F3: Marketable Securities and Business Combinations Flashcards
Equity Securities
320
Marketable Debt (bonds) and Equity Securities (stock)
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
include: ownership shares, rights to acquire ownership shares, and rights to dispose of ownership shares (put)
excludes: preferred stock redeemable at the option of the investor or stock that must be redeemed by the issuer, treasury stock, and convertible bonds
Classification of Securities
3 categories:
- Trading Securities
- Available-for-Sale Securities
- Held-to-Maturity Securities
Trading Securities
securities bought and held for sale in near term
- GR: current assets, but can be noncurrent
- both debt and equity
~ classified into operating cash flows (if current) or investing cash flows (if noncurrent)
Available-for-Sale Securities
is not Trading or Held-to-Maturity
- GR: noncurrent assets, but can be current
- both debt and equity
~ aggregate cost is original cost (not adjusted for previous unrealized gain/loss)
Held-to-Maturity Securities
only if corp has the positive intent and ability to hold these securities to maturity
- GR: noncurrent assets, depends on time to maturity
- debt securities only
- equity doesn’t mature
Trading and AFS Valuation/ unrealized g/l
Marketable Securities
- fair value
- changes in FV result in unrealized holding gains/losses
unrealized g/l- Trading Securities
- included in earnings
- shown in IS
- dr: unrealized loss, cr: valuation acct
unrealized g/l- AFS
- reporting in OCI
- PUFE
- dr: unrealized loss, cr: valuation acct
- accumulated until realized in AOCI, but comprehensive income is just gain/loss for the period bc previous was already in AOCI
realized g/l
- when security is sold
- when AFS security is deemed impaired
- all g/l are recognized on IS
Held-to-Maturity Securities Valuation
Marketable Securities
valued at amortized cost (which you add, JE “discount on bonds” and it’s part of Interest Revenue*)
- no unrealized g/l
- investing cash flow
Reclassification
Marketable Securities
transfer b/w categories, should only occur when justified
- any transfer is accounted for at fair value
Unrealized Holding G/L
- from Trading: already recognized in earnings and shall not be reversed
- to Trading: recognize in earnings immediately
- debt security HTM transferred to AFS: reported in OCI (HTM was valued at amortized cost and AFS is FV)
- debt security AFS transferred to HTM: already reported in OCI (amortize into IS any gain/loss that was in OCI over remaining life)
Impairment of Securities
Marketable Securities
enterprise determines if decline in value for AFS or HTM is permanent
- if so, the cost basis is written down to fair value and the amount of the write-down is accounted for as a realized* loss and included in earnings
- IS
- new cost basis not changed for subsequent recoveries
- HTM can’t recognize subsequent increase
- AFS subsequent increase in FV is included in OCI
- not on IS
- subsequent decreases for AFS included in OCI and accounted for as an unrealized loss
Financial Instruments used to Hedge the FV of Investments
Marketable Securities
Used to Hedge Trading Securities
- gains and losses on financial instruments that hedge TS is reported in earnings
- consistent w reporting of unrealized gains and losses on trading securities
Used to Hedge AFS Securities
- gains and losses on derivative instruments that hedge AFS are recognized currently in earnings together w the offsetting losses or gains on the AFS securities attributable to the hedged risk
Sale of Security
results in realized gain or loss reported on IS
- valuation acct would also have to be removed
- for Trading: realized gain or loss is diff b/w adjusted cost and the selling price
- for AFS: diff b/w selling price and original cost
- any unrealized g/l in AOCI must be reversed (out of AOCI/PUFE and into the IS)
Income Tax Effect When Sold
Marketable Securities
tax effects of unrealized gains or losses entering into Net Income must be reflected in computation of deferred income taxes
- bc unrealized gains and losses are not deductible for tax purposes
- then you’ll have real income tax expense instead of deferred when sold
- but unrealized capital losses should only be recognized when it is certain the benefit will be realized by the offset of the capital losses against cap gains
Required Disclosures~
Marketable Securities
for AFS and HTM
- aggregate FV
- gross unrealized holding gains and losses
- amortized cost basis by major security type
- info about contractual maturities of debt securities
Consolidated Financial Statements
consolidated FSs ignore important legal relationships and emphasize economic entity* substance over form
- an economic truth but legal fiction
- prepared by parent not by sub
*Acquisition Method- Fundamental Principles (req for acq of sub under both GAAP and IFRS)
- Recognition Principle: recognizes all sub’s assets and liabilities, including identifiable intangible assets
