beams10e ch02 investor accounting and reporting
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Ppt for chapter 2 of Pearson's Advanced Accounting text 10th editionTRANSCRIPT
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5/26/2018 Beams10e ch02 Investor Accounting and Reporting
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Chapter 2: Stock Investments
Investor Accounting and Reporting
by Jeanne M. David, Ph.D., Univ. of Detroit Mercy
to accompany
Advanced Accounting, 10thedition
by Floyd A. Beams, Robin P. Clement,Joseph H. Anthony, and Suzanne Lowensohn
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Stock Investments: Objectives
1. Recognize investors' varying levels of influence
or control, based on the level of stock ownership.
2. Anticipate how accounting adjusts to reflect the
economics underlying varying levels of investor
influence.
3. Apply the fair value/cost and equity methods of
accounting for stock investments.4. Identify factors beyond stock ownership that
affect an investor's ability to exert influence or
control.
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Objectives (continued)
5. Apply the equity method to purchase price
allocations.
6. Learn how to test goodwillfor impairment.
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1: Levels of Influence or Control
Stock InvestmentsInvestor Accounting and Reporting
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Levels of Influence
Percent Ownership of Voting Stock
>50%
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2: Accounting Reflects Economics
Stock InvestmentsInvestor Accounting and Reporting
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Accounting for the Investment
Degree of
influence
Investment's carrying
value
Investment
income
Lack of
significantinfluence
Fair value (cost, if
nonmarketable)
Dividends declared
Significant
influence
Original cost adjusted to
reflect periodic earnings
and dividends, e.g., aproportionate share of
investee's net assets
Proportionate share
of investee's
periodic earnings*
*If income were measured as dividends declared, by influencing or controlling
dividend decisions, the investor could manipulate its own investment income.
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3a: Fair Value/Cost Method
Stock InvestmentsInvestor Accounting and Reporting
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Fair Value (Cost) Method
FASB Statement No. 115
At acquisition: Pilzner buys 2,000 shares of Sud
for $100,000.
Pilzner receives $4,000 in dividends from Sud.
Investment in Sud 100,000
Cash 100,000
Cash 4,000
Dividend income 4,000
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Fair Value Method, at Year-end
Reduce dividend income recognized, if needed
Adjust investment to fair value
Allowance to adjust available-for-
sale securities to fair value
21,000
Other comprehensive income 21,000
If fair value of increases to $120,000 and the Investment inSud account balance is $99,000.
Dividend income 1,000
Investment in Sud 1,000
If Pilzner determines that cumulative dividends exceed itscumulative share of income by $1,000.
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3b: Equity Method
Stock InvestmentsInvestor Accounting and Reporting
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Equity Method
APB Opinion No. 18
At acquisition: Pilzner buys 2,000 shares of Sud
for $100,000.
Pilzner receives $4,000 in dividends from Sud.
Investment in Sud 100,000
Cash 100,000
Cash 4,000
Investment in Sud 4,000
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Equity Method, at Year-end
Pilzner determines that its share of Sud's income is
$5,000.
The ending balance in the Investment in Sud is:
$100,000 cost - $4,000 dividends + $5,000 income
= $101,000.
Cash 4,000
Investment in Sud 4,000
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4: Ability to Influence or Control
Stock InvestmentsInvestor Accounting and Reporting
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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 ofsignificant influence
1. Opposition by investee,
2. Surrender of significant shareholder rights,
3. Concentration of majority ownership,4. Lack of information for equity method, and
5. 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 control is temporary or
if the parent lacks control
1. Legal reorganization or bankruptcy
2. Severe foreign restrictions.
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5: Applying the Equity Method
Stock InvestmentsInvestor Accounting and Reporting
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Acquisition Cost > FV net assets
FV net assets > BV net assetsPayne acquires 30% of Sloan for $5,000. Sloan's identifiable netassets (assets less liabilities) are:
Fair value: A L = $18,800 - $2,800 =$16,000.
Book value: A L = E = $15,000 - $3,000 = $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.
