Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
TRUE/FALSE
1. Accounting standards for intercorporate equity investments represent the most extensive
application of flexible uniformity in accounting practice.
2. The relevant circumstances that justify differential accounting for intercorporate equity
investments depend on the level of influence held by the investor.
3. The SEC prohibits consolidation of a subsidiary company unless majority ownership exists.
4. The equity method is the required reporting method for all less-than-majority owned companies.
5. The relevant circumstance in determining the reporting method for non-consolidated
intercorporate equity investments is effective control.
6. In the terminology suggested by the FASB related to consolidation reporting, the term parent
company refers to the company whose stockholders as a group end up with control of the voting
stock of the other company entering into the business combination.
7. The central accounting issue in a business combination is the valuation of the assets and liabilities
of the separate entities being combined for reporting purposes.
8. With pooling of interests, total stockholders’ equity of the combined enterprise would be equal to
the sum of the separate companies’ equities immediately prior to the combination.
9. A FASB survey found that most enterprises entering into a pooling of interest believed that the
combination would not have occurred if purchase accounting had been acquired.
10. A purchase combination is argued to be simply the formal unification of two previously separate
ownership groups.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
11. The new proportionate consolidation approach results in the use of current values for the assets
and liabilities of all the separate entities as of the date the combination is consummated.
12. With the new entity approach, consolidation of assets and liabilities occurs only to the extent of
the stock acquired by the parent.
13. Application of the purchase method may be complicated by part of the purchase price being of a
non-cash nature.
14. An advantage of proportionate consolidation is that the minority interest category does not arise.
15. Research has provided evidence that the stock market may be fooled by the higher income
reported under the pooling method.
16. The equity method is questionable in terms of both relevance and representational faithfulness.
17. According to SFAS No. 115, the fair market value method applies for investments of less than 50
percent where market values are readily determinable
18. Currently, there are moves to extend consolidated reporting.
19. The pooling of interests consolidation method has been eliminated for new acquisitions by SFAS
No. 141.
20. SFAS 141 requires acquisitions previously accounted for as poolings be converted to purchase
accounting.
21. The essence of SFAS No. 142 is that goodwill must now be amortized over 40 years.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
22. According to SFAS No. 142, goodwill is an intangible asset with an indefinite life.
23. SFAS 142 equates goodwill with other intangible costs to be immediately expensed.
24. A reporting unit for the impairment test would be an operating segment of the firm or one level
below.
25. The FASB was the first standard-setting body to address translation of foreign-based operations
and holdings into U.S. dollars.
26. The U.S. dollar orientation approach to the translation of foreign operations requires an
enterprise to account for foreign operations as if those operations actually occurred in U.S.
dollars.
27. The U.S. dollar orientation approach to the translation of foreign operations assumes that foreign
currency denominated assets, liabilities, revenues, and expenses are measured in the foreign
currency but are translated to U.S. dollars for reporting purposes.
28. SFAS NO. 8 required the temporal method of translation.
29. Under the temporal method of translation, all balance sheet items that are carried at current or
future exchange prices are translated at the current exchange rate, while items carried at past
prices are translated at exchange rates existing at the time the item was acquired.
30. Accounting exposure is the exposure to exchange gains and losses resulting from translating
U.S.-dollar-denominated financial statements into foreign denominations.
31. Economic exposure directly affects consolidated cash flows.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
32. SFAS No. 52 adopted a currency U.S. dollar orientation to accounting for foreign currency
operations.
33. An objective of translation under SFAS No. 52 is to avoid reporting foreign-currency-
denominated operations as if they had occurred in U.S. dollars.
34. Under SFAS No. 52, if the results of foreign-currency-denominated operations will not affect
U.S. dollar cash flows, no exchange gain or loss is recorded.
35. The key question addressed by SFAS No. 52 involves how to report exchange gains and losses on
the income statement.
36. Financing indicators are included in the guidelines provided by SFAS No. 52 for determining the
functional currency.
37. The functional currency is defined as the currency of the country in which the foreign subsidiary
is located.
38. SPEs are designed to conduct just one well-defined activity.
39. It is difficult to attract investors to SPEs because the cash flows and the risks involved are hard to
predict.
40. In many SPE transactions, the tax benefits were likely to outweigh maintenance costs associated
with the SPE.
