Stock Investments

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
GAAPfor
for recording
recording common
common stock
stock
acquisitions
acquisitions require
require that
that the
the investor
investor
record
record the
the investment
investment at
at its
its cost.
cost.
Fair value/cost method
Equity method
2-3
Concept Underlying Fair

Value/Cost
and Equity Methods
Under
Under the
the fair
fair value/cost
value/cost method
method
investments
investments in
in common
common stock
stock
are
are recorded
recorded at
at cost.
cost.
Dividends
Dividends from
from subsequent
subsequent earnings
earnings
are
are reported
reported as
as dividend
dividend income.
income.
2-4
Concept Underlying Fair

Value/Cost
and Equity Methods
The
The equity
equity method
method of
of accounting
accounting
isis essentially
essentially accrual
accrual accounting
accounting
for
for equity
equity investments.
investments.
Investments
Investments are
are recorded
recorded at
at cost
cost
and
and adjusted
adjusted for
for earnings,
earnings,
losses,
losses, and
and dividends.
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.
2-7

Methods
Investor can significantly influence or
control the operations of the investee.
Fair value/cost method is unacceptable.
2-8

Methods
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

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.
2 - 11
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.
2 - 17
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.
2 - 18
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
Assets
Cash
Net receivables
Inventories
Other current assets
Equipment, net
Total assets
Book
Value
Fair
Value
$ 1,500
2,200
3,000
3,300
5,000
$15,000
$ 1,500
2,200
4,000
3,100
8,000
$18,800
2 - 26
Combination
Liabilities
Accounts payable
Note payable
Common stock
Retained earnings
Total liabilities and
stockholders equity
Book
Value
Fair
Value
$ 1,000
2,000
10,000
2,000
$ 1,000
1,800
$15,000
$15,000 3,000 = $12,000 $12,000 30% = $3,600

2 - 27
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
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?
2 - 31

Investment
July 1
Cash
300,000
Investment in SR
300,000
To record additional dividends received
from SR at 30% equity interest in SR
2 - 32

Investment
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

Investment
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

Investment
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

Investment
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
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

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
Combination
Saxons net assets
Assets
Inventories
Equipment, net
Building, net
Total assets
Liabilities
Net assets
Book
Value
Fair
Value
$240,000
100,000
50,000
140,000
$530,000
130,000
$400,000
$260,000
100,000
50,000
200,000
$610,000
130,000
$480,000
2 - 42

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.
2 - 45
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.
2 - 46
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.
2 - 47
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
2 - 48
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
2 - 49
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.
2 - 53
End of Chapter 2
2 - 54

Stock Investments - Investor Accounting

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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

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

Concept Underlying Fair

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

Economic Consequences of Using

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

Economic Consequences of Using

Economic Consequences of Using

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

Accounting Procedures Under the

Fair Value/Cost Method

Fair Value/Cost Method

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

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

Equity Investments at Acquisition

PJ, Inc., purchases 30% of SR outstanding

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

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

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

Assignment of Excess Cost

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

Assignment of Excess Cost

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

Assignment of Excess Cost

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

Accounting for Excess of

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

Accounting for Excess of

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

Accounting for Excess of

Accounting for Excess of

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

Accounting for Excess of

Accounting for Excess of

Accounting for Excess of

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

Excess of Book Value Acquired

Assignment of Excess Cost

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

Excess of Book Value Acquired

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

Assignment of Excess Cost

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

$110,000 $120,000 = $10,000

This is the excess of FMV over cost.

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