Homework see handout

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1 BUS512M Accounting for Investment Decisions: Property, Plant, & Equipment & Intangibles; Long-term Investments including Available for Sale, Equity, and Consolidations Module 8

2 Homework see handout

3 Investments

4 P8-1 Applying mark-to-market rule to equity securities O Leary Enterprises began investing in short-term equity securities in The following information was extracted from its 2014 internal financial records. Houser and Miller were classified as trading securities, while Letter and Nordic were classified as available-for-sale securities. a. Compute the effect on reported 2014 income from all investment transactions and price changes. b. Compute the effect on reported income if O Leary Enterprises exercised the fair market value option for all its investments.

5 P8-1 Applying mark-to-market rule to equity securities continued Security Purchases Sales Total Dividends Received Market Value per share Houser Company $40 $25 Miller, Inc. 85 $35 Letter Books 30 $46 Nordic Equipment 50 $90

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7 E8-4 Short-term investment account across time periods On Wadsworth Company purchased 20 shares of ZZZ for $8 per share. Wadsworth held the investment for the remainder of 2014, and as of 12.31, the per share market value of ZZZ had risen to $10. During 2015, Wadsworth sold 10 shares of ZZZ for $9 each, and at the end of 2015, the per-share market price of the remaining 10 shares was $12. During 2016, the remaining shares of ZZZ were sold for $14 each. Assume that Wadsworth held no other equity investments during this time period. a. Complete the chart. The first column assumes that the investment was classified as trading securities; the second column assumes the investment was classified as available-for-sale securities. b. Comment on the differences.

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9 E8-4 Short-term investment account across time periods continued Trading Available-for-Sale 2014 income balance sheet investment value 2015 income balance sheet investment value 2016 income Total income( )

10 Your Turn E8-3 Mark-to-Market Accounting a. Prepare journal entries for each transaction, excluding the June 30 AJE. Use the asset account Short-term Investments and assume that dividends were declared and paid on the same day. b. Prepare the June 30 AJE and describe the effect on reported income, assuming that: (1) Able and Baker shares are both considered trading securities; (2) Able is considered a trading security, and Baker is considered available-forsale security; (3) Able is considered an available-for-sale security, and Baker is considered a trading security; and (4) both Able and Baker are considered available-for-sale securities. c. What combination in (b) depicts management as most successful in the current period?

11 E8-3 Mark-to-Market Accounting The following information relates to the activity in the short-term investment account of Lido International which held no shortterm investments as of January Jan 28 Purchased 10 shares of Able Co. stock at $14/share. 2. Feb 18 Purchased 20 shares of Baker Co. stock at $26/share. 3. Mar 15 Received dividends from Able Co. of $1/share. 4. April 29 Sold 5 shares of Able Co. for $15/share. 5. May 18 Received dividends from Baker Co. of $2/share. 6. June 1 Sold 5 shares of Baker Co. for $22 per share. June 30 Market value Able Co. is $17/share. Market value of Baker Co. is $20/share. (1) Assume Able and Baker shares are both considered trading securities;

12 E8-3 Mark-to-Market Accounting The following information relates to the activity in the short-term investment account of Lido International which held no shortterm investments as of January Jan 28 Purchased 10 shares of Able Co. stock at $14/share. 2. Feb 18 Purchased 20 shares of Baker Co. stock at $26/share. 3. Mar 15 Received dividends from Able Co. of $1/share. 4. April 29 Sold 5 shares of Able Co. for $15/share. 5. May 18 Received dividends from Baker Co. of $2/share. 6. June 1 Sold 5 shares of Baker Co. for $22 per share. June 30 Market value Able Co. is $17/share. Market value of Baker Co. is $20/share. Assume (2) Able is considered a trading security, and Baker is considered available-for-sale security;

13 E8-3 Mark-to-Market Accounting The following information relates to the activity in the short-term investment account of Lido International which held no short-term investments as of January Jan 28 Purchased 10 shares of Able Co. stock at $14/share. 2. Feb 18 Purchased 20 shares of Baker Co. stock at $26/share. 3. Mar 15 Received dividends from Able Co. of $1/share. 4. April 29 Sold 5 shares of Able Co. for $15/share. 5. May 18 Received dividends from Baker Co. of $2/share. 6. June 1 Sold 5 shares of Baker Co. for $22 per share. June 30 Market value Able Co. is $17/share. Market value of Baker Co. is $20/share. Assume (3) Able is considered an available-for-sale security, and Baker is considered a trading security;

14 E8-3 Mark-to-Market Accounting The following information relates to the activity in the short-term investment account of Lido International which held no shortterm investments as of January Jan 28 Purchased 10 shares of Able Co. stock at $14/share. 2. Feb 18 Purchased 20 shares of Baker Co. stock at $26/share. 3. Mar 15 Received dividends from Able Co. of $1/share. 4. April 29 Sold 5 shares of Able Co. for $15/share. 5. May 18 Received dividends from Baker Co. of $2/share. 6. June 1 Sold 5 shares of Baker Co. for $22 per share. June 30 Market value Able Co. is $17/share. Market value of Baker Co. is $20/share. Assume (4) both Able and Baker are considered available-for-sale securities.

15 Long-term Equity Investments

16 Long-Term Equity Investments

17 Inter-corporate Equity Investments 3 Categories of Equity Investors: Passive Investors: Less than 20% of the outstanding voting stock. Use Mark-to-Market method if shares are readily marketable. Otherwise, use Cost method. Influential Investors: 20% to 50% of the outstanding voting stock. Use the Equity method. Controlling Investors: More than 50% of the outstanding voting stock. Use the Equity method, along with Consolidation.

