Advanced accounting 10th by a beams athony ch02

Chapter 2: Stock Investments – Investor Accounting and Reporting by Jeanne M David, Ph.D., Univ of Detroit Mercy to accompany Advanced Accounting, 10th edition by Floyd A Beams, Robin P Clement, Joseph H Anthony, and Suzanne Lowensohn © Pearson Education, Inc publishing as Prentice Hal 2-1 Stock Investments: Objectives Recognize investors' varying levels of influence or control, based on the level of stock ownership Anticipate how accounting adjusts to reflect the economics underlying varying levels of investor influence Apply the fair value/cost and equity methods of accounting for stock investments Identify factors beyond stock ownership that affect an investor's ability to exert influence or control © Pearson Education, Inc publishing as Prentice Hal 2-2 Objectives (continued) Apply the equity method to purchase price allocations Learn how to test goodwill for impairment © Pearson Education, Inc publishing as Prentice Hal 2-3 Stock Investments – Investor Accounting and Reporting 1: Levels of Influence or Control © Pearson Education, Inc publishing as Prentice Hal 2-4 Levels of Influence • 50% – presumes control – consolidated financial statements Consolidated financial statements © Pearson Education, Inc publishing as Prentice Hal Fair value (cost) method Equity method 2-5 Stock Investments – Investor Accounting and Reporting 2: Accounting Reflects Economics © Pearson Education, Inc publishing as Prentice Hal 2-6 Accounting for the Investment Degree of influence Investment's carrying value Investment income Lack of significant influence Fair value (cost, if nonmarketable) Dividends declared Significant influence Original cost adjusted to reflect periodic earnings and dividends, e.g., a proportionate 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 © Pearson Education, Inc publishing as Prentice Hal 2-7 Stock Investments – Investor Accounting and Reporting 3a: Fair Value/Cost Method © Pearson Education, Inc publishing as Prentice Hal 2-8 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 Cash 100,000 Cash Dividend income © Pearson Education, Inc publishing as Prentice Hal 100,000 4,000 4,000 2-9 Fair Value Method, at Year-end • Reduce dividend income recognized, if needed Dividend income 1,000 Investment in Sud 1,000 If Pilzner determines that cumulative dividends exceed its cumulative share of income by $1,000 • Adjust investment to fair value Allowance to adjust available-forsale securities to fair value 21,000 Other comprehensive income 21,000 If fair value of increases to $120,000 and the Investment in Sud account balance is $99,000 © Pearson Education, Inc publishing as Prentice Hal 2-10 Year-end Entry & Balance Record the investment income Investment in Sloan The ending balance in the investment account is: Income from Sloan 603 603 5,000 – 300 + 603 = 5,303 Cost – dividends + investment income © Pearson Education, Inc publishing as Prentice Hal 2-23 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 © Pearson Education, Inc publishing as Prentice Hal 2-24 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 © Pearson Education, Inc publishing as Prentice Hal 2-25 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 Cash, CS, APIC Gain on bargain purchase © Pearson Education, Inc publishing as Prentice Hal xxx xxx xxx 2-26 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 © Pearson Education, Inc publishing as Prentice Hal 2-27 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 any Investment in XYZ Retained earnings © Pearson Education, Inc publishing as Prentice Hal xxx xxx 2-28 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 © Pearson Education, Inc publishing as Prentice Hal 2-29 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 © Pearson Education, Inc publishing as Prentice Hal 2-30 Investee with Preferred Stock • 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 • Investment income is based on income available to common shareholders = investee net income – PS dividends** ** Pref Div = current dividend if cumulative, or dividends declared if noncumulative © Pearson Education, Inc publishing as Prentice Hal 2-31 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 © Pearson Education, Inc publishing as Prentice Hal 2-32 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 disclosures FASB Statement No 57 © Pearson Education, Inc publishing as Prentice Hal 2-33 Stock Investments – Investor Accounting and Reporting 6: Impairment of Goodwill © Pearson Education, Inc publishing as Prentice Hal 2-34 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 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 is not needed – Use quoted market prices of reporting unit, or valuation techniques applied to similar groups of assets and liabilities If the implied fair value of the goodwill < the carrying value of the goodwill, record an impairment loss for the difference © Pearson Education, Inc publishing as Prentice Hal 2-35 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 © Pearson Education, Inc publishing as Prentice Hal 2-36 All rights reserved No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher Printed in the United States of America Copyright © 2009 Pearson Education, Inc   Publishing as Prentice Hall © Pearson Education, Inc publishing as Prentice Hal 2-37 ... publishing as Prentice Hal 2-18 Acquisition of Sloan Stock At 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... and $100 in consulting fees Investment in Sloan 5,000 Cash 2,000 Common stock, at par 2,000 Additional paid in capital 1,000 Additional paid in capital Investment expense Cash © Pearson Education,... recorded at the fair value of the identifiable net assets Investment in ABC Cash, CS, APIC Gain on bargain purchase © Pearson Education, Inc publishing as Prentice Hal xxx xxx xxx 2-26 Interim Acquisitions