Stock Investments – Investor Accounting and Reporting
Levels of Influence or Control
Levels of Influence
Percentage Ownership Of Voting Accounting Method
Stock
<20% – Presumes Lack Of Fair Value (Cost) Method
Significant Influence
20% To 50%– Presumes Significant Equity Method
Influence
>50% – Presumes Control Consolidated Financial
Statements
Fair Value/cost and Equity Method Accounting procedures
a. Assume that Pop Corporation acquires 2,000 of the 10,000 outstanding shares of
Son Corporation at $25 per share on July 1.
b. Assume the book value and fair value of Son’s assets and liabilities are equal.
c. Further, the cash paid equals 20 percent of the fair value of Son’s net assets.
d. Son’s net income for the fiscal year ending December 31 is $25,000, and
dividends of $10,000 are paid on November 1.
If there is evidence of an inability to exercise significant influence, Pop should
apply the fair value/cost method, revaluing the investment account to fair market
value at the end of the accounting period. Otherwise, the equity method is
required.
Accounting by Pop under the two methods is as follows:
Under the fair value/cost method, Pop recognizes income of $2,000 and reports its
investment in Son at its $50,000 cost at December 31.
Under the equity method, Pop recognizes $2,500 in income and reports the investment
in Son at $50,500 at December 31.
Keterangan Perhitungan untuk Equity Method:
Liquidating Dividends
An exception arises when dividends received exceed the investor’s share of earnings
after the investment has been acquired. From the investor’s point of view, the excess
dividends since acquisition of the investment are a return of capital, or liquidating
dividends.
For example, if Son’s net income for the year had been $15,000, Pop’s share would have
been $1,500 ($15,000 * 1/2 year * 20%). The $2,000 dividend received exceeds the
$1,500 equity in Son’s income, so the $500 excess would be considered a return of
capital and credited to the Investment in Son account.
Assuming that Pop records the $2,000 cash received on November 1 as dividend
income, a year-end entry to adjustdividend income and the investment account is
needed. Pop would record as follows:
Dividend income (-R, - SE) 500
Investment in Son (-A) 500
To adjust dividend income and investment accounts for dividends received in excess of
earnings.
If, after the liquidating dividend, the stock (classified as an available-for-sale security)
had a fair value of $60,000 at December 31, then another entry would be required to
increase the investment to fair value:
Allowance to adjust available-for-sale securities to market value (+A) 10,500
Unrealized gain on available-for-sale securities (+SE)
10,500
The unrealized gain on available-for-sale securities is included in reporting other
comprehensive income for the period.
Equity Method—A One-Line Consolidation
The equity method of accounting is often called a one-line consolidation. This is because
the investment is reported in a single amount on one line of the investor’s balance sheet,
and investment income is reported in a single amount on one line of the investor’s
income statement (except when the investee has discontinued operations items that
require separate disclosure).
Consolidated financial statements show the same income and the same net assets but
include the details of revenues and expenses and assets and liabilities.
Basic accounting procedures for applying the equity method are the same whether the
investor has the ability to exercise significant influence over the investee (20 percent to
50 percent ownership) or the ability to control the investee (more than 50 percent
ownership). This is important because investments of more than 50 percent are
business combinations and require preparation of consolidated financial statements.
Equity Investments at Acquisition
Equity investments in voting common stock of other entities measure the investment
cost by the cash disbursed or the fair value of other assets distributed or securities
issued. Similarly, we charge direct costs of registering and issuing equity securities
against additional paid-in capital, and we expense other direct costs of acquisition. We
enter the total investment cost in an investment account under the one-line
consolidation concept.
Assume that Pam Company purchases 30 percent of Sun Company’s outstanding voting
common stock on January 1 from existing stockholders for $2,000,000 cash plus
200,000 shares of Pam Company $10 par common stock with a market value of $15 per
share. Additional cash costs of the equity interest consist of $50,000 for registration of
the shares and $100,000 for consulting and advisory fees.
Pam Company records these events with the following journal entries (in thousands):
January 1
Investment in Sun (+A) 5,000
Common stock (+SE) 2,000
Additional paid-in capital (+SE) 1,000
Cash (-A) 2,000
To record acquisition of a 30% equity investment in Sun Company.
January 1
Investment expense (E, - SE) 100
Additional paid-in capital (-SE) 50
Cash (-A) 150
To record additional direct costs of purchasing the 30% equity interest in Sun.
Under a one-line consolidation, these entries can be made without knowledge of book
value or fair value of Sun Company’s assets and liabilities.
