1. Stock Investments – Investor Accounting and Reporting
Chapter 2:
Stock Investments – Investor Accounting and Reporting
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2. Stock Investments: Objectives
Recognize investors' varying levels of influence or control, based on the level of stock ownership.
Anticipate how accounting adjusts to reflect the economics underlying varying levels of investor influence.
Apply the fair value/cost and equity methods of accounting for stock investments.
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3. Objectives (continued)
Identify factors beyond stock ownership that affect an investor's ability to exert influence or control over an investee.
Apply the equity method to stock investments.
Learn how to test goodwill for impairment.
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4. 1: Levels of Influence or Control
Stock Investments – Investor Accounting and Reporting
1: Levels of Influence or Control
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5. Fair value (cost) method Consolidated financial statements
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
Consolidated financial statements
Equity method
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6. 2: Accounting Reflects Economics
Stock Investments – Investor Accounting and Reporting
2: Accounting Reflects Economics
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7. Accounting for the Investment
Degree of influence
Investment's carrying value
Investment 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.
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8. 3a: Fair Value/Cost Method
Stock Investments – Investor Accounting and Reporting
3a: Fair Value/Cost Method
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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)
Cash (+A)
4,000
Dividend income (R, +SE)
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10. Fair Value Method, at Year-end
Reduce dividend income recognized, if needed
Adjust investment to fair value
Dividend income (-R, -SE)
1,000
Investment in Sud (-A)
If Pil determines that cumulative dividends exceed its cumulative share of income by $1,000.
Allowance to adjust available-for-sale securities to market value (+A)
21,000
Unrealized gain on available-for-sale 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. Pil receives $4,000 in dividends from Sud.
Investment in Sud (+A)
100,000
Cash (-A)
Cash (+A)
4,000
Investment in Sud (-A)
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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)
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14. 4: Ability to Influence or Control
Stock Investments – Investor Accounting and Reporting
4: Ability to Influence or Control
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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
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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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17. 5: Applying the Equity Method
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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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
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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)
Additional paid in capital (+SE)
1,000
Additional paid in capital (-SE) 50
Investment expense (E, -SE)
100
150
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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:
Amount
Amortization
Inventories 30%(+1,000)
$300
1st year
Other curr. assets 30%(-200)
(60)
Equipment 30%(+3,000)
900
20 years
Note payable 30%(+200) 60
5 years
Goodwill (to balance)
200
None
Total
$1,400
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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)
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23. Amortization and Investment Income
Cost/book value differences:
Initial amount
1st year amort.
Unamortized excess at year-end
Inventories
$300
($300) $0
Other current assets
(60) 60
Equipment
900
(45)
855
Note payable
(12) 48
Goodwill
200
Total
$1,400
($297)
$1,103
Investment income is 30% of Sloan's net income – amortization
30%($3,000) – $297 = $603.
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24. Year-End Entry & Balance
Record the investment income The ending balance in the investment account is: 5,000 – = 5,303
Investment in Sloan (+A)
603
Income from Sloan (R, +SE)
Cost – dividends + investment income
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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
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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.
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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
XXX
Cash, CS, APIC
Gain on bargain purchase
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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)
XXX
Retained earnings (+SE)
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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
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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
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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
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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 ]
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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 ]
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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, two-step process [FASB ASC ]
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.
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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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.
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