Chapter 2: Stock Investments - Investor Accounting and Reporting

Report
Chapter 2:
Stock Investments
– Investor
Accounting and
Reporting
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
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Inc. Publishing as Prentice Hall
2-1
Stock Investments: Objectives
1. Recognize investors' varying levels of
influence or control, based on the level of
stock ownership.
2. Anticipate how accounting adjusts to reflect
the economics underlying varying levels of
investor influence.
3. Apply the fair value/cost and equity
methods of accounting for stock
investments.
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Objectives (continued)
4. Identify factors beyond stock ownership
that affect an investor's ability to exert
influence or control over an investee.
5. Apply the equity method to stock
investments.
6. Learn how to test goodwill for impairment.
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Stock Investments – Investor Accounting and
Reporting
1: LEVELS OF INFLUENCE OR
CONTROL
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Levels of Influence
Percent Ownership of Voting Stock
• <20% presumes lack of
significant influence  fair
value (cost) method
• 20% to 50% presumes
significant influence 
equity method
• >50% presumes control
 consolidated financial
statements
<20%
>50%
Consolidated
financial
statements
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Fair value
(cost)
method
Equity
method
20-50%
2-5
Stock Investments – Investor Accounting and
Reporting
2: ACCOUNTING REFLECTS
ECONOMICS
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Accounting for the Investment
Degree of
influence
Lack of
significant
influence
Significant
influence
Investment's carrying value Investment income
Fair value (cost, if
nonmarketable)
Dividends declared
Original cost adjusted to
reflect periodic earnings and
dividends, e.g., a
proportionate share of
investee's net assets
Proportionate share
of investee's periodic
earnings*
* The investor could manipulate its own investment income if income
is measured by dividends.
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Stock Investments – Investor Accounting and
Reporting
3A: FAIR VALUE/COST
METHOD
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Fair Value (Cost) Method
FASB Statement No. 115
Pil buys 2,000 shares of Sud for $100,000 and
does not have significant influence over Sud.
Investment in Sud (+A)
Cash (-A)
100,000
100,000
Pil receives $4,000 in dividends from Sud.
Cash (+A)
Dividend income (R, +SE)
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4,000
4,000
2-9
Fair Value Method, at Year-end
Reduce dividend income recognized, if needed
Dividend income (-R, -SE)
1,000
Investment in Sud (-A)
1,000
If Pil determines that cumulative dividends exceed its cumulative share
of income by $1,000.
Adjust investment to fair value
Allowance to adjust available-for-sale
21,000
securities to market value (+A)
Unrealized gain on available-for-sale
21,000
securities (+SE)
If fair value of increases to $120,000 and the Investment in Sud
account balance is $99,000.
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Stock Investments – Investor Accounting and
Reporting
3B: EQUITY METHOD
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Equity Method
At acquisition: Pil buys 2,000 shares of Sud for
$100,000.
Investment in Sud (+A)
Cash (-A)
100,000
100,000
Pil receives $4,000 in dividends from Sud.
Cash (+A)
Investment in Sud (-A)
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4,000
4,000
2-12
Equity Method, at Year-end
Pil determines that its share of Sud's income is
$5,000.
Investment in Sud (+A)
5,000
Income from Sud (R, +SE)
5,000
The ending balance in the Investment in Sud
is:
$100,000 cost
- $4,000 dividends
+ $5,000 income
= $101,000
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Stock Investments – Investor Accounting and
Reporting
4: ABILITY TO INFLUENCE OR
CONTROL
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Significant Influence
20% to 50% voting stock ownership is a
presumption of significant influence. Use the
equity method.
Don't use equity method if there is a lack of
significant influence.
 Opposition by investee,
 Surrender of significant shareholder rights,
 Concentration of majority ownership,
 Lack of information for equity method, and
 Failure to obtain board representation
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Control
More than 50% voting stock ownership is
presumptive evidence of control. Prepare
consolidated financial statements.
Don't consolidate if the parent lacks control
 Legal reorganization or bankruptcy
 Severe foreign restrictions
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Stock Investments – Investor Accounting and
Reporting
5: APPLYING THE EQUITY
METHOD
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Acquisition Cost > FV net assets, and
FV net assets > BV net assets
Payne acquires 30% of Sloan for $5,000. Sloan's
identifiable net assets (assets less liabilities)
are:
Fair value: A – L = $18,800 - $2,800 = $16,000
Book value: A – L = E = $15,000 - $3,000 = $12,000
$5,000 > 30%(16,000) > 30%(12,000)
$5,000 > $4,800 > $3,600
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Differences between FV and BV
Fair value: $16,000
Book value: $12,000
The $4,000 difference ($16,000 - $12,000) is due
to:
 $1,000 undervalued inventories sold this year,
 $200 overvalued other current assets used this
year,
 $3,000 undervalued equipment with a life of 20
years, and
 $200 overvalued notes payable due in 5 years
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Acquisition of Sloan Stock
At acquisition, Payne pays $2,000 cash and issues
common stock with a fair value of $3,000 and par
value of $2,000. Payne also pays $50 to register
the securities and $100 in consulting fees.
Investment in Sloan (+A)
Cash (-A)
Common stock, at par (+SE)
Additional paid in capital (+SE)
Additional paid in capital (-SE)
Investment expense (E, -SE)
Cash (-A)
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5,000
2,000
2,000
1,000
50
100
150
2-20
Cost/Book Value Assignment
Investment in Sloan
Less 30% book value = 30%(12,000)
Excess of cost over book value
Assigned to:
Inventories 30%(+1,000)
Other curr. assets 30%(-200)
Equipment 30%(+3,000)
Note payable 30%(+200)
Goodwill (to balance)
Total
$5,000
3,600
$1,400
Amount Amortization
$300
1st year
(60)
1st year
900
20 years
60
5 years
200
None
$1,400
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Dividends and Income
Payne receives $300 dividends from Sloan.
