Financial Exam #2
The shareholders' equity of FSU Industries includes $200,000 of $1 par common stock and $400,000 par value of 6% cumulative preferred stock. The board of directors declared cash dividends of $50,000 in 2021 after paying $20,000 cash dividends in 2020 and $40,000 in 2019. What is the amount of dividends common shareholders will receive in 2021?
$22,000
Accounting for Equity Investments Critical events that an investor experiences in the life of an investment:
-Purchasing the investment -Recognizing investment revenue •For equity: Dividends (For debt: Interest) -Holding the investment during periods in which the investment's fair value changes •Unrealized holding gains and losses -Selling the investment
Three Classifications of Debt Investments
1. Held-to-Maturity 2. Trading 3. Available for Sale
Shares Issued for Noncash Consideration
A company might issue its shares for consideration other than cash. That is: -May be to pay for promotional and legal services with shares rather than with cash -Shares may be given in payment for land, or for equipment, or for some other noncash asset •Issuance of shares should be recorded at grant-date fair value •This treatment is consistent with the accounting requirement for employee share-based payment awards and with the general rule for accounting for noncash transactions
Components of Shareholders' Equity (continued)
Accumulated Other Comprehensive Income •Extends our view of income beyond net income reported in an income statement to include four types of gains and losses not included in income statements: 1.Net holding gains (losses) on available-for-sale investment in debt securities 2.Gains (losses) from and amendments to postretirement benefit plans 3.Deferred gains (losses) on derivatives 4.Adjustments from foreign currency translation
Which of the following statements is true regarding retained earnings?
Accumulated, undistributed net income results in a credit balance in retained earnings
Concept Check: Equity Method Adjustments KB purchased 40% of the stock of RiteCo, Inc. for $500,000 on 1/1/2018, and accounts for the investment using the equity method. At 1/1/2018, 40% of the fair value of RiteCo's net assets is $500,000, and 40% of the book value of RiteCo's net assets is $200,000. One half of the difference is attributable to land, and the other half to a building being depreciated over 10 years. To account for this difference, during 2018 KB would reduce its investment in RiteCo by:
Answer- $15,000 ½ × ($500,000 − $200,000) ÷ 10 = $15,000
Shares Sold for Cash •Dow Industrial sells 10 million of its common shares, $1 par per share, for $10 per share:
Cash $100. (10m shares x $10) Common Stock $10. (10m shares x $1) Paid in Capital-excess of par $90 •If the shares are no-par, the entry is as follows: Cash $100. (10m shares x $10) Common Stock $100
If an Equity Method Investment is Sold Ex- The balance of United's 30% investment in Arjent at December 31, 2022, is $1,545,000. United sells its investment in Arjent on January 1, 2022, for $1,446,000.
Cash 1,466,000 Loss on Sale of Investment 99,000 Investment in Arjent Stock 1,545,000
More Than One Security Sold for a Single Price (continued) AP&P issues 4 million of its common shares, $1 par per share, and 2 million of its preferred shares, $5 par, for $100 million. Today's issue of The Wall Street Journal lists AP&P's common at $10 per share. There is no established market for the preferred shares.
Cash 100 Common Stock 4 Paid-in Capital- excess of par, common 36 Preferred Stock 10 Paid-in Capital- excess of par, preferred 50
Share Issue Costs In 2018, AveXis, Inc., sold 4,509,840 shares of its $0.0001 par common stock at $102 per share. the company received net proceeds from the public offering of $431,857,000, after deducting underwriting discounts and commissions and other offering expenses. AveXis's entry to record the sale was as follows:
Cash 431,857,000 Common Stock 451 ($0.0001 x 431,857,000 shares) Paid-in Capital- excess of par 431,856,549
Equity Method—Receiving Dividends
Cash 75,000. 30% x 250,000 Investment in Arjent Stock 75,000
The investor controls the investee (typically more than 50% of voting stock)
Consolidation- the financial statements of the investor and investee combine as if they are a single company
Impairment of AFS Investments (continued) Case 2: If United does not intend to sell the investment and does not believe it is more likely than not that it will have to sell the investment before fair value recovers, it will make the following journal entries:
Credit Loss Expense 120,097 Allowance for Credit Losses 120,097 Loss on AFS investment (unrealized, OCI) 64,524 Fair Value Adjustment 64,524
Concept Check: Treasury Stock Accounting and Subsequent Sale of Shares In 2021, Broyles, Inc. reacquired 3,000 shares of its common stock as treasury shares at $55 per share. In 2022, Broyles, Inc. sold 1,000 shares of the treasury stock at $75 per share. Which of the following would be included in the 2022 entry?
