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To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 2: Stock Investments – Investor Accounting and Reporting.

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Presentation on theme: "To accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 2: Stock Investments – Investor Accounting and Reporting."— Presentation transcript:

1 to accompany Advanced Accounting, 11th edition by Beams, Anthony, Bettinghaus, and Smith Chapter 2: Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-1

2 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-2

3 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-3

4 1: LEVELS OF INFLUENCE OR CONTROL Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-4

5 Levels of Influence <20% presumes lack of significant influence  fair value (cost) method 20% to 50% presumes significant influence  equity method >50% presumes control  consolidated financial statements Fair value (cost) method Equity method Consolidated financial statements Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-5

6 2: ACCOUNTING REFLECTS ECONOMICS Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-6

7 Accounting for the Investment Degree of influence Investment's carrying valueInvestment income Lack of significant influence Fair value (cost, if nonmarketable) Dividends declared Significant influence 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-7

8 3A: FAIR VALUE/COST METHOD Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-8

9 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. Pil receives $4,000 in dividends from Sud. Investment in Sud (+A)100,000 Cash (-A) 100,000 Cash (+A)4,000 Dividend income (R, +SE) 4,000 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-9

10 Fair Value Method, at Year-end Allowance to adjust available-for-sale securities to market value (+A) 21,000 Unrealized gain on available-for-sale securities (+SE) 21,000 If fair value of increases to $120,000 and the Investment in Sud account balance is $99,000. Reduce dividend income recognized, if needed Adjust investment to fair value 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-10

11 3B: EQUITY METHOD Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-11

12 Equity Method At acquisition: Pil buys 2,000 shares of Sud for $100,000. Pil receives $4,000 in dividends from Sud. Investment in Sud (+A)100,000 Cash (-A) 100,000 Cash (+A)4,000 Investment in Sud (-A) 4,000 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-12

13 Equity Method, at Year-end Pil determines that its share of Sud's income is $5,000. The ending balance in the Investment in Sud is: $100,000 cost - $4,000 dividends + $5,000 income = $101,000 Investment in Sud (+A)5,000 Income from Sud (R, +SE) 5,000 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-13

14 4: ABILITY TO INFLUENCE OR CONTROL Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-14

15 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-15

16 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-16

17 5: APPLYING THE EQUITY METHOD Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-17

18 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-18

19 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-19

20 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)5,000 Cash (-A) 2,000 Common stock, at par (+SE)2,000 Additional paid in capital (+SE)1,000 Additional paid in capital (-SE)50 Investment expense (E, -SE)100 Cash (-A)150 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-20

21 Cost/Book Value Assignment Investment in Sloan$5,000 Less 30% book value = 30%(12,000)3,600 Excess of cost over book value$1,400 Assigned to:AmountAmortization Inventories 30%(+1,000)$3001st year Other curr. assets 30%(-200)(60)1st year Equipment 30%(+3,000)90020 years Note payable 30%(+200)605 years Goodwill (to balance)200None Total$1,400 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-21

22 Dividends and Income Payne receives $300 dividends from Sloan. 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. Cash (+A)300 Investment in Sloan (-A) 300 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-22

23 Amortization and Investment Income Cost/book value differences: Initial amount 1 st year amort. Unamortized excess at year-end Inventories$300($300)$0 Other current assets(60)600 Equipment900(45)855 Note payable60(12)48 Goodwill2000 Total$1,400($297)$1,103 Investment income is 30% of Sloan's net income – amortization 30%($3,000) – $297 = $603. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-23

24 Year-End Entry & Balance Record the investment income The ending balance in the investment account is: 5,000 – = 5,303 Cost – dividends + investment income Investment in Sloan (+A)603 Income from Sloan (R, +SE) 603 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-24

25 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-25

26 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-26

27 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 ABCXXX Cash, CS, APIC XXX Gain on bargain purchaseXXX Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-27

28 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-28

29 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)XXX Retained earnings (+SE) XXX Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-29

30 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-30

31 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-31

32 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 Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-32

33 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 ] Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-33

34 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 ] Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-34

35 6: GOODWILL IMPAIRMENT Stock Investments – Investor Accounting and Reporting Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-35

36 Goodwill Impairment Test annually, and if significant events occur, two- step process [FASB ASC ] 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-36

37 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. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-37

38 This work is protected by United States copyright laws and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it is should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. ! All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. Copyright ©2012 Pearson Education, Inc. Publishing as Prentice Hall 2-38


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