Investments in Investments in Equity SecuritiesEquity Securities

Presentations for Chapter 8 by Glenn Owen

Key PointsKey Points Criteria that must be met before a security can be listed in the

current assets section of the balance sheet. Trading and available-for-sale securities and how the mark-to-

market rule is used to account for them. Why companies make long-term investments in equity securities. The mark-to-market method, the cost method, and the equity

method of accounting for long-term equity investments, and the conditions under which each method is used.

Consolidated financial statements, when they are prepared, and how they differ from financial statements that account for equity investments using the equity method.

Equity Securities Equity Securities Classified as CurrentClassified as Current

Existence of a ready market– Readily marketable meaning that a security can be sold

and converted into cash on demand Intention to convert

Trading and Trading and Available-For-Sale SecuritiesAvailable-For-Sale Securities

Purchasing trading and available-for-sale securities Declaration and receipt of cash dividends Sale of securities Price changes of securities on hand at the end of the

accounting period Reclassifications and permanent

market value declines Mark-to-market accounting and

comprehensive income

Purchasing Trading and Purchasing Trading and Available-for-sale SecuritiesAvailable-for-sale Securities

Dr. Cr. Trading Securities xxxAvailable-for Sale Securities xxx

Cash xxx

Purchased trading and available-for-sale securities for cash.

Declaration and Receipt of Declaration and Receipt of Cash DividendsCash Dividends

Dr. Cr. Dividends Receivable xxx

Dividend Income xxxRecognize declaration of dividend.

Cash xxxDividend Receivable xxx

Recognize declaration of dividend.

Sale of Trading SecuritiesSale of Trading SecuritiesDr. Cr.

Cash xxxTrading Securities xxxRealized Gain on Sale of Trading Securities xxx

Sold trading securities for a gainorCash xxxRealized Loss on Sale of Trading Securities xxx

Trading Securities xxxSold trading securities sold for a loss

Sale of Sale of Available-for-Sale SecuritiesAvailable-for-Sale SecuritiesDr. Cr.

Cash xxxAvailable-for-Sale Securities xxxRealized Gain on Sale of Available-for-Sale Securities xxx

Sold available-for-sale securities for a gainorCash xxxRealized Loss on Sale of Available-for-Sale Securities xxx

Available-for-Sale Securities xxxSold available-for-sale securities for a loss

Price Changes of Securities On Price Changes of Securities On Hand at the End of the PeriodHand at the End of the Period

Dr. Cr. Trading Securities xxx

Unrealized Gain on Trading Securities xxxRevalued trading securities to marketorUnrealized Loss on Trading Securities xxx

Trading Securities xxxRevalued trading securities to market

Price Changes of Securities On Price Changes of Securities On Hand at the End of the PeriodHand at the End of the Period

Dr. Cr. Available-for-Sale Securities xxx

Unrealized Gain on Available-for-Sale Securities xxx

Revalued available-for-sales securities to marketorUnrealized Loss on Available-for-Sale Securities xxx

Available-for-Sale Securities xxxRevalued available-for-sales securities to market

Long-Term Equity InvestmentsLong-Term Equity Investments The cost method

– Market value is indeterminable– Ownership is less than 20 percent– No change is made in the carrying value of the investment

The equity method– Significant influence (20 - 50 percent ownership)– Periodically increase(decrease) the carrying value of the investment by

the investor’s proportionate share of the net income (loss) of the investee.

– Decrease the carrying value of the investmentby dividends received.

Equity method cautions– This method will give rise to a difference between reported

net income (loss) and cash flow from operations.– It ignores market price.– 20-50 percent is not always a valid indication of significant

influence.– It generates off-balance sheet financing

Consolidated financial statements– Greater than 50 percent ownership– Purchase or pooling methods

Long-Term Equity InvestmentsLong-Term Equity Investments

Accounting for Equity SecuritiesAccounting for Equity Securities

Intend to liquidate within time period of current assets?

Marketable?

Proportion of voting shares

Accounting Treatment

Yes

Yes

Mark-to-Market

Mark-to-Market

Equity Method

Consoli-date

No

>50%20-50%<20%

Accounting for Equity SecuritiesAccounting for Equity Securities

Intend to liquidate within time period of current assets?

Marketable?

Proportion of voting shares

Accounting Treatment

No

No (implied)

CostMethod

Equity Method

Consoli-date

No

>50%20-50%<20%

Goodwill Accounting ControversyGoodwill Accounting Controversy Goodwill is defined as the excess amount paid for

a corporation over the fair market value of the acquired company’s assets and liabilities.

