Beams11 ppt02

Chapter 2:
Stock Investments
Investor
Accounting and
Reporting
to accompany
Advanced Accounting, 11th edition
by Beams, Anthony, Bettinghaus, and Smith
Copyright 2012 Pearson Education,
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.

2-2
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.

2-3
Stock Investments Investor Accounting and

Reporting
1: LEVELS OF INFLUENCE OR
CONTROL

2-4
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
2-5

Reporting
2: ACCOUNTING REFLECTS
ECONOMICS

2-6
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.
2-7

Reporting
3A: FAIR VALUE/COST

METHOD

2-8
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)
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
securities (+SE)
21,000
If fair value of increases to $120,000 and the Investment in Sud

account balance is $99,000.
2-10

Reporting
3B: EQUITY METHOD

2-11
Equity Method
At acquisition: Pil buys 2,000 shares of Sud for
$100,000.
Cash (-A)
100,000
100,000
Pil receives $4,000 in dividends from Sud.

Cash (+A)
4,000
Investment in Sud (-A)
4,000

2-12
Equity Method, at Year-end

Pil determines that its share of Sud's income is
$5,000.
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
2-13

Reporting
4: ABILITY TO INFLUENCE OR
CONTROL

2-14
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
2-15
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

2-16

Reporting
5: APPLYING THE EQUITY

METHOD

2-17
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

2-18
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
2-19
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)
5,000
2,000
2,000
1,000
50
100
150
2-20
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)
1st year
Equipment 30%(+3,000)
900
20 years
Note payable 30%(+200)
60
5 years
Goodwill (to balance)
200
None
Total
$1,400
2-21
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.

2-22
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
Equipment
900
(45)
855
60
(12)
48
200
$1,400
0
($297)
200
$1,103
Note payable
Goodwill
Total
Investment income is 30% of Sloan's net income amortization

30%($3,000) $297 = $603.
2-23
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
2-24
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

2-25
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.
2-26
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
XXX
XXX
XXX
2-27
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.
2-28
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 investees retained earnings
amortization, if any
Investment in XYZ (+A)
Retained earnings (+SE)
XXX
XXX
2-29
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
2-30
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

2-31
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
2-32
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]

2-33
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]

2-34

Reporting
6: GOODWILL IMPAIRMENT

2-35
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.
2-36
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 Sams interest has a fair value of less than
$4,200, an impairment loss on the Investment in
Lake is recorded.
2-37
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2-38

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Chapter 2:

Stock Investments: Objectives

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Stock Investments Investor Accounting and

Copyright 2012 Pearson Education,

<20% presumes lack of

Copyright 2012 Pearson Education,

Stock Investments Investor Accounting and

Copyright 2012 Pearson Education,

Accounting for the Investment

Investment's carrying value Investment income

Fair value (cost, if

Original cost adjusted to

* The investor could manipulate its own investment income if income

Stock Investments Investor Accounting and

3A: FAIR VALUE/COST

Copyright 2012 Pearson Education,

Fair Value (Cost) Method

Pil receives $4,000 in dividends from Sud.

Fair Value Method, at Year-end

If fair value of increases to $120,000 and the Investment in Sud

Stock Investments Investor Accounting and

3B: EQUITY METHOD

Copyright 2012 Pearson Education,

Pil receives $4,000 in dividends from Sud.

Copyright 2012 Pearson Education,

Equity Method, at Year-end

Stock Investments Investor Accounting and

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Stock Investments Investor Accounting and

5: APPLYING THE EQUITY

Copyright 2012 Pearson Education,

Acquisition Cost > FV net assets, and

Copyright 2012 Pearson Education,

Differences between FV and BV

Acquisition of Sloan Stock

Cost/Book Value Assignment

Dividends and Income

Investment in Sloan (-A)

Sloan reports net income of $900.

Copyright 2012 Pearson Education,

Amortization and Investment Income

Initial 1st year

Other current assets

Investment income is 30% of Sloan's net income amortization

Year-End Entry & Balance

The ending balance in the investment account

More on Cost/Book Value Assignment

Copyright 2012 Pearson Education,

Fair Values Used in Assignment

Sale of Equity Investment

Stock Purchased from Investee

Copyright 2012 Pearson Education,

Investee with Preferred Stock

Dividends received will be a portion of the

Investment income is based on income available

Special Reporting Issues

Copyright 2012 Pearson Education,

Copyright 2012 Pearson Education,

Stock Investments Investor Accounting and

Copyright 2012 Pearson Education,