Module 7:
Intercorporate Investments
1
Investment in Marketable Equity
Securities - Overview
Equity investments represent ownership of
another company’s outstanding common stock.
Marketable equity investments are actively traded
on a public stock exchange.
By owning shares of common stock, the investor
“owns” a part of the company, represented by the
percentage ownership.
There are different accounting rules for:
(1) less than 20 percent ownership (passive).
(2) between 20 and 50 percent ownership
(significant influence).
(3) greater than 50 percent ownership (control).
2
(1) Less than 20 % ownership.
If marketable securities, use the mark-to
market method.
Carries securities on balance sheet at
market value.
Revaluation at the end of each period
based on new market price
Unrealized gains (or losses) are recognized
as the investment is valued up (or down).
Treatment of the Unrealized G/L depends
on classification of security:
– (a) Trading securities.
– (b) Available-for-sale securities.
3
(a) Trading Securities
Trading securities held for the short term,
with purpose of selling securities for profit.
At purchase - record at cost to acquire.
Activity during the year - record
declaration/receipt of cash dividends, and
recognize “Dividend Income” on the
Income Statement.
4
(a) Trading Securities
For securities on hand at the end of the
accounting period - revalue to market value
and record “Unrealized Gain/Loss” on
Income Statement.
When sold - recognize “Gain/Loss on
Sale” on Income Statement for any
balance since the last revaluation.
5
(b) Available-for-sale Securities
Available-for-sale (AFS) securities may be
held for the short term or for long term,
depending on management’s intentions.
At purchase - record at cost to acquire.
Activity during the year - record
declaration/recept of cash dividends, and
recognize “Dividend Income” on the
Income Statement.
6
(b) Available-for-sale Securities
For securities on hand at the end of the
accounting period - revalue to market value
and record “Unrealized Gain/Loss” on
Balance Sheet, as part of Other
Comprehensive Income in Stockholders’
Equity (more on OCI in Module 9).
When sold - recognize “Gain/Loss on
Sale” on Income Statement for total
difference between original cost and selling
price.
7
(2) From 20% to 50% Investment
Because investment represents significant
influence of investor, we cannot account
for investments the same way as Trading
or AFS.
Specifically, we cannot recognize
“Dividend Income” as dividends are
declared, because the investor can control
dividend payout, and therefore control the
creation of income.
8
(2) From 20% to 50% Investment
The equity method increases the
investment account and recognizes
investor’s portion of income as investee
earns it (as investee reports income to
investor).
The equity method decreases the
investment account as investee declares
dividends to the investor.
Note: additional complications from equity
method from cost exceeding fair value of
investment (e.g., goodwill) are not
addressed here for unconsolidated
investments.
9
Cautions Regarding Equity Method
The equity ignores market value for the investment
account. Instead the investment account
fluctuates as the investee’s equity fluctuates
(income in excess of dividends).
20-50 percent is not always a valid indication of
significant influence.
It generates off-balance sheet financing - one line
on the balance sheet may actually represent a
percentage ownership in a number of assets and
liabilities. (Consolidated investments show all the
detail of assets and liabilities, where
unconsolidated investments show only a net asset
amount).
10
(3)Greater than 50% Investment
If an investor has majority control, the
investment is recorded using the equity
method, and a parent/subsidiary
relationship is established.
At the end of the period, the financials of
the parent and subsidiary must be
combined, or consolidated, for external
financial reporting.
Goodwill is recognized as a separate
asset in the consolidation.
11
0
