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Stock Investments – Investor Accounting. Chapter 2. Learning Objective 1. Recognize investors’ varying levels of influence or control based on the level of stock ownership. Accounting for Stock Investment. GAAP for recording common stock acquisitions require that the investor

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learning objective 1
Learning Objective 1

Recognize investors’ varying

levels of influence or control

based on the level of

stock ownership.

accounting for stock investment
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

concept underlying fair value cost and equity methods
Concept Underlying Fair Value/Costand 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.

concept underlying fair value cost and equity methods1
Concept Underlying Fair Value/Costand 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.

learning objective 2
Learning Objective 2

Anticipate how accounting adjusts

to reflect the economics underlying

varying levels of investor influence.

economic consequences of using fair value cost and equity methods
Economic Consequences of UsingFair 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.

economic consequences of using fair value cost and equity methods1
Economic Consequences of UsingFair Value/Cost and Equity Methods

When

Investor can significantly influence or

control the operations of the investee.

Fair value/cost method is unacceptable.

economic consequences of using fair value cost and equity methods2
Economic Consequences of UsingFair 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.

learning objective 3
Learning Objective 3

Apply the fair value/cost and

equity methods of accounting

for stock investments.

accounting procedures under the fair value cost and equity methods
Accounting Procedures Under theFair 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.

fair value cost method
Fair Value/Cost Method

July 1

Investment in Sud 100,000

Cash 100,000

November 1

Cash 4,000

Dividend income 4,000

December 31 No entry

Net marketable stock or market price = $50

fair value cost method1
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 1,000

equity method
Equity Method

July 1

Investment in Sud 100,000

Cash 100,000

November 1

Cash 4,000

Investment in Sud 4,000

equity method1
Equity Method

December 31

Investment in Sud 5,000

Income from Sud 5,000

$50,000 ×½× 20% = $5,000

learning objective 4
Learning Objective 4

Identify factors beyond stock

ownership that affect an

investor’s ability to

exert influence or control.

influence or control
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.

influence or control1
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.

influence or control2
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.

learning objective 5
Learning Objective 5

Apply the equity method to

purchase price allocations.

equity method a one line consolidation
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.

equity investments at acquisition
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)

equity investments at acquisition1
Equity Investments at Acquisition

Additional direct costs

SEC fees: $ 50,000

Consulting and advisory fees: $100,000

How are these transactions recorded?

equity investments at acquisition2
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 2,000,000

To record acquisition of a 30% equity investment

in SR

equity investments at acquisition3
Equity Investments at Acquisition

Investment in SR 100,000

Additional Paid-in Capital 50,000

Cash 150,000

To record additional direct costs of purchasing

a 30% equity interest in SR

illustration of a purchase combination
Illustration of a PurchaseCombination

Book

Value

Fair

Value

Assets

Cash $ 1,500 $ 1,500

Net receivables 2,200 2,200

Inventories 3,000 4,000

Other current assets 3,300 3,100

Equipment, net 5,000 8,000

Total assets $15,000 $18,800

illustration of a purchase combination1
Illustration of a PurchaseCombination

Book

Value

Fair

Value

Liabilities

Accounts payable $ 1,000 $ 1,000

Note payable 2,000 1,800

Common stock 10,000

Retained earnings 2,000

Total liabilities and

stockholders’ equity $15,000

$15,000 – 3,000 = $12,000

$12,000 × 30% = $3,600

assignment of excess cost over underlying equity1
Assignment of Excess CostOver 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

assignment of excess cost over underlying equity2
Assignment of Excess CostOver Underlying Equity

Amount Assigned

Inventories $ 300,000

Other current assets (60,000)

Equipment 900,000

Note payable 60,000

Total $1,200,000

accounting for excess of investment cost over book value
Accounting for Excess of InvestmentCost 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?

accounting for excess of investment cost over book value1
Accounting for Excess of InvestmentCost Over Book Value

July 1

Cash 300,000

Investment in SR 300,000

To record additional dividends received

from SR at 30% equity interest in SR

accounting for excess of investment cost over book value2
Accounting for Excess of InvestmentCost Over Book Value

December 31

Investment in SR 900,000

Income from SR 900,000

To record equity in income of SR

December 31

Income from SR 300,000

Investment in SR 300,000

To write off excess allocated to inventory

accounting for excess of investment cost over book value3
Accounting for Excess of InvestmentCost Over Book Value

December 31

Investment in SR 60,000

Income from SR 60,000

To record income credit for overvalued

other current assets disposed of

accounting for excess of investment cost over book value4
Accounting for Excess of InvestmentCost Over Book Value

December 31

Income from SR 45,000

Investment in SR 45,000

To record depreciation on excess allocated

to undervalued equipment with a 20-year

remaining useful life ($900,000 ÷ 20)

accounting for excess of investment cost over book value5
Accounting for Excess of InvestmentCost Over Book Value

December 31

Income from SR 12,000

Investment in SR 12,000

To amortize the excess allocated to the

overvalued note payable over the remaining

life of the note ($60,000 ÷ 5)

accounting for excess of investment cost over book value6
Accounting for Excess of InvestmentCost Over Book Value

Income from SR

300,000 900,000

45,000 60,000

12,000

Investment

5,100,000 300,000

900,000 300,000

60,000 45,000

12,000

excess of book value acquired over investment cost
Excess of Book Value AcquiredOver 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 20,000

Deduct: Dividends paid 7/1 – 5,000

Stockholders’ equity 12/31 $115,000

excess of book value acquired over investment cost1
Excess of Book Value AcquiredOver 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)

negative goodwill
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

illustration of a purchase combination2
Illustration of a PurchaseCombination

Saxon’s net assets

Book

Value

Fair

Value

Assets

Inventories $240,000 $260,000

Other current assets 100,000 100,000

Equipment, net 50,000 50,000

Building, net 140,000 200,000

Total assets $530,000 $610,000

Liabilities 130,000 130,000

Net assets $400,000 $480,000

assignment of excess cost over underlying equity4
Assignment of Excess Costover Underlying Equity

FMV

$120,000

Cost

$110,000

BV

$100,000

negative goodwill1
Negative Goodwill

$110,000– $120,000 = – $10,000

This is the excess of FMV over cost.

interim acquisitions of an investment interest
Interim Acquisitions of anInvestment Interest

Accounting for equity investments

becomes more specific when the

firm makes acquisitions within

an accounting period.

investment in a step by step acquisition
Investment in a Step-by-StepAcquisition

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.

sale of an equity interest
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.

stock purchases directly from the investee
Stock Purchases Directlyfrom 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, 2003 20,000

Issued to Karl 20,000

Total 40,000

stock purchases directly from the investee1
Stock Purchases Directlyfrom the Investee

Master’s stockholders’ equity before issuance

($200,000 capital stock

+ $150,000 retained earnings) $350,000

Sale to Karl 450,000

Master’s stockholder after issuance $800,000

Book value acquired by Karl $400,000

investee corporation with preferred stock
Investee Corporation withPreferred Stock

Some adjustments are necessary when

an investee has preferred as well as

common stock outstanding.

APB Opinion No. 18.

extraordinary items cumulative effect type and other considerations
Extraordinary Items, Cumulative-Effect-Type, and Other Considerations

Ordinary

Extraordinary

Cumulative-effect

disclosures for equity investees
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.

related party transactions
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