1 / 20

Chapter 8: Investment in Equity Securities

Chapter 8: Investment in Equity Securities. Equity investments represent ownership of another company’s outstanding common stock. Marketable equity investments are actively traded on a public stock exchange.

yule
Download Presentation

Chapter 8: Investment in Equity Securities

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript


  1. Chapter 8:Investment in Equity Securities

  2. Equity investments represent ownership of another company’s outstanding common stock. Marketable equity investments are actively traded on a public stock exchange. By owning shares of common stock, the investor “owns” a part of the company, represented by the percentage ownership. There are different accounting rules for: (1) less than 20 percent ownership. (2) between 20 and 50 percent ownership. (3) greater than 50 percent ownership. Investment in Marketable Equity Securities - Overview

  3. If marketable securities, use the mark-to market method. Carries securities on balance sheet at market value. Revaluation at the end of each period based on new market price Unrealized gains (or losses) are recognized as the investment is valued up (or down). Treatment of the Unrealized G/L depends on classification of security: (a) Trading securities. (b) Available-for-sale securities. (1) Less than 20 % ownership.

  4. Trading securities held for the short term, with purpose of selling securities for profit. At purchase - record at cost to acquire. Activity during the year - record declaration of cash dividends, and recognize “Dividend Income” on the Income Statement: Dividends Receivable xx Dividend Income xx (a) Trading Securities

  5. For securities on hand at the end of the accounting period - revalue to market value and record “Unrealized Gain/Loss” on Income Statement. When sold - recognize “Gain/Loss on Sale” on Income Statement for any balance since the last revaluation. (a) Trading Securities

  6. Available-for-sale (AFS) securities may be held for the short term or for long term, depending on management’s intentions. At purchase - record at cost to acquire. Activity during the year - record declaration of cash dividends, and recognize “Dividend Income” on the Income Statement: Dividends Receivable xx Dividend Income xx (b) Available-for-sale Securities

  7. For securities on hand at the end of the accounting period - revalue to market value and record “Unrealized Gain/Loss” on Balance Sheet (as part of Other Comprehensive Income in Stockholders’ Equity). When sold - recognize “Gain/Loss on Sale” on Income Statement for total difference between original cost and selling price. (b) Available-for-sale Securities

  8. Because investment represents significant influence of investor, we cannot account for investments the same way as Trading or AFS. Specifically, we cannot recognize “Dividend Income” as dividends are declared, because the investor could “dictate” income to be recognized from the investee (investor could have investee declare a dividend to investor). (2) From 20% to 50% Investment

  9. The equity methodincreases the investment account and recognizes investor’s portion of income as investee earns it (reports income to investor). The equity method decreases the investment account as investee declares dividends to the investor. The equity method reflects the investor’s portion of “goodwill” purchased. (2) From 20% to 50% Investment

  10. On investor’s books: 1. When investment purchased: L.T. Investment xx Cash, etc. xx 2. When dividends declared to investor: Dividends Receivable xx L.T. Investment xx 3. When income reported by investee to investor (from investee’s I/S): L.T. Investment xx Income from Investment xx Equity Method Journal Entries

  11. Note: the Investment account contains any implied goodwill in the purchase. Goodwill is not explicitly reported until the ownership is sufficient to consolidate the investment (more discussion in the appendix). Equity Method and Goodwill

  12. Company P purchases 30% of the outstanding common stock of Company S on January 2, 2005 for $400,000 cash. At the time of acquisition, Company S had total net assets of $1,000,000 fair value (and book value). Note that net assets = assets - liabilities = equity. During 2005, Company S reported net income of $300,000 to its shareholders, and declared $100,000 dividends to its shareholders. Illustration - Equity Method

  13. Required: 1. Prepare all journal entries necessary (on Company P’s books) to record this investment using the equity method of accounting. 2. Calculate (a) the value that would be reported in Company P’s 12/31/05 balance sheet for its L.T. Investment in Company S, and (b) the Income from Company S reported on P’s income statement for 2005. Illustration - Equity Method

  14. 1. Acquisition: Note: the $400,000 investment includes $100,000 goodwill, calculated as: Cash paid: $400,000 - Fair market value acquired: 1,000,000 x 30% -300,000 Difference = goodwill = $100,000 Requirement 1.Journal Entries on P’s Books: L.T. Investment 400,000 Cash 400,000

  15. 2. Dividends declared (100,000 x 30%) 3. Income reported (300,000 x 30%) Requirement 1.Journal Entries on P’s Books: Div. Receivable 30,000 L.T. Investment 30,000 L. T. Investment 90,000 Income from S 90,000

  16. The L.T. Investment account = $400,000 (DR) Invest. - 30,000 (CR) Dividends from S + 90,000 (DR) Income from S $460,000 (DR) balance at 12/31/05 The Income from S account = 90,000 (CR) Income from S for 2005 Requirement 2 - Calculate balances:

  17. This method will give rise to a difference between reported net income (loss) and cash flow from operations. It ignores market price. 20-50 percent is not always a valid indication of significant influence. It generates off-balance sheet financing - one line on the balance sheet may actually represent a percentage ownership in a number of assets and liabilities (more in appendix). Issues are more complex than illustrated in this chapter. Cautions Regarding Equity Method

  18. If an investor has majority control, the investment is recorded using the equity method, and a parent/subsidiary relationship is established. At the end of the period, the financials of the parent and subsidiary must be combined, or consolidated, for external financial reporting. Goodwill is recognized as a separate asset in the consolidation. (3)Greater than 50% Investment

  19. Yes No <20% 20-50% >50% Mark-to-Market (Trading or AFS) Mark-to-Market (AFS) Equity Method Equity & Consoli-date Accounting for Equity Securities Marketable? Yes Intend to liquidate within time period of current assets? Proportion of voting shares Accounting Treatment

  20. No is implied <20% 20-50% >50% Cost Method Equity Method Consoli-date Accounting for Equity Securities Marketable? No Intend to liquidate within time period of current assets? Proportion of voting shares Accounting Treatment

More Related