- Measurement Principle: measure each recognized asset and liability and any noncontrolling interest at FV
(even if you only buy 60%, write up sub’s 100% FV)
~limitations F3-10
Criteria of When to and When Not to Consolidate
Business Combinations/Consolidations
- consolidate ALL majority-owned subsidiaries (over 50% of voting interest) to have one management and one economic entity
- do NOT consolidate when control is not w owners (e.g. under legal reorganization or control is w a bankruptcy trustee)
- companies w diff year ends can be consolidated
IFRS vs GAAP: for GAAP, disclose gap period for IFRS, adjust for transactions during gap - if parent owns >50% of subsidiary and sub owns >50% of a third comp, consolidate third into sub then sub (w third) into parent
GAAP vs IFRS
- for IFRS, parent must consolidate unless all are met:
- parent comp is a wholly owned sub or partially owned and the owners do not object to parent not presenting
- parent company is not publicly traded and not in the process of issuing securities in a public market
- ultimate or any intermediate parent of the parent comp produces consolidated FSs in compliance w IFRS
Degree of Control
Business Combinations/Consolidations
No Significant Influence <20%
- cost method
- do not consolidate
Significant Influence but 20% to 50%
- equity method
- do not consolidate
Control >50%
- consolidate
- internally, can use cost or equity
Cost Method
does not exercise significant influence (< 20%)
- aka FV method or AFS method
- if own < 20% but with sig. influence, use equity method
Balance Sheet- Investment in Investee
- carrying amt is original cost (FV of consideration given + legal fees)
- marketable securities: adjust to FV, unrealized holding gains and losses to OCI
- reduce Investment in Investee for Return of Capital Distributions (when distribution is more than EandP)
Income Statement
- record cash dividends from investee’s RE (EandP)
- do not recognize stock dividends (memo entry only)
Most Freq. Tested Cost Concepts
- Investment in Investee is not adjusted for investee earnings
- Investment in Investee is adjusted to FV
- Cash Dividends from the investee are reported as income by the investor (parent)
Equity Method
exercises significant influence (20-50%) they’ll say:
- largest shareholder
- majority of
- even if < 20%, if sig influence use equity method*
- when not to use equity method: F3-14
- equity method = bank account
Balance Sheet - Investment In Investee
- carrying amt is orignal cost + legal fee
- increase by ownership percentage of earnings
(dr: investment in investee, cr: equity in earnings/investee income) - decrease by ownership percentage of cash dividends from investee
(dr: cash, cr: investment in investee)
Income Statement
- record ownership % of investee’s earnings as income
(dr: investment in investee, cr: equity in earnings/investee income) - dividends are not income
- stock dividends are memo entry only
Investment in Investee CS and PS
Equity Method
if an investor company owns both CS and PS
- significant influence test generally met by amt of CS, which is usually the only voting stock
- calculation of income from subsidiary includes:
a. preferred stock dividends and
b. share of earnings available to CS (NI - preferred div)
Differences b/w Purchase Price and Book Value (NBV) of the Investee’s Net Assets
Equity Method
why you paid premium
- amortize over the premium (remember to do every year*)
- if it’s land or goodwill, don’t amortize
- amortize proportionally if more than 1 item you paid premium on
Diff b/w NBV and FV
- premium that you amortize (unless land or goodwill)
- causes net income to decrease
(dr: equity in investee income, cr: investment in investee) - like a bank service charge
Diff b/w FV and Purchase Price
- is goodwill
- not amortized and no impairment test*
~ but total equity method investment (including goodwill) must be analyzed at least annually for impairment*
Joint Venture Accounting
under both GAAP and IFRS, investors account for joint venture investments using equity method
- like partnership 50/50 so neither controls
Step by Step Acquisition
corp may acquire an investment in an investee in more than one transaction
- any goodwill must be computed at each transaction
Change from Cost Method to Equity Method
- when sig. influence is acquired, must record change from cost/AFS to equity method
- investment acct and RE acct are adjusted retrospectively, using prior period’s OLD %, not the new % that requires equity method bc you didn’t own that back then**
- To Equity from Cost
- must start using equity, periods that used cost method retrospectively adjusted w the prior % - Equity in Investee Income Calculation
- if add. investment made during the year, multiply the:
- investee’s income by % owned prior year
- then add to investee’s income multiplied by the fraction of the year remaining and the % of ownership after change
From Equity to Cost
