Financial accounting 9th jamie pratt chapter 08

Trading and Available-for-Sale Securities 4 Investments in readily marketable equity securities are classified into one of two categories: 1 trading securities current asset or 2 avail

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Chapter 8:

Investments in Equity Securities

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Equity Securities Classified as Current

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Two criteria must be met for an investment in a security to be considered current and thus warrant inclusion as a current asset:

2. Management must intend to convert the investment into cash within the time period of

current assets (one year or the operating cycle, whichever is longer)

Trading and Available-for-Sale Securities

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Investments in readily marketable equity securities are classified into one of two

categories:

(1) trading securities (current asset) or

(2) available-for-sale securities (current or long-term depending on management’s

intention).

Trading and Available-for-Sale Securities

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• Purchasing Trading and Available-for-Sale Securities - Recorded on the

balance sheet at cost, including acquisition costs

• Declaration and Receipt of Dividends – recorded as a receivable and revenue

• Sale of Securities – if proceeds exceed balance sheet value, a realized gain is

recognized, otherwise – a realized loss

Price Changes of Securities on Hand at the End of the Accounting Period

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• Adjusting journal entries restate the balance sheet values of the securities to

reflect their current market values These adjustments give rise to unrealized gains and losses

• In the case of trading securities, these gains or losses are considered temporary

accounts, appear on the income statement, and are reflected in retained earnings.

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• In the case of available-for-sale securities, the unrealized price changes are

considered permanent accounts and are carried in the shareholders’ equity section of the balance sheet.

Reclassifications and Permanent Market Value Declines

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• Investments sometimes suffer a permanent market value decline.

• The price declines and is not expected to recover

• The security should be written down to its market value, and a realized loss that reduces net

income should be recognized immediately whether the security is classified as trading or available-for-sale

Mark-to-Market Accounting and Comprehensive Income

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• In a move toward pure mark-to-market accounting, the FASB now requires companies to

provide a statement of comprehensive income

• The statement of comprehensive income must disclose total comprehensive income.

• This includes all nonowner-related changes in shareholders’ equity that do not

appear on the income statement and

• are not reflected in the balance of retained earnings

Long-Term Equity Investments

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• Companies invest in equity of other companies to

• Get investment income in the form of dividends and stock price appreciation

And primarily

• Acquisitions are common for large U.S companies

Accounting for Long-Term Equity Investments

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Figure 8-1 Accounting for long-term investment

in equity securities

The Cost Method

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Figure 8-2 The cost method of accounting for long-term equity investments

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1 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.

Dividend Receivable (+A) 20,000

Dividend Revenue (R, +SE) 20,000

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4 Sold 4,500 shares of Bayhe Enterprises for $30 per share.

Cash (+A) 135,000

5 Sold 8,000 shares of Thayers International for $32 per share

Cash (+A) 256,000

The Equity Method

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Figure 8-3 The equity method of accounting for long-term equity investments

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Investments in Affiliates

Figure 8-4 The relative importance of investments in affiliate companies (selected U.S companies

Business Acquisition, Mergers, and Consolidated Financial Statements

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• A business acquisition occurs when an investor company acquires a controlling interest (more

than 50 percent of the voting stock) in another company

• If the two companies continue as separate legal entities, the investor company is referred to as the

parent company, and the investee company is called the subsidiary

• Consolidated financial statements should be prepared

single legal entity

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Goodwill

Goodwill is a noncurrent intangible asset – created when a company pays

an amount to acquire a controlling interest of another company that is more than the fair market value of net assets.

Figure 8-5 Computation of goodwill

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Equity Method or Consolidated Statements?

Figure 8-6 The balance sheet of Megabucks and Tiny Inc.

The user needs to understand the effect of the different presentations on the financial statements

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Figure 8-7 Consolidated balance sheet

Equity Method or Consolidated Statements?

Special Purpose Entities (SPEs)

 Companies often create separate entities to carry out activities or transactions directly related

to specific purposes The entities (called special purpose entities or special purpose

vehicles) take on various legal forms.

 The key accounting question related to SPEs is whether the sponsoring company (e.g.,

Company A) should include (consolidate) the financial statements of the SPE with its own financial statements

 Retain control – consolidate

 Relinquish control – no reason to consolidate

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Accounting for Equity Investments

Figure 8-8 Accounting for equity securities

Appendix 8A – Accounting for Acquisitions and Mergers: The Purchase Method

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Figure 8A-1 Balance sheets for Multi Corporation and Littleton Company (before acquisition)

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Appendix 8A – Accounting for Acquisitions and Mergers: The Purchase Method

Figure 8A-2 FMV of Littleton’s net assets

Appendix 8A – Purchase 100% of Stock at a Price Greater than the Per-Share Market Value

of the Net Assets

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Figure 8A-3 Consolidated journal entries for Multi Corporation: Case 1

Appendix 8A – Purchase 100% of Stock at a Price Greater than the Per-Share Market Value

of the Net Assets

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Figure 8A-4 Work sheet for Multi Corporation: Case 1

Appendix 8A – Purchase Between 50 and 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets

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Figure 8A-5 Consolidated journal entries for Multi Corporation: Case 2

Appendix 8A – Purchase Between 50 and 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets

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Figure 8A-6 Work sheet for Multi Corporation: Case 2

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