RCJ4Ch16 - Intercorporate Equity Investments...

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Unformatted text preview: Intercorporate Equity Investments Revsine/Collins/Johnson: Chapter 16 Hot Seat Questions 1. A minority passive investment is one in which the shareholder has no ability to influence the acquired company's operating and financial policies. 2. Equity securities designated by the investor to be held for a short period of time are classified as available-for-sale securities. 3. An investment of 30% of a company's voting shares must be accounted for using the equity method. 4. An unrealized loss does not reduce income from operations for an equity securities investment classified as trading securities. 5. The realized gain on an investment classified as trading securities is calculated by comparing the selling price to the original cost. 6. When the ownership percentage of voting stock exceeds 20 percent, GAAP requires that the investor use the equity method to account for the investment. 7. The investment account is adjusted for the investor's share of the reported income of the investee when the investor uses the equity method to account for the stock investment. 8. The acquired goodwill is $30,000 when the investor pays $100,000 to acquire 40% of a company's outstanding voting shares at a time when the fair value of the company's net assets was $175,000. 9. Once a company decides to use the fair value option to account for an equity method investment, the decision is irrevocable. 10. Consolidated financial statements must be prepared when a corporation acquires more than 50% of the voting stock of another corporation. 11. The minority interest's share of the net assets of a consolidated entity is shown as a contra-asset on the consolidated balance sheet when the purchase method is used. 12. When using the acquisition method to account for a business combination, the subsidiary's assets and liabilities are reported on the consolidated balance sheet at their fair values regardless of the level of ownership attributable to the minority shareholders. RCJ ©Spring 2009 2 Learning objectives 1. Debt Security Investment and Equity Security Investment 1. How a company benefits from owning another company’s common stock. 1. How and why an investor’s ownership share determines the accounting treatment for equity investments. 1. How the accounting for short-term speculative investments differs from the accounting for long-term investments. 1. The equity accounting method and when to use it. 1. What consolidated financial statements are, and how they are compiled. RCJ ©Spring 2009 3 Learning objectives 1. What goodwill is, and when it is shown on the financial statements. 1. How business acquisitions and mergers are recorded and why the recording method matters to statement readers. 1. How foreign subsidiaries are treated when financial statements in U.S. dollars are prepared. RCJ ©Spring 2009 4 Overview of Financial Assets RCJ ©Spring 2009 5 Fair Value Measurements RCJ ©Spring 2009 6 Classification of Investments Debt Held­to­ maturity Cost Method Equity Available­ for­sale Trading Mark2Market Equity Method Net Assets Fair Value Option (FAS159) RCJ ©Spring 2009 7 Noncontrolling passive investment: Trading securities—mark­to­market accounting Sinto’s o/s shares are 1000 shares. 1/1/x1 Pinto purchased 100 1/1/x1 shares of Sinto’s common stock at $10/shr. Sinto’s net T.S. invest $1,000 Cash $1,000 asset was $9,000. 12/31/x1 Sinto reported $1,000 12/31/x1 net income and $400 Div. Receivable 40 dividend. Market price /share Div Income 40 is $13. V.A. for Sinto 300 Unrealized gain 300 3/1/x2 Pinto sold 100 shares of 3/1/x2 Sinto at $12/share Cash 1,200 realized loss 100 T.S. Invest 1,000 V.A. for Sinto 300 RCJ ©Spring 2009 8 Noncontrolling passive investment: A4S securities—mark­to­market accounting Sinto’s o/s shares are 1,000 shares. 1/1/x1 Pinto purchased 100 1/1/x1 shares of Sinto’s common stock at $10/shr. Sinto’s net A4S. invest $1,000 Cash $1,000 asset was $9,000. 12/31/x1 Sinto reported $1,000 12/31/x1 net income and $400 Div. Receivable 40 dividend. Market price /share Div. Income 40 is $13. V.A. for Sinto 300 3/1/x2 Pinto sold 100 shares of Unrealized gain 300 Sinto at $12/share 3/1/x2 Cash 1,200 Unrealized gain 300 T.S. Invest 1,000 V.A. for Sinto 300 realized gain 200 ©Spring 2009 RCJ 9 Noncontrolling active investment: the equity method Sinto’s o/s shares are 300 shares. 1/1/x1 Pinto purchased 100 1/1/x1 shares of Sinto’s common stock at $10/shr. Sinto’s net Investment $1,000 Cash $1,000 asset was $9,000. 