4. Zee Company buys 60 percent of the voting stock of Bee Company with the remai

Question

4. Zee Company buys 60 percent of the voting stock of Bee Company with the remaining<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

40 percent noncontrolling interest held by Bee%u2019s former owners, who negotiated the following

minority rights:

%u2022 Any new debt above $1,000,000 must be approved by the 40 percent noncontrolling

shareholders.

%u2022 Any dividends or other cash distributions to owners in excess of customary historical

amounts must be approved by the 40 percent noncontrolling shareholders.

According to the FASB ASC, what are the issues in determining whether Zee should consolidate

Bee or report its investment in Bee under the equity method?

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Explanation / Answer

The rationale underlying the equity method is that an investor begins to gain the ability to influence the decision-making process of an investee as the level of ownership rises. According to FASB ASC Topic 323 on equity method investments, achieving this %u201Cabil-ity to exercise significant influence over operating and financial policies of an investee

even though the investor holds 50 percent or less of the voting stock%u201D is the sole criterion for requiring application of the equity method [FASB ASC (para. 323-10-15-3)].

Clearly, a term such as the ability to exercise significant influenceis nebulous and sub-ject to a variety of judgments and interpretations in practice. At what point does the ac-quisition of one additional share of stock give an owner the ability to exercise significant

influence? This decision becomes even more difficult in that only the abilityto exercise significant influence need be present. There is no requirement that any actual influence

must have ever been applied.FASB ASC Topic 323 provides guidance to the accountant by listing several condi-tions that indicate the presence of this degree of influence:

%u2022Investor representation on the board of directors of the investee.

%u2022Investor participation in the policymaking process of the investee.

%u2022Material intra-entity transactions.

%u2022Interchange of managerial personnel.

%u2022Technological dependency.

%u2022Extent of ownership by the investor in relation to the size and concentration of other

ownership interests in the investee.

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