1. Stock Investments – Investor Accounting
Chapter 2

2. Recognize investors’ varying levels of influence or control
Learning Objective 1
Recognize investors’ varying
levels of influence or control
based on the level of
stock ownership.

3. Accounting for Stock Investment
GAAP for recording common stock
acquisitions require that the investor
record the investment at its cost.
Fair value/cost method
Equity method

4. Concept Underlying Fair Value/Cost and Equity Methods
Under the fair value/cost method
investments in common stock
are recorded at cost.
Dividends from subsequent earnings
are reported as dividend income.

5. Concept Underlying Fair Value/Cost and Equity Methods
The equity method of accounting
is essentially accrual accounting
for equity investments.
Investments are recorded at cost
and adjusted for earnings,
losses, and dividends.

6. Anticipate how accounting adjusts to reflect the economics underlying
Learning Objective 2
Anticipate how accounting adjusts
to reflect the economics underlying
varying levels of investor influence.

7. Economic Consequences of Using Fair Value/Cost and Equity Methods
The different methods of accounting result in
different investment amounts in the balance
sheet of the investor corporation and different
income amounts in the income statement.

8. Economic Consequences of Using Fair Value/Cost and Equity Methods
When
Investor can significantly influence or
control the operations of the investee.
Fair value/cost method is unacceptable.

9. Economic Consequences of Using Fair Value/Cost and Equity Methods
Although
The equity method is not a substitute for
consolidation, the income reported is
generally the same as the income reported
in consolidated financial statements.

10. Apply the fair value/cost and equity methods of accounting
Learning Objective 3
Apply the fair value/cost and
equity methods of accounting
for stock investments.

11. Accounting Procedures Under the Fair Value/Cost and Equity Methods
July 1: Pilzner acquires 2,000 of the 10,000
outstanding shares of Sud at $50 per share.
$50 per share equals the book value
and fair value of Sud’s net assets.
Sud net income for the year is $50,000.
Dividends of $20,000 are paid on November 1.

12. Fair Value/Cost Method
July 1
Investment in Sud 100,000
Cash ,000
November 1
Cash ,000
Dividend income ,000
December 31 No entry
Net marketable stock or market price = $50

13. Fair Value/Cost Method
Assume that Sud’s net income had been $30,000.
What is Pilzner’s share?
$30,000 × ½ × 20% = $3,000
December 31
Dividend Income 1,000
Investment in Sud ,000

14. Equity Method July 1 Investment in Sud 100,000 Cash 100,000 November 1

15. Equity Method December 31 Investment in Sud 5,000
Income from Sud ,000
$50,000 × ½ × 20% = $5,000

16. Identify factors beyond stock ownership that affect an
Learning Objective 4
Identify factors beyond stock
ownership that affect an
investor’s ability to
exert influence or control.

17. Influence or Control An investment of 20% or more of the
voting stock of an investee should
lead to a presumption that an investor
has the ability to exercise significant
influence over an investee.

18. Influence or Control The equity method should be followed
by an investor whose investment in
voting stock gives it the ability to
exercise significant influence over
operating and financial policies on
an investee even though the investor
does not control the investee.

19. Influence or Control An investor may be able to exert significant
influence over its investee with an
investment interest of less then 20%.
The equity method should not be applied if
the investor’s ability to exert significant
influence is temporary or if the investees
are foreign companies operating under
severe exchange restrictions or controls.

20. Apply the equity method to purchase price allocations.
Learning Objective 5
Apply the equity method to
purchase price allocations.

21. Equity Method: A One-Line Consolidation
Investment is reported in a single
amount on one line of the investor
company’s balance sheet
Investment income is reported in
a single amount on one line of the
investor’s income statement.

22. Equity Investments at Acquisition
PJ, Inc., purchases 30% of SR outstanding
voting common stock on January 1
from existing stockholders.
($2,000,000 cash plus 200,000 shares
of PJ $10 par common with a market
value of $15 per share)

23. Equity Investments at Acquisition
Additional direct costs
SEC fees: $ 50,000
Consulting and advisory fees: $100,000
How are these transactions recorded?

24. Equity Investments at Acquisition
Investment in SR 5,000,000
Common Stock, $10 par 2,000,000
Additional Paid-in Capital 1,000,000
Cash ,000,000
To record acquisition of a 30% equity investment
in SR

25. Equity Investments at Acquisition
Investment in SR ,000
Additional Paid-in Capital 50,000
Cash ,000
To record additional direct costs of purchasing
a 30% equity interest in SR

26. Illustration of a Purchase Combination
Book
Value
Fair
Value
Assets
Cash $ 1,500 $ 1,500
Net receivables , ,200
Inventories , ,000
Other current assets 3, ,100
Equipment, net , ,000
Total assets $15,000 $18,800

27. Illustration of a Purchase Combination
Book
Value
Fair
Value
Liabilities
Accounts payable $ 1,000 $ 1,000
Note payable , ,800
Common stock ,000
Retained earnings ,000
Total liabilities and
stockholders’ equity $15,000
$15,000 – 3,000 = $12,000
$12,000 × 30% = $3,600

