F3 Flashcards
(Ownership, right to acquire or dispose)
Equity securities are defined as securities that represent an ownership interest in an enterprise or the right to acquire or dispose of an ownership interest in an enterprise at fixed or determinable prices.
(Equity represented by ownership,right to buy,and right to sell)
- Ownership shares (common,preferred, and other forms of capital stock),
(PTC)
- Preferred stock redeemable at the option of the investor or stock that must be redeemed by the issuer,
Classifications of securities(3)
- Trading securities
- Trading Securities = Current assets
Trading securities are those securities (both debt and equity) that are bought and held principally for the purpose of selling them in the near term.
- Available-for-sale securities = Non-current assets (GR)
Are those securities (both debt & equity) not meeting the definitions of the other two classifications (trading or held-to-maturity). Available-for-sale securities are reported as either current assets or non-current assets, depending on the intent of the corporation. If the security represents cash available for current operations, it is appropriate to report the security as a current asset.
- Held-to-Maturity Securities (debt securities only) = Non-Current assets (GR)
Investments in debt securities are classified as held-to-maturity securities only if the corporation has the positive intent and ability to hold these securities to maturity. Held-to-Maturity securities are reported as current or noncurrent assets, based on their time to maturity.
U.S.GAAP VS. IFRS: Under IFRS, marketable security investments can be classified as follows:
- Financial assets at FV through profit or loss,
@ Fair Value = Mark to market
Trading and available-for-sale securities must be reported at FV. Changes in the FV of trading and available-for-sale securities result in unrealized holdings gains or losses.
Unrealized Gains and Losses of Trading securities: included in earnings ( I of I-D-E-A)
Journal entry to record loss on the income statement:
Unrealized Gains and Losses of Available-for-sale Securities: Reported in OCI ( P[U]FE)
Journal entry to record unrealized loss reported in OCI:
U.S.GAAP VS. IFRS
Under IFRS, unrealized gains and losses on available- for- sale securities are reported in OCI, except for foreign exchange gains and losses on available-for-sale debt securities, which are reported directly on the IS. Foreign exchange gains and losses on available-for-sale equity securities are included in OCI.
Held-to-Maturity Securities
Held-to-Maturity Securities are valued at amortized cost.
Reclassification: Any transfer of a particular security from one group to another group is accounted for at FV. Any unrealized holding gain or loss on that security is accounted for as follows:
1.From Trading Category: the unrealized holding G/L at the date of transfer is already recognized in earnings and shall not be reversed.
(permanent declined in FV)
Under U.S.GAAP, if the decline in FV is permanent, the cost basis of the individual security is written down to FV as the new cost basis and the amount of the write-down is accounted for as a realized loss and included in earnings (IS).
U.S. GAAP VS. IFRS: Impairment of securities
Under IFRS, an impairment loss is recognized in earnings and the idv.security is written down by either directly reducing the cost basis of the security or through the use of a valuation allowance. Additionally, previously recognized impairment loss on held-to-maturity debt securities and available-for-sale debt security may be reversed, with the amount of the reversal recognized on the IS. For a held-to-maturity security, the CV of the security after the reversal cannot exceed what the amortized cost of the security would have been had the impairment not been recognized.
Sale of security
A sale of a security from any category results in a realized gain or loss and is reported on the IS for the period. Any unrealized gains or losses in accumulated OCI must be reversed at the time the security is sold.
Sale of Trading securities
Journal entry:
Sale of available-for-sale securities
Journal entry:
Income tax effect of sale of security
Tax effects of unrealized gains or losses entering into the determination of net income must be reflected in the computation of deferred income taxes, because unrealized gains and losses are not deductible for tax purposes.
Consolidated Financial statements
Consolidated financial statements ignore important legal relationships and emphasize economic substance over form. Consolidated financial statements are an economic truth but a legal fiction.
Criteria of when to consolidate
- Consolidate All majority-owned subsidiaries (over 50% of voting interest is owned by parent company) to have one management and one economic entity.
Criteria of when not to consolidate
DO NOT consolidate when control is not with owners (e.g., under legal reorganization or when control of a subsidiary is with a trustee).
U.S. GAAP VS. IFRS
Under U.S. GAAP, significant transactions during the gap period require disclosure. Under IFRS, the subsidiary financial statements must be adjusted for significant transactions during the gap period.
Degree of control
The degree of control the investor has over the investee dictates how the investor reports the investment in corporate equity securities.
