Acct 415/515 Prof.

Teresa Gordon
Accounting for Investments under FASB No. 115
A Review
For commercial enterprises
(nonprofit entities follow SFAS No.124)
Presentation on
Financial Statements
!an"e in Fair #al$e
Temporar%
&t!er t!an
Temporar%
'oss
(oes t!e in)estor !a)e s$*stantial infl$ence or
control+
,n)estor owns 2-. to 5-. of stoc/ and !as
si"nificant infl$ence *$t not control of t!e
corporation
Use Equity et!od
&n 0S at !istorical cost
pl$s s!are of earnin"s
since ac1$isition less
di)idends recei)ed
(amorti2ation ma% also
*e re1$ired)
N/A
3eali2ed
loss on ,S4
new *asis
on 0S
,n)estor owns o)er 5-. of stoc/ or ot!erwise
controls t!e corporation
"onso#id$tion required
onsolidated financial
statements
N/A N/A
(oes a readil% determina*le fair )al$e e5ist+
If not% use "ost et!od
&n 0S at !istorical cost N/A
3eali2ed
loss on ,S4
new *asis
on 0S
For de*t sec$rities4 does t!e enterprise !a)e t!e
positi)e intent and a*ilit% to !old to mat$rit%+
"#$ssify $s !e#d&to&m$turity
&n 0S at amorti2ed
cost
,S incl$des
amorti2ation of
premi$ms 6 disco$nts
(isclose fair )al$e in
notes
N/A
3eali2ed
loss on ,S4
new cost
*asis on 0S
,s t!e in)estment o*7ecti)e to "enerate profits on
s!ort8term differences in price+
"#$ssify $s 'r$ding Securities
&n 0S at fair )al$e
,S reports $nreali2ed
"ain/loss for period
3eco"ni2ed
on ,S and
incl$ded in
39
No
additional
entries
needed
All ot!er de*t and e1$it% sec$rities are classified
as
Av$i#$(#e&for&S$#e Securities
&n 0S at fair )al$e
S, reports !oldin"
"ain/loss for period
3eported
on S, and
incl$ded in
A&,
3eali2ed
loss on ,S4
new cost
*asis on 0S
0S : *alance s!eet; ,S : income statement; S, : statement of compre!ensi)e income;
A&, : acc$m$lated ot!er compre!ensi)e income (owners< e1$it% acco$nt); F# : fair )al$e;
N/A : not applica*le since in)estments are not carried at fair )al$e
24=-44>2>.doc as of 1-/1-/14 Pa"e 1
Acct 415/515 Prof. Teresa Gordon
Accounting for investment on )$rent*s (oo+s
"ost et!od versus Equity et!od
Cost Method
T!e ori"inal cost of t!e in)estment is recorded on t!e parent<s *oo/s.
No ad7$stments are made to reflect s$*se1$ent c!an"es in fair )al$e
($nless serio$s do$*t as to t!e reali2ation of t!e in)estment e5ists in
w!ic! case a permanent write8down is made).
?!en di)idends are declared4 di)idend income is reco"ni2ed.
@ndistri*$ted earnin"s !a)e no affect on parent<s *oo/s.
onsolidation proced$resA
0ot! t!e in)estment acco$nt and di)idend income are eliminated w!en
t!e s$*sidiar% and parent financial statements are consolidated.
T!is and all ot!er ad7$stments are made onl% on t!e consolidation
wor/papers.
24=-44>2>.doc as of 1-/1-/14 Pa"e 2
Acct 415/515 Prof. Teresa Gordon
Equity Method
At ac1$isition4 t!e in)estment is recorded at cost.
S$*sidiar% earnin"s after ac1$isition increase t!e in)estment acco$nt
and increase earnin"s on t!e income statement.
S$*sidiar% losses after ac1$isitions decrease t!e in)estment acco$nt and
decrease earnin"s on t!e income statement.