Credit Treasury Stock for $55,000
Chan Inc. purchased bonds for $800,000 that have a maturity value of $900,000. Chan's journal entry to record the purchase would include a:
Credit of $100,000 to Discount on bond investment
Concept Check: Shares Issued for Cash Beamer Co. issued 50,000 shares of $0.01 par common stock for $230,000. Which of the following will Beamer Co. record as part of the journal entry for this transaction:
Credit to Common stock for $500 Cash 230,000 Common Stock 500. (50,000 shares x $0.01) Paid-in Capital- excess of par 229,500
Concept Check: Held-to-Maturity Securities On July 1, 2018, Williams issued $600,000 of 10% bonds, dated July 1. Interest is payable semiannually on June 30 and December 31. The bonds mature in ten years. The market interest rate for bonds of similar risk and maturity is 12%. The entire bond issue was purchased by Joe, Inc. Due to unforeseen circumstances the company decided to sell its debt investment for $550,000 on January 1, 2020, at which time the bonds have an amortized cost of $580,000. Joe's journal entry to record the sale would include a:
Credit to investment in bonds for $600,000 Cash 550,000 Discount on bond investment 20,000 Loss on sale of investments 30,000 Investment in bonds 600,000
Concept Check: Available-for-Sale S&L Financial buys and sells securities which it classifies as available-for-sale. On December 31, 2018, a bond has an amortized cost of $800,000. The bond's fair value adjustment has a debit balance of $20,000, but the bond's fair value is now $825,000. The journal entry to adjust the fair value adjustment will include:
Debit to fair value adjustment for $5,000 Fair value adjustment 5,000 Unrealized holding gain—OCI 5,000
Accounting for Debt Investments
Debt Security -Specified date when it matures -Face amount paid to investors on maturity -In the meantime, interest paid to investors
Concept Check: Components of Paid-In Capital Which of the following is not a component of paid-in capital?
Earnings accumulated on behalf of the shareholders
financial instruments
Equities Securities - Common Stock, Preferred Stock Debt Securities- Bonds, Notes •Purchased by individual investors, mutual funds, and corporations Primary Objective:-To earn a return from the dividends or interest the securities pay or from increases in the market prices of the securities
The investor has significant influence over the operating and financial policies of the investee (typically between 20% and 50% of voting stock)
Equity Method- Investment reported at cost adjusted for investors share of subsequent earnings and dividends of the investee
Adjust AFS Investments to Fair Value Let's assume the Masterwear bond investment is classified as AFS. As of December 31, 2021, Masterwear has recorded the purchase of the bonds on July 1, 2021, as well as receipt of the first semiannual interest payment, so the bonds have an amortized cost of $671,297. The fair value of the bonds on December 31, 2021, is $714,943.
Fair Value Adjustment 43,646 Unrealized Holding Gain-OCI 43,646
The investor lacks significant influence over the operating and financial policies of the invested (typically owns less than 20% of voting stock):
Fair Value Through Net Income- similar to the trading-securities approach used for debt; Investment reported at fair value, unless fair value is not readily determinable
Concept Check: Components of Other Comprehensive Income Which of the following items would not be reported in the statement of comprehensive income as Other Comprehensive Income?
