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2 - 1©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Stock Investments –Investor Accounting
Chapter 2
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2 - 2©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 1
Recognize investors’ varying
levels of influence or control
based on the level of
stock ownership.
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2 - 3©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Stock Investment
GAAP for recording common stockacquisitions require that the investor
record the investment at its cost.
GAAP for recording common stockacquisitions require that the investor
record the investment at its cost.
Fair value/cost method Equity method
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2 - 4©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Concept Underlying Fair Value/Cost
and Equity Methods
Under the fair value/cost methodinvestments in common stock
are recorded at cost.
Under the fair value/cost methodinvestments in common stock
are recorded at cost.
Dividends from subsequent earningsare reported as dividend income.
Dividends from subsequent earningsare reported as dividend income.
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2 - 5©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Concept Underlying Fair Value/Cost
and Equity Methods
The equity method of accountingis essentially accrual accounting
for equity investments.
The equity method of accountingis essentially accrual accounting
for equity investments.
Investments are recorded at costand adjusted for earnings,
losses, and dividends.
Investments are recorded at costand adjusted for earnings,
losses, and dividends.
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2 - 6©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 2
Anticipate how accounting adjusts
to reflect the economics underlying
varying levels of investor influence.
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2 - 7©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Economic Consequences of UsingFair Value/Cost and Equity
Methods
The different methods of accounting result indifferent investment amounts in the balance
sheet of the investor corporation and differentincome amounts in the income statement.
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2 - 8©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Economic Consequences of UsingFair Value/Cost and Equity
Methods
Investor can significantly influence orcontrol the operations of the investee.
Fair value/cost method is unacceptable.
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2 - 9©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Economic Consequences of UsingFair Value/Cost and Equity
Methods
The equity method is not a substitute forconsolidation, the income reported is
generally the same as the income reportedin consolidated financial statements.
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2 - 10©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 3
Apply the fair value/cost and
equity methods of accounting
for stock investments.
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2 - 11©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting Procedures Under theFair Value/Cost and Equity
Methods
July 1: Pilzner acquires 2,000 of the 10,000outstanding shares of Sud at $50 per share.
$50 per share equals the book valueand fair value of Sud’s net assets.
Sud net income for the year is $50,000.
Dividends of $20,000 are paid on November 1.
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2 - 12©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Fair Value/Cost Method
July 1Investment in Sud 100,000
Cash 100,000
November 1Cash 4,000
Dividend income 4,000
December 31 No entryNet marketable stock or market price = $50
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2 - 13©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Fair Value/Cost Method
Assume that Sud’s net income had been $30,000.
What is Pilzner’s share?
$30,000 × ½ × 20% = $3,000
December 31Dividend Income 1,000
Investment in Sud 1,000
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2 - 14©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Equity Method
July 1Investment in Sud 100,000
Cash 100,000
November 1Cash 4,000
Investment in Sud 4,000
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2 - 15©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Equity Method
December 31Investment in Sud 5,000
Income from Sud 5,000
$50,000 × ½ × 20% = $5,000
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2 - 16©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 4
Identify factors beyond stock
ownership that affect an
investor’s ability to
exert influence or control.
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2 - 17©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Influence or Control
An investment of 20% or more of thevoting stock of an investee should
lead to a presumption that an investorhas the ability to exercise significant
influence over an investee.
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2 - 18©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Influence or Control
The equity method should be followedby an investor whose investment invoting stock gives it the ability toexercise significant influence overoperating and financial policies on
an investee even though the investordoes not control the investee.
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2 - 19©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Influence or Control
An investor may be able to exert significantinfluence over its investee with an
investment interest of less then 20%.
The equity method should not be applied ifthe investor’s ability to exert significantinfluence is temporary or if the investeesare foreign companies operating under
severe exchange restrictions or controls.
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2 - 20©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Learning Objective 5
Apply the equity method to
purchase price allocations.
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2 - 21©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Equity Method:A One-Line Consolidation
Investment is reported in a singleamount on one line of the investor
company’s balance sheet
Investment income is reported ina single amount on one line of the
investor’s income statement.
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2 - 22©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Equity Investments at Acquisition
PJ, Inc., purchases 30% of SR outstandingvoting common stock on January 1
from existing stockholders.($2,000,000 cash plus 200,000 sharesof PJ $10 par common with a market
value of $15 per share)
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2 - 23©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Additional direct costs
SEC fees: $ 50,000Consulting and advisory fees: $100,000
How are these transactions recorded?
