Chapter2

STOCKINVESTMENTS-INVESTORACCOUNTINGANDREPORTING

ChapterOutline

ACCOUNTINGFORSTOCKINVESTMENTS

ATheequitymethodisrequiredforinvestmentsof50%orlessthatgivetheinvestoran

abilitytoexercisesignificantinfluenceovertheinvestee.

Illustration2-1AccountingforInvestments

%ownershipNormalAccountincMethod

0-19Cost(adjustedtoFMVasappropriate)

20-50Equity

(presumedsignificantinfluence)

51&upConsolidatedFinancialStatements

(assumedcontrollinginterest)(FASB94)

Intheabsenceofevidencetothecontrary,aninvestmentof20%ormoreispresumed

togivetheinvestoranabilitytoexercisesignificantinfluence.Thisisarebuttable

presumption.

1Theequitymethodshouldnotbeusediftheabilitytoexercisesignificant

influenceistemporaryoriftheinvesteeisaforeigncompanyoperatingunder

severeexchangerestrictionsorcontrols.

2FASBInterpretationNo.35providesindicatorsofwhentheabilitytoexercise

significantinfluencemaybeimpaired:

aOppositionbytheinvesteethatchallengestheinvestor'sinfluence

bSurrenderofsignificantstockholderrightsbyagreementbetween

investorandinvestee

Concentrationofmajorityownership

dInadequateoruntimelyinformationtoapplytheequitymethod

eFailuretoobtainrepresentationontheinvestee9sboardofdirectors

CThefairvalue/costmethodisusedforcominonstockinvestmentsoflessthan20%

unlessitcanbedemonstratedthattheinvestorcompanyhastheabilitytoexercise

significantinfluenceovertheinvesteecompany.

ACCOUNTINGFORNONCURRENTCOMMONSTOCKINVESTMENTSUNDER

THEFAIRVALUE/COSTMETHOD:

AIfthestockismarketable,theinvestmentshouldbeaccountedforatfairvalue

accordingtotheprovisionsofFASBStatementNo.115,"AccountingforCertain

InvestmentsinDebtandEquitySecurities.

1Investmentisinitiallyrecordedatcost

2Theinvestmentisadjustedtofairvalueattheendofthefiscalperiod

3Unrealizedgainsorlossesarereportedeitherinincomeorasanequity

adjustmenttothebalancesheet,dependingonthecompany'sintentionfbr

holdingthestock

4Unrealizedgainsandlossesassociatedwith'trading'securitiesare

recordedaspartofincome

aTradingsecuritiesareveryshorttermholdings,continuedrelationships

arenotexpected.

5Unrealizedgainsandlossesassociatedwith'availablefbrsale9securities

areconsidered“othercomprehensiveincome^^andarereportedonthebalance

sheetasanequityadjustment.

aOnlydividendincomeandrealizedgainsandlossesimpactincome

andEPSfbravailableforsalesecurities

BIfthestockisnotmarketable,theinvestmentisaccountedforusingthecostmethod

1Investmentisinitiallyrecordedatcost

2Dividendsreceivedarerecordedasdividendincome

aAnexception:Liquidatingdividendsaredeductedfromthe

investmentaccount.Liquidatingdividendsarethosedividends

?2009PearsonEducation,Inc.publishingasPrenticeHal!14

receivedinexcessoftheinvestor'sshareofearningsafterthestockis

acquiredandareconsideredareturnofcapital.

THEEQUITYMETHODANDFASBSTATEMENTNO.94FORACCOUNTINGFOR

INVESTMENTSINCOMMONSTOCKUNDERTHEEQUITYMETHOD

AFASBStatementNo.94

1CurrentGAAPrequiresconsolidationofallmajority-ownedsubsidiaries,

exceptthoseforwhichcontrolistemporaryordoesnotrestwiththeparent

company.

2Aninvestmentinanunconsolidatedsubsidiaryisreportedintheparent

company'sfinancialstatementsusingthecostorequitymethod,according

totheparent'sabilitytoexercisesignificantinfluence(morecoverageinchapter

3).

BApplicationoftheequitymethod

1Theinvestmentisinitiallyrecordedatcost

2Subsequently,theinvestorrecordsitsshareoftheinvestee'sincomeasan

increasetotheinvestmentaccount(losseswilldecreasetheinvestment

account)

3Dividendsreceivedfromtheinvesteearerecordedasadecreasetothe

investmentaccount

aTheinvestmentaccountmovesinthesamedirectionastheinvestee's

netassets(forexample,incomeincreasesassetsforboth)

4Additionaladjustmentsarerequired

aIntercompanyprofitsandlossesareeliminateduntilrealized.

bCost-bookvaluedifferentialsareaccountedforasiftheinvesteewere

aconsolidatedsubsidiary

(1)Thedifferencebetweentheinvestmentcostandthe

underlyingequityisassignedtoidentiflableassetsand

liabilitiesbasedontheirfairvalueswithanyremaining

differenceallocatedtogoodwill.

