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1、Chapter 2 Accounting for Stock Investment additional readings: CAS No.2 1. Fair Value/Cost Method and Equity Method 11. Fair value/Cost method 1) characteristics records an investment at cost recognizes dividend in excess of earnings are considered as a return of investment (reduction of investment)
2、 2) conditions for cost method no ability to influence: 20% ownership test If the stock is marketable, the investment should be accounted for at fair value,2020/7/31,1,12. Equity method 1) characteristics initially records an investment at cost recognizes the share of the investees earnings as incom
3、e dividends received reduce the carrying amount of the investment adjusts the investment account to recognize the share of the investees earnings after the date of acquisition, by * eliminating unrealized gains and losses * amortizing the FMV-BV differential incomplete equity method vs. equity metho
4、d note: equity method goodwill shall not be tested for impairment.,2020/7/31,2,2) conditions for equity method significant influence over the financial and operating policies of the investee, indicated by * representation on the board of directors * participation in policy making processes * materia
5、l intercompany transaction * interchange of managerial personnel * technological dependency 2050% ownership (US) control the financial and operating policies of the investee: over 50% ownership if no influence or control, even more than 20% or 50% ownership interest held, only cost method is used 13
6、. Comparison of cost method to equity method,2020/7/31,3,percentage of outstanding voting stock acquired 0% 20% 50% 100% 1. level of economic influence | nominal |sig. influence| control | 2. valuation basis | cost m. | equity method | 3. balance sheet presentation | investment account | CFS | illus
7、tration (P46-47) 2. Equity Method (One-line Consolidation) 21. Equity method and full consolidation 1) one-line consolidation investment account is reported in a single amount on one line of the investors B/S,2020/7/31,4,investment income is reported in a single amount on one line of the investors I
8、/S2) exceptions for one-line consolidation extraordinary items cumulative effect of an accounting change effect of discontinued operations prior period adjustment illustration: p.57-583) full consolidation investment account is replaced by investees assets and liabilities in consolidated B/S investm
9、ent income is replaced by investees revenue and expenses in consolidated I/S Ps income and owners equity under equity method are as same as those in the CFS,2020/7/31,5,4) illustration assumptions * no cost-BV differential * no intercompany transaction Table 2-1: Balance Sheet P (equity m) S (80%) C
10、onsolidated E. Other assets 520 200 720 Investment in S 80 - - total assets 600 200 720 Liabilities 100 100 200 Minority interest - - 20 Owners equity 500 100 500 total equity 600 200 720,2020/7/31,6,Table 2-2: Income Statement P (ex. S) S (80%) P (e.m) C. E. Sales 100 30 100 130 Cost of sales 50 10
11、 50 60 Gross profit 50 20 50 70 Other expenses 20 10 20 30 Operating income 30 10 30 40 Income from S - - 8 - Income before MII - - - 40 MI income - - - (2) Net income 30 10 38 38 the difference between the two procedures stems from * consolidated statements focus on economic entity * equity method
12、focuses on parent (investor) company,2020/7/31,7,22. Application of the equity method 1) equity method at acquisition valuation: FMV of considerations given up equity securities exchange: registration and issuance costs are charged against addl PIC other direct costs are added to the acquisition cos
13、t 2) assignment and amortization of cost-BV differentials FMV-BV differential: be assigned to related assets and liabilities cost-FMV differential: goodwill or negative goodwill if BVcost, check whether assets are overvalued examples: p.4853,2020/7/31,8,3) disclosures for equity investees the name o
14、f each investee and ownership percentage accounting policies of stock investment cost-BV differential and accounting for the differential related party transactions (p.58-60) other important information 3. Interim Acquisition of an Investment Interest 31. Determination of the underlying equity 1) in
15、vestees stockholders equity= beginning balance + income earned from year beginning to acquisition date-dividends declared during the period underlying equity=investees stockholders equity%,2020/7/31,9,2) basic assumption investees income is earned evenly thru. the year 32. Determination of the investment income 1) investment income = investees income realized from the acquisition date to the year end %+/- amortization of FMV-BV differential 2) example: p.54-55 33. Stock purchases directly from the investee 1) the number of shares increases when investor purchases stock directly fro