18 Passive(<20%): Mark-to-Market Method & Cost Method Recap 1. Record initial investment at cost. 2. Dividends received are recognized as income on IS. If no dividends are received, then no income is recorded. 3. At the end of each period, the investment is adjusted to market value with the increase or decrease in market value reported as an: Unrealized gain or loss on the IS (and closed to RE) if investments are held in a trading account, i.e. Trading securities are a current asset). Unrealized gain or loss not on IS but in a special SHE account for Unrealized Holding Gains or Losses and reported as part of Comprehensive Income if investments held in an AFS portfolio. 4. If securities are not readily marketable, the Cost Method is used, which includes only Steps 1 &2 above. Under the cost method, investment only written down if there is an other than temporary loss in value, i.e., a permanent write down or the investment is sold.

19 Influential (20-50%): Equity Method Recap 1. Record investment at original cost. 2. At year-end, the Investor s proportionate share of Investee s net income or loss is recognized by Investor as investment income on IS and offset by an increase or decrease in the equity investment account. [i.e., single line consolidation] 3. Dividends received are recognized as a reduction in the investment account (not as dividend income on IS). 4. The investment is not marked to market; however, the market value is disclosed in the footnotes. 5. If there is goodwill implied by the purchase price, it is not amortized or evaluated for impairment separately from the investment. 6. If more than 20% equity does not result in significant influence, the investment should not be accounted for by the equity method, but by the mark-to-market method, if readily marketable.

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21 The Cost Method- Market value hard to determine

22 E8-8 Cost Method Mystic Lakes Food Company began investing in equity securities for the first time in During 2014, the company engaged in the following transactions involving equity securities. Assume that the stock of Thayers International and Bayhe Enterprises is not considered marketable that ownership is less than 20 percent of the equity. Prepare journal entries to record these transactions.

23 E Purchased 10,000 shares of Thayers International for $26 per share. 2. Purchased 25,000 shares of Bayhe Enterprises for $35 per share. 3. Thayers International declared a $2-per-share dividend to be paid at a later date.

24 E Sold 4,500 shares of Bayhe Enterprises for $30 per share. 5. Sold 8,000 shares of Thayers International for $32 per share.

25 The Equity Method

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27 E8-10 Equity Method On January 1, Nover Solar Systems purchased 10,000 shares of Reilly Inc for $190,000. The investment represented 25% of Reilly s outstanding common stock. Nover intended to hold the investment indefinitely. During the year, Reilly earned net income of $75,000, and during the next year Reilly suffered a net loss of $6,000. Reilly paid dividends both years of $1.50 per share. a. Prepare all relevant entries that Nover would have recorded during both years. b. Compute the book value of Nover s long-term equity investment account at the end of both years.

28 E8-12 Equity Method Inference from FS Mainmont Industries uses the equity method for its long-term equity investments from affiliates. The following information from the financial statements of Mainmont refers to an investment in the securities of Tumbleweed Construction, a company owned 30% by Mainmont Long-term investment in equity securities $29,000 $25,000 Income from equity securities 12,000 7,000 Mainmont neither purchased nor sold any equity securities during a. How much net income did Tumbleweed Construction earn during 2014? b. What was the dollar amount of the total dividend declared by Tumbleweed during 2014? c. Provide the journal entries recorded by Mainmont during 2014 with respect to its investment in Tumbleweed.

29 Consolidation Method Controlling investments of more than 50% are accounted for by the Equity method and then the parent and subsidiary financials are consolidated on a spreadsheet at the end of the accounting period. 1. The Investment account balance on the Investor s balance sheet is replaced with the Investor s share of the actual assets and liabilities of the Investee plus any goodwill implied by the Investor s purchase. 2. The assets and liabilities of the investee attributable to the non-controlling shareholders are added to the Investor s balance sheet along with the noncontrolling interest equity in those net assets, based on the fair market value of the non-controlling equity on the acquisition date. Any goodwill implied by such mark to fair value would also be recognized. [Minority Interest liability] 3. The income statement of the investee company is combined with the income statement of the investor. The equity income of the Investee recognized by the Investor is eliminated to avoid double counting this income. The total net income is apportioned between the net income attributable to the controlling shareholders and non-controlling shareholders. [Minority interest income] 4. Goodwill recognized in the consolidated financials is not amortized; however, if goodwill becomes impaired, it is written down. Goodwill must be evaluated each period of possible impairment.

30 Business Combinations Two Ways to Obtain Control: Asset acquisition-all the company s net assets are acquired directly from the company-the books of acquired company are closed and only one set of books remain. Stock acquisition-a controlling interest in another firm s voting common stock is acquired two sets of books remain and an Investment in Sub account is carried on the acquirer s books.

31 Stock Acquisition and Consolidated Financial Statements A business acquisition occurs when an investor company acquires a controlling interest (more than 50 percent of the voting stock) in another company. The companies continue as separate legal entities, the investor company is referred to as the parent company, and the investee company is called the subsidiary. A Corp + B Corp = Consolidated A and B A merger, or business combination, occurs when two or more companies combine to form a single legal entity.

32 Asset Acquisition-Purchase Method All identifiable net assets (assets less liabilities assumed) are recorded at their FMV, both tangible and intangible (assuming a controlling interest is acquired). Goodwill is created when the price paid exceeds the FMV of the net assets acquired. A gain is recorded when the price paid is less than the FMV of the net assets acquired. Direct acquisition costs (costs paid to consultants) and indirect acquisition costs (internal costs) are expensed. A single combined entity exists, no consolidation process is necessary.

33 Legal Forms of Business Combinations Statutory consolidation (100% ownership) A Corp + B Corp = C Corp (new company) Statutory merger (100% ownership) A Corp + B Corp = A Corp