(2)Thedifferencebetweeninvestmentcostandbookvalue

acquiredwilldisappearovertheremaininglivesof

identifiableassetsandliabilities,exceptforamounts

assignedtoland,goodwill,andintangibleassetshavingan

indeterminatelife,whicharenotamortized.

(3)Ifthebookvalueacquiredisgreaterthantheinvestment

cost,thedifferenceshouldbeallocatedagainstnon-current

assetsotherthanmarketablesecuritieswithanyremaining

amounttreatedasanextraordinarygain(negativegoodwill).

cTheinvestmentisreportedononelineoftheinvestor'sbalancesheet

andincomeononelineoftheinvestor'sincomestatement,aone-line

consolidation

(1)Exceptextraordinaryandotherbelow-the-lineitems

CAccountingforaninteriminvestment

1Absentevidencetothecontrary,incomeoftheinvesteeisassumedtobe

earnedproportionatelythroughouttheyear

2Theinvestee'sbookvalueataninterimdateisdeterminedbyaddingincome

earnedfromthelaststatementdatetobeginningstockholders9equityand

deductingdividendsdeclaredtothedateofpurchase

DInvestmentsacquiredstep-by-step

1Aninvestormayacquiresignificantinfluencethroughaseriesofpurchases

2Priortoobtainingsignificantinfluence,thefairvalue/costmethodisused.

Whenaninvestmentqualifiesfortheequitymethod,theinvestmentaccountis

adjustedtotheequitymethodandtheinvestor'sretainedearningsare

adjustedretroactively.

aThisisachangeinreportingentityandisrequiresretroactive

restatementifmaterial

ESaleofanequityinterest

1Whenaninvestorreducesitsequityinterestinaninvesteetobelow20%,the

retainedinvestmentisaccountedforunderthefairvalue/costmethod

?2009PearsonEducation,Inc.publishingasPrenticeHal!16

aGainorlossfromtheequityinterestsoldisthedifferencebetweenthe

sellingpriceandthebookvalueoftheequityinterestimmediatelybefore

thesale

bImmediatelyafterthesale,thebalanceoftheinvestmentaccount

becomesthenewcostbasis

FInvesteeswithpreferredstock

1Specialadjustmentsarenecessarywheninvesteeshavebothcommonand

preferredstockoutstanding

2Investee'sstockholders5equitymustbeallocatedintoitscommonand

preferredstockcomponents

3Investee'snetincomemustalsobeallocatedintocommonandpreferredstock

components

4Callorliquidatingpremiumsanddividendsinarrearsmustalsobe

considered

5FurthercoverageinChapter1()

DISCLOSURESFOREQUITYINVESTMENTS

AMaterialinvestmentsaccountedforbytheequitymethodrequiredisclosureof

1Summarizedinformationabouttheinvestee'sassets,liabilities,andresults

ofoperationsinfinancialstatementnotes

2Theinvestee'snameandpercentofownershipincommonstock,the

investor'saccountingpolicieswithrespecttoinvestmentsincommonstock,

thecost/bookvaluedifferentialsandaccountingtreatment

3Theaggregatevalueofeachidentifiedinvestmentforwhichquotedmarket

pricesareavailable

BRelatedpartytransactions

1Relatedpartytransactionsarisewhenoneofthetransactingpartieshasthe

abilitytosignificantlyinfluencetheoperationsoftheother

2Thereisnopresumptionofarms-lengthbargainingbetweentherelated

parties

3Requireddisclosuresincludethenatureoftherelationship,adescriptionof

thetransaction,thedollaramountofthetransaction(andanychangeinthe

methodusedtoestablishthetermsofthetransaction),andamountsduetoor

duefromrelatedpartiesatthebalancesheetdatefbreachbalancesheet

presented.

