Chapter 2

Stock Investments-
Investor Accounting and Reporting
Aprilia Beta Suandi
Faculty of Economics and Business
Universitas Gadjah Mada
 Levels of Influence or Control

<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
 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
 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
 Fair Value (Cost) Method

July 1: Pop buys 2,000 shares of the 10,000

outstanding shares of Son for $50,000 ($25/share)
and does not have significant influence over Son.
Investment in Son (+A) 50,000 blank
Cash (-A) blank 50,000

Nov 1: Pop receives $2,000 in dividends from Son.

Cash (+A) 2,000 blank

Dividend income (+R, +SE) blank 2,000
 Fair Value (Cost) Method, at Year-end
Dec 31: Son’s net income at year end is $25,000.

No record.
Note: market price: $25/share; no revaluation needed.
 An Exception
If dividend received exceeds the investor’s share of
earnings after the investment has been acquired:
Net income is $15,000 and $2,000 dividend is received.

Reduce dividend income recognized

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
 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 $2,000 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.

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
One-line
Consolidation
= $50,500
Applying the Equity Method

Stock Investments – Investor

Accounting and Reporting
 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

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

Additional paid in capital (-SE) 50 blank

Cash (-A) blank 150
 Cost/Book Value Assignment
BV Net Assets = $12,000; FV Net Assets = $16,000
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

July 1: Pam receives $300 dividends from Sun.

Cash (+A) 300 blank

Investment in Sun (-A) blank 300

Dec 31: 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.
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 Year-End Entry
Record net income
Investment in Sun (+A) 900 blank
Income from Sun (R, +SE) blank 900
Amortizations
Income from Sun (-R, -SE) 300 Blank
Investment in Sun (-A) blank 300
Investment in Sun (+A) 60 blank
Income from Sun (R, +SE) blank 60
Income from Sun (-R, -SE) 45 blank
Investment in Sun (-A) blank 45
Income from Sun (-R, -SE) 12 blank
Investment in Sun (-A) blank 12

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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 – 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
 Illustration: Bargain Purchase
Jan 1: Pop buys 25% of Sax for $110.
Net assets:
Book value: A-L = 530-130 = $400
Fair value: A-L = 610-130 = $480  25% = $120
Cost < FV = 110 < 120  BARGAIN PURCHASE
Investment in Sax 120 blank

Cash blank 110

Gain on bargain purchase blank 10
 Illustration: Bargain Purchase
Dividends paid
Cash (+A) 10 blank
Investment in Sax (-A) blank 10

Net Income: $60

Investment cost – BV = 110 – 100 = $10
Allocated to: Inventory ($5) and buildings ($15; 4 years)
Investment in Sax (+A) 6.25 blank
Income from Sax(+R, +SE) blank 6.25
Investment Income = (25%x$60)-$5-($15/4) =$6.25
Other Possible Situations

Stock Investments – Investor

Accounting and Reporting
 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
Entry to adjust investment
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

Further discussion in Chapter 10

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
 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.
 Homework
• P2-5
• P2-9