Gain on sale of equipment
Hybrid Organizations
Have characteristics of both regular corporations and partnerships Limited liability companies: •Owners are not liable for the debts of the business, except to the extent of their investment •All members can be involved with managing the business without losing liability protection •Income and expenses are passed through to the owners as in a partnership, avoiding double taxation •There are no limitations on the number of owners Limited liability partnerships: •Partners are liable for their own actions but not entirely liable for the actions of other partners
Equity Method—Adjustments for Additional Depreciation
Investment Revenue 30,000 Investment in Arjent Stock 30,000 30% x [2,000,000 - 1,000,000] / 10 years
Equity Method—Purchase of Investment
Investment in Arjent stock 1,500,000 Cash 1,500,000
Equity Method—Recognizing Investment Income
Investment in Arjent stock 150,000. 30% x 500,000 Investment Revenue 150,000
Ellsworth Corporation was organized on January 1, 2021. The firm was authorized to issue 150,000 shares of $1 par common stock. During 2021, Ellsworth had the following transactions relating to shareholders' equity: •Issued 20,000 shares of common stock at $7 per share •Issued 20,000 shares of common stock at $8 per share •Reported a net income of $100,000 •Paid dividends of $50,000 •Purchased 3,000 shares of treasury stock at $10 What was total shareholders' equity at the end of 2021?
Issue of stock (20,000 × $7) $ 140,000 Issue of stock (20,000 × $8) 160,000 Net income 100,000 Dividends (50,000) Treasury stock (3,000 × $10) (30,000) Total SE $320,000
Cash Dividends (concluded) On June 1, the board of directors of Craft Industries declares a cash dividend of $2 per share on its 100 million shares, payable to shareholders of record June 15, to be paid July 1:
June 1—Declaration Date Retained Earnings 200 Cash Dividends Payable 200 June 14—Ex-Dividend Date No entry June 15—Date of Record No entry July 1—Payment Date Cash Dividends Payable 200 Cash 200
The Corporate Organization—Advantages
Limited Liability •A corporation is a separate legal entity (separate and distinct from its owners), responsible for its own debts -The owners are not personally liable for debts of a corporation •Shareholders' liability is limited to the amounts they invest in the company when they purchase shares Ease of Raising Capital •Corporations sell ownership interest in the form of shares of stock and hence ownership rights are easily transferred
Impairment of AFS Investments Case 1: If United intends to sell the bonds, or thinks it will have to sell the bonds before the fair value of the bonds can recover to amortized cost, United would make the following journal entry to write down the investment and recognize a loss in net income:
Loss on Impairment (NI). 185,021 Discount on Bond Investment. 185,021
Stock Splits
Objective: •To induce the per share market price decline that follows •The motivation for reducing the per share market price is to increase the stock's marketability by making it attractive to a larger number of potential investors Example: •After a company declares a 100% stock dividend on 100 million shares of common stock, with a per share market price of $12, it then has 200 million shares, each with an approximate market value of $6
Property Dividends (concluded) On October 1, the board of directors of Craft Industries declares a property dividend of 2 million shares of Beaman Corporation's preferred stock. •Craft had purchased in March as an investment (book value: $9 million). •The investment shares have a fair value of $5 per share, $10 million. •The property dividend is payable to shareholders of record October 15, to be distributed November 1.
October 15—Date of Record No entry November 1—Payment Date Property Dividends Payable 10 Investment in Equity Securities 9 Fair Value Adjustment. 1
Property Dividends (continued) On October 1, the board of directors of Craft Industries declares a property dividend of 2 million shares of Beaman Corporation's preferred stock. •Craft had purchased in March as an investment (book value: $9 million). •The investment shares have a fair value of $5 per share, $10 million. •The property dividend is payable to shareholders of record October 15, to be distributed November 1.
October 1—Declaration Date Fair Value Adjustment 1 Unrealized Holding Gain - NI ($10 - $9) 1 Retained Earnings 10 Property Dividends Payable 10
The balance sheet of Chunn Industries included the following shareholders' equity section at December 31, 2021 ($ in millions): Common stock ($1 par value, authorized 100M shares, issued and outstanding 90M shares) $ 90 Paid-in capital—excess of par 540 Retained earnings 280 Total shareholders' equity $910 On January 5, 2022, Chunn purchased and retired 1 million shares for $9 million. Immediately after the purchase of the shares, the balances in the paid-in capital—excess of par and retained earnings accounts are:
Paid in Cap- $534 Retained Earnings- $278
Components of Shareholder's Equity
Paid-in Capital •Consists primarily of amounts: -Invested by shareholders when they purchase shares of stock from the corporation or -Arise from the company buying back some of those shares or -From share-based compensation activities Retained Earnings •Earnings accumulated on behalf of the shareholders and reported as a single amount. Treasury Stock •Shares previously sold to shareholders that are bought back by the corporation
Shares Sold for Noncash Consideration DuMont Chemicals issues 1 million of its common shares, $1 par per share, in exchange for a custom-built factory for which no cash price is available. Today's issue of The Wall Street Journal lists DuMont's stock at $10 per share.