$5,000> 30%(16,000) > 30%(12,000)
$5,000> $4,800 > $3,600
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Acquisition of Sloan StockAt acquisition, Payne pays $2,000 cash and issues common
stock with a fair value of $3,000 and par value of $2,000.
Payne also pays $50 to register the securities and $100 in
consulting fees.
Investment in Sloan 5,000
Cash 2,000
Common stock, at par 2,000
Additional paid in capital 1,000Additional paid in capital 50
Investment expense 100
Cash 150
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Cost/Book Value Assignment
Cost of acquisition $5,000
Less 30% book value = 30%(12,000) 3,600Excess of cost over book value $1,400
Assigned to: Amount Amortization
Inventories 30%(+1,000) $300 1st yearOther curr. assets 30%(-200) (60) 1st year
Equipment 30%(+3,000) 900 20 years
Note payable 30%(+200) 60 5 yearsGoodwill (to balance) 200 NoneTotal $1,400
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Dividends and Income
Payne receives $300 dividends from Sloan.
Sloan reports net income of $900.
Payne will recognize its share (30%) of Sloan's
income, but will adjust it for amortization of thedifferences between book and fair values.
Cash 300
Investment in Sloan 300
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Amortization and Investment Income
Cost/book value
differences:
Initial
amount
1styear
amort.
Unamortized
excess at year-end
Inventories $300 ($300) $0
Other curr. Assets (60) 60 0
Equipment 900 (45) 855
Note payable 60 (12) 48
Goodwill 200 0 200Total $1,400 ($297) $1,103
Investment income is 30% of Sloan's net income amortization
30%($3,000)$297 = $603.
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Year-end Entry & Balance
Record the investment income
The ending balance in the investment account is:
5,000300 + 603
= 5,303.
Costdividends + investment income
Investment in Sloan 603
Income from Sloan 603
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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
= assetsliabil i ties, or
= stockholders' equi ty
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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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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
Cash, CS, APIC xxx
Gain on bargain purchase xxx
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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 partialyear's amortization for equipment,
buildings, and debt to be written off over
multiple years.
Record dividends if after the acquisition date.
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Acquisition in Stages
Also called a step-by-step acquisition.
Fair value (cost) method equity method
Retroactive adjustment
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
retained earnings amortization, if anyInvestment in XYZ xxx
Retained earnings xxx
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Sale of Equity Investment
Sale of investment that results in a lack of
significant influence over the investee
Equity method fair value (cost) method
Prospective treatment
For the sale
Reduce the investment account for a
proportionate share of the stock sold
Record a gain or loss on the sale
Apply the fair value (cost) method to remaining
investment
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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
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Investee with Preferred Stock Compare cost of acquisition to the book value of the
common stock.
= Total equitybook 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 dividendscurrent PS dividends
Investment income is based on income available to
common shareholders
= investee net incomePS dividends**
**Pref. Div. = current dividend if cumulative, or
dividends declared if noncumulative.
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Special Reporting Issues
If material, the investor continues separate
reporting of extraordinary items and/or
discontinued operations of the investee
Income from Investee is based on income
before discontinued operations or
extraordinary items
Optionally, the investor may report its equity
investments at fair market value,FASB
Statement Nos. 159 and 157
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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 asset, liability, operations
Related party disclosuresFASB Statement No. 57
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6: Impairment of Goodwill
Stock InvestmentsInvestor Accounting and Reporting
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Impairment of Goodwill Test annually, and if significant events occur (e.g.,
adverse legal factors or loss of key personnel)
FASB Statement No. 142: Two step process
1. If the fair value of the whole reporting unit < the
carrying value of the reporting unit including itsgoodwill, 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 ofassets and liabilities.
2. If the implied fair value of the goodwill < the carrying
value of the goodwill, record an impairment loss for the
difference.
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Impairment of Equity Investments
Goodwill implied in equity investments is not
tested for impairment.
The investment itself is tested for impairment.
APB Opinion No. 18
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