12/31/x1 Sinto reported $1,000 12/31/x1 net income and $400 Investment 200 dividend. Market price /share Div receivable 133 is $13. Investment Income 333 3/1/x2 Pinto sold 100 shares of 3/1/x2 Sinto at $12/share Cash 1,200 Investment 1,200 RCJ ©Spring 2009 10 Various Investments RCJ ©Spring 2009 11 Various Investments RCJ ©Spring 2009 12 Various Investments In Warren Buffett's words, "We won't 'smooth' quarterly or annual results: If earnings figures are lumpy when they reach headquarters, they will be lumpy when they reach you." RCJ ©Spring 2009 13 Review Question #1 On December 31, 2004, Ott Co. had investments in trading securities with cost of $30,000 and fair value of $28,000. The current (pre-adjustment) balance in the market adjustment account was a $3,000 debit balance. What is the unrealized gain or loss on these trading securities? a. $2,000 unrealized loss. b. $5,000 unrealized loss. c. $3,000 unrealized gain. d. $5,000 unrealized gain. RCJ ©Spring 2009 14 . Review Question #2 The following information was taken from Gil Co.’s December 31, 2004 balance sheet: Investments in available-for-sale securities (at fair value) $96,450 Net unrealized loss on available-for-sale securities (shareholders’ equity) (19,800) Historical cost of the available-for-sale securities was: a. $63,595. b. $76,650. c. $96,450. d. $116,250. RCJ ©Spring 2009 . 15 Noncontrolling active investments: Equity method When the ownership percentage equals or exceeds 20%, GAAP presumes two elements: 1. The investor can exert influence over the company. 1. The investment represents a continuing relationship between the two companies. The accounting approach usedfor minority passive investments is no longer suitable. RCJ ©Spring 2009 16 Noncontrolling active investments: Equity method illustration RCJ ©Spring 2009 17 Noncontrolling active investments: Equity method illustration (concluded) Balance sheet amount at the end of 2005 RCJ ©Spring 2009 18 Noncontrolling active investments: Equity method when cost and book value differ There are two reasons why Willis willingly paid more than book value for a 30% stake in Planet Burbank: 1. The books show balance sheet items at GAAP historical cost rather than current fair value. 1. The business is worth more than the sum of its individual parts (i.e., more than the current fair value of all balance sheet items). This is goodwill. RCJ ©Spring 2009 19 Noncontrolling active investments: Equity method—purchase price allocation RCJ ©Spring 2009 20 Noncontrolling active investments: Equity method—purchase price allocation RCJ ©Spring 2009 21 Noncontrolling active investments: Equity method journal entries RCJ ©Spring 2009 22 Controlling ownership When the ownership percentage exceeds 50% of the voting shares, GAAP presumes the parent controls the subsidiary. The financial statements of the subsidiary are then combined—line by line—with those of the parent using a process called consolidation. This consolidation process occurs each reporting period. If the ownership percentage is exactly 50% of the voting shares, the equity method is used and no line-by-line consolidation is necessary. RCJ ©Spring 2009 23 Controlling ownership: Presumptive control According to the FASB, control is “the ability of one entity to direct the policies and management that guide the ongoing activities of another entity.” [FASB Exposure Draft, February 1999]. The Exposure Draft presumes that control exists if any of the following conditions are met: Majority voting interest in the election of the board, or the right to appoint the majority of the board. Large minority voting interest (e.g., more than 50% of the votes typically cast) and no other significant minority interest exists. Convertible securities are owned which (if converted) would give it the right to obtain or appoint a majority of the board. Consolidation would then be required unless presumptive control is temporary. RCJ ©Spring 2009 24 MS’s Announcement of Buying Yahoo RCJ ©Spring 2009 25 Controlling ownership: Consolidation example Alphonse and Gastin Acquisition 100% After the acquisition Alphonse Gaston Gaston(FMV) Assets Current assets $5,000,000 Fixed assets, net $20,000,000 Investment in Gaston $10,000,000 Goodwill $35,000,000 Liabilities and Equity Current liabilities $1,000,000 Common stock $32,000,000 APIC $2,000,000 $35,000,000 RCJ $2,000,000 $2,000,000 $6,500,000 $8,000,000 $8,500,000 $500,000 $8,000,000 500000 Investment 10,000,0000/1.0 = NBV = Purchase Premium FMA-BV: (8,000,000-6,500,000) = Goodwill 10,000,000 8,000,000 2,000,000 1,500,000 500,000 $8,500,000 ©Spring 2009 26 Noncontrolling ownership: Consolidation example (continued) Alphonse and Gastin Acquisition 100% After the acquisition Adj.