Property, plant, and equipment 10 Common Stock 1 Paid-In Capital- excess of par 9
When the Investor Lacks Significant Influence (continued) Purchase Investment JE
Purchase Investment JE Investment in Arjent Stock 1,500,000 Cash 1,500,000 Recognize Investment Revenue JE Cash 75,000 Dividend Revenue 75,000
Stock Dividends (continued) Craft declares and distributes a 10% common stock dividend (10 million shares) when the market value of the $1 par common stock is $12 per share.
Retained Earnings 120 Common Stock 10 Paid-in Capital, excess of par 110
Comparison of Share Retirement and Treasury Stock Accounting—Share Buybacks, Case 2: Shares repurchased at $13 per share
Retirement JE Common stock ($1 par × 1 million shares) 1 Paid-in capital—excess of par ($9 per sh.) 9 Paid-in capital—share repurchase 2 Retained earnings (difference). 13 Cash 13 Treasury Stock JE Treasury Stock 13 Cash 13
Comparison of Share Retirement and Treasury Stock Accounting—Subsequent Sale of Shares (continued) American Semiconductor sold 1 million shares after reacquiring shares at $13 per share.
Retirement JE Case B: Shares sold at $10 per share Cash 10 Common Stock 1 Paid-in Capital, excess of par 9 Treasury Stock JE Cash 10 Retained Earnings 1 Paid-in Capital, excess of par 2 Treasury Stock 13
Comparison of Share Retirement and Treasury Stock Accounting—Share Buybacks, Case 1: Shares repurchased at $7 per share
Retirement JE Common stock ($1 par × 1 million shares) 1 Paid-in Capital- excess of par 9 Paid-in capital—share repurchase (difference) 3 Cash 7 Treasury Stock JE Treasury Stock 7 Cash. 7
Comparison of Share Retirement and Treasury Stock Accounting—Subsequent Sale of Shares American Semiconductor sold 1 million shares after reacquiring shares at $13 per share.
Retirement JE Sold 1 million shares Case A: Shares sold at $14 per share Cash 14 Common Stock(par) 1 Paid-in Capital, excess of par 13 Treasury Stock JE Cash 14 Treasury Stock(cost) 13 Paid-in Capital, excess of par 1
Which of the following is false about the sale of an equity investment?
Securities should remain on the balance sheet at amortized cost after sale
Adjust Trading Security Investments to Fair Value (2021) Assuming the Masterwear bonds have a fair value of $714,943 as of December 31, 2021, the table shows the calculation of the balance in the fair value adjustment account that is required on that date.
Security-Masterwear Amortized Cost-$671,297 Fair Value-$714,943 FV Adj Bal-$43,646 Fair Value Adjustment 43,646 Unrealized Holding Gain- NI 43,646
Fair Value Option (FVO—HTM & AFS)
The election is optional but irrevocable on the date of investment purchase. Under FVO: •HTM and AFS investments are shown in the balance sheets at fair value •Unrealized gains and losses are recognized in net income in the period in which they occur •Purchases and sales of investments are likely to be classified as investing activities
Which of the following is False about trading securities?