41. SPEs were widely used by U.S. companies for legitimate purposes.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
MULTIPLE CHOICE
1. Which of the following is not one of the three ways of reporting on intercorporate equity
investments?
a. Consolidated reporting as if the two separate legal entities are an accounting entity using the
purchase method.
b. Consolidated reporting using the pooling method
c. Non-consolidation using the equity method of accounting
d. Non-consolidation using a fair market value approach
2. Which of the following criteria has been most used by standard-setting bodies as the basis for
evaluating the level of investor influence?
a. Controlling influence on the board of directors
b. Operating control
c. Managerial control
d. Percentage of voting stock owned
3. Which of the following is not a true statement?
a. ARB 51 prohibited consolidation of a subsidiary company unless majority ownership exists.
b. ARB 51 took the view that majority ownership per se did not indicate control if ownership
were temporary or if for some reason control did not reside with the majority owner.
c. ARB 51 permitted separate reporting for heterogeneous subsidiaries instead of consolidation.
d. ARB 43 permitted separate reporting for foreign subsidiaries instead of consolidation.
4. Which of the following is not a true statement regarding SFAS No. 94?
a. SFAS No. 94 rejected the exclusionary arguments of ARB 51 and ARB 43.
b. SFAS No. 94 requires all majority-owned companies to be consolidated except when control
is only temporary or if the majority owner does not have effective control.
c. SFAS No. 94 says that neither legal reorganization nor bankruptcy is an instance of non-
control by a majority owner.
d. There is some evidence that the FASB was attempting to “level the playing field” in SFAS
No. 94 by requiring companies to provide more information to financial statement users who
might not have been aware of debt levels carried by unconsolidated subsidiaries.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
5. What is the appropriate reporting method for less than majority owned companies?
a. The equity method
b. The fair value method
c. Either the equity method or the fair value method depending on whether the investor can
exercise significant influence over operating and financial policies
d. Either the equity method or the fair value method depending on whether the investor has
effective control over operating and financial policies
6. In the terminology suggested by the FASB, which of the following terms refers to the accounting
entity that results from a business combination?
a. Parent enterprise
b. Combined enterprise
c. Consolidated enterprise
d. Controlling enterprise
7. In the terminology suggested by the FASB, which of the following terms refers to the separate
business enterprises that enter into a business combination?
a. Constituent companies
b. Combined companies
c. Subsidiary companies
d. Consolidated companies
8. In the terminology suggested by the FASB, which of the following terms refers to the company
whose stockholders as a group end up with control of the voting stock of the other company
entering into the business combination?
a. Parent
b. Subsidiary
c. Combinee
d. Combinor
9. In a 1976 discussion memorandum, the FASB defined the purchase method of accounting for
business combinations as a method which:
a. results in the assets and liabilities of the subsidiary being valued at market value at the time
of acquisition, and the parent’s assets and liabilities being valued at book value.
b. results in the assets and liabilities of the parent being valued at market value at the time of
acquisition, and the subsidiary’s assets and liabilities being valued at book value.
c. results in all entities’ assets and liabilities being revalued to market values at the time the
combination originates.
d. uses the book values of the combining companies.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
10. In a 1976 discussion memorandum, the FASB defined the new entity approach to accounting for
business combinations as a method which:
a. results in the assets and liabilities of the subsidiary being valued at market value at the time
of acquisition, and the parent’s assets and liabilities being valued at book value.
b. results in the assets and liabilities of the parent being valued at market value at the time of
acquisition, and the subsidiary’s assets and liabilities being valued at book value.
c. results in all entities’ assets and liabilities being revalued to market values at the time the
combination originates.
d. uses the book values of the combining companies.
11. In a 1976 discussion memorandum, the FASB defined the pooling-of-interest method of
accounting for business combinations as a method which:
a. results in the assets and liabilities of the subsidiary being valued at market value at the time
of acquisition, and the parent’s assets and liabilities being valued at book value.
b. results in the assets and liabilities of the parent being valued at market value at the time of
acquisition, and the subsidiary’s assets and liabilities being valued at book value.
c. results in all entities’ assets and liabilities being revalued to market values at the time the
combination originates.
d. uses the book values of the combining companies.
12. A _____ occurs when the subsidiary’s stock is sold for cash, assets, or in settlement of a debt.
a. spin-off
b. split-off
c. split-up
d. sell-off
13. A _____ occurs when the subsidiary’s stock is distributed to the combinor’s shareholders as a
dividend.
a. spin-off
b. split-off
c. split-up
d. sell-off
14. A _________ occurs when the shares of two or more subsidiaries are distributed to the
combinor’s shareholders in exchange for all of the parent’s shares with the parent then liquidated.
a. spin-off
b. split-off
c. split-up
d. sell-off
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
15. A _________ occurs when the subsidiary’s shares are distributed to the combinor’s shareholders
in exchange for shares of the parent’s stock.
a. spin-off
b. split-off
c. split-up
d. sell-off
16. Which of the following methods of accounting for a business combination is based on the
premise that no substantive transaction occurs between the companies involved?
a. Pooling of interests
b. The purchase method
c. The new entity approach
d. Proportionate consolidation
17. With which of the following methods of accounting for a business combination does
consolidation of assets and liabilities occur only to the extent of the stock acquired by the parent?
