ACCT 3202 Topic #8
equity method
- "adjusted historical cost" approach to valuation - initial investment recorded at cost as long term asset - JE: dr. investment equity method xxx cr. cash xxx - amount will be subsequently adjusted for investor's share of the changes in investor's net assets (changes mostly caused by investee's net income)
fair value option
- GAAP now allows fair value option for most financial instruments - unrealized gains and losses run through net income - elected on an instrument to instrument basis (irrevocable) - also applies to liabilities - can be tough to find fair value for illiquid or complex instruments - balance sheet has mix of fair values and historical costs - managers have discretion
cost method
- assets without a readily determinable FMV are carried at historical cost (NO MARK TO MARKET) - purchase JE: dr. investment cost method xxx cr. cash xxx - no other JEs until sold (except for dividend revenue or impairment)
evidence of significant influence
- board members from investing company - larger intracompany transactions - investor active in decision making - technological dependence
accounting for HTM securities
- can be current or long term - carried on balance sheet at amortized cost - interest revenue recognized as income when earned (effective interest method) - NO RECOGNITION OF UNREALIZED HOLDING GAINS/LOSSES - when sold, realized gains and losses are recognized in income (sales price - current book value)
investment types
- debt investments - ex. buying bonds from another company - equity investments - ex. buying stock from another company
accounting for investments in other companies
- driven by level of investment - 0%-20% = little/no influence --> minority passive investment - 20%-50% = significant influence --> minority active investment - 50%-100% = control --> majority investment
minority active investments
- for strategic reasons - ownership between 20%-50% --> significant influence - GAAP takes step towards combining books but does not go all the way
available for sale securities
- intended to be held longer term (longer than 3 months) - fair value accounting, enter unrealized gains and losses into stockholder's equity directly through OCI - only interest revenue included in income
trading securities
- intended to be sold in short-term (3 months or less) - fair value accounting, include unrealized gains/losses in net income - interest revenue and gain/loss included in income
horizontal integration (equity investments)
- invest in or acquire competitor - possible benefits: expansion into new markets, increased market power, synergies, economies of scale
held to maturity securities
- not intended to be sold (held until mature) - do not recognize unrealized gains/losses - no fair value accounting - only interest revenue included in income
accounting for passive investments
- record assets at cost initially - any dividends recognized income for investor (dividend revenue) - at end of each period, if FMV is known, FMV method is used - use fair value adjustment to to mark to market - changes in fair value recorded as unrealized gain/loss on income statement - assets are on balance sheet at current costs
transfers between categories
- sometimes managers intentions change - for all transfers between categories, fair value at time of transfer becomes book value in new category
vertical integration (equity investments)
- upstream = invest in or acquire supplier - downstream = invest in or acquire customer - possible benefits: improve control over value chain, capture upstream or downstream profit margins
impairment of investments
- value of investment has decreased - only matters when not using fair value method (so important when using equity method and debt investments) - book value is reduced and loss is recognized in net income
why invest in other companies?
1) put excess cash to use 2) strategic control reasons
majority investment
GAAP requires parent company to consolidate subsidiary
interest formula
bond price x yield (market rate)
investments intended to be held to maturity
changes in fair value less important since not for sale
investments intended to be held longer term
changes in fair value may induce unnecessary volatility if included in earnings
one
combine unrealized holding gains and losses on income statement into _____ item
coupon payment formula
face value x stated rate
minority passive investments
for excess cash or strategic reasons
investments intended to be sold in short term
makes some sense to recognized gains/losses as income before they are realized
fair value or equity method
when a company has acquired interest in another corporation with significant influence, the acquiring company may use _____ or _____