The investment account is increased/decreased to reflect the fair value
Adjust Equity Investments to Fair Value (2022)
Unrealized holding loss—NI 150,000 Fair Value Adjustment 150,000
Sell the Equity Investment
Unrealized holding loss—NI 4,000 Fair Value adjustment 4,000 Cash 1,466,000 Fair Value Adjustment 54,000 Investment in Stock. 1,500,000
Adjust Equity Investments to Fair Value (2021)
Unrealized holding loss—NI 50,000 Fair value adjustment. 50,000
Held-to-Maturity
Used for debt for which the investor has the "positive intent and ability" to hold to maturity. Unrealized holding gains/ losses not recognized Carried at balance sheet at Amortized Cost
The equity method:
Views the dividend payment as returning assets to its investors in the form of cash payment
Fair Value Changes in Period of Sale From ASC 320-10-40-1:
With respect to trading securities, because all changes in a trading security's fair value are reported in earnings as they occur, the sale of a trading security does not necessarily give rise to a gain or loss. Generally, a debit to cash (or trade date receivable) is recorded for the sales proceeds, and a credit is recorded to remove the security at its fair value (or sales price).
Recording Interest Revenue
dr- Cash dr- Discount on Bond Investment cr- Interest Revenue
Sale of HTM Investments (Realised Gain) On July 1, 2021, Masterwear Industries issued $700,000 of 12% bonds, dated July 1. Interest of $42,000 is payable semiannually on June 30 and December 31. The bonds mature in three years, on June 30, 2024. The market interest rate for bonds of similar risk and maturity is 14%. The entire bond issue was purchased by United Intergroup, Inc. Due to unforeseen circumstances the company decided to sell its debt investment for $725,000 on January 1, 2022.
dr- Cash 725,000 dr- Discount on Bond Investment 28,703. (700k-671,297) cr- Investment in Masterwear Bonds 700,000 cr-Gain on Sale of Investments. 53,703
Credit Losses for Held-to-Maturity Investments (concluded) On July 1, 2021, United Industries purchased bonds with a face value of $700,000 from Masterwear Industries. The stated rate of interest for the bonds is 12%, so $42,000 of interest is receivable semiannually on June 30 and December 31. The bonds mature in three years, on June 30, 2024. The market interest rate for bonds of similar risk and maturity is 14%. United purchased the bonds for $666,633, reflecting a discount of $33,367. United received its $42,000 interest payment on December 31, 2021, so it amortized $4,664 of discount, leaving the amortized cost of the bond investment at $671,297.* When preparing its 2021 financial statements, United considered whether credit losses had occurred with respect to the Masterwear investment. United concluded that it was likely to receive interest payments of only $30,000 each period and a return of principal at maturity of only $600,000. To record the $120,497 credit loss, United makes the following journal entry:
dr- Credit Loss Expense 120,297 cr- Allowance for Credit Loss 120,297
Recording the Purchase of a Debt Instrument
dr- Investment in Bonds $700k cr- Discount on Bond Investment $33,367 cr- Cash $666,633
Available for Sale
used for debt that does not qualify as held-to-maturity or trading. Recognized in other comprehensive income, and therefore in accumulated other comprehensive income in shareholders' equity. Carried at balance sheet at Fair Value
Trading
used for debt that is held in an active trading account for immediate resale. Recognized in net income, and therefore in retained earnings as part of shareholders' equity Carried at balance sheet at Fair Value
What If Conditions Change?