Cash (+A)
300
Investment in Sloan (-A)
300
Sloan reports net income of $900.
Payne will recognize its share (30%) of Sloan's
income, but will adjust it for amortization of the
differences between book and fair values.
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Amortization and Investment Income
Cost/book value
differences:
Inventories
Initial 1st year
Unamortized
amount amort. excess at year-end
$300 ($300)
$0
Other current assets
(60)
60
0
Equipment
900
(45)
855
60
(12)
48
200
0
200
$1,400
($297)
$1,103
Note payable
Goodwill
Total
Investment income is 30% of Sloan's net income – amortization
30%($3,000) – $297 = $603.
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Year-End Entry & Balance
Record the investment income
Investment in Sloan (+A)
Income from Sloan (R, +SE)
603
603
The ending balance in the investment account
is:
Cost – dividends + investment income
5,000 – 300 + 603
= 5,303
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More on Cost/Book Value Assignment
On acquisition date, compare:
 Cost of acquisition,
 Book value of net assets, and
 Fair value of identifiable net assets
Cost of the investment includes cash paid, fair
value of securities issued, and debt assumed.
The book value of the investee's net assets
 = assets – liabilities, or
 = stockholders' equity
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Fair Values Used in Assignment
Identifiable net assets include all the investee's
assets and liabilities, whether recorded or not
 Fair value of research in progress
 Fair value of contingent liabilities
 Fair value of unrecorded patents
Exception: use book value for pensions and
deferred taxes.
If cost > fair value, goodwill exists.
If cost < fair value, a bargain purchase exists.
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Bargain Purchase
When the acquisition cost is less than the fair
value of the identifiable net assets, a gain is
recognized on the acquisition.
The investment is recorded at the fair value of
the identifiable net assets
Investment in ABC
Cash, CS, APIC
Gain on bargain purchase
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XXX
XXX
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Interim Acquisitions
Book value of net assets = BV equity.
If equity is given as beginning of year, add
current earnings and deduct dividends to date.
Amortization for first, partial, year:
 Take full amortization for inventory and other
current assets disposed of by year-end.
 Take partial year's amortization for equipment,
buildings, and debt to be written off over multiple
years.
Record dividends if after the acquisition date.
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Acquisition in Stages
Also called a step-by-step acquisition.
Fair value (cost) method
equity method
 Restate prior-period statements
Investee's growth in retained earnings is
 Excess of income over dividends declared
Investment account desired balance using
equity method = original cost + share of
growth in investee’s retained earnings –
amortization, if any
Investment in XYZ (+A)
Retained earnings (+SE)
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XXX
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Sale of Equity Investment
Sale of investment that results in a lack of
significant influence over the investee
Equity method
fair value (cost) method
 Prospective treatment
1. For the sale
 Reduce the investment account for a proportionate
share of the stock sold
 Record a gain or loss on the sale
2. Apply the fair value (cost) method to
remaining investment
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Stock Purchased from Investee
If stock is purchased from old shareholders,
the percentage ownership is based on the
shares outstanding and the investee's equity
is not changed.
If acquired directly from the investee:
 Percentage acquired = shares acquired / (shares
acquired + previously outstanding shares)
 Investee's new stockholders' equity = Previous
equity + value received for new shares
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Investee with Preferred Stock
Compare cost of acquisition to the book value
of the common stock
 = Total equity – book value of preferred stock*
 * BV of PS = call value + dividends in arrears
Dividends received will be a portion of the
dividends to common shareholders
 = total dividends – current PS dividends
Investment income is based on income available
to common shareholders
 = investee net income – PS dividends**
 ** PS Div. = current dividend if cumulative, or dividends
declared if noncumulative
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Special Reporting Issues
If material, the investor continues separate
reporting of extraordinary items and/or
discontinued operations of the investee
 Income from Investee is based on income before
discontinued operations or extraordinary items
Optionally, the investor may report its equity
investments at fair market value, [FASB ASC
825-10-25]
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Disclosures
For significant equity investees
 Name, percent ownership
 Accounting policy
 Difference between investment carrying value and
underlying equity in net assets
 Aggregate market value
 Summarized asset, liability, operations
Related party disclosures [FASB ASC 323-1050]
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Stock Investments – Investor Accounting and
Reporting
6: GOODWILL IMPAIRMENT
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Goodwill Impairment
Test annually, and if significant events occur, twostep process [FASB ASC 350-20-35]
1. If the fair value of the whole reporting unit < the
carrying value of the reporting unit including its
goodwill, there might be impairment.
 If no implied impairment, step 2 is not needed.
 Use quoted market prices of reporting unit, or valuation
techniques applied to similar groups of assets and
liabilities.
2. If the implied fair value of the goodwill < the
carrying value of the goodwill, record an
impairment loss for the difference.
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Impairment of Equity Investments
 Goodwill implied in equity investments is not
tested for impairment.
 The investment itself is tested for impairment.
Sam has a 30% interest in Lake, Investment in
Lake, with a carrying value of $4,200; this
includes implied goodwill of $350.
 The $350 implied goodwill is not tested for
impairment.
 If Sam’s interest has a fair value of less than
$4,200, an impairment loss on the Investment in
Lake is recorded.
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