Goodwill appears on the balance sheet. Until recently, goodwill was amortized over a

future period not to exceed forty years. In July 2001, the FASB passed an accounting

standard with removes the requirementto amortize goodwill.

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Mark-to-market journal entry on 12/31/xx for AAA:

* Trading security ** Available-for-sale security

Trading Securities (AAA) (+A) 30 Unrealized Gain on Trading Securities(R, +SE) 30

Review Problem I (a) Review Problem I (a)

Review Problem I (a) Review Problem I (a)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Mark-to-market journal entry on 12/31/xx for BBB:

* Trading security ** Available-for-sale security

Unrealized Loss on Trading Securities (Lo, -SE) 25 Trading Securities (BBB) (-A) 25

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Mark-to-market journal entry on 12/31/99 for CCC:

* Trading security ** Available-for-sale security

Available-for-Sale Securities (CCC) (+A) 30 Unrealized Loss on Available-for-Sale Securities (+SE) 30

Review Problem I (a) Review Problem I (a)

Review Problem I (b) Review Problem I (b)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Sold all of AAA in 2000 for $180:

* Trading security ** Available-for-sale security

Cash (+A) 180 Trading Securities (-A) 170 Realized Gain on Trading Securities (Ga, +SE) 10

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Sold 20% of BBB in 2000 for $65:

* Trading security ** Available-for-sale security

Cash (+A) 65Realized Loss on Trading Securities (Lo, -SE 5 Trading Securities (-A) 70

20%

Review Problem I (b) Review Problem I (b)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Received $60 in BBB dividends and $30 in dividends were declared on CCC stock:

* Trading security ** Available-for-sale security

Cash (+A) 60Dividends Receivable (+A) 30 Dividend Revenue (R, +SE) 90

Review Problem I (b) Review Problem I (b)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Revalued BBB shares to market 12/31/00:

* Trading security ** Available-for-sale security

Unrealized Loss on Trading Securities (Lo, -SE) 40 Trading Securities (BBB) (-A) 40

$2 per share x 20 shares.

Review Problem I (b) Review Problem I (b)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Revalued CCC shares to market 12/31/00:

* Trading security ** Available-for-sale security

Unrealized Price Increase on Available-for-Sale Securities (-SE) 15 Available-for-Sale Securities (CCC) (-A) 15

$1 per share x 15 shares.

Review Problem I (b) Review Problem I (b)

Review Problem I (c) Review Problem I (c)

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Sold 20 shares of BBB stock during 2001:

* Trading security ** Available-for-sale security

Cash (+A) 260 Trading Securities (BBB) (-A) 240 Realized Gain on Trading Securities (R, +SE) 20Gain of $1 per share x 20 shares.

Securities Cost Market Value MV - Cost

*AAA $140 $170 $30 *BBB 375 350 (25)

**CCC 120 150 30

Sold 15 shares of CCC stock during 2001:

* Trading security ** Available-for-sale security

Cash (+A) 165Unrealized Gain on Available-for-Sale Securities (-SE) 15 Available-for-Sale Securities (CCC) (-A) 135 Realized Gain on Available-for-Sale Securities (Ga, +SE) 45

Review Problem I (c) Review Problem I (c)

C O P Y R I G H TC o p y r i g h t © 2 0 0 3 , J o h n W i l e y & S o n s , I n c . A l l r i g h t s r e s e r v e d .R e p r o d u c t i o n o r t r a n s l a t i o n o f t h i s w o r k b e y o n d t h a t p e r m i t t e d i n S e c t i o n 1 1 7 o f t h e 1 9 7 6 U n i t e d S t a t e s C o p y r i g h t A c t w i t h o u t t h ee x p r e s s w r i t t e n p e r m i s s i o n o f t h e c o p y r i g h t o w n e r i s u n l a w f u l . R e q u e s t f o r f u r t h e r i n f o r m a t i o n s h o u l d b e a d d r e s s e d t o t h e P e r m i s s i o n s D e p a r t m e n t , J o h n W i l e y & S o n s , I n c . T h e p u r c h a s e r m a y m a k e b a c k - u p c o p i e s f o r h i s / h e r o w n u s e o n l y a n d n o t f o r d i s t r i b u t i o n o r r e s a l e . T h e P u b l i s h e r a s s u m e s n o r e s p o n s i b i l i t yf o r e r r o r s , o m i s s i o n s , o r d a m a g e s , c a u s e d b y t h e u s e o f t h e s e p r o g r a m s o r f r o m t h e u s e o f t h e i n f o r m a t i o n c o n t a i n e d h e r e i n .