Equity Investments at Acquisition
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2 - 24©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Investment in SR 5,000,000Common Stock, $10 par 2,000,000Additional Paid-in Capital 1,000,000Cash 2,000,000
To record acquisition of a 30% equity investmentin SR
Equity Investments at Acquisition
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2 - 25©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Investment in SR 100,000Additional Paid-in Capital 50,000
Cash 150,000To record additional direct costs of purchasinga 30% equity interest in SR
Equity Investments at Acquisition
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2 - 26©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Illustration of a PurchaseCombination
BookValue
AssetsCash $ 1,500 $ 1,500Net receivables 2,200 2,200Inventories 3,000 4,000Other current assets 3,300 3,100Equipment, net 5,000 8,000
Total assets $15,000 $18,800
FairValue
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2 - 27©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Illustration of a PurchaseCombination
BookValue
LiabilitiesAccounts payable $ 1,000 $ 1,000Note payable 2,000 1,800
Common stock 10,000Retained earnings 2,000Total liabilities and stockholders’ equity $15,000
FairValue
$15,000 – 3,000 = $12,000 $12,000 × 30% = $3,600
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2 - 28©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Assignment of Excess CostOver Underlying Equity
BV$3,600
FMV$4,800
Cost$5,100
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2 - 29©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Assignment of Excess CostOver Underlying Equity
Investment in SR $5,100,000Book value of the interest acquired –3,600,000Excess cost over book value $1,500,000
Fair value – Book value × 30% = $1,200,000Amount assigned
Remainder assigned to goodwill $ 300,000
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2 - 30©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Assignment of Excess CostOver Underlying Equity
Inventories $ 300,000Other current assets (60,000)Equipment 900,000Note payable 60,000 Total $1,200,000
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2 - 31©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
What are PJ’s journal entries?
Assume SR pays dividends of $1,000,000on July 1, and reports net income of
$3,000,000 for the year.
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2 - 32©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
July 1Cash 300,000
Investment in SR 300,000To record additional dividends receivedfrom SR at 30% equity interest in SR
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2 - 33©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
December 31Investment in SR 900,000
Income from SR 900,000To record equity in income of SR
December 31Income from SR 300,000
Investment in SR 300,000To write off excess allocated to inventory
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2 - 34©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
December 31Investment in SR 60,000
Income from SR 60,000To record income credit for overvaluedother current assets disposed of
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2 - 35©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
December 31Income from SR 45,000
Investment in SR 45,000To record depreciation on excess allocatedto undervalued equipment with a 20-yearremaining useful life ($900,000 ÷ 20)
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2 - 36©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
December 31Income from SR 12,000
Investment in SR 12,000To amortize the excess allocated to theovervalued note payable over the remaininglife of the note ($60,000 ÷ 5)
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2 - 37©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Accounting for Excess of Investment
Cost Over Book Value
Investment5,100,000 300,000 900,000 300,000 60,000 45,000
12,000
Income from SR 300,000 900,000 45,000 60,000 12,000
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2 - 38©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Excess of Book Value AcquiredOver Investment Cost
Post Corporation purchases 50% of the outstanding voting common stock of
Taylor on January 1 for $40,000.
Taylor’s stockholders’ equity Jan 1: $100,000Add: Income 20,000
Deduct: Dividends paid 7/1 – 5,000Stockholders’ equity 12/31 $115,000
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2 - 39©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Assignment of Excess Costover Underlying Equity
BV$50,000
FMV+
Cost$40,000
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2 - 40©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Excess of Book Value AcquiredOver 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)
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2 - 41©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Negative Goodwill
Post acquires a 25% interest inSaxon for $110,000
Saxon net income and dividends forthe year are $60,000 and $40,000
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2 - 42©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Illustration of a PurchaseCombination
BookValue
AssetsInventories $240,000 $260,000Other current assets 100,000 100,000Equipment, net 50,000 50,000Building, net 140,000 200,000
Total assets $530,000 $610,000Liabilities 130,000 130,000Net assets $400,000 $480,000
FairValueSaxon’s net assets
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2 - 43©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Assignment of Excess Costover Underlying Equity
BV$100,000
FMV$120,000
Cost$110,000
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2 - 44©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Negative Goodwill
$110,000 – $120,000 = – $10,000
This is the excess of FMV over cost.
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2 - 45©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Interim Acquisitions of anInvestment Interest
Accounting for equity investmentsbecomes more specific when thefirm makes acquisitions within
an accounting period.
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2 - 46©2003 Prentice Hall Business Publishing, Advanced Accounting 8/e, Beams/Anthony/Clement/Lowensohn
Investment in a Step-by-StepAcquisition
An investor may acquire the ability to exercisesignificant influence over the operating and
financial policies of an investee in a series ofstock acquisitions, rather than in a single purchase.
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Sale of an Equity Interest
When an investor sells a portion of an equityinvestment that reduces its interest at 20%or less than the level necessary to exercise
significant influence the equity methodis no longer appropriate.
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Stock Purchases Directlyfrom the Investee
Karl Corporation purchases 20,000 of previouslyunissued common stock from Master Co. for
$450,000 on January 1, 2004.
Shares outstanding after new shares are issued:December 31, 2003 20,000Issued to Karl 20,000Total 40,000
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Stock Purchases Directlyfrom the Investee
Master’s stockholders’ equity before issuance($200,000 capital stock+ $150,000 retained earnings) $350,000Sale to Karl 450,000Master’s stockholder after issuance $800,000Book value acquired by Karl $400,000
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Investee Corporation withPreferred Stock
Some adjustments are necessary whenan investee has preferred as well as
common stock outstanding.
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Extraordinary Items, Cumulative-Effect-Type, and Other
Considerations
Ordinary
Extraordinary
Cumulative-effect
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Disclosures for Equity Investees
Name of each investee and percentage of ownership.
Accounting policies of the investor with respectto investments in common stock.
Difference between the carried amount of investment and the amount of underlying equity in net assets.
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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