- no retroactive
- use equity for that time still, but then change to cost
Acquisition Recognition
Acquisition Method
For Cash
- dr: investment in sub, cr: cash
For Parent Co Stock
- use FV at date transaction closes, not announced
- dr: investment in sub, cr: common stock, cr: APIC
Application of Acquisition Method
2 distinct characteristics
- 100% of net assets acquired (regardless of % acquired) are recorded at FV w any unallocated balance to goodwill
- subsidiary’s entire equity is eliminated
"CAR IN BIG" in Eliminating Journal Entry (EJE) Common stock APIC Retained earnings - CAR is eliminated by debiting
Investment in Subsidiary is eliminated by crediting
Noncontrolling Interest (NCI) is created
- FV of subsidiary not acquired by parent
- goes in equity of consolidated FS separate from parent’s equity, so credit
Balance sheet of subsidiary is adjusted to FV
- 100% assets and liabilities, even if acquired less
Identifiable intangible assets of the sub recorded at FV
Goodwill (or gain) is required
- excess of FV of sub over FV of sub’s net assets
- if net assets >, then record the shortage/negative as a gain instead of goodwill
- debit BIG
CAR
Acquisition Method
CAR Formula
- assets - liab = equity/NBV/CAR
- have to backtrack BASE to get beginning retained earnings if they give you end of year retained earnings**
Acquisition Date Calculation
* F3-27
Investment in Subsidiary
IN
Acquisition Method
- original cost: FV on date acq. is completed of the consideration given
- business combination costs/expenses in acq. are treated as follows:
a. direct out of pocket costs like finder’s fee or legal fees are expensed (dr: expense)
b. stock registration and issuance costs like SEC filing fees are a direct reduction of value of stock issued (dr: APIC of parent)
c. indirect costs are expensed as incurred (dr: expense)
d. bond issue costs are capitalized and amortized (dr: bond issue costs)
Noncontrolling Interest (NCI)
IN
Acquisition Method
must be reported at FV in equity section of consolidated BS**, separately from the parent’s equity (both make up total stockholders equity in consolidated BS)
- this will include the NCI’s share of goodwill, even though there is no cost basis
Balance Sheet
- report NCI in consolidated equity
- the consolidated BS will include 100% of sub’s assets and liabilities
1. NCI = subsidiary FV * NCI % at acquisition date
2. NCI after acquisition = beginning NCI + NCI share of sub net income - NCI share of sub dividends = ending NCI
3. Allocation of Sub Net Loss to NCI even if it exceeds the equity attributable to the NCI
Income Statement
- consolidated IS includes 100% of sub’s revenues and expenses AFTER the date of acquisition
- should separately show: consolidated net income, net income attributable to the NCI, and net income attributable to the parent
GAAP vs IFRS
- GAAP uses full goodwill method (FV of sub)
- IFRS can use full or partial goodwill method (FV on sub’s net identifiable assets)
BIG
Acquisition Method
FV of Subsidiary (Acq Cost + NCI) reconciliation to Book Value of Sub Net Assets
- Balance Sheet Adjustment from book value to FV
- Identificable Intangible Assets related to acq. of sub is recorded at FV
- In Process RandD is carried as an intangible asset; expense the RandD costs after acq; if success, amortize IP RandD; if failure, impair/write off IP RandD
- Goodwill is recognized for any excess of the FV of sub over FV of sub’s net assets, if FV is sub is less a gain is recognized
Determining Acquisitions with Goodwill
BIG
Acquisition Method
parent paid more than FV of assets
step 1- BS Adjusted to FV
- FV of 100% of BS accounts
- recalculate depreciation
step 2- Identifiable Intangible Assets to FV
- FV of 100% of identifiable intangibles
- Finite Life: amortize over remaining life, subject to 2 step impairment test
- Indefinite Life: do not amortize. subject to impairment step
Step 3- Goodwill
- allocate any remaining acquisition costs
- not amortized, subject to impairment test
- written down and charged as expense against income on IS
Private Company Accounting Alternative for Goodwill
under GAAP, a private company can
- elect to amortize goodwill (max 10 years)
- elect an acct policy where it would not separately recognize some intangible assets and instead include it in goodwill
the acct policy also applies when a private company is required to recognize the FV of intangible assets bc:
- applying equity method to joint ventures
- adopting fresh-start reporting in a reorganization
can only elect the acct policy if also elects the goodwill alternative, but can elect goodwill w/o electing accting policy
- once elected, must apply prospectively to all business combinations
IFRS Goodwill
GAAP vs IFRS
- GAAP uses full goodwill method (FV of sub)
+ goodwill = FV of sub - FV of sub’s net assets
- IFRS can use full or partial goodwill method (FV on sub’s net identifiable assets)
+ goodwill = acquisition cost - FV of sub’s net assets acquired