&Elimination Alphonse Gaston(BV) Gaston(MV) Dr. Cr. Assets Current assets $5,000,000 Fixed assets, net 20,000,000 Investment in Gaston0,000,000 1 Goodwill $35,000,000 Liabilities and Equity Current liabilities 1,000,000 Common stock 32,000,000 APIC 2,000,000 $35,000,000 Investment 10,000,0000/1.0 = NBV = Purchase Premium FMA-BV: (8,000,000-6,500,000) = Goodwill RCJ $2,000,000 6,500,000 1,500,000 10,000,000 500,000 $8,500,000 500,000 8,000,000 $8,500,000 8,000,000 $10,000,000 $10,000,000 Consolidated B/S 7,000,000 28,000,000 0 500,000 $35,500,000 1,500,000 32,000,000 2,000,000 $35,500,000 10,000,000 8,000,000 2,000,000 1,500,000 500,000 ©Spring 2009 27 Controlling ownership: Noncontrolling interest Suppose Alphonse only bought 80% of Gaston: 20% Owned by Alphonse Owned by other “noncontrolling” investors 80% Consolidation is still required, but the financial statements will also reflect a noncontrolling interest in Gaston. Noncontrolling interest Liabilities Assets = Noncontrolling interest Shareholders’ equity Profit Or loss Consolidated Balance sheet RCJ = Available to Shareholders Consolidated Income statement ©Spring 2009 28 Controlling ownership: Consolidation example Alphonse and Gastin Acquisition 80% After the acquisition Alphonse Gaston Gaston(FMV) Assets Current assets $5,000,000 Fixed assets, net $20,000,000 Investment in Gaston$8,000,000 Goodwill $33,000,000 Liabilities and Equity Current liabilities $1,000,000 Common stock $32,000,000 APIC $2,000,000 $35,000,000 RCJ $2,000,000 $6,500,000 $8,500,000 $500,000 $8,000,000 500000 $8,500,000 ©Spring 2009 = 1,500,000 500,000 Noncontrolling owners’ OE 10,000,000*20% = $2,000,000 $8,000,000 Investment $8,000,000/0.8 = NBV Purchase Premium FMA-BV: (8,000,000-6,500,000) Goodwill 2,000,000 10,000,000 8,000,000 2,000,000 29 Controlling ownership: Noncontrolling interest example Alphonse and Gastin Acquisition 80% After the acquisition Adj.&Elimination Alphonse Gaston(BV) Gaston(MV) Dr. Cr. Assets Current assets $5,000,000 Fixed assets, net 20,000,000 Investment in Gaston 8,000,000 Goodwill $33,000,000 Liabilities and Equity Current liabilities 1,000,000 Noncontrolling Common stock 32,000,000 APIC 2,000,000 $35,000,000 RCJ $2,000,000 6,500,000 Consolidated B/S $7,000,000 28,000,000 1,500,000 8,000,000 500,000 500,000 $35,500,000 $8,500,000 500,000 2,000,000 8,000,000 $8,500,000 8,000,000 $10,000,000 ©Spring 2009 $10,000,000 1,500,000 2,000,000 32,000,000 2,000,000 $37,500,000 30 Accounting goodwill Goodwill arises when the purchase price paid for another business exceeds the fair market value of the acquired net assets of that business. $0.5 million $1.5 million Goodwill Excess of net asset FMV over BV $10 million $8 million Purchase price Net asset BV Allocation Prior to 2002, acquired goodwill in the U.S. was amortized to income over a period not exceeding 40 years. SFAS No. 142 no longer permits amortization but instead requires periodic impairment tests. RCJ ©Spring 2009 31 Accounting goodwill: Goodwill impairment charges RCJ ©Spring 2009 32 Review Question #4 Mill Corp. acquired a 100% interest in Vore Corp for a cash price of $5,000,000. At the acquisition date, Vore’s plant and equipment had a carrying amount of $750,000 and a fair value of $875,000. The total assets of Vore Company were $10,000,000 and the total liabilities were valued at $6,000,000. What value will the combined entity record the plant and equipment and goodwill as a result of the purchase? Plant and equipment Goodwill a. $750,000 $1,000,000 b. $750,000 $ 875,000 c. $875,000 $ 875,000 . ©Spring 200 RCJ d. $875,000 $1,000,000 9 33 Summary Financial reporting for intercorporate equity investments depends on the size of the parent company’s ownership shares. When the ownership share is less than 20% (minority passive investment), mark-to-market accounting is used. When the ownership share is from 20% to 50% (minority active investment), the equity method is used. When the ownership share exceeds 50% (majority investment), full consolidation is required. RCJ ©Spring 2009 34 Summary concluded Accounting goodwill arises when the purchase price for another company exceeds the fair value of identifiable net assets. Goodwill is no longer amortized to income, but it is subject to impairment tests. RCJ ©Spring 2009 35 ...
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This note was uploaded on 05/21/2011 for the course ACCT 326 taught by Professor Joh during the Spring '11 term at San Diego State.

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