TESTINGGOODWILLFORIMPAIRMENT

AFASBStatementNo.142eliminatesformerrequirementstoamortizegoodwill,rather,

goodwillmustbeperiodicallytestedforimpairment

1Firmsmayfindthisvaluablefortworeasons

aFirmsmayrecognizesignificantimpairmentlossesoninitial

adoptionwhicharetreatedasa"cumulativeeffectofanaccounting

change,,(appearsafter“incomefromoperations^^)

bFirmswillnolongerreportannualgoodwillexpensecharges

BRecognizingandmeasuringimpairmentlossesisatwo-stepprocess

1First,carryingvalueiscomparedtofairvalueatthebusinessreportingunit

level

aIffairvalueisgreaterthancarryingvalue,goodwillisdeemed

unimpairedandnofurtheractionisnecessary

bIfcarryingvalueisgreaterthanfairvalue,thefirmproceedstostep

2

2Step2,whennecessary,requiresacomparisonofthecarryingvalueof

goodwillwithitsimpliedfairvalue

3Theimpliedfairvalueofgoodwillisdeterminedinthesamemannerusedto

originallyrecordthegoodwillatthebusinesscombinationdate

aAllocatethefairvalueofthereportingunittoallidentifiableassetsand

liabilitiesasiftheyhadmadethepurchaseonthemeasurementdate,and

anyexcessistheimpliedfairvalueofgoodwill

4Thefairvalueofthereportingunitistheamountforwhichitcouldbe

purchasedorsoldinacurrent,arm's-lengthtransaction

?2009PearsonEducation,Inc.publishingasPrenticeHal!18

aCurrentmarketprices(inanactivemarket)areconsideredthemost

reliableindicatoroffairvalue

CGoodwillimpairmenttestingmustbedoneatleastannually

1Morefrequenttestingmayberequiredifcertaineventsoccursuchas

adversechangesinthelegalorbusinessclimate,newandunanticipated

competition,lossofkeypersonnel,andothersimilarevents

DReportinganddisclosure

1Materialaggregateamountsofgoodwillmustbereportedasaseparateline

itemonthebalancesheet

2Goodwillimpairmentlossesareshownseparatelyintheincomestatement

EEquitymethodinvestments

1Manyoftherulesregardinggoodwillinpurchasemethodbusiness

combinations(parentacquiringacontrollinginterestinasub)alsoapplyto

goodwillarisingfromuseoftheequitymethod

2Onenotableexceptionistheruleregardinggoodwillimpairments

aImpairmenttestsforequityinvestmentscontinuetofollowguidance

fromAPBOpinionNo.18whichrequireimpairmenttestsbe

performedbasedonfairvalueversusbookvalueoftheinvestment

takenasawhole

NEWSTANDARD-FASStatement159-TheFairValueOptionforFinancialAssets

andFinancialLiabilities-IncludinganamendmentofFASBStatementNo.115

1)Firmshaveoptiontorecordequitymethodinvestmentsatfairvalue.Theoption

maybeelectedonaninvestmentbyinvestmentbasis.

2)Optionmustcontinueaslongasinvestmentisowned.

3)FairValueisrecalculatedannually.Changesareincludedininvestor'snetincome

withtheoffsettingcumulativeamountrecordedinavaluationallowance.

4)Separatedisclosureisrequired.

DescriptionofassignmentmaterialMinutes

Questions(14)

Exercises(16)

E2-15MCgeneral10

E2-2AICPA8MCgeneralandproblem-type35

E2-3[Trevor/Bowman]Calculatepercentageownershipandgoodwillfrom12

investmentacquireddirectlyfrominvestee

E2-4fCarson/Medley]Calculateincomefor30%midyearinvestment15

E2-5[Dokey/Oakey]Calculateincomeandinvestmentbalancefor40%full15

yearinvestmentwithallocationofexcesstoundervaluedassets

E2-6[Martin/Neighbors]Journalentrytorecordincomefrom40%investeewith10

lossfromdiscontinuedoperations

E2-74MCproblem-type20

E2-8[Raython/Treaton]Calculateinvestmentbalance4yearsafteracquisition15

E2-9[Nickie/Runner]Calculateincomefrominvesteeandtheinvestment20

balancewhentheinvestee'scapitalstructureincludespreferredstock

E2-10[Arbor/Tree]Calculateincomeandinvestmentbalancefbr25%midyear15

?2009PearsonEducation,Inc.publishingasPrenticeHal!20

investment

E2-11[Ratterman/Twizzle]Adjustinvestmentaccountanddetermineinvestment25

incomewhenanadditionalinvestmentqualifiesinvesteefortheequity

methodofaccounting

E2-12[River/Tall]Journalentries(investmentinpreviouslyunissuedstock)15

E2-13[BIP/Crown]Preparejournalentriesandanincomestatement,and20

determinetheinvestmentaccountbalance(investeewithextraordinary

loss)

E2-14[Valley/Water]Calculateincomeandinvestmentaccountbalance20

(investeehaspreferredstock)

E2-15[Park/Steele]Calculateimpliedfairvalueofgoodwill10

E2-16[Flash/Alpha/Beta]Calculatingandreportingimpairmentlosses

intheincomestatement10

Problems(16)

P2-1[Ritter/Telly]Computationsforamidyearpurchase(investeehas25

anextraordinarygain)

P2-2[Putter/Siegal]Journalentriesformidye