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ACCOUNTING FOR VARIOUS INVESTMENTS. Investment in Debt Securities. Investment in Equity Securities. Classification. Control -greater than 50% ownership of voting stock. Not applicable. Consolidation. Significant influence - 20% to 50% ownership of voting stock. Not applicable. - PowerPoint PPT Presentation
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Concepts of Equity Method. - 1
ACCOUNTING FOR VARIOUS INVESTMENTS
Classification Investment inDebt Securities
Investment inEquity Securities
Control-greater than 50%ownership of voting stock
Not applicable Consolidation
Significant influence - 20% to50% ownership of voting stock
Not applicable Equity method
Debt securities classified as heldto maturity, and equity securitiesfor which fair value is not readilydeterminable
Amortized cost method Cost method
Debt and equity securitiesclassified as trading securities
Fair value method, with unrealized holding gain or lossincluded in earnings
Debt and equity securitiesclassified as available for sale
Fair value method, with unrealized holding gain or lossincluded as a component of comprehensive income/stockholders’ equity
Concepts of Equity Method. - 2
{
In some cases, influence or control may exist with less than 20% ownership.
In some cases, influence or control may exist with less than 20% ownership.
Investor Ownership of the Investee’s Shares
Outstanding
0% 20% 50% 100%
Fair Value
Equity Method
Consolidated Financial Statements
Size (of the Investment) Matters!!!
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Concepts of Equity Method. - 3
{Significant influence is generally
assumed with 20% to 50% ownership.
Significant influence is generally assumed with 20% to 50%
ownership.
Investor Ownership of the Investee’s Shares
Outstanding
The Significance of the Size of the Investment
0% 20% 50% 100%
Fair Value
Equity Method
Consolidated Financial Statements
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Concepts of Equity Method. - 4
{Financial Statements of all related Financial Statements of all related companies must be consolidated.companies must be consolidated.
Financial Statements of all related Financial Statements of all related companies must be consolidated.companies must be consolidated.
Investor Ownership of the Investee’s Shares
Outstanding
The Significance of the Size of the Investment
0% 20% 50% 100%
Fair Value
Equity Method
Consolidated Financial Statements
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Concepts of Equity Method. - 5
Criteria for Determining Whether There is “Significant” Influence
(APB Opinion 18)
Representation on the investee’s Board of Directors
Representation on the investee’s Board of Directors
Participation in the investee’s policy-making process
Participation in the investee’s policy-making process
Material intercompany transactions.Material intercompany transactions.
Interchange of managerial personnel.Interchange of managerial personnel.
Technological dependency.Technological dependency.
Extent of ownership in relationship to other investor ownership percentages. Extent of ownership in relationship to other investor ownership percentages.
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Concepts of Equity Method. - 6
Equity Method
Requires that the investor has the potential for “significant” influence.
Generally used when ownership is between 20% and 50%.– Significant Influence might be
present with much smaller ownership percentages. (The accountant must consider the particulars!!!)
Requires that the investor has the potential for “significant” influence.
Generally used when ownership is between 20% and 50%.– Significant Influence might be
present with much smaller ownership percentages. (The accountant must consider the particulars!!!)
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Concepts of Equity Method. - 7
Remember: The ability to exert significant
influence is the determining factor in applying the equity method
No actual influence need have been applied!!
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Concepts of Equity Method. - 8
EQUITY METHODEvidence against Significant
Influence
Investee opposition Investor/investee agreement Closely held majority stockholder Lack of information Lack of board representation
Concepts of Equity Method. - 9
Equity Method
Step 1: The investor records its investment in the investee at cost.
Journal entry:Debit – Investment in Investee
Credit – Cash (or other Assets/Stock)
Cost can be defined by cash paid or the Fair Cost can be defined by cash paid or the Fair Market Value of Stock or Assets given up.Market Value of Stock or Assets given up.
Cost can be defined by cash paid or the Fair Cost can be defined by cash paid or the Fair Market Value of Stock or Assets given up.Market Value of Stock or Assets given up.
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Concepts of Equity Method. - 10
Equity Method
Step 2: The investor recognizes its proportionate (pro rata) share of the investee’s net income (or net
loss) for the period.
Journal entry at end of period:Debit – Investment in Investee
Credit – Equity in Investee Income
This will appear as a separate line-item on the investor’s
income statement.
This will appear as a separate line-item on the investor’s
income statement.
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Concepts of Equity Method. - 11
Equity Method
Step 3: The investor reduces the investment account by the amount
of cash dividends received from the investee.
Journal entry when cash dividends received:Debit – Cash
Credit – Investment in Investee
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Concepts of Equity Method. - 12
Excess of Cost Over BV Acquired
When Cost > BV acquired, the difference must be identified and accounted for.
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When Cost > BV acquired, the difference must be identified and
accounted for.
Concepts of Equity Method. - 13
Excess of Cost Over BV Acquired
The amortization of the difference associated with the undervalued assets is recorded as a
reduction of both the Investment account and the Equity in Investee Income account.
The amortization of the difference associated with the undervalued assets is recorded as a
reduction of both the Investment account and the Equity in Investee Income account.
1-13
Concepts of Equity Method. - 14
Special Procedures for Special Situations
Reporting a change to the equity method.
Reporting a change to the equity method.
Reporting investee income from sources other than continuing
operations.
Reporting investee income from sources other than continuing
operations.
Reporting investee losses.
Reporting investee losses.
Reporting the sale of an equity
investment.
Reporting the sale of an equity
investment.
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Concepts of Equity Method. - 15
?
Reporting a Change to the Equity Method. (Retroactive
Adjustment) An investment that is too small to have
significant influence is accounted for using the fair-value method.
When ownership grows to the point where significant influence is established . . .
. . . all accounts are restated so that the investor’s financial statements appear as if the equity method had been applied from the date
of the first [original] acquisition. - - APB Opinion 18
. . . all accounts are restated so that the investor’s financial statements appear as if the equity method had been applied from the date
of the first [original] acquisition. - - APB Opinion 18
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Concepts of Equity Method. - 16
Reporting Investee Losses
A permanent decline in the investee’s fair market value is recorded as an impairment loss
and the reduction of the investment account to the fair
value.
A permanent decline in the investee’s fair market value is recorded as an impairment loss
and the reduction of the investment account to the fair
value.
A temporary decline is ignored!!!
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Concepts of Equity Method. - 17
Possible Criticisms:
Over-emphasis on possession of 20-50% voting stock in deciding on “significant influence” vs. “control”
Possibility of “off-balance sheet financing”
Potential manipulation of performance ratios
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