(i)idends recei)ed from t!e s$*sidiar% red$ce t!e in)estment acco$nt.
?!en t!e fair )al$e of identifia*le assets e5ceeds t!eir carr%in" )al$e on
t!e s$*sidiar%<s *oo/s4 t!e e5cess is amorti2ed o)er t!e remainin"
economic life of t!e assets. T!is amorti2ation red$ces t!e in)estment
acco$nt on t!e parent<s *oo/s and red$ces s$*sidiar% earnin"s reported
on t!e income statement.
onsolidation proced$resA
T!e in)estment acco$nt and earnin"s of s$*sidiar% acco$nts are
eliminated in t!e consolidation process.
!ec/ fi"$resA
onsolidated net income will *e t!e same as t!e parent compan%<s net
income.
onsolidated retained earnin"s will *e t!e same as t!e parent compan%<s
retained earnin"s.
24=-44>2>.doc as of 1-/1-/14 Pa"e >
Acct 415/515 Prof. Teresa Gordon
Equity et!od on ,$rent*s Boo+s
,n)estment in s$*sidiar% (*alance s!eet acco$nt)
Bistorical cost of in)estment S!are of reported losses of
s$*sidiar%
S!are of reported earnin"s of
s$*sidiar%
(i)idends recei)ed from
s$*sidiar%
Amorti2ation of e5cess )al$e
of identifia*le assets of
s$*sidiar%
9arnin"s of s$*sidiaries (income statement acco$nt)
S!are of reported losses of
s$*sidiar%
S!are of reported earnin"s of
s$*sidiar%
Amorti2ation of e5cess )al$e
of identifia*le assets of
s$*sidiar%
24=-44>2>.doc as of 1-/1-/14 Pa"e 4
Acct 415/515 Prof. Teresa Gordon
Bot! met!ods $re wide#y used (ut e$c! !$s $dv$nt$ges
$nd dis$dv$nt$ges
ost Cet!od 91$it% Cet!od
Financial anal%sis complicated
*eca$se amo$nts needed m$st
*e trac/ed on wor/in" papers
rat!er t!an t!ro$"! t!e "eneral
led"er
Facilitates financial anal%sis
s$c! as ret$rn on in)estment for
s$*sidiaries
'ess *oo//eepin" is in)ol)ed Parent compan% financial
statements are more $sef$l for
internal mana"ement p$rposes
No self8c!ec/in" feat$re Self8c!ec/in" feat$re $sef$l
w!en consolidated financial
statements are prepared
NoteA
T!e consolidated financial statements will *e identical re"ardless of
w!ic! *oo//eepin" met!od is $sed internall% *% t!e parent compan%.
24=-44>2>.doc as of 1-/1-/14 Pa"e 5
Acct 415/515 Prof. Teresa Gordon
The COMPLETE EQUITY method gives
rise to a
ONE LINE CONSOLIDATION TEO!Y"
A L W A Y S
Consolidated Net Income = Parents Net Income
Consolidated Retained
Earnings
= Parents Retained Earnings
Consolidated Stockholders
Equity
= Parents Stockholders Equity
(if 1! Su"sidiary#
Consolidated Stockholders
Equity
= Parents Stockholders Equity
$ minority interest
(if % 1! Su"sidiary#
24=-44>2>.doc as of 1-/1-/14 Pa"e D
Acct 415/515 Prof. Teresa Gordon
Tips for tac/lin" consolidation pro*lems
1. ,dentif% t!e nat$re of t!e pro*lem
Parent acco$ntin" (e1$it% met!od )s. cost met!od)
Noncontrollin" (Cinorit%) interest
,ntercompan% transactions
2. Note important details
ost of in)estment
Fair )al$e of assets ac1$ired
Amorti2ation of fair )al$es
&wners!ip interest of parent
(AT9S
>. ,dentif% specific re1$irements
Eo$rnal entries
?or/s!eet entries
ompletion of wor/s!eet
95planation of items
'i)s for t$c+#ing conso#id$tion )ro(#ems
,t is !elpf$l to start wit! a "lo*al anal%sisA
1. (etermine in)estment cost
2. (etermine *oo/ )al$e of net assets
>. (etermine fair )al$e of net assets
4. ,n)estment cost 8 0oo/ )al$e of net assets
: F(ifferentialG
5. ,n)estment cost 8 Fair )al$e of net assets
: Goodwill
D. Fair )al$e of net assets 8 0oo/ )al$e of net assets
: F95cess )al$e componentG
24=-44>2>.doc as of 1-/1-/14 Pa"e =
Acct 415/515 Prof. Teresa Gordon
Parent $ses 91$it% Cet!od
"onso#id$tion wor+s!eet entries needed
-$ssumes non&)us!down $ccounting.
