation?
They are **eliminated** to prevent the balance sheet from being overstated.
39
How are intercompany sales of inventory adjusted in consolidation?
Inventory must be reported at the **value recorded by the original purchaser**, and any profit recognized on intercompany sales not yet sold to an unrelated third party must be eliminated.
40
What adjustments are made for an **intercompany sale of fixed assets** at a gain for the seller?
* Adjust carrying value to the amount it would have been if the fixed asset had never been sold * Eliminate intercompany gain recorded by seller; make the same adjustment every year * Adjust depreciation to what it would have been if the asset had not been sold * Adjust accumulated depreciation to what it would have been if the asset had not been sold; make same adjustment every year * Reduce retained earnings of the seller to eliminate the gain recognized by the seller on the sale of the fixed asset
41
What is the treatment of noncontrolling interests in consolidated financial statements?
Noncontrolling interests are shown as a separate caption in the stockholders’ equity section, and net income attributable to noncontrolling interests is separately identified.
42
How is **net income** presented on the consolidated income statement when there are noncontrolling interests?
The amount of net income belonging to the parent and to the noncontrolling interests are **consolidated**, but they must be **separately identified**. Net income (net loss) attributable to the noncontrolling interest is subtracted from (added to) the consolidated net income. The remainder is net income attributable to the parent.
43
What does **proportionate consolidation** involve?
An investor reporting its **pro rata share** of the assets, liabilities, revenues, and expenses of the venture within its financial statements on each applicable line of the balance sheet and income statement.
44
Under what circumstances may **proportionate consolidation** be used?
When the **investor** does not have ownership interest in a legal entity but has an **undivided ownership interest** in assets and is proportionately liable for its share of each related liability. ## Footnote For example, proportionate consolidation may be used If there is no entity and no common stock of the investee, so the equity method cannot apply.
45
Is proportionate consolidation permitted under IFRS?
No
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