Advanced Accounting

Thirteenth Edition, Global Edition

Chapter 2
Stock Investments –
Investor Accounting
and Reporting

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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.

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

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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

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2.2: Accounting Reflects Economics
Stock Investments – Investor Accounting and Reporting

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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.

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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 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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2.3: Factors Beyond Stock Ownership
that Affect Control Over an Investee
Stock Investments – Investor Accounting and Reporting

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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

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2.4A: Fair Value/Cost Method
Stock Investments – Investor Accounting and Reporting

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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) 4,000 blank

Dividend income (R, +SE) blank 4,000

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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

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2.4B: Equity Method
Stock Investments – Investor Accounting and Reporting

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

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

Investment in Son (-A) blank 2,000

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

Investment in Son (+A) 2,500 blank

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

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2.5: Applying the Equity Method
Stock Investments – Investor Accounting and Reporting

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Acquisition Cost > FV net assets, and FV
net assets > BV net assets
Pam acquires 30% of Son for $5,000,000. Son'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

•
$16,667 > 16,000 > 12,000
•
GW 667 BV vs FV 4,000

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 Fair Over/
Blank Book Value
Value Under
Cash $ 1,500 $1,500
Net receivables 2,200 2,200
Inventory 3,000 4,000 1,000
Other current
3,300 3,100 (200)
assets
Equipment, net 5,000 8,000 3,000
Total assets $15,000 $18,800
Accounts payable $1,000 $1,000
Notes payable 2,000 1,800 (200)
Total liabilities $3,000 $2,800
Net assets $12,000 $16,000 4,000

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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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Acquisition of Son 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 Son (+A) 5,000 blank

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

Additional paid in capital (+SE) blank 1,000

Cash (-A) blank 2,000
Investment expense (E, -SE) 100 blank

Additional paid in capital (-SE) 50 blank

Cash (-A) blank 150

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Cost/Book Value Assignment
Investment in Son 30% $5,000

Implied value 100% 16,667

Less Book Value Net Assets 12,000

Excess of cost over book value $4,667

Assigned to Beginning Adjustme Ending Amortizati
balance nt to NI Balance on
Inventories $1,000 (1,000) 0 1st year
Other curr. Assets (200) 200 0 1st year
Equipment 3,000 (150) 2,850 20 years
Note payable 200 (40) 160 5 years
Total 4,000
Goodwill (to balance) 667 0 667 None
Total $4,667 (990) 3,677

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Dividends and Income
Son declared and paid dividend for total
$1,000,000. Pam receives $300,000 dividends
from Sun.
Cash (+A) 300 blank
Investment in Son (-A) blank 300

Son reports net income of $3,000,000.

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

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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 – (1,000*30%)+ ((3,000-990)*30%)
= 5,000-300+603
= 5,303
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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
• = assets – liabilities, or
• = stockholders' equity

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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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Exercise for Homework-KP Y
• In group of 2 students:
Task 1
1. Find the real case of business combination. It can be
local or international companies.
2. Identify it whether the business combination is vertical,
horizontal or conglomeration.
3. Analyze it whether the business combination make one
surviving entity and disolution of other entity/entities (chp
1), or all of them are still surviving-stock investment (chp.
2)

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Exercise for Homework-A & B
• In group of 3 students:
Task 1
1. Find the real case of business combination. It can be
local or international companies.
2. Identify it whether the business combination is vertical,
horizontal or conglomeration.
3. Analyze it whether the business combination make one
surviving entity and disolution of other entity/entities (chp
1), or all of them are still surviving-stock investment (chp.
2)

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Exercise for Homework-A
• In group of 4 students:
Task 2
1 E1-2 & P 2-9 6 P1-4 & E 2-6
2 E1-4 & P 2-5 7 P1-5 & E 2-5
3 P1-1 & E 2-13 8 E2-5 & P1-1
4 P1-2 & E 2-8 9 E2-6 &P 1-2
5 P1-3 &E 2-7 10 E2-7 & P 1-4

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Exercise for Homework-B
• In group of 4 students:
Task 2
6 E1-2 & P 2-9 1 P1-4 & E 2-6
7 E1-4 & P 2-5 2 P1-5 & E 2-5
8 P1-1 & E 2-13 3 E2-5 & P1-1
9 P1-2 & E 2-8 4 E2-6 &P 1-2
10 P1-3 &E 2-7 5 E2-7 & P 1-4

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