Question

An investee company incurs an extraordinary loss during the period. The investor appropriately applies the equity method. Which of the following statements is true?

A) Under the equity method, the investor only recognizes its share of investee's income from continuing operations.
B) The extraordinary loss would reduce the value of the investment.
C) The extraordinary loss should increase equity in investee income.
D) The extraordinary loss would appear on the income statement but would be a component of comprehensive income.
E) The loss would be ignored but shown in the investor's notes to the financial statements.

Answer 1

The extraordinary loss would reduce the value of the investment on the investor's balance sheet when using the equity method.

Step-by-step explanation:

If an investee company incurs an extraordinary loss and the investor is using the equity method to account for its investment, the correct statement is that the extraordinary loss would reduce the value of the investment. Under the equity method, investors recognize their share of the profits and losses from the investee in their own income statement. Therefore, any extraordinary loss reported by the investee reduces the investor's share of investee's income, and consequently the carrying value of the investment on the investor's balance sheet decreases.