•A change to or from the equity method to another method -No adjustment is made to the remaining carrying amount of the investment (except to account for any purchase or sale of shares) -Previous method is discontinued and the new method applied from then on -The balance in the investment account serves as the starting point for the new method
Stock Splits (continued)
•A stock distribution of 25% or higher can be accounted for in one of two ways: -As a "large" stock dividend (stock split effected in the form of a stock dividend) -As a stock split (thus, a 100% stock dividend could be labeled a 2-for-1 stock split and accounted for as such) •Accounting treatment of a stock split is to make no journal entry •Since the total par represents twice as many shares in a 2-for-1 stock split, the par value per share will reduce by one-half •All records that refer to the previous amount must be changed to reflect the new amount •Account for the large stock distribution as stock split effected in the form of a stock dividend avoids the change to the records by recording an entry to change the balance in the stock account
Debt Investments Classified as Available-for-Sale Securities
•Available-for-sale (AFS) securities aren't held for trading or designated as held to maturity, thus neither HTM nor TS but falls in the middle -The investment is available for sale -Reported in balance sheet at fair value -Unrealized gains and losses are not included in net income but reported in statement of comprehensive income as other comprehensive income (OCI) -Unrealized gains and losses are reclassified to net income (NI) when the investment is actually sold
Financial Statement Presentation—Equity Securities
•Balance sheet: -Short term: Current assets -Long term: Noncurrent assets •Cash flow statement: -Short term: Operating activities -Long term: Investing activities •Notes to financial statement: -Disclose the portion of unrealized gains and losses for the period -How carrying value was calculated when fair value is not readily determinable
More Than One Security Issued for a Single Price
•Cash received usually is the sum of the separate market values of the two securities •If only one security's value is known, the second security's market value is inferred from the total selling price •The total selling price is allocated between the two securities, in proportion to their relative market values
Fundamental Share Rights
•Common shares: Ownership rights held by common shareholders, unless specifically withheld by agreement with the shareholders, are: -The right to vote on matters that come before the shareholders •Including the election of corporate directors -The right to share in profits when dividends are declared -The right to share in the distribution of assets if the company is liquidated •Preemptive right: Right to maintain one's percentage share of ownership when new shares are issued
Impairment of AFS Investments
•Companies are required to account for impairments of AFS investments, but the accounting is somewhat complex: -If fair value is less than amortized cost, impairment exists. accounting for the impairment depends on management's belief about whether it will sell the investment •If management either intends to sell the investment or believes it is more likely than not that it will have to sell it before fair value recovers, the AFS investment is written down to fair value and the impairment loss recognized in net income •If management does not intend to sell the investment and does not believe it is more likely than not it will have to sell the investment before fair value recovers, management is required to estimate and recognize credit losses and reduce the carrying value of the AFS investment with an allowance for credit losses
Credit Losses for Held-to-Maturity Investments
•Companies recognize credit losses for HTM investments by using a contra asset account, an allowance for credit losses, to reduce the carrying value of HTM investments to the net amount expected to be collected. -Each period they record whatever credit loss expense or recovery of credit loss is necessary to adjust that allowance to its appropriate balance -The CECL model allows for various methods to estimate credit losses for HTM debt investments •A very common approach is for the investor to estimate the future cash flows it expects to receive and then discount those cash flows at the effective interest rate that existed when the debt investment was purchased •The investor then compares that discounted cash flow estimate to the balance (amortized cost) of the debt, and adjusts the allowance for credit losses to reduce the carrying value of the debt to that estimate.
Reasons for Stock Dividends
•Company tries to give shareholders the illusion that they are receiving a real dividend •Merely to enable the corporation to take advantage of the accepted accounting practice of capitalizing retained earnings
How the Equity Method Relates to Consolidated Financial Statements
•Consolidate if the investor has a controlling interest: -Company owns more than 50% of the voting stock of another company -The investor is referred to as the parent and the investee is termed the subsidiary -The parent and subsidiary are considered to be a single reporting entity •Consolidated financial statements: -Combine the individual elements of the parent and subsidiary statements into a single financial statement •Goodwill: -Difference on the date of acquisition between the acquisition price and the sum of the fair values of the acquired net assets -Recognized as an asset
Cash Dividends (continued)
•Date of record -Stated specific date as to when the determination will be made of the recipients of the dividends -Registered owners of shares of stock on this date are entitled to receive the dividend To be a registered owner -->Investor must purchase the shares before the ex-dividend date -->Usually is one business day before the date of record
