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
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Stock Investments: Objectives
1.
2.
3.
4.
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.
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Objectives (continued)
5.
6.
Apply the equity method to purchase price allocations.
Learn how to test goodwill for impairment.
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Stock Investments – Investor Accounting and Reporting
1: Levels of Influence or Control
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Levels of Influence
• <20% – presumes lack of
significant influence – fair
value (cost) method
• 20% to 50% – presumes
significant influence – equity
method
• >50% – presumes control –
consolidated financial
statements
Consolidated
financial
statements
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Fair value
(cost)
method
Equity
method
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Stock Investments – Investor Accounting and Reporting
2: Accounting Reflects Economics
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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.
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Stock Investments – Investor Accounting and Reporting
3a: Fair Value/Cost Method
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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
Cash
100,000
Cash
Dividend income
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100,000
4,000
4,000
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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.
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Stock Investments – Investor Accounting and Reporting
3b: Equity Method
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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
Cash
100,000
Cash
Investment in Sud
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100,000
4,000
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:
Cash
4,000
$100,000
cost - $4,000 dividends + $5,000 income
Investment
in Sud
= $101,000.
•
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4,000
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Stock Investments – Investor Accounting and Reporting
4: Ability to Influence or Control
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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
1.
2.
3.
4.
5.
Opposition by investee,
Surrender of significant shareholder rights,
Concentration of majority ownership,
Lack of information for equity method, and
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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Stock Investments – Investor Accounting and Reporting
5: Applying the Equity Method
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Acquisition Cost > FV net assets
FV net assets > BV net assets
Payne acquires 30% of Sloan for $5,000. Sloan's identifiable
net assets (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 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 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
1,000
Additional paid in capital
Investment expense
Cash
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50
100
150
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Cost/Book Value Assignment
Cost of acquisition
Less 30% book value = 30%(12,000)
Excess of cost over book value
Assigned to:
Inventories 30%(+1,000)
Other curr. assets 30%(-200)
Equipment 30%(+3,000)
Note payable 30%(+200)
Goodwill (to balance)
Total
$5,000
3,600
$1,400
Amount Amortization
$300
(60)
900
60
200
$1,400
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1st year
1st year
20 years
5 years
None
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Dividends and Income
Payne receives $300 dividends from Sloan.
Cash
300
Sloan reports net income of $900.
PayneInvestment
will recognize its share
(30%)
of Sloan's income, but will adjust it for amortization
of
in
Sloan
300
the differences between book and fair values.
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Amortization and Investment Income
Cost/book value
differences:
Initial
amount
1st year
amort.
Unamortized
excess at year-end
$300
($300)
$0
Other curr. Assets
(60)
60
0
Equipment
900
(45)
855
60
(12)
48
200
0
200
$1,400
($297)
$1,103
Inventories
Note payable
Goodwill
Total
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
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
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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
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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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