a. Pooling of interests
b. The purchase method
c. The new entity approach
d. Proportionate consolidation
18. With which of the following methods of accounting for a business combination does a minority
interest category not arise?
a. Pooling of interests
b. The purchase method
c. The new entity approach
d. Proportionate consolidation
19. Which of the following methods of accounting for a business combination assumes that the
parent company purchases the subsidiary and must account for the acquisition as it would for the
acquisition of any asset?
a. Pooling of interests
b. The purchase method
c. The new entity approach
d. Proportionate consolidation
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
20. Which of the following methods of accounting for business combinations has been viewed as an
important motivation for business combinations?
a. Pooling of interests
b. The purchase method
c. The new entity approach
d. Proportionate consolidation
21. Which of the following is not true regarding an equity carve-out?
a. It can result in the creation of minority interests.
b. It arises when a combinor sells a portion of its interest in a combinee.
c. It arises when a combinor dilutes its interest through an initial public offering of the
subsidiary.
d. The SEC requires resulting carve-out gains to be booked as non-operating income.
e. It can result in the creation of minority interests.
22. If the proportionate ownership method of accounting for business combinations were to be used
throughout the ownership range, it would be an example of:
a. finite uniformity.
b. flexible uniformity.
c. rigid uniformity.
d. definable uniformity.
23. “One-line consolidation” refers to:
a. the equity method.
b. the fair value method.
c. the purchase method.
d. pooling of interests.
24. Which of the following is not a true statement?
a. Consolidated reporting emerged in the early 1900s in response to the growth of holding
companies.
b. Consolidation reporting presumes that the accounting fiction of a group entity is more
meaningful than defining the reporting entity in legal terms.
c. There are moves afoot to curtail consolidated reporting.
d. The relevant circumstance in the reporting of intercorporate equity investments centers on the
notion of investor control, but, in practice, the magnitude of ownership has been the guiding
criterion.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
25. Which of the following is not true regarding SFAS No. 142?
a. Goodwill may be defined as the excess earning power of an acquisition.
b. Goodwill is defined as the difference between the amount paid for an acquired subsidiary and
the fair market value of its individual net assets.
c. Tests of goodwill impairment must be made on an annual basis.
d. Because goodwill has an indefinite life, it is not subject to write-off as an expense.
26. Which of the following standard-setting bodies was the first to address translation of foreign-
based operations and holdings into U.S. dollars?
a. CAP
b. APB
c. FASB
d. SEC
27. Which of the following does not apply to the Bretton Woods Agreement of 1944?
a. The developments surrounding the agreement have heightened the importance of how
translation of foreign-based operations should be handled.
b. It established controlled exchange rates worldwide.
c. It allowed monetary authorities to buy or sell gold or foreign exchange with the intent of
maintaining an allowable exchange rate fluctuation.
d. It collapsed in 1971 resulting in freer and more volatile exchange rate fluctuations.
28. Which of the following applies to the U.S. dollar orientation approach to the translation of
foreign operations?
a. It requires an enterprise to account for foreign operations as if those operations actually
occurred in U.S. dollars.
b. It recognizes that the foreign operations occurred in a foreign currency and that those
operations may not affect U.S. dollars.
c. Foreign currency denominated assets, liabilities, revenues, and expenses are assumed to be
measured in the foreign currency but are translated to U.S. dollars for reporting purposes.
d. The effects of changing exchange rates are not reported in income until the net assets are
exchanged.
29. Which of the following is not a true statement regarding SFAS No. 8?
a. SFAS was faithful to the historical cost accounting model, but from an economic viewpoint,
it produced illogical results.
b. SFAS No. 8 required the temporal method of translation.
c. In empirical studies made of the economic impact of SFAS No. 8 on American multinational
enterprises, only foreign exchange risk and management policies regarding hedging of foreign
currency exposures were found to have any possible impact.
d. SFAS No. 8 was consistent with the foreign currency orientation.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
30. Accounting exposure is:
a. the exposure to exchange gains and losses resulting from translating U.S.-dollar-denominated
financial statements into foreign denominations.
b. the exposure to exchange gains and losses resulting from translating foreign-currency-
denominated financial statements into U.S. dollars.
c. the exposure to cash flow changes resulting from dealings in foreign-denominated
transactions and commitments.
d. a result of the need to use more U.S. dollars to settle a foreign-currency-denominated debt.
31. Economic exposure is:
a. the exposure to exchange gains and losses resulting from translating U.S.-dollar-denominated
financial statement into foreign denominations.
b. the exposure to exchange gains and losses resulting from translating foreign-currency-
denominated financial statements into U.S. dollars.
c. the exposure to cash flow changes resulting from dealings in foreign-denominated
transactions and commitments.
d. a result of the need to use more foreign currency to settle U.S.-dollar-denominated debt.