Retained Earnings Restrictions
•Designates a portion of the balance as being unavailable for dividends •Indicated by a disclosure note to the financial statements •Rarely, a formal journal entry may be used to reclassify a portion of retained earnings to an "appropriated" retained earnings account •A restriction of retained earnings communicates management's intention to withhold assets represented by a specified portion of the retained earnings balance
Stock Dividends
•Distribution of additional shares of stock to current shareholders of the corporation •Affects neither the assets nor the liabilities of the firm •Shareholders' proportional interest in the firm remains unchanged
Dividends
•Distributions of assets the company has earned on behalf of its shareholders Liquidating Dividend •Dividend exceeds the balance in retained earnings, the excess is referred to as a liquidating dividend •Any portion of a dividend not representing a distribution of earnings should be debited to additional paid-in capital
Distinguishing Classes of Shares
•If more than one class of shares is authorized by the articles of incorporation, the specific rights of each must be stated •Terminologies of different share types: -Class A, class B, and so on (Tyson Foods) -Preferred stock, common stock, and class B stock (Hershey's) -Common and preferred (HP) -Common stock and capital stock (Alphabet, Inc.) -Common and serial preferred (Smucker's)
Adjustments for Other Net Assets
•If the fair value of purchased inventory exceeds its book value, the period in which that inventory is sold should be identified -Inventory is usually sold in the next year •Investment revenue and its investment in the stock is reduced in the next year by the amount of the differential attributable to inventory
Financial Statement Presentation—HTM
•Income Statement and Statement of Comprehensive Income: -Realized gains and losses are shown in net income in the period in which securities are sold -Unrealized holding gains and losses are disclosed in notes to financial statements -Do not affect other comprehensive income (OCI) •Balance Sheet: -Investments in HTM securities are reported at amortized cost -Fair values of those investments are disclosed in the notes to financial statements •Cash Flow Statement: -Cash flows from buying and selling trading securities are classified as investing activities
Financial Statement Presentation: Trading Securities
•Income statement and statement of comprehensive income: -Gains and losses are included in the income statement in the periods in which fair value changes, regardless of whether they are realized or unrealized -Do not affect other comprehensive income (OCI) •Balance sheet: -Investments in trading securities are reported at fair value, typically as current assets •Cash flow statement: -Cash flows from buying and selling trading securities are classified as operating activities
Financial Statement Presentation: AFS
•Income statement and statement of comprehensive income: -Gains and losses are shown in OCI in the periods in which changes in fair value occur -Those amounts are reclassified out of OCI and recognized in net income in the periods in which securities are sold •Balance sheet: -Investments in AFS securities are reported at fair value -Unrealized holding gains and losses become part of AOCI in shareholders' equity, and are reclassified out of AOCI in the periods in which securities are sold •Cash flow statement: -Cash flows from buying and selling AFS securities are classified as investing activities
Trading Securities (TS)
•Investments in debt or equity securities acquired principally for the purpose of selling them in the near term -Active buying and selling of securities -Holding period generally is measured in hours and days rather than months or years -Typically reported among the investor's current assets •Fair value information is more relevant, so -Reported at fair value on the balance sheet, and -Unrealized holding gains and losses are included in net income in the period in which fair value changes
Fair Value Option: Equity Method
•Irrevocable decision about whether to elect the fair value option or not is made by the company •Company carries the investment at fair value in the balance sheet and unrealized gains and losses are included in earnings •Investments are shown on their own line in the balance sheet or can be combined with equity method investments with the amount at fair value shown parenthetically
No Adjustments for Land or Goodwill
•Land: -Land is not depreciated -Difference between the fair value and book value of the land would not cause higher expenses •Goodwill: -Unlike most of the other intangible assets, goodwill is not amortized -Acquiring goodwill will not cause higher expenses
Stock Market Reaction to Stock Distributions
•Market price per share will decline in proportion to the increase in the number of shares distributed in a stock dividend •Early rule-makers felt that per share market prices do not adjust in response to an increase in the number of shares •Capitalizing retained earnings for a stock dividend artificially reclassifies earned capital as invested capital •A corporation cannot increase its market value simply by distributing additional stock certificates
The Concept of Par Value
•Most shares continue to bear arbitrarily designated par amounts •Shares with nominal par amounts became common to dodge elaborate statutory rules pertaining to par value shares •Like the designations of common and preferred shares, the concepts of par value and legal capital have been eliminated entirely from the Model Business Corporation Act
Cash Dividends
