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What could/would lower the expected rate of return on an equity method investment?

AUD Becker A4 - Question #CPA-06691

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Mary - do you have a question on this?

Yes: What could/would lower the expected rate of return on an equity method investment? I also attached the Becker question that prompted my question, for reference (to my original post).

Thanks!

Rob @ Pederson CPA Review said:

Mary - do you have a question on this?

What they are saying is that the company has an equity method investment and the company has a higher cost than the fair value of the investment.  As a result, this excess has to be amortized.  It's like when a company buys another company under the acquisition method and pays more for fixed assets or intangibles.  That step-up has to be depreciated or amortized.

The expected return of an equity method investment is the amount of income and gain the company expects from its investment.  Amortization is included in this expected return.  The amortization offsets the income or gain the company expects.

Of the options presented, it is the only one that impacts the expected gain.  Available for sale securities and trading securities do not impact the equity method investment account or the expected income.  The price of the common stock does not impact the equity method investment because some amount of fluctuation is expected and equity method investments are not marked to market (fair value) each period.  Finally, dividends from equity method investments are reductions of the investment.  They are not reported as income, so they are not part of the expected return.

Hopefully that helps.  Let me know if you have additional questions.

Rob 

Yes, that helps! Thanks, Rob! I really appreciate you taking the time!! This stuff has always been a little confusing to me, and the way they have that question worded kept throwing me off and making it worse.

Thx again!

~Mary

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