hoyle 11ed chapter 1 powerpoints

8/9/2019 Hoyle 11ed Chapter 1 PowerPoints

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Accounting for Investments inCorporate Equity Securities

GAAP recognizes 3 ways to report

investments in other companies:

Fair!a"ue #etho$Conso"i$ation

Equity #etho$

%he metho$ se"ecte$ $epen$s upon the $egree

of inf"uence the investor has over the investee&

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Fair !a"ue #etho$

*se when:investor ho"$s a sma"" percentage

+usua""y "ess than ,-./ of equity

securities of investee

Investor cannot significant"y affect

investee0s operations

Investment is ma$e in anticipation

of $ivi$en$s or mar1et appreciation&

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Conso"i$ation ofFinancia" Statements

2equire$ when: Investor0s ownership ecee$s 4-. of

investee

ecept when contro" $oes not rest with

the ma5ority investor

(ne set of financia" statements prepare$

to conso"i$ate a"" accounts of the parentcompany an$ a"" of its contro""e$ su6si$iaries

AS A SINGLE ENTITY.

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Equity #etho$

*se when: Investor has the a6i"ity to eercise

significant inf"uence on the

investee operations +whether inf"uence isapp"ie$ or not/

Genera""y use$ when ownership is 6etween ,-. an$ 4-.&

Significant Inf"uence might 6e present

with much "ower ownership percentages&

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8hat is Significant Inf"uence9+FAS ASC %opic 3,3/

2epresentation on the investee0s oar$ of ;irectors

Participation in the investee0s po"icyma1ing

process

#ateria" intraentity transactions

Interchange of manageria" personne"

%echno"ogica" $epen$ency

(ther investor ownership percentages

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Investor (wnership of the Investee0s Shares(utstan$ing

-. ,-. 4-. )--.

Fair

!a"ue

Equity

#etho$

Conso"i$ate$ Financia"

Statements

Genera" (wnership Gui$e"ines

Significantinf"uence

genera""y assume$

+,-. to 4-.

ownership/&

*sua""y "ac1of contro"

or

significant

inf"uence&

Financialstatements of all

related

companies must

be consolidated.

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Fair

!a"ue

Equity

#etho$

Conso"i$ate$Financia"

Statements

Genera" 2eporting Gui$e"ines

): Same as Fair

!a"ue,: Investor recognizes

its share +. ofownership/of investee0s net

income +net "oss/as an increase+$ecrease/ in theinvestment

account an$

3& 2ecor$s $ivi$en$s

as a $ecrease&

)& Investor

recor$sinvestment at

=cost>&

,& Investor

recognizes cash$ivi$en$s from

investee as

income&

(ne set of

financia"statements are

prepare$ to

com6ine accounts

of the investor an$

a"" of its investees

AS A SI?G'E

E?%I%@&

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Equity #etho$ B App"ie$

Step )Investment in Investee Cash +or other AssetsDStoc1/

Step ,

;e6it Cre$it

Investment in Investee

Equity in Investee Income

If net loss: ;e6it Cre$itEquity in Investee Income

Investment in Investee

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Equity #etho$ B App"ie$+Continue$/

Step 3: Investor reduces the investment

account 6y the amount of cash

$ivi$en$s receive$ from the investee&

;e6it

Cre$it

Cash Investment in Investee

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2eporting a Changeto the Equity #etho$

2eport a change to the equity metho$ if:

An investment that was recor$e$ using the fair

va"ue metho$ reaches the point where

significant inf"uence is esta6"ishe$&

A"" accounts are restate$ retroactive"y so the

investor0s financia" statements appear as if the

equity metho$ ha$ 6een app"ie$ from the $ateof the first acquisition& +FAS ASC para& 3,3

)-3433/

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2eporting a Change to the Equity#etho$ +2etroactive A$5ustment/

Giant Company acquires a )-. ownership in

Sma"" Company on Hanuary ) ,-),&

Giant company $oes not have the a6i"ity to eert

significant inf"uence over Sma""&

Giant proper"y recor$s the investment using the

fairva"ue metho$ as an avai"a6"eforsa"e

security& (n Hanuary ) ,-)7 Giant purchases another

3-. of Sma""0s outstan$ing stoc1 there6y

achieving the a6i"ity to significant"y inf"uence

Sma""0s $ecisions&

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2eporting a Change to the Equity#etho$ +2etroactive A$5ustment/

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@earEquity in Investee

Income +)-./Income 2eporte$ from

;ivi$en$s2etrospectiveA$5ustment

,-), J--- J,--- J4---

,-)3 ))--- 7--- ---

%ota" A$5ustment to2etaine$ Earnings: J),---

%he income restatement for these ear"ier

years can 6e compute$ as fo""ows:

8ou"$ have reporte$ un$er

the equity metho$ ;i$ report un$er the fair

mar1et va"ue metho$

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Hourna" Entries to 2eportChange to Equity #etho$

;e6it Cre$it

Investment in Sma"" Company & & & & & & & & & & & & & & & & & ),---

2etaine$ Earnings Prior Perio$ A$5ustment

Equity in Investee Income & & & & & & & & & & & & & & & & & & & & & & & ),---

%o a$5ust ,-), an$ ,-)3 recor$s so that investment isaccounte$ for using the equity metho$ in a consistent manner&

*nrea"ize$ Ko"$ing GainShareho"$ers0 Equity& & & & &)3---

Fair !a"ue A$5ustment +Avai"a6"eforSa"e/& & & & & & & & &)3---

%o remove the investor0s percentage of the increase in fair va"ue

+)-. J)3----/ from stoc1ho"$ers0 equity an$ the avai"a6"e

forsa"e portfo"io va"uation account&

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2eporting Investee Income fromSources other than (perations