28. Assignment of Excess Cost Over Underlying Equity
$5,100
FMV
$4,800 BV
$3,600

29. Assignment of Excess Cost Over Underlying Equity
Investment in SR $5,100,000
Book value of the interest acquired –3,600,000
Excess cost over book value $1,500,000
Fair value – Book value × 30% = $1,200,000
Amount assigned
Remainder assigned to goodwill $ 300,000

30. Assignment of Excess Cost Over Underlying Equity
Amount Assigned
Inventories $ 300,000
Other current assets (60,000)
Equipment ,000
Note payable ,000
Total $1,200,000

31. Accounting for Excess of Investment Cost Over Book Value
Assume SR pays dividends of $1,000,000
on July 1, and reports net income of
$3,000,000 for the year.
What are PJ’s journal entries?

32. Accounting for Excess of Investment Cost Over Book Value
July 1
Cash ,000
Investment in SR ,000
To record additional dividends received
from SR at 30% equity interest in SR

33. Accounting for Excess of Investment Cost Over Book Value
December 31
Investment in SR 900,000
Income from SR ,000
To record equity in income of SR
December 31
Income from SR 300,000
Investment in SR ,000
To write off excess allocated to inventory

34. Accounting for Excess of Investment Cost Over Book Value
December 31
Investment in SR 60,000
Income from SR ,000
To record income credit for overvalued
other current assets disposed of

35. Accounting for Excess of Investment Cost Over Book Value
December 31
Income from SR 45,000
Investment in SR ,000
To record depreciation on excess allocated
to undervalued equipment with a 20-year
remaining useful life ($900,000 ÷ 20)

36. Accounting for Excess of Investment Cost Over Book Value
December 31
Income from SR 12,000
Investment in SR ,000
To amortize the excess allocated to the
overvalued note payable over the remaining
life of the note ($60,000 ÷ 5)

37. Accounting for Excess of Investment Cost Over Book Value
5,100, ,000
900, ,000
60, ,000
12,000
Income from SR
300, ,000
45, ,000
12,000

38. Excess of Book Value Acquired Over Investment Cost
Post Corporation purchases 50% of the
outstanding voting common stock of
Taylor on January 1 for $40,000.
Taylor’s stockholders’ equity Jan 1: $100,000
Add: Income ,000
Deduct: Dividends paid 7/ – 5,000
Stockholders’ equity 12/31 $115,000

39. Assignment of Excess Cost over Underlying EquityBV
$50,000
FMV +
Cost
$40,000

40. Excess of Book Value Acquired Over Investment Cost
$100,000 × 50% – $40,000 = $10,000
This is the excess book value over cost.
The excess is assigned to:
Inventories $(1,000)
Equipment $(9,000)

41. Negative Goodwill Post acquires a 25% interest in Saxon for $110,000
Saxon net income and dividends for
the year are $60,000 and $40,000

42. Illustration of a Purchase Combination
Saxon’s net assets
Book
Value
Fair
Value
Assets
Inventories $240,000 $260,000
Other current assets 100, ,000
Equipment, net , ,000
Building, net , ,000
Total assets $530,000 $610,000
Liabilities , ,000
Net assets $400,000 $480,000

43. Assignment of Excess Cost over Underlying Equity
FMV
$120,000
Cost
$110,000 BV
$100,000

44. This is the excess of FMV over cost.
Negative Goodwill
$110,000 – $120,000 = – $10,000
This is the excess of FMV over cost.

45. Interim Acquisitions of an Investment Interest
Accounting for equity investments
becomes more specific when the
firm makes acquisitions within
an accounting period.

46. Investment in a Step-by-Step Acquisition
An investor may acquire the ability to exercise
significant influence over the operating and
financial policies of an investee in a series of
stock acquisitions, rather than in a single purchase.

47. Sale of an Equity Interest
When an investor sells a portion of an equity
investment that reduces its interest at 20%
or less than the level necessary to exercise
significant influence the equity method
is no longer appropriate.

48. Stock Purchases Directly from the Investee
Karl Corporation purchases 20,000 of previously
unissued common stock from Master Co. for
$450,000 on January 1, 2004.
Shares outstanding after new shares are issued:
December 31, ,000
Issued to Karl ,000
Total ,000

49. Stock Purchases Directly from the Investee
Master’s stockholders’ equity before issuance
($200,000 capital stock
+ $150,000 retained earnings) $350,000
Sale to Karl ,000
Master’s stockholder after issuance $800,000
Book value acquired by Karl $400,000

50. Investee Corporation with Preferred Stock
Some adjustments are necessary when
an investee has preferred as well as
common stock outstanding.
APB Opinion No. 18.

51. Extraordinary Items, Cumulative- Effect-Type, and Other Considerations

52. Disclosures for Equity Investees
Name of each investee and percentage of ownership.
Accounting policies of the investor with respect
to investments in common stock.
Difference between the carried amount of investment
and the amount of underlying equity in net assets.

53. Related Party Transactions
These transactions arise when one of the
transacting parties has the ability to influence
significantly the operations of the other.
FASB Statement No. 57

54. End of Chapter 2