Beams10e ch02 Investor Accounting and Reporting

5/26/2018 Beams10e ch02 Investor Accounting and Reporting

1/37 Pearson Education, Inc. publishing as Prentice Hall Pearson Education, Inc.

publishing as Prentice Hall

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Chapter 2: Stock Investments

Investor Accounting and Reporting

by Jeanne M. David, Ph.D., Univ. of Detroit Mercy

to accompany

Advanced Accounting, 10thedition

by Floyd A. Beams, Robin P. Clement,Joseph H. Anthony, and Suzanne Lowensohn




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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.4. Identify factors beyond stock ownership that

affect an investor's ability to exert influence or

control.




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Objectives (continued)

5. Apply the equity method to purchase price

allocations.

6. Learn how to test goodwillfor impairment.


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1: Levels of Influence or Control

Stock InvestmentsInvestor Accounting and Reporting


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Levels of Influence

Percent Ownership of Voting Stock

>50%


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2: Accounting Reflects Economics



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Accounting for the Investment

Degree of

influence

Investment's carrying

value

Investment

income

Lack of

significantinfluence

Fair value (cost, if

nonmarketable)

Dividends declared

Significant

influence

Original cost adjusted to

reflect periodic earnings

and dividends, e.g., aproportionate share of

investee's net assets

Proportionate share

of investee's

periodic earnings*

*If income were measured as dividends declared, by influencing or controlling

dividend decisions, the investor could manipulate its own investment income.


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3a: Fair Value/Cost Method



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Fair Value (Cost) Method

FASB Statement No. 115

At acquisition: Pilzner buys 2,000 shares of Sud

for $100,000.

Pilzner receives $4,000 in dividends from Sud.

Investment in Sud 100,000

Cash 100,000

Cash 4,000

Dividend income 4,000


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Fair Value Method, at Year-end

Reduce dividend income recognized, if needed

Adjust investment to fair value

Allowance to adjust available-for-

sale securities to fair value

21,000

Other comprehensive income 21,000

If fair value of increases to $120,000 and the Investment inSud account balance is $99,000.

Dividend income 1,000


If Pilzner determines that cumulative dividends exceed itscumulative share of income by $1,000.


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3b: Equity Method



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Equity Method

APB Opinion No. 18

At acquisition: Pilzner buys 2,000 shares of Sud

for $100,000.

Pilzner receives $4,000 in dividends from Sud.


Cash 100,000

Cash 4,000



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Equity Method, at Year-end

Pilzner 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.

Cash 4,000



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4: Ability to Influence or Control



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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 ofsignificant influence

1. Opposition by investee,

2. Surrender of significant shareholder rights,

3. Concentration of majority ownership,4. Lack of information for equity method, and

5. 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 control is temporary or

if the parent lacks control

1. Legal reorganization or bankruptcy

2. Severe foreign restrictions.


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5: Applying the Equity Method



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Acquisition Cost > FV net assets

FV net assets > BV net assetsPayne acquires 30% of Sloan for $5,000. Sloan's identifiable netassets (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

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.

$5,000> 30%(16,000) > 30%(12,000)

$5,000> $4,800 > $3,600


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Acquisition of Sloan StockAt 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 5,000

Cash 2,000

Common stock, at par 2,000

Additional paid in capital 1,000Additional paid in capital 50

Investment expense 100

Cash 150


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Cost/Book Value Assignment

Cost of acquisition $5,000

Less 30% book value = 30%(12,000) 3,600Excess of cost over book value $1,400

Assigned to: Amount Amortization

Inventories 30%(+1,000) $300 1st yearOther curr. assets 30%(-200) (60) 1st year

Equipment 30%(+3,000) 900 20 years

Note payable 30%(+200) 60 5 yearsGoodwill (to balance) 200 NoneTotal $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 thedifferences between book and fair values.

Cash 300

Investment in Sloan 300


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Amortization and Investment Income

Cost/book value

differences:

Initial

amount

1styear

amort.

Unamortized

excess at year-end

Inventories $300 ($300) $0

Other curr. Assets (60) 60 0

Equipment 900 (45) 855

Note payable 60 (12) 48

Goodwill 200 0 200Total $1,400 ($297) $1,103

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

30%($3,000)$297 = $603.


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Year-end Entry & Balance

Record the investment income

The ending balance in the investment account is:

5,000300 + 603

= 5,303.

Costdividends + investment income

Investment in Sloan 603

Income from Sloan 603


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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

= assetsliabil i ties, or

= stockholders' equi ty


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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 xxx

Gain on bargain purchase xxx


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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 partialyear'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

Retroactive adjustment

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

retained earnings amortization, if anyInvestment in XYZ xxx

Retained earnings xxx


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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

For the sale

Reduce the investment account for a

proportionate share of the stock sold

Record a gain or loss on the sale

Apply the fair value (cost) method to remaining

investment


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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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Investee with Preferred Stock Compare cost of acquisition to the book value of the

common stock.

= Total equitybook 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 dividendscurrent PS dividends

Investment income is based on income available to

common shareholders

= investee net incomePS dividends**

**Pref. Div. = current dividend if cumulative, or

dividends declared if noncumulative.


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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

Statement Nos. 159 and 157


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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 disclosuresFASB Statement No. 57


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6: Impairment of Goodwill



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Impairment of Goodwill Test annually, and if significant events occur (e.g.,

adverse legal factors or loss of key personnel)

FASB Statement No. 142: Two step process

1. If the fair value of the whole reporting unit < the

carrying value of the reporting unit including itsgoodwill, 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 ofassets and liabilities.

2. 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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Impairment of Equity Investments

Goodwill implied in equity investments is not

tested for impairment.

The investment itself is tested for impairment.

APB Opinion No. 18


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Beams10e ch02 Investor Accounting and Reporting

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