8hen net income inc"u$es e"ements other

than (perating Income these e"ements

shou"$ 6e presente$ separate"y on the

investor0s income statement&

Eamp"es inc"u$e:

;iscontinue$ operations

Etraor$inary items

(ther comprehensive income

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2eporting Investee Incomefrom (ther Sources

'arge Company owns 7-. of the voting stoc1 of %iny Companyan$ accounts for this investment using the equity metho$& In ,-),%iny reports net income of J,----- resu"ting from J,4---- inincome from continuing operations an$ a J4---- etraor$inary"oss&

'arge Company increases the va"ue of its investment 6y J----6ase$ on 7-. of the J,----- net figure&

'arge0s Equity #etho$ entry at yearen$ is:

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;e6it Cre$it

Investment in %iny Company & & & & & & & & & & & ----Etraor$inary 'oss of Investee& & & & & & & & & & &,----

Equity in Investee Income & & & & & & & & & & & & & & & & & & & & & & &)-----

%o accrue operating income an$ etraor$inary "oss from equity

investment&

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2eporting Investee 'osses

A permanent $ec"ine in the investee0s fair

mar1et va"ue is recor$e$ as an impairment

"oss an$ the investment account is re$uce$ to

the fair va"ue&

A temporary $ec"ine is ignore$LLL

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2eporting Investee 'osses+Continue$/

Investment 2e$uce$ to Mero

8hen accumu"ate$ "osses incurre$ an$ $ivi$en$s

pai$ 6y the investee re$uce the investment account

to J- ?( A;;I%I(?A' '(SSES are accrue$+un"ess a further commitment has 6een ma$e/&

a"ance remains at J- unti" su6sequent profits

e"iminate a"" *?2EA'IME; "osses&

Investor $iscontinues using the equity metho$

rather than recor$ a negative 6a"ance&

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Ecess of Cost (ver oo1 !a"ueof Acquire$ Investment

8hen Cost N oo1 !a"ue of an investment

acquire$ the $ifference must 6e i$entifie$&

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Assets may 6e un$erva"ue$ on the investee0s 6oo1s

6ecause:

)&%he fair va"ues +F!/ of some assets an$ "ia6i"ities

are $ifferent than their 6oo1 va"ues +!/&

,&%he investor may 6e wi""ing to pay etra 6ecausefuture 6enefits are epecte$ to accrue from the

investment&

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8hen Cost N ! of asset acquire$ the $ifference must6e i$entifie$ an$ accounte$ for correct"y in the

accounting recor$s&

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Source of $ifference:

Assets un$erva"ue$ onthe investee0s 6oo1

Goo$wi""

Accounting metho$:

Amortize the $ifference +F!

B !/ over the remaining

usefu" "ife of the associate$

asset&

Goo$wi"" is carrie$ forwar$

without a$5ustment unti" theinvestment is so"$ or a

permanent $ec"ine in va"ue

of the investment occurs&

Ecess of Cost (ver oo1 !a"ue+Continue$/

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Ecess of Cost (ver oo1 !a"ue+Continue$/

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A;;I%I(?A' amount pai$ in ecess of 6oo1

va"ue not a""ocate$ to un$erva"ue$ assets is

attri6ute$ to an intangi6"e future va"ue an$

recor$e$ as

G((;8I''

Equity metho$ goo$wi"" accounts are notsepara6"e from the investment an$ are not

separate"y teste$ for impairment&

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2eporting Sa"e of Equity Investment

%he equity metho$ continues to 6e app"ie$ up to

the $ate of the transaction&

At the transaction $ate the Investment account

6a"ance is re$uce$ 6y the percentage of shares

so"$&

If significant inf"uence is "ost ?(2E%2(AC%I!E A;H*S%#E?% is recor$e$

6ut the equity metho$ is no "onger app"ie$&

If part of an investment is so"$ $uring the perio$:

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2eporting the Sa"e of an EquityInvestment +Continue$/

%op Company owns 7-. of the )-----outstan$ing shares of ottom Co& an$ accounts for

it using the equity metho$&

%he 7---- shares were acquire$ for J,----- an$

un$er the equity metho$ the asset 6a"ance

increase$ to J3,---- as of Hanuary ) ,-),&

ottom Company reporte$ income of J----

$uring the first si months of ,-), an$ $istri6ute$

cash $ivi$en$s of J3----&

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2eporting the Sa"e of an EquityInvestment +Continue$/

(n Hu"y ) ,-), %op se""s )---- of the shares +)D7

of its investment/ for J))---- in cash re$ucing

ownership in ottom from 7-. to 3-.&

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;e6it Cre$it

Cash & & & & & & & & & & & & & & & & & & & & & & & & & & ))----

Investment in ottom Company & & & & & & & & &7---

Gain on Sa"e of Investment& & & & & & & & & & & & & &,


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DownstreamSale

UpstreamSale

*nrea"ize$ Profits in Inventory

Sometimes affi"iate$ companies se"" or 6uy

inventory from each other in intraentity

transactions that necessitate specia"

accounting proce$ures&

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*nrea"ize$ Profits in Inventory

%he se""er of the goo$s retains a partia" sta1e in

the inventory for as "ong as the 6uyer ho"$s it&

%he earning process is not consi$ere$ comp"ete at

the time of the origina" sa"e&

2eporting the profit is $e"aye$ unti" the inventory

is consume$ within operations or reso"$ to an

unre"ate$ party&

At the $isposition of the inventory the origina"

sa"e is cu"minate$ an$ gross profit is recognize$&

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Criticisms of the Equity #etho$

(veremphasis on possession of ,-4-.

voting stoc1 in $eci$ing on significant

inf"uence vs& contro"

A""owing off6a"ance sheet financing

Potentia" manipu"ation of performance

ratios

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