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CPA FAR > F3: Marketable Securities and Business Combinations > Flashcards

F3: Marketable Securities and Business Combinations Flashcards

1
Q

Equity Securities

320

A

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

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2
Q

Classification of Securities

A

3 categories:

  1. Trading Securities
  2. Available-for-Sale Securities
  3. Held-to-Maturity Securities
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3
Q

Trading Securities

A

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)

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4
Q

Available-for-Sale Securities

A

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)

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5
Q

Held-to-Maturity Securities

A

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
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6
Q

Trading and AFS Valuation/ unrealized g/l

Marketable Securities

A
  • 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
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7
Q

Held-to-Maturity Securities Valuation

Marketable Securities

A

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
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8
Q

Reclassification

Marketable Securities

A

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)
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9
Q

Impairment of Securities

Marketable Securities

A

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
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10
Q

Financial Instruments used to Hedge the FV of Investments

Marketable Securities

A

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

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11
Q

Sale of Security

A

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)
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12
Q

Income Tax Effect When Sold

Marketable Securities

A

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
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13
Q

Required Disclosures~

Marketable Securities

A

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
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14
Q

Consolidated Financial Statements

A

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

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15
Q

Criteria of When to and When Not to Consolidate

Business Combinations/Consolidations

A
  • 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
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16
Q

Degree of Control

Business Combinations/Consolidations

A

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
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17
Q

Cost Method

A

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)
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18
Q

Equity Method

A

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
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19
Q

Investment in Investee CS and PS

Equity Method

A

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)
20
Q

Differences b/w Purchase Price and Book Value (NBV) of the Investee’s Net Assets

Equity Method

A

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*

21
Q

Joint Venture Accounting

A

under both GAAP and IFRS, investors account for joint venture investments using equity method
- like partnership 50/50 so neither controls

22
Q

Step by Step Acquisition

A

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**
  1. To Equity from Cost
    - must start using equity, periods that used cost method retrospectively adjusted w the prior %
  2. 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
23
Q

Acquisition Recognition

Acquisition Method

A

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
24
Q

Application of Acquisition Method

A

2 distinct characteristics

  1. 100% of net assets acquired (regardless of % acquired) are recorded at FV w any unallocated balance to goodwill
  2. 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

25
Q

CAR

Acquisition Method

A

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

26
Q

Investment in Subsidiary

IN
Acquisition Method

A
  • 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)
27
Q

Noncontrolling Interest (NCI)

IN
Acquisition Method

A

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)
28
Q

BIG

Acquisition Method

A

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
29
Q

Determining Acquisitions with Goodwill

BIG
Acquisition Method

A

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
30
Q

Private Company Accounting Alternative for Goodwill

A

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

31
Q

IFRS Goodwill

A

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
32
Q

Determine Acquisition with Gain

BIG
Acquisition Method

A

parent acquired at a discount and paid less than NBV

  • credit gain instead of debiting goodwill
  • FV of identifiable assets greater than acquisition cost
33
Q

Consolidated Statement of Cash Flow

Acquisition Method

A

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
34
Q

Step Acquisition- Consolidation and Deconsolidation

Acquisition Method

A

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

35
Q

Acquisition Method Disclosures

805

A
  • 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

36
Q

Intercompany Transactions

A

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
37
Q

Intercompany Inventory Transaction

A
  • 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
38
Q

Intercompany Bond Transactions

A

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
39
Q

Intercompany Sale of Land

A

workpaper elimination entry in period of sale eliminates the intercompany gain/loss and adjusts the land to its original cost

40
Q

Intercompany Profit on Sale of Depreciable Fixed Assets

A

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

41
Q

Combined Financial Statements

A

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
42
Q

Push Down Accounting

A

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

43
Q

Consolidated Equity and Consolidated NI

Equity Method

A
  • 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
44
Q

List of Identifiable Intangibles

A

F3-32

45
Q

Trading Security reclassified to Held to Maturity

SIM

A

ineligible transaction because only applies to debt securities

CPA FAR (10 decks)

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