•No legal obligation exists for paying dividends to shareholders •Liability is not recorded until a company's board of directors votes to declare a dividend
Property Dividends
•Noncash asset distributed to shareholders as dividend •Often called a dividend in kind or a nonreciprocal transfer to owners •Securities held as investments are the assets most often distributed in a property dividend •Should be recorded at the fair value of the assets to be distributed (as in any noncash transaction)
Types of Corporations
•Not-for-profit corporations may be owned: -By the public sector -By a governmental unit Examples: Churches, hospitals, universities, and charities; Government-owned—the Federal Deposit Insurance Corporation (FDIC) •Corporations organized for profit may be: -Publicly held: Stock of publicly held corporations is available for purchase by the general public -Privately held: Shares are owned by only a few individuals (perhaps a family) and are not available to the general public •Frequently, companies begin as privately held corporations and then go public. Example: Facebook
Further Adjustments under the Equity Method
•Occur when investor's expenditure to acquire an investment exceeds the book value of the underlying net assets acquired •Purpose: -To approximate the effects of consolidation, without actually consolidating financial statements •Amortizing the differential between purchase price and book value: -Adjust investment account and investment revenue to act as if consolidation procedures had been followed •If assets would have been written up to fair value, act as if that happened •Impute higher expenses in subsequent periods when those assets are expensed, such that •Earnings are lower by the investor's share in that additional expense
Typical Rights of Preferred Shares
•Often, shares with certain preferences or features that distinguish them from common shares are designated as preferred stock Rights include one or both of the following: 1. If the board of directors declares dividends, preferred shareholders will receive the designated dividend before any dividends are paid to common shareholders 2. Preferred shareholders customarily have a preference over common shareholders as to the distribution of assets in the event the corporation is dissolved
Is It Equity or Is It Debt?
•Preferred shares are somewhat hybrid securities— a cross between equity and debt •Equity because preferred shareholders receive dividends each year the company pays dividends •Debt because the company is obligated to pay cash (or other assets) at a fixed or determinable rate in the future -Mandatorily redeemable preferred shares must be reported in the balance sheet as a liability, not as shareholders' equity
Accounting for Treasury Stock
•Purchase of treasury stock is viewed as a temporary reduction of shareholders' equity •Cost of acquiring the shares is "temporarily" debited to the treasury stock account •Shares are considered to be issued, but not outstanding •Purchase of treasury stock and its subsequent resale is considered to be a "single transaction" •This approach to accounting for treasury stock is referred to as the "cost method"
Characteristics of Retained Earnings
•Retained earnings represents a corporation's accumulated, undistributed net income (or net loss) •A more descriptive title would be reinvested earnings
When the Investor Has Significant Influence—The Equity Method
•Significant influence usually is assumed to exist if the investor owns between 20% and 50% of the investee's voting shares •What does significant influence mean? -Decisions can be swayed in the direction the investor desires •Investment is accounted for by the equity method -Investment initially recorded at cost -Increase by investors' percentage share of net income -Decrease by investors' percentage share of dividend
Resale of Shares
•Subsequent sale of shares after shares are retired is recorded exactly like any sale of shares •Resale of treasury shares is viewed as the consummation of the "single transaction" begun when the treasury shares were purchased •Allocating the cost of treasury shares occurs when the shares are resold
The Corporate Organization—Disadvantages
•The state and federal governments impose extensive reporting requirements -Primarily the required paperwork is intended to ensure adequate disclosure of information needed by investors and creditors •Double taxation -Corporations first pay income taxes on their earnings -Then, when those earnings are distributed as cash dividends, shareholders pay personal income taxes on the previously taxed earnings
Impairment of HTM Investments
•There is one important exception to the general rule that companies don't recognize unrealized gains and losses for HTM investments. If viewed as an HTM investment: -Companies likewise are required to use the Current Expected Credit Loss (CECL) model to account for credit losses on HTM investments •This requires companies to make an estimate of the amount of interest and principal payments they won't receive in the future •Companies account for that estimate by recognizing a credit loss in net income and reducing the carrying value of the HTM investment with an allowance for credit losses
Share Repurchases
•Viewed as a way to "distribute" company profits without paying dividends •Decreasing the supply of shares in the marketplace supports the price of remaining shares •Acquisition of a company's own shares does not create an asset •Companies buy back shares to offset the increase in shares issued to employees in compensation plans
Statement of Comprehensive Income
•We report two attributes of OCI: -Components of comprehensive income created during the reporting period in the statement of comprehensive income -The comprehensive income accumulated (AOCI) over the current and prior periods in the balance sheet
