Advanced Accounting: Stock Investments - Investor Accounting and Reporting

Advanced Accounting
Thirteenth Edition, Global Edition
Chapter 2
Stock Investments –
Investor Accounting
and Reporting
Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Stock Investments: Objectives
2.1 Recognize investors' varying levels of influence or
control, based on the level of stock ownership.
2.2 Understand how accounting adjusts to reflect the
economics underlying varying levels of investor
influence.
2.3 Identify factors beyond stock ownership that affect
an investor’s ability to exert influence or control over
an investee.
2.4 Apply the fair value/cost and equity methods of
accounting for stock investments.
2.5 Apply the equity method to stock investments.
2.6 Learn how to test goodwill for impairment.

2.1: Levels of Influence or Control
Stock Investments – Investor Accounting and Reporting

Levels of Influence
<20% presumes lack of

significant influence ➔ fair Fair
value (cost) method value
(cost)
20% to 50% presumes method
Consolidated
significant influence ➔ equity financial
statements
method Equity
method
>50% presumes control ➔
consolidated financial
statements

2.2: Accounting Reflects Economics

Accounting for the Investment
Degree of Investment's Investment

influence carrying value income
Lack of significant Fair value (cost, if

Dividends declared
influence nonmarketable)
Original cost adjusted

to reflect periodic Proportionate share
Significant
earnings and of investee's
influence
dividends, e.g., a periodic earnings*
proportionate share of
investee's net assets
* The investor could manipulate its own investment income if income is measured by dividends.

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

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

2.3: Factors Beyond Stock Ownership
that Affect Control Over an Investee

Indicators of Inability to Exert Influence
● Opposition by the investee that challenges the
investor’s influence
● Surrender of significant stockholder rights by
agreement between investor and investee
● Concentration of majority ownership
● Inadequate or untimely information to apply the
equity method
● Failure to obtain representation on the investee’s
board of directors

2.4A: Fair Value/Cost Method

Fair Value (Cost) Method
FASB Statement No. 115
Pop buys 2,000 shares of Son for $50,000 and does
not have significant influence over Son.
Investment in Son (+A) 50,000 blank
Cash (-A) blank 50,000
Pop receives $4,000 in dividends from Son.
Cash (+A) 2,000 blank

Dividend income (R, +SE) blank 2,000

Fair Value (Cost) Method, at Year-end
Reduce dividend income recognized, if needed
Dividend income (-R, -SE) 500 blank
Investment in Son (-A) blank 500
If Pop determines that cumulative dividends exceed its
blank blank
cumulative share of income by $500
Adjust investment to fair value

Allowance to adjust available-for-sale securities to market 10,500 blank
value (+A)
Unrealized gain on available-for-sale securities (+SE) Blank 10,500
If fair value of the stock increases to $60,000, and the blank
Blank
Investment in Son account balance is $49,500

2.4B: Equity Method

Equity Method
At acquisition, Pop buys 2,000 shares of Son for
$50,000.

Pop receives $4,000 in dividends from Son.
Cash (+A) 2,000 blank

Investment in Son (-A) blank 2,000

Equity Method, at Year-end
Pop determines that its share of Son's income is $2,500.

Income from Son (R, +SE) blank 2,500
The ending balance in the Investment in Son is:
$50,000 cost
- $2,000 dividends
+ $2,500 income
= $50,500

2.5: Applying the Equity Method

Acquisition Cost > FV net assets, and FV
net assets > BV net assets
Pam acquires 30% of Son for $5,000,000. Sheen's
identifiable net assets (assets less liabilities) are (in
thousands):
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

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.

Acquisition of Sun Stock
At acquisition, Pam pays $2,000 cash and issues
common stock with a fair value of $3,000 and par
value of $2,000. Pam also pays $50 to register the
securities and $100 in consulting fees.
Investment in Sun (+A) 5,000 blank
Common stock, at par (+SE) blank 2,000

Additional paid in capital (+SE) blank 1,000
Investment expense (E, -SE) 100 blank
Additional paid in capital (-SE) 50 blank
Cash (-A) blank 150

Cost/Book Value Assignment
Investment in Sun $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 blank

Dividends and Income
Pam receives $300 dividends from Sun.
Cash (+A) 300 blank

Investment in Sun (-A) blank 300
Sun reports net income of $3 million.

Penny will recognize its share (30%) of Sheen's
income, but will adjust it for amortization of the
differences between book and fair values.

Amortization and Investment Income
Cost/book value Initial 1st year Unamortized
differences amount amort. excess at year-end
Inventories $300 ($300) $0
Other current assets (60) 60 0
Equipment 900 (45) 855
Note payable 60 (12) 48
Goodwill 200 0 200
Total $1,400 ($297) $1,103
Investment income is 30% of Sun's net income –

amortization
30%($3,000) – $297 = $603.
Year-End Entry & Balance
Record the investment income (single entry)
Investment in Sun (+A) 603 blank

Income from Sun (R, +SE) blank 603
The ending balance in the Investment account is:
Cost – dividends + investment income
5,000 – 300 + 603

= 5,303
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

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.

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 blank
Cash, CS, APIC blank XXX

Gain on bargain purchase blank XXX

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.

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 blank

Retained earnings (+SE) blank XXX

Sale of Equity Interest
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

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

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

Investee with Preferred Stock (continued)
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

Special Reporting Issues
If accounting for an investment under the equity
method, one-line consolidation does not apply to the
reporting of investment income when the investee’s
income includes discontinued operations.
In this case, discontinued operations is recorded as

separate from investment income.

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 assets, liabilities, results of
operations
Related party disclosures
FASB ASC 850-10-50-5

2.6: Goodwill Impairment

Goodwill Impairment
Test annually, and if significant events occur, then
use this two-step process:
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.

Goodwill Impairment (continued)
2. If the implied fair value of the goodwill < the
carrying value of the goodwill, record an
impairment loss for the difference.

2011 Amendment by FASB:
The amendment gives companies an option of
making a qualitative evaluation to determine if the
first step is needed.
If it is more likely than not that FMV < carrying

amount, the company need not perform the two-
step test.

Impairment of Equity Investments
Goodwill implied in equity investments is not
tested for impairment. The investment itself is
tested for impairment.
Example:
Sam has a 30% interest 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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Advanced Accounting

Thirteenth Edition, Global Edition

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

<20% presumes lack of

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Degree of Investment's Investment

Lack of significant Fair value (cost, if

Original cost adjusted

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Copyright © 2018 Pearson Education, Ltd. All Rights Reserved.

Pop receives $4,000 in dividends from Son.

Cash (+A) 2,000 blank

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Adjust investment to fair value

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Investment in Son (+A) 50,000 blank

Pop receives $4,000 in dividends from Son.

Cash (+A) 2,000 blank

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Investment in Son (+A) 2,500 blank

The ending balance in the Investment in Son is:

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Fair value: A – L = $18,800 - $2,800 = $16,000

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The $4,000 difference ($16,000 - $12,000) is due to

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Investment in Sun (+A) 5,000 blank

Common stock, at par (+SE) blank 2,000

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Assigned to Amount Amortization

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Cash (+A) 300 blank

Sun reports net income of $3 million.

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Investment income is 30% of Sun's net income –

Record the investment income (single entry)

Investment in Sun (+A) 603 blank

The ending balance in the Investment account is:

Cost – dividends + investment income

5,000 – 300 + 603

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If cost > fair value, goodwill exists.

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The investment is recorded at the fair value of the

Investment in ABC XXX blank

Cash, CS, APIC blank XXX

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Investment in XYZ (+A) XXX blank