Cost Method/Do Not Consolidate = No significant influence (typically
The investor accounts for the investment using the cost method (FV method/AFS method) if the investor does not have the ability to exercise significant influence over the investee.
Equity Method/Do Not consolidate = Significant influence but 50% or less ownership (20%-50%)
The investor accounts for the investment using the equity method of accounting if the investor can exercise significant influence over the investee and holds 50% or less of the voting stock.
Consolidate = Control (greater than 50% ownership)
The investor should prepare consolidated financial stmts w/ its investees when the investor has control(>50% ownership) of the subsidiary. Internally, the investor may use either the cost method or the equity method to account for its investments.
Cost method (
also known as the fair value method or the available-for-sale method, should be used when the investor owns
Note:
if a company owns less than 20% of the stock of an investee company, but exercise significant influence, the equity method must be used.
Balance sheet-Investment in Investee
The carrying amt of the investments acct on the investor’s(parent’s) books is “original cost” measured by the FV of the consideration given, including legal fees.
The investment account stays the same from the date of acquisition unless:
a. Share of stock in the investee are purchased or sold.
Journal entry to record all costs of acquisition(FV of consideration+legal fees)
Record at cost:
Marketable Securities-Adjust to FV
Journal entry to record unrealized loss and adjust to FV at year-end:
Reduce Investment in Investee for Return of Capital Distributions
Journal entry to record a return of capital distribution or liquidating dividend is a dividend in excess of investor’s share of retained earnings:
Income Statement
Record cash dividends from the investee’s retained earnings. Do not recognize stock dividends (Memo entry only).
- Dividends to the investor/Parent (from investee) are Income (earnings) to the investor /Parent (out of the sub’s undistributed earning/RE)
Journal entry to record the cost method does not recognize a prorated share of the investee’s earning as income to the investor/parent:
- Distribution that exceed investor’s share of the investee’s RE (reduce basis/return of capital distribution)
Journal entry to record distribution:
Pass Key
The following 3 issues are the most frequently tested “cost” concepts:
Equity method (20%- 50% or exercises significant influence, record at cost)
The investment acct increases by the investor’s share of the investee’s net income w/ a corresponding credit to the investor’s income stmt acct, Equity in sub/Investee income. The distribution of dividends by the investee reduces the investment balance. Continuing losses by an investee may result in a decrease of the investment acct to a zero balance.
Exercises significant influence:
Exercises significant influence:
Equity method not appropriate (even if the investor owns 20% to 50% of sub)
a. Bankruptcy of subsidiary
Investment in Investee using equity method: Journal entry to record at cost (FV of consideration plus legal fees):
DR: Investment in investee
Journal entry to record increase by the investor’s/ parent’s ownership % of earnings of investee
DR: Investment in investee
Journal entry to record decrease by the investor’s/parent’s ownership % of cash dividends from investee (stock dividends reduce unit cost of stock owned in investee):
DR: Cash
*** Stock dividend = Memo entry only
Stock dividend = Memo entry only
Pass Key
An easy way to remember all the GAAP accting rules for the “equity method” is to think of it like a bank account and use BASE account analysis: Beginning balance + Investor’s share of investee’s earning (like bank interest; it is income when earned, not when taken out) - Investor’s share of investee’s dividends (like bank withdrawals; and it is not income) = Ending balance.
Example_Equity method: On Jan 01, year 1, Big corp. acquired a 40% interest in Small company for $300,000. At the date of acquisition, Small Co.’s equity(net assets) had a BV $750,000. During year 1, Small Co. had net income of $90,000 and paid a $40,000 dividend.
*JE to record the initial investment of 40%:
On December 31, Year 1, what is the balance of investment account on the balance sheet?
Investment account = $300,000 +$36,000 - $16,000 = $320,000.
Investments in Investee Common stock and Preferred Stock:
- The “significant influence” test = Common Stock owned(voting)
Goodwill:
Purchase Price if Investment > FV of Equity acquired
Under Equity method, Goodwill Difference is not amortized and No Impairment Test
However, the total equity method investment (including goodwill) must be analyzed at least annually for impairment.
Asset Fair Value Difference (Premium):
FV of Equity Acquired > Book Value of Equity Acquired
Under Equity method, Asset FV difference (Premium) is amortized over Related Asset life
JE:
Workpaper Elimination- Intercompany merchandise Transactions
DR: Intercompany Sales[Parent]