Determine Acquisition with Gain
BIG
Acquisition Method
parent acquired at a discount and paid less than NBV
- credit gain instead of debiting goodwill
- FV of identifiable assets greater than acquisition cost
Consolidated Statement of Cash Flow
Acquisition Method
Period of Acquisition
- net cash spent or received in acq. must be reported in the investing section of the statement of cash flows
- assets and liabilities of the sub on acq. date must be added to parent’s assets and liabs at beg. of year in order to determining change in cash due to operating, investing, and financing activities during the period
Subsequent Periods
- similar to prep of a statement of cash flows for a nonconsolidated entity except for:
- when reconciling net income to net cash provided by operating activities, total consolidated net income (net income from both parent and NCI) should be used
- financing section should report dividends paid by the sub to noncontrolling shareholders, but not to parent
- investing section may report acquisition of add. subsidiary shares by the parent if acq. was an open market purchase
Step Acquisition- Consolidation and Deconsolidation
Acquisition Method
cost/equity to consolidation (control)
- remeasure previously held equity interests to FV
- previous CS adj. to FV
- IS will reflect this adjustment
movement within control (still over 50%)
- equity transaction: no gain or loss recognized on IS; APIC is adjusted
- treat like a treasury stock transaction
control to non control
- recognize gain or loss on sale of stock (sale = gain or loss to IS)
- remeasure remaining non-consolidating interest to FV (adjust remaining CS to FV)
- recognize the adj. to the FV on the IS (recognize ^ that adj. in IS as gain/loss**)
anytime you cross over control, recognize everything at FV and all adj. will go through IS
- gaining control and losing control are remeasurement events bc F3-42 pass key
Acquisition Method Disclosures
805
- in a business combination achieved in stages:
a. acquisition date FV of equity interest held before acquisition date
b. amt of any gain or loss recognized from remeasuring the equity interest held before the business combo to FV
c. valuation techniques used to measure……. - if the acquirer is a public entity…….
Consolidation Disclosures
- consolidated FSs should disclose the consolidated policy that is being followed
F3-44
Intercompany Transactions
eliminate 100% of intercompany transactions, even when noncontrolling interest exists
Balance Sheet
- payables and receivables
- intercompany gross profit in ending inventory and fixed assets of parent or subsidiary
Income Statement
- interest expense/ interest income (bonds)
- gain on sale/ depreciation expense (intercompany fixed asset sales)
- sales/ COGS (intercompany inventory transactions)
Not Consolidated
- don’t eliminate intercompany transactions
- separate report in financial statements
- footnote disclosure
Intercompany Inventory Transaction
- reverse the original intercompany transaction (sale and cost of goods sold, internally) and
- inventory sold to outsiders: correct COGS
- inventory still on hand: correct ending inventory
Intercompany Bond Transactions
if one member of the consolidated group acquires an affiliate’s debt from an outsider, the debt is considered to be retired and a gain/loss is recognized on the consolidated income statement
- gain/loss on extinguishment of bonds
- intercompany interest eliminated: expense, income, payable, receivable
- eliminate amortization or premium
Intercompany Sale of Land
workpaper elimination entry in period of sale eliminates the intercompany gain/loss and adjusts the land to its original cost
Intercompany Profit on Sale of Depreciable Fixed Assets
working paper elimination entry in period of sale eliminates intercompany gain/loss and adjusts the asset and accumulated depreciation to original balance on date of sale
Combined Financial Statements
combined financial statements of a group of related companies
- not consolidated bc there is no parent company
Types
- companies under common control
- companies under common management
- unconsolidated subsidiaries
Requires
- intercompany transactions and balances eliminated
- noncontrolling interests treated like consolidated FSs
- capital stock and retained earnings be added across, not eliminated
- income statements be added across
Push Down Accounting
reports assets and liabilities at FV in separate FSs of the subsidiary
- in effect, consolidated adjustments are pushed down into the records (and separate FSs) of each sub
F3-54
Consolidated Equity and Consolidated NI
Equity Method
- Equity: parent company’s equity + FV on any NCI (equity method so add their share of income and dec for share of distributions)
- NI: parent company’s NI
List of Identifiable Intangibles
F3-32
Trading Security reclassified to Held to Maturity
SIM
ineligible transaction because only applies to debt securities
