Financial accounting 9th jamie pratt chapter 08

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Chapter 8: Investments in Equity Securities  Equity Securities Classified as Current Two criteria must be met for an investment in a security to be considered current and thus warrant inclusion as a current asset: The investment must be readily marketable 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 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 • 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 • 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  Cont’d • 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 • 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 • 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 not appear on the income statement and • are not reflected in the balance of retained earnings  Long-Term Equity Investments • Companies invest in equity of other companies to • Get investment income in the form of dividends and stock price appreciation And primarily • • Exert influence over company operations and management Acquisitions are common for large U.S companies  10 The Equity Method Figure 8-3 The equity method of accounting for long-term equity investments  16 Investments in Affiliates Figure 8-4 The relative importance of investments in affiliate companies (selected U.S companies  17 Business Acquisition, Mergers, and Consolidated Financial Statements • 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 A merger, or business combination, occurs when two or more companies combine to form a single legal entity  18 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  19 Equity Method or Consolidated Statements? The user needs to understand the effect of the different presentations on the financial statements Figure 8-6 The balance sheet of Megabucks and Tiny Inc  20 Equity Method or Consolidated Statements? Figure 8-7 Consolidated balance sheet  21 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  22 Accounting for Equity Investments  23 Figure 8-8 Accounting for equity securities Appendix 8A – Accounting for Acquisitions and Mergers: The Purchase Method Figure 8A-1 Balance sheets for Multi Corporation and Littleton Company (before acquisition)  24 Appendix 8A – Accounting for Acquisitions and Mergers: The Purchase Method Figure 8A-2 FMV of Littleton’s net assets  25 Appendix 8A – Purchase 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets Figure 8A-3 Consolidated journal entries for Multi Corporation: Case  26 Appendix 8A – Purchase 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets Figure 8A-4 Work sheet for Multi Corporation: Case  27 Appendix 8A – Purchase Between 50 and 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets Figure 8A-5 Consolidated journal entries for Multi Corporation: Case  28 Appendix 8A – Purchase Between 50 and 100% of Stock at a Price Greater than the Per-Share Market Value of the Net Assets Figure 8A-6 Work sheet for Multi Corporation: Case  29 Copyright © 2014 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein  30 ... companies  10 Accounting for Long-Term Equity Investments Figure 8-1 Accounting for long-term investment in equity securities  11 The Cost Method Figure 8-2 The cost method of accounting for... 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... Relinquish control – no reason to consolidate  22 Accounting for Equity Investments  23 Figure 8-8 Accounting for equity securities Appendix 8A – Accounting for Acquisitions and Mergers: The Purchase
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