1. 0asic elimination entr% (s$*sidiar% net assets *oo/ )al$e at
*e"innin" of %ear pl$s earnin"s and di)idends for %ear)
2. 9liminate e5cess cost element (at end of period )al$es)
>. Amorti2ation of t!e allocated differential.
4. 9liminate acc$m$lated depreciation at ac1$isition
5. 9limination of intercompan% transactions
Parent $ses ost Cet!od
onsolidation wor/s!eet entries needed
(ass$mes non8p$s!down acco$ntin"
1. 0asic elimination entr% (*oo/ )al$e of net assets at ac1$isition4 t!is
entr% is alwa%s t!e same)
2. 3ecord e5cess cost elements (amo$nts at ac1$isition4 t!is entr% is
alwa%s t!e same)
>. Amorti2ation of t!e differential (prior periods affect on retained
earnin"s4 c$rrent affect on income statement and *alance s!eet)
4. 9liminate di)idend income.
5. 9liminate acc$m$lated depreciation at ac1$isition
D. 9limination of intercompan% transactions
24=-44>2>.doc as of 1-/1-/14 Pa"e H
Acct 415/515 Prof. Teresa Gordon
Inde/ to "onso#id$tion E/$m)#es
,oo cre$tes Soo "re$ted 1001&owned su(sidi$ry
At ac1$isition pl$s wor/ papers for two %ears4 cost
and e1$it% met!ods
,e((#e 2 Stone "re$ted su(sidi$ry wit! noncontro##ing interest
A. Pe**le sells 2-.
?or/ papers for cost and e1$it% met!ods4 >
%ears eac!
0. Stone iss$es more stoc/
?or/ papers for cost and e1$it% met!ods4 >
%ears eac!
Business "om(in$tions3 ,A $nd Sun
E/$m)#es
I##ustr$tions of $cquisition of $ssets% $cquisition of
stoc+% st$tutory merger% st$tutory conso#id$tion% etc.
Also4 s!ort e5amples of parent compan% acco$ntin"
$nder Parent o and 9conomic @nit approac!es
,#$te 2 S$ucer 1001&owned $cquired su(sidi$ry
At ac1$isition pl$s t!ree %ears cost and e1$it%
met!od wor/ papers.
,#$y 2 Swing 4ess t!$n 1001 owned $cquired su(sidi$ry
At ac1$isition pl$s t!ree %ears cost and e1$it%
met!od wor/ papers. @ses GAAP 9conomic @nit
approac!.
,ound 2 Sound 5ownstre$m s$#es to w!o##y&owned cre$ted su(sidi$ry
,u) 2 Su) U)stre$m s$#es from )$rti$##y&owned cre$ted
su(sidi$ry
6t!er fi#es $v$i#$(#e -notes.
ost )s. 91$it% Cet!od.doc
reated partiall% owned s$*.doc
0$som*.doc
Ac1$ired S$* wit! N,.doc
24=-44>2>.doc as of 1-/1-/14 Pa"e I
Acct 415/515 Prof. Teresa Gordon
24=-44>2>.doc as of 1-/1-/14 Pa"e 1-