CPA Becker Review Financial 3(B) Class Notes FINANCIAL 3(B) CLASS NOTES Financial 3 includes the following: I. MARKETABLE SECURITIES A. 1. 2. Marketable securities have readily determinable fair values. These include equity and/or debt securities. There are three marketable securities portfolio classifications: trading securities, available-for-sale securities and debt securities intended to be held until maturity. The trading securities portfolio can contain debt and/or equity securities intended for active trading. The portfolio itself is carried at cost and is reported at fair value in the financial statements through the use of a valuation account. Unrealized gains or losses are reported on the income statement. The available-for-sale securities portfolio can contain debt and/or equity securities that do not fit into either of the other two portfolios. The portfolio itself is carried at cost and is reported at fair value in the financial statements through the use of a valuation account. Unrealized gains or losses are reported in Other Comprehensive Income (the "U" in PUFE). The held-to-maturity portfolio can contain only debt securities where the investor has the ability and intent to hold to maturity. The portfolio itself is reported in the financial statements at amortized cost. Special rules apply to reclassifications and impairment.
3.
4.
5. II.
DETERMINING THE CORRECT METHOD TO USE A. B. C. D. Use the cost method when the investor cannot exercise significant influence over the investee - generally ownership of less than 20% of outstanding voting shares. Use the equity method when the investor can exercise significant influence (generally from 20% to 50% of ownership of outstanding shares). Usually consolidate when "control" is present - 50+% ownership. Special circumstances may affect significant influence or control.
III.
THE COST METHOD A. Record the investment at cost. Generally, dividends received by the investor are treated as dividends revenue. Dividends in excess of earnings, or liquidating dividends, reduce the investment account. Sale of a cost method investment merely involves comparing the proceeds with the cost basis of the securities sold to determine the realized gain/loss. [Note that liquidating dividends lower the cost basis.]
B.
IV.
THE EQUITY METHOD A. Record the investment at cost. Generally, dividends received from the investee reduce the Investment account and the investor "picks up" its share of investee's earnings by increasing the Investment account and recognizing the earnings on its income statement. Under the equity method, the Investment account is similar to a bank account.
1
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Becker CPA Review Financial 3(B) Class Notes B. Differences between the price paid for an investment and the book value of the investee's net assets are allocated first to the FMV of assets and then to Goodwill. Excess fixed asset FMV is depreciated, while the excess value of Land and Goodwill are not amortized. In a step-by-step acquisition, Goodwill is computed separately for each transaction. When significant influence is obtained, the equity method may be applied retroactively to prior periods when the cost method was applicable. Increased ownership may also require changing the investment classification from available-for-sale to equity.
C.
V.
CONSOLIDATED FINANCIAL STATEMENTS [Ownership over 50%] A. B. C. The purchase is recorded for the fair value of any consideration paid. Direct expenses are added to cost and securities issuance reduce costs Additional Paid-In Capital. If the purchase price exceeds the fair value of the net identifiable assets acquired, the excess is goodwill. If the purchase price is less than the fair value of the net identifiable assets acquired, the shortfall is used to reduce proportionately the book values of non-current assets acquired (other than non-current investments). If these non-current assets acquired have been reduced to zero without having used up the shortfall entirely, the remaining shortfall is treated as an extraordinary gain.
The consolidating journal entry eliminates the owners' equity accounts of the subsidiary (common stock, A.P.I.C. and retained earnings), eliminates the Investment account, recognizes the minority interest (MI percent ownership of subsidiary's equity), adjusts acquired assets to their fair values and recognizes goodwill in the consolidated balance sheet. The mnemonic CARIMAG is used for the elements of the eliminating journal entry. When later years' balance sheets are shown, it is necessary to adjust RE back to purchase date. VI. INTERCOMPANY TRANSACTIONS A. B. C. Eliminate 100% regardless of whether there is a minority interest. Eliminate all intercompany accounts. Examples: (a) interest revenue and interest expense, (b) interest receivable and interest payable. Intercompany inventory transactions require the elimination of the intercompany sales and cost of goods sold and any intercompany profit that remains in ending inventory of the buying entity. Intercompany bond transactions require the elimination of the Bonds Payable account from the issuer's balance sheet and the Investment in Bonds account from the balance sheet of the investor. Do not assume the issuer sold these bonds directly to the investor. Intercompany transactions involving land require an elimination making the consolidated financial statements look as though the transaction had not even occurred. Put the Land account back to the value that had been in the seller's books and also eliminate the gain/loss. Intercompany transactions involving depreciable assets involve essentially the same steps as for land with two complications. There is an Accumulated Depreciation account that has to be put back where it was at the time of the intercompany transaction, and depreciation expense after the sale must be adjusted back to what it would have been had the transaction never occurred.
D.
E.
F.
2
2009 DeVry/Becker Educational Development Corp. All rights reserved.
Becker CPA Review Financial 3(B) Class Notes VII. PUSH DOWN ACCOUNTING The subsidiary's books are adjusted to reflect the fair values of assets and liabilities as seen by the parent firm by "pushing down" the consolidation adjustments to the financial statements of the subsidiary. If goodwill was implicit in the purchase price, the goodwill is recorded explicitly in the subsidiary's books. The owners' equity accounts of the subsidiary are adjusted to make the sub's book balance after these adjustments. The SEC requires push down accounting for all "substantially owned" subsidiaries. The Pooling of Interests method of accounting for ownership is no longer GAAP; however, it may still be used for entities that qualified for the treatment prior to June 30, 2001. The Homework Reading contains a detailed description of the method and requirements for pooling treatment. The Becker Simulations are an important part of the exam preparation process and there are two excellent F3 simulations on Consolidations.
3
2009 DeVry/Becker Educational Development Corp. All rights reserved.