Investments in Equity Securities Presentations for Chapter 8 by Glenn Owen Key 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 markto-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 Classified 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 Available-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 Available-for-sale Securities Trading Securities Available-for Sale Securities Cash Dr. xxx xxx Purchased trading and available-for-sale securities for cash. Cr. xxx Declaration and Receipt of Cash Dividends Dividends Receivable Dividend Income Recognize declaration of dividend. Cash Dividend Receivable Recognize declaration of dividend. Dr. xxx Cr. xxx xxx xxx Sale of Trading Securities Dr. xxx Cr. Trading Securities Realized Gain on Sale of Trading Securities Sold trading securities for a gain or Cash xxx Realized Loss on Sale of Trading Securities xxx Trading Securities Sold trading securities sold for a loss xxx xxx Cash xxx Sale of Available-for-Sale Securities Cash Available-for-Sale Securities Realized Gain on Sale of Available-for-Sale Securities Sold available-for-sale securities for a gain or Cash Realized Loss on Sale of Available-for-Sale Securities Available-for-Sale Securities Sold available-for-sale securities for a loss Dr. xxx Cr. xxx xxx xxx xxx xxx Price Changes of Securities On Hand at the End of the Period Dr. Trading Securities xxx Unrealized Gain on Trading Securities Revalued trading securities to market or Unrealized Loss on Trading Securities xxx Trading Securities Revalued trading securities to market Cr. xxx xxx Price Changes of Securities On Hand at the End of the Period Dr. xxx Available-for-Sale Securities Unrealized Gain on Available-for-Sale Securities Revalued available-for-sales securities to market or Unrealized Loss on Available-for-Sale Securities xxx Available-for-Sale Securities Revalued available-for-sales securities to market Cr. xxx xxx Long-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 investment by dividends received. Long-Term Equity Investments 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 Accounting for Equity Securities Marketable? Intend to liquidate within time period of current assets? Yes Yes Proportion of voting shares Accounting Mark-toTreatment Market No <20% Mark-toMarket 20-50% >50% Equity ConsoliMethod date Accounting for Equity Securities Marketable? No Intend to No liquidate within time period of (implied) current assets? Proportion of voting shares Accounting Treatment No <20% Cost Method 20-50% >50% Equity ConsoliMethod date Goodwill 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 requirement to amortize goodwill. Review Problem I (a) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value $170 350 150 MV - Cost $30 (25) 30 Mark-to-market journal entry on 12/31/xx for AAA: Trading Securities (AAA) (+A) 30 Unrealized Gain on Trading Securities(R, +SE) 30 * Trading security ** Available-for-sale security Review Problem I (a) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value $170 350 150 MV - Cost $30 (25) 30 Mark-to-market journal entry on 12/31/xx for BBB: Unrealized Loss on Trading Securities (Lo, -SE) Trading Securities (BBB) (-A) 25 * Trading security ** Available-for-sale security 25 Review Problem I (a) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value $170 350 150 MV - Cost $30 (25) 30 Mark-to-market journal entry on 12/31/99 for CCC: Available-for-Sale Securities (CCC) (+A) Unrealized Loss on Available-for-Sale Securities (+SE) 30 * Trading security ** Available-for-sale security 30 Review Problem I (b) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value $170 350 150 MV - Cost $30 (25) 30 Sold all of AAA in 2000 for $180: Cash (+A) 180 Trading Securities (-A) 170 Realized Gain on Trading Securities (Ga, +SE) 10 * Trading security ** Available-for-sale security Review Problem I (b) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value $170 350 150 Sold 20% of BBB in 2000 for $65: MV - Cost $30 (25) 30 20% Cash (+A) 65 Realized Loss on Trading Securities (Lo, -SE 5 Trading Securities (-A) 70 * Trading security ** Available-for-sale security Review Problem I (b) Securities *AAA *BBB **CCC Cost Market Value $140 375 120 MV - Cost $170 350 150 $30 (25) 30 Received $60 in BBB dividends and $30 in dividends were declared on CCC stock: Cash (+A) Dividends Receivable (+A) Dividend Revenue (R, +SE) 60 30 * Trading security ** Available-for-sale security 90 Review Problem I (b) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value MV - Cost $170 350 150 $30 (25) 30 Revalued BBB shares to market 12/31/00: Unrealized Loss on Trading Securities (Lo, -SE) Trading Securities (BBB) (-A) 40 $2 per share x 20 shares. * Trading security ** Available-for-sale security 40 Review Problem I (b) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value MV - Cost $170 350 150 $30 (25) 30 Revalued CCC shares to market 12/31/00: Unrealized Price Increase on Available-for-Sale Securities (-SE) Available-for-Sale Securities (CCC) (-A) 15 $1 per share x 15 shares. * Trading security ** Available-for-sale security 15 Review Problem I (c) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value MV - Cost $170 350 150 $30 (25) 30 Sold 20 shares of BBB stock during 2001: Cash (+A) Trading Securities (BBB) (-A) Realized Gain on Trading Securities (R, +SE) Gain of $1 per share x 20 shares. 260 240 * Trading security ** Available-for-sale security 20 Review Problem I (c) Securities Cost *AAA *BBB **CCC $140 375 120 Market Value MV - Cost $170 350 150 $30 (25) 30 Sold 15 shares of CCC stock during 2001: Cash (+A) Unrealized Gain on Available-for-Sale Securities (-SE) Available-for-Sale Securities (CCC) (-A) Realized Gain on Available-for-Sale Securities (Ga, +SE) 165 15 * Trading security ** Available-for-sale security 135 45 COPYRIGHT Copyright © 2003, John Wiley & Sons, Inc. 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