Assignment of Excess Investment cost over Book Value of Equity
Information about the individual assets and liabilities of Sun Company at acquisition is
important because subsequent accounting under the equity method requires accounting
for any differences between the investment cost and the book value of equity in the net
assets of the investee.
Assume that the following book value and fair value information for Sun Company at
January 1 is available (in thousands)
Accounting for Excess of Investment cost over Book Value
Assume that Sun pays dividends of $1,000,000 on July 1 and reports net income of
$3,000,000 for the year. The excess cost over book value is amortized as follows:
Pam makes the following entries under a one-line consolidation to record its dividends
and income from Sun (in thousands):
July 1
Cash (+A) 300
Investment in Sun (-A) 300
To record dividends received from Sun ($1,000,000 * 30%).
December 31
Investment in Sun (+A) 900
Income from Sun (R, +SE) 900
To record equity in income of Sun ($3,000,000 * 30%).
December 31
Income from Sun (-R, -SE) 300
Investment in Sun (-A) 300
To record write-off of excess allocated to inventory items that were sold in the current
year.
December 31
Investment in Sun (+A) 60
Income from Sun (R, +SE) 60
To record income credit for overvalued other current assets disposed of in the current
year.
December 31
Income from Sun (-R, - SE) 45
Investment in Sun (-A) 45
To record depreciation on excess allocated to undervalued equipment with a 20-year
remaining useful life ($900,000/20).
December 31
Income from Sun (-R, -SE) 12
Investment in Sun (-A) 12
To amortize the excess allocated to the overvalued note payable over the remaining life
of the note ($60,000/5 years).
Pam reports its investment in Sun at December 31 on one line of its balance sheet at
$5,303,000 and its income from Sun at $603,000 on one line of its income statement.
Excess of Book Value over Investment cost
The book value of the interest acquired in an investee may be greater than the
investment cost or fair value. This indicates that the identifiable net assets of the
investee are overvalued or that the interest was acquired at a bargain price.
To illustrate, assume that Pop Corporation purchases 50 percent of the outstanding
voting common stock of Son Corporation on January 1 for $40,000 in cash. A summary
of the changes in Son’s stockholders’ equity during the year appears as follows (in
thousands):
The $10,000 excess of book value acquired over investment cost ($100,000*50%) -
$40,000 was due to inventory items and equipment that were overvalued on Son’s
books.
Son’s January 1 inventory was overvalued by $2,000 and was sold in December. The
remaining $18,000 overvaluation related to equipment with a 10-year remaining useful
life from January 1.
No goodwill results because the $40,000 cost is equal to the fair value of the net assets
acquired (50% * $80,000). 80,000 dari (100,000 -20,000)
The assignment of the difference between book value acquired and investment cost is as
follows (in thousands):
Journal entries to account for Pop’s investment in Son are as follows (in thousands):
January 1
Investment in Son (+A) 40
Cash (-A) 40
To record purchase of 50% of Son’s outstanding voting stock.
July 1
Cash (+A) 2.5
Investment in Son (-A) 2.5
To record dividends received (5,000 * 50%).
December 31
Investment in Son (+A) 10
Income from Son (R, +SE) 10
To recognize equity in the income of Son (20,000 * 50%).
December 31
Investment in Son (+A) 1.9
Income from Son (R, +SE) 1.9
To amortize excess of book value over investment cost assigned to:
Inventory (1,000 * 100%) $1.0
Equipment (9,000 * 10%) $0.9
Because assets were purchased at less than book value, Pop reports investment income
from Son of $11,900 ($10,000 + $1,900) and an Investment in Son balance at December
31 of $49,400.
Bargain purchase
Assume that Pop also acquires a 25 percent interest in Sax Corporation for $110,000 on
January 1, at which time Sax’s net assets consist of the following (in thousands):
Sax’s net income and
dividends for the year are
$60,000 and $40,000, respectively. The undervalued inventory items were sold during
the year, and the undervalued buildings had a four-year remaining useful life when Pop
acquired its 25 percent interest.
Journal entries for Pop to account for its investment in Sax follow (in thousands):
January 1
Investment in Sax (+A) 120
Cash (-A) 110
Gain on bargain purchase (Ga, +SE) 10
To record purchase of a 25% interest in Sax’s voting stock.
Throughout the year
Cash (+A) 10
Investment in Sax (-A) 10
To record dividends received ($40,000 * 25%).
December 31
Investment in Sax (+A) 6.25
Income from Sax (R, +SE) 6.25
To recognize investment income from Sax computed as follows:
Pop’s investment in Sax balance at December 31 is $116,250, and the underlying book
value of the investment is $105,000 ($420,000 * 25%) on that same date. The $11,250
difference is due to the $11,250 unamortized excess assigned to buildings.
