STOCK INVESTMENTS INVESTOR ACCOUNTING AND REPORTING

Copyright © 2015 Pearson Education, Inc.2-1 Chapter 2

STOCK INVESTMENTS — INVESTOR ACCOUNTING AND REPORTING

Answers to Questions

• Only the investor’s accounts are affected when outstanding stock is acquired from existing stockholders.

The investor records the investment at its cost. Since the investee company is not a party to the transaction, its accounts are not affected.Both investor and investee accounts are affected when unissued stock is acquired directly from the investee. The investor records the investment at its cost and the investee adjusts its asset and owners’ equity accounts to reflect the issuance of previously unissued stock.

• Goodwill arising from an equity investment of 20 percent or more is not recorded separately from the

investment account. Under the equity method, the investment is presented on one line of the balance sheet in accordance with the one-line consolidation concept.

• Dividends received from earnings accumulated before an investment is acquired are treated as decreases in

the investment account balance under the fair value/cost method. Such dividends are considered a return of a part of the original investment.

• The equity method of accounting for investments increases the investment account for the investor’s share

of the investee’s income and decreases it for the investor’s share of the investee’s losses and for dividends received from the investee. In addition, the investment and investment income accounts are adjusted for amortization of any investment cost-book value differentials related to the interest acquired. Adjustments to the investment and investment income accounts are also needed for unrealized profits and losses from transactions between the investor and investee companies. A fair value adjustment is optional under SFAS No. 159.

• The equity method is referred to as a one-line consolidation because the investment account is reported on

one line of the investor’s balance sheet and investment income is reported on one line of the investor’s income statement (except when the investee has extraordinary gain/loss or discontinued operations). In addition, the investment income is computed such that the parent company’s income and stockholders’ equity are equal to the consolidated net income and consolidated stockholders’ equity that would result if the statements of the investor and investee were consolidated.

• If the equity method of accounting is applied correctly, the income of the parent company will generally

equal the controlling interest share of consolidated net income.

• The difference in the equity method and consolidation lies in the detail reported, but not in the amount of

income reported. The equity method reports investment income on one line of the income statement whereas the details of revenues and expenses are reported in the consolidated income statement.

• The investment account balance of the investor will equal underlying book value of the investee if (a) the

equity method is correctly applied, (b) the investment was acquired at book value which was equal to fair value, the pooling method was used, or the cost-book value differentials have all been amortized, and (c) there have been no intercompany transactions between the affiliated companies that have created investment account-book value differences.

• The investment account balance must be converted from the cost to the equity method when acquisitions

increase the interest held to 20 percent or more. The amount of the adjustment is the difference between the investment income reported under the cost method in prior years and the income that would have been reported if the equity method of accounting had been used. Changes from the cost to the equity method of accounting for equity investments are changes in the reporting entity that require restatement of prior years’ financial statements when the effect is material.Advanced Accounting 12th Edition Beams Solutions Manual Visit TestBankDeal.com to get complete for all chapters

2-2 Stock Investments — Investor Accounting and Reporting

Copyright © 2015 Pearson Education, Inc.10 The one-line consolidation is adjusted when the investee’s income includes extraordinary items and gains or losses from discontinued operations. In this case, the investor’s share of the investee’s ordinary income is reported as investment income under a one-line consolidation, but the investor’s share of extraordinary items and gains and losses from discontinued operations is combined with similar items of the investor.

11 The remaining 15 percent interest in the investee is accounted for under the fair value/cost method, and the investment account balance immediately after the sale becomes the new cost basis.

12 Yes. When an investee has preferred stock in its capital structure, the investor has to allocate the investee’s income to preferred and common stockholders. Then, the investor takes up its share of the investee’s income allocated to common stockholders in applying the equity method. The allocation is not necessary when the investee has only common stock outstanding.

13 Goodwill impairment losses are calculated by business reporting units. For each reporting unit, the company must first determine the fair values of the net assets. The fair value of the reporting unit is the amount at which it could be purchased in a current market transaction. This may be based on market prices, discounted cash flow analyses, or similar current transactions. This is done in the same manner as is done to originally record a combination. The first step requires a comparison of the carrying value and fair value of all the net assets at the business reporting level. If the fair value exceeds the carrying value, goodwill is not impaired and no further tests are needed. If the carrying value exceeds the fair value, then we proceed to step two. In step two, we calculate the implied value of goodwill. Any excess measured fair value over the net identifiable assets is the implied fair value of goodwill. The company then compares the goodwill’s implied fair value estimate to the carrying value of goodwill to determine if there has been an impairment during the period.

14 Yes. Impairment losses for subsidiaries are computed as outlined in the solution to question 13. Companies compare fair values to book values for equity method investments as a whole. Firms may recognize impairments for equity method investments as a whole, but perform no separate goodwill impairment tests.

SOLUTIONS TO EXERCISES

Solution E2-1

• d
• c
• c
• d
• b

Chapter 2 2-3

Copyright © 2015 Pearson Education, Inc.Solution E2-2 [AICPA adapted]

• d
• b
• d
• b

Gar’s investment is reported at its $ 600,000 cost because the equity method is not appropriate and because Gar’s share of Med’s income exceeds dividends received since acquisition [($ 520,000  15%) >

$40,000].

• c

Dividends received from Z ef for the two years were $10,500 ($70,000  15% - all in 2012), but only $9,000 (15% of Zef’s income of $60,000 for the two years) can be shown on Two’s income statement as dividend income from the Zef investment. The remaining $1,500 reduces the investment account balance.

• c

[$100,000 + $300,000 + ($600,000  10%)]

• a
• d

Investment balance January 2 $250,000

Add: Income from Pod ($100,000  30%) 30,000

Investment in Pod December 31 $280,000

Solution E2-3

• Bow’s percentage ownership in Tre

Bow’s 10,000 shares/(30,000 + 10,000) shares = 25%

• Goodwill

Investment cost $250,000 Book value ($500,000 + $250,000)  25% (187,500) Goodwill $ 62,500

Solution E2-4

Income from Med for 20 11

Share of Med’s income ($200,000  1/2 year  30%) $ 30,000

2-4 Stock Investments — Investor Accounting and Reporting

Copyright © 2015 Pearson Education, Inc.Solution E2-5

• Income from Oak

Share of Oak’s reported income ($ 400,000  30%) $ 120,000

Less: Excess allocated to inventory (50,000)

Less: Depreciation of excess allocated to building

($100,000/4 years)

(25,000)

Income from Oak $ 45,000

• Investment account balance at December 31

Cost of investment in Oak $1,000,000

Add: Income from Oak 45,000

Less: Dividends ($100,000 x 30%) (30,000)

Investment in Oak December 31 $1,015,000

Alternative solution Underlying equity in Oak at January 1 ($ 750,000/.3) $2,500,000 Income less dividends 300,000 Underlying equity December 31 2,800,000 Interest owned 30% Book value of interest owned December 31 840,000

Add: Unamortized excess 175,000

Investment in Oak December 31 $1,015,000

Solution E2-6

Journal entry on Man’s books

Investment in Nib ($1,200,000 x 40%) 480,000 Loss from discontinued operations 80,000 Income from Nib 560,000

To recognize income from 40% investment in N ib.