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CHAPTER 2
Stocks Investments – Investor Accounting and Reporting
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Basic methods of accounting for common stock investments :
1
...

Dividends received in excess of the investor’s share of earnings after the stock is
acquired are considered a return of capital (liquidating dividend) and recorded as
reduction in the investment account
...
Trading securities  bought and held principally for resale purpose in the
near term, valued using fair value, includes unrealized gains and losses in
net income
b
...

2
...

Record investment at cost (equal to fair value at the acquisition date) and asjust for
earnings, losses, and dividends
...

Dividends received from investees are disinvestments under equity method (decrease
investment account)
Investment income  investor’s share of the net income of the investee
Investment account  investor’s share of the investee’s net assets

Levels of Influence
<20% presumes lack of significant influence  fair value (cost) method
20% to 50% presumes significant influence  equity method
>50% presumes control  consolidated financial statements

By: Anita Eva Erdina

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Accounting for Investment

Degree of
influence

Investment's carrying
value

Investment
income

Lack of
significant
influence

Fair value (cost, if
nonmarketable)

Dividends declared

Significant
influence

Original cost adjusted to
reflect periodic earnings and
dividends, e
...
, a
proportionate share of
investee's net assets

Proportionate
share of investee's
periodic earnings*

FAIR VALUE (COST) METHOD vs EQUITY METHOD
Pal Corporation acquires 2,000 of the 10,000 outstanding shares of Sid Corporation (1/5 or
20% ownership) at $25 per share on July 1
...
Further, tha cash paid equals 20% of the fair value of Sid’s
net assets
...
If there is evidence of an inability to exercise significant
influence, Pal Should apply the fair value/cost method revaluing the investment account to
fair market value at the end of the accounting period
...
Accounting by Pal under the two methods is as follows:
Fair value (cost) method
Equity method
Entry on July 1 to record the Investment
Investment in Sid (+A)
50,000
Investment in Sid (+A)
50,000
Cash (-A)
50,000
Cash (-A)
Entry on November 1 to record the dividends
Cash (+A)
2,000
Cash (+A)
2,000
Dividends Income (-A)
2,000
Investment in Sid (-A)
Entry on December 31 to recognize earnings
None (assume the stock is either Investment in Sid (+A)
2,500
nonmarketable or has a market price =$25
Income from Sid (R, +SE)
per share so that no revaluing is needed

50,000
2,000
2,500

*under fair value method Pal recognizes income of $2,000 and reports its investment in Sid at
its $50,000 cost at December 31
...

Summary of Pal’s equity under equity method:
July 1
Nov 1
Dec 31
Dec 31

Initial cost
Dividends received
Recognize 20% of Sid’d net income for ½ year
Ending Balance

$50,000
(2,000)
(2,500)
$50,500

An exception arises when dividends received exceed the investor’s share of earnings after the
investment has been acquired  return capital or liquidating dividends
Example:
Sid’s net income for the year had been $15,000, Pal’s share would have been $1,500 ($15,000
x 1/2 year x 20%)
...
Assume Pal records the $2,000 cash on Nov 1 as dividend income, a year-to-year
entry to adjust dividend income and investment account needed
...
If
after liquidating dividend, the stock had fair value of $60,000 at December 31, then the entry
to increase the investment to its fair value is required:
Allowance to adjust AFS securities to MV
Unrealized gains on AFS securities*
*included in other comprehensive income

By: Anita Eva Erdina

10,500
10,500

APPLYING THE EQUITY METHOD
 Acquisition Cost > FV net assets, and FV net assets > BV net assets
Payne acquires 30% of Sloan for $5,000
...
Payne also pays $50 to register the securities and $100 in
consulting fees
...
assets 30%(-200)

(60)

1st year

Equipment 30%(+3,000)

900

20 years

Note payable 30%(+200)

60

5 years

Goodwill (to balance)

200

None

Total

$1,400

 Dividends Income
Payne receives $300 dividends from Sloan
...

Payne will recognize its share (30%) of Sloan's income, but will adjust it for amortization
of the differences between book and fair values
...

($300)

Other current assets

(60)

60

0

Equipment

900

(45)

855

Note payable

60

(12)

48

Goodwill

200

0

200

Total

$1,400

($297)

$1,103

Investment income is 30% of Sloan's net income – amortization
30%($3,000) – $297 = $603
...
The book value of the investee's net assets
= assets – liabilities, or
= stockholders' equity
 Fair Values Used in Assignment
Identifiable net assets include all the investee's assets and liabilities, whether recorded or
not
 Fair value of research in progress
 Fair value of contingent liabilities
 Fair value of unrecorded patents
Exception: use book value for pensions and deferred taxes
...

If cost < fair value, a bargain purchase exists
...
The investment is recorded at the fair value of the
identifiable net assets

By: Anita Eva Erdina

 Interim Acquisitions
- Book value of net assets = BV equity
...

- Amortization for first, partial, year:
o Take full amortization for inventory and other current assets disposed of by
year-end
...

Record dividends if after the acquisition date
...

Fair value (cost) method  equity method
o Restate prior-period statements
Investee's growth in retained earnings is
o Excess of income over dividends declared
Investment account desired balance using equity method = original cost + share of growth
in investee’s retained earnings – amortization, if any

 Sale of Equity Interest
Sale of investment that results in a lack of significant influence over the investee
Equity method  fair value (cost) method
o Prospective treatment
1
...
Apply the fair value (cost) method to remaining investment
 Stock Purchased from Investee
If stock is purchased from old shareholders, the percentage ownership is based on the
shares outstanding and the investee's equity is not changed
...
= current dividend if cumulative, or dividends declared if noncumulative
 Goodwill Impairment
Test annually, and if significant events occur, two-step process [FASB ASC 350-20-35]
1
...

o If no implied impairment, step 2 is not needed
...

2
...

 Impairment of Equity Investment
- Goodwill implied in equity investments is not tested for impairment
...

Sam has a 30% interest in Lake, Investment in Lake, with a carrying value of $4,200; this
includes implied goodwill of $350
...

- If Sam’s interest has a fair value of less than $4,200, an impairment loss on the
Investment in Lake is recorded

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