32. With the temporal method of translation:
a. all balance sheet items that are carried at current or future exchange prices are translated at
the current exchange rate.
b. balance sheet items carried at past prices, such as fixed assets, are translated at the current
exchange rate.
c. income statement items are translated at the current exchange rate.
d. income statement items are translated at historical exchange rates.
33. Which of the following directly affects consolidated cash flows?
a. Accounting exposure
b. Economic exposure
c. Both accounting exposure and economic exposure
d. Neither accounting exposure nor economic exposure
34. SFAS No. 52 adopted:
a. a U.S. dollar orientation to accounting for foreign currency operations.
b. a functional currency orientation to accounting for foreign currency operations.
c. a foreign currency orientation to accounting for foreign currency operations.
d. none of the above.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
35. What is the objective of translation under SFAS No. 52?
a. To avoid reporting accounting exchange gains and losses when an economic gain or loss has
not occurred
b. To avoid reporting foreign-currency-denominated operations as if they had occurred in U.S.
dollars
c. To maintain a U.S. dollar orientation
d. Both a and b
36. Which of the following is a true statement regarding SFAS No. 52?
a. When a foreign entity’s currency is the functional currency, net income is measured in the
foreign currency and then restated into dollars at the current exchange rate at the end of the
period.
b. When a foreign entity’s currency is the functional currency, any exchange adjustment
resulting from translating balance sheet and income statement items at different exchange rates is
recognized as a gain or loss on the income statement.
c. When a foreign entity’s currency is the functional currency, all balance sheet items are
translated at the average exchange rate for the period.
d. If the results of foreign-currency-denominated operations will not affect U.S. dollar cash
flows, no exchange gain or loss is recorded.
37. Which of the following is not a true statement regarding SFAS No. 52?
a. The key question brought up in SFAS No. 52 involves how to report exchange gains and
losses on the income statement.
b. The six guidelines or economic factors provided by SFAS No. 52 for determining the
functional currency have a differential cash flow orientation.
c. The six indicators provided by SFAS No. 52 have been found to provide adequate guidance
for determining the functional currency.
d. The six indicators provided by SFAS No. 52 for determining the functional currency have a
foreign currency component and a parent’s currency component.
38. Which of the following is not one of the six guidelines or economic factors provided by SFAS
No. 52 for determining the functional currency?
a. Sales price indicators
b. Interest rate indicators
c. Expense indicators
d. Intercompany transactions and arrangements
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
39. Which of the following is not true if the functional currency of a foreign operation is U.S.
dollars?
a. All balance sheet items that were carried at current or future exchange prices are translated at
the current exchange rate.
b. All balance sheet items carried at past prices are translated at exchange rates existing at the
time the item was acquired.
c. All income statement items are translated at the average exchange rate for the reporting
period.
d. Exchange gains and losses arising from translation from the currency of record into the
functional currency are recognized on the income statement.
40. What is meant by the term “functional currency”?
a. The functional currency is the currency of the parent corporation.
b. The functional currency is the currency of the country in which the foreign subsidiary is
located.
c. The functional currency is the currency of the parent’s primary economic environment where
cash is primarily received and spent.
d. The functional currency is the currency of the subsidiary’s primary economic environment
where cash is primarily received and spent.
ESSAY
1. Respond to the following:
a. What does the term functional currency mean?
b. What is the accounting treatment if the foreign entity’s currency in the functional currency?
c. What is the accounting treatment if the U.S. currency is the functional currency?
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
2. Respond to the following:
a. What are the six guidelines that SFAS No. 52 provides for determining the functional
currency?
b. What were the findings of the FASB research report by Evan and Doupnik regarding these six
criteria?
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
3. Respond to the following:
a. Explain the differences between the pooling of interests and purchase methods in terms of
related assumptions and application.
b. Why may companies not be indifferent to purchase and pooling accounting?
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
4. What is meant by proportionate consolidation, and what are its advantages?
5. What are the relevant circumstances that justify differential accounting for intercorporate equity
investments?
6. What is “one-line consolidation,” and when is it used?
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
7. Discuss why the reporting of disaggregated data may be preferable to consolidated data.
8. Summarize the provisions of SFAS No. 142 related to the definition of goodwill, impairment
testing of goodwill, and the proper handling of goodwill in the event of the sale of an acquired
subsidiary.
Chapter 17—INTERCORPORATE EQUITY INVESTMENTS
9. What were special purpose entities (SPEs) and what were their advantages?
10. How and why were SPEs changed by FASB Interpretation No. 46 and Interpretation 46R?