Beams PPT Chap 2

Stock Investments Investor Accounting Chapter 2
2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
2-1
Learning Objective 1
Recognize investors varying levels of influence or control based on the level of stock ownership.
2-2
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
2-3
Concept Underlying Fair Value/Cost and 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.
2-4
Concept Underlying Fair Value/Cost and 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.
2-5
Anticipate how accounting adjusts to reflect the economics underlying varying levels of investor influence.
2-6
Economic Consequences of Using Fair 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.
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Investor can significantly influence or control the operations of the investee.
Fair value/cost method is unacceptable.

2-8
The equity method is not a substitute for consolidation, the income reported is generally the same as the income reported in consolidated financial statements.
2-9
Apply the fair value/cost and equity methods of accounting for stock investments.
2 - 10
Accounting Procedures Under the Fair 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 Suds net assets. Sud net income for the year is $50,000. Dividends of $20,000 are paid on November 1.
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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
2 - 12
Fair Value/Cost Method

Assume that Suds net income had been $30,000.
What is Pilzners share? $30,000 20% = $3,000 December 31 Dividend Income Investment in Sud 1,000
1,000
2 - 13
Equity Method
July 1 Investment in Sud Cash November 1 Cash Investment in Sud
100,000 100,000 4,000 4,000
2 - 14
Equity Method
December 31 Investment in Sud 5,000 Income from Sud 5,000 $50,000 20% = $5,000
2 - 15
Identify factors beyond stock ownership that affect an investors ability to exert influence or control.
2 - 16
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.
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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.
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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 investors ability to exert significant influence is temporary or if the investees are foreign companies operating under severe exchange restrictions or controls.
2 - 19
Apply the equity method to purchase price allocations.
2 - 20
Equity Method: A One-Line Consolidation

Investment is reported in a single amount on one line of the investor companys balance sheet Investment income is reported in a single amount on one line of the investors income statement.
2 - 21
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)
2 - 22

Additional direct costs
SEC fees: $ 50,000 Consulting and advisory fees: $100,000 How are these transactions recorded?
2 - 23
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
2 - 24
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
2 - 25
Illustration of a Purchase Combination

Book Value Assets Cash Net receivables Inventories Other current assets Equipment, net Total assets $ 1,500 2,200 3,000 3,300 5,000 $15,000 Fair Value $ 1,500 2,200 4,000 3,100 8,000 $18,800
2 - 26

Book Value Liabilities Accounts payable Note payable Common stock Retained earnings Total liabilities and stockholders equity $ 1,000 2,000 10,000 2,000 Fair Value $ 1,000 1,800
$15,000
2 - 27
$15,000 3,000 = $12,000 $12,000 30% = $3,600

Assignment of Excess Cost Over Underlying Equity
BV $3,600
FMV $4,800
Cost $5,100
2 - 28

Investment in SR Book value of the interest acquired Excess cost over book value Fair value Book value 30% = Amount assigned Remainder assigned to goodwill $5,100,000 3,600,000 $1,500,000 $1,200,000
$ 300,000
2 - 29
Inventories Other current assets Equipment Note payable Total
$ 300,000 (60,000) 900,000 60,000 $1,200,000

2 - 30
Accounting for Excess of Investment Cost 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 PJs journal entries?
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July 1 Cash 300,000 Investment in SR 300,000 To record additional dividends received from SR at 30% equity interest in SR
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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
2 - 33
December 31 Investment in SR 60,000 Income from SR 60,000 To record income credit for overvalued other current assets disposed of
2 - 34

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)
2 - 35

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)
2 - 36

Investment 5,100,000 300,000 900,000 300,000 60,000 45,000 12,000
Income from SR 300,000 900,000 45,000 60,000 12,000
2 - 37
Excess of Book Value Acquired Over Investment Cost

Post Corporation purchases 50% of the outstanding voting common stock of Taylor on January 1 for $40,000. Taylors stockholders equity Jan 1: $100,000 Add: Income 20,000 Deduct: Dividends paid 7/1 5,000 Stockholders equity 12/31 $115,000
2 - 38
Assignment of Excess Cost over Underlying Equity
BV $50,000
FMV + Cost $40,000

2 - 39
Excess of Book Value Acquired Over 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)
2 - 40
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
2 - 41

Saxons net assets Assets Inventories Other current assets Equipment, net Building, net Total assets Liabilities Net assets Book Value $240,000 100,000 50,000 140,000 $530,000 130,000 $400,000 Fair Value $260,000 100,000 50,000 200,000 $610,000 130,000 $480,000
2 - 42
Assignment of Excess Cost over Underlying Equity
BV $100,000
FMV $120,000
Cost $110,000
2 - 43
Negative Goodwill
$110,000 $120,000 = $10,000
This is the excess of FMV over cost.
2 - 44
Interim Acquisitions of an Investment Interest

Accounting for equity investments becomes more specific when the firm makes acquisitions within an accounting period.
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Investment in a Step-by-Step Acquisition
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.
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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.
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Stock Purchases Directly from 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
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Stock Purchases Directly from the Investee

Masters stockholders equity before issuance ($200,000 capital stock + $150,000 retained earnings) $350,000 Sale to Karl 450,000 Masters stockholder after issuance $800,000 Book value acquired by Karl $400,000
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Investee Corporation with Preferred Stock

Some adjustments are necessary when an investee has preferred as well as common stock outstanding.
2 - 50
Extraordinary Items, CumulativeEffect-Type, and Other Considerations

Ordinary
Extraordinary Cumulative-effect
2 - 51
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.
2 - 52
Related Party Transactions

These transactions arise when one of the transacting parties has the ability to influence significantly the operations of the other.
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End of Chapter 2
2 - 54

Beams PPT Chap 2

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Stock Investments Investor Accounting Chapter 2

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Stock Investment

Fair value/cost method

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Concept Underlying Fair Value/Cost and Equity Methods

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Concept Underlying Fair Value/Cost and Equity Methods

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Economic Consequences of Using Fair Value/Cost and Equity Methods

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Economic Consequences of Using Fair Value/Cost and Equity Methods

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 Methods

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting Procedures Under the Fair Value/Cost and Equity Methods

Fair Value/Cost Method

Fair Value/Cost Method

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

100,000 100,000 4,000 4,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Apply the equity method to purchase price allocations.

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Equity Method: A One-Line Consolidation

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Equity Investments at Acquisition

Equity Investments at Acquisition

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Equity Investments at Acquisition

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Equity Investments at Acquisition

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Illustration of a Purchase Combination

$15,000 3,000 = $12,000 $12,000 30% = $3,600

Assignment of Excess Cost Over Underlying Equity

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Assignment of Excess Cost Over Underlying Equity

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Assignment of Excess Cost Over Underlying Equity

Inventories Other current assets Equipment Note payable Total

$ 300,000 (60,000) 900,000 60,000 $1,200,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Excess of Investment Cost Over Book Value

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Excess of Investment Cost Over Book Value

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Excess of Investment Cost Over Book Value

Accounting for Excess of Investment Cost Over Book Value

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Accounting for Excess of Investment Cost Over Book Value

Accounting for Excess of Investment Cost Over Book Value

Accounting for Excess of Investment Cost Over Book Value

Income from SR 300,000 900,000 45,000 60,000 12,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn

Excess of Book Value Acquired Over Investment Cost

Assignment of Excess Cost over Underlying Equity

FMV + Cost $40,000

2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn