FAR 4 - Investments, Business Combinations, and Goodwill

Question 1

Fair Value Option

Answer 1

Unrealized gains and losses are reported in earnings

Question 2

Trading Securities

Answer 2

Debt securities that are bought and held for the purpose of selling them in the near term

1) Current asset - CFO
2) Fair value - All G/L on income statement

Question 3

Available for sale (AFS)

Answer 3

Debt securities not meeting the definition of trading or held to maturity securities.

1) Can be current or non-current - CFI
2) Fair value
a. Realized G/L (from sale) on income statement
b. Unrealized G/L part of OCI

Question 4

Held to Maturity

Answer 4

Debt securities where the corporation has the positive intent and ability to hold the security until maturity.

1) Can be current or non-current - CFI
2) On books at AMORTIZED COST (FV is a distractor)

Question 5

Income from Investments in Debt Securities

Answer 5

Interest income from an investment in debt securities classified as trading or AFS is recorded as interest income on IS

Question 6

Impairment of Debt Securities

Answer 6

1) Find expected credit loss by taking the present value of FCF - CV.
a. HTM book:
Dr Credit Loss (=difference)
Cr Allowance for credit losses

b. AFS
2) Find the unrealized G/L by taking fair value - CV. Any unrealized loss up to the expected credit loss value is booked like HTM above. Any amount exceeding expected credit loss is a reduction to the valuation account of the security
Dr Credit Loss
Dr Unrealized loss on AFS (remain. amt after ECL)
Cr Allowance for credit losses
Cr Valuation account (fair value adjustment)

Question 7

Sale of Debt Securities

Answer 7

A sale of debt security from any category (TS or AFS typically since HTM is held to maturity) results in realized gain and is recognized in net income.

Sale of TS:
Dr Cash
Cr Trading Security
Cr Realized gain on trading security

Sale of AFS:
Dr    Cash 
Dr    Unrealized gain on AFS (accumulated in OCI)
Cr        AFS
Cr        Realized gain on AFS

Question 8

Income from investments in equity securities

Answer 8

1) Normal (nonliquidating) dividend
Dr Cash
Cr Dividend income

2) Liquidating dividend - (when dividend exceeds RE)
Dr Cash
Cr Investment in investee

Question 9

Equity Method

Answer 9

1) A company that owns 20-50 percent of voting stock
2) It is explicitly stated that the company has “ability to exercise significant influence”

**Treat like a bank account!

Question 10

3 main JE in the equity method

Answer 10

1) Record investment
Dr Investment in investee
Cr Cash
*FV = Cost so include legal fees

2) Record increase in investment through share of earnings
Dr Investment in investee
Cr Equity in earnings/investee income (reported as income on the IS)

3) Record the share of cash dividends (like a withdrawal)
Dr Cash
Cr Investment in investee
*Stock dividends = memo entry only

Question 11

Investment in Investee w/ CS and PS

Answer 11

the increase to investment in investee through share of earnings is only applicable to CS (Voting stock), therefore:
Subsidiary earnings
-preferred dividends
=subsidiary income available to common shareholders

Question 12

Equity method building block box

Answer 12

1st = Book value (Net Assets) of equity acquired (x %)
2nd = Fair value of equity acquired (x %)
3rd = Purchase price of investment 

1st to 2nd = premium which is AMORTIZED over the life of the asset (except for excess caused by land)
Dr Equity in investee income
Cr Investment in investee
*Reduces income and the investment asset

2nd to 3rd = Goodwill (not amortized)

Question 13

Equity Method Impairment

Answer 13

If fair value of the investment falls below carrying value an impairment loss needs to be recognized to write down investment (found after share of earnings and dividend calculations)

Question 14

Variable interest entities (VIEs)

Answer 14

A corporation used for business purposes that either does not have equity investors with voting rights or lacks financial resources to support its activities

Question 15

Primary Beneficiary

Answer 15

The entity that is required to consolidate the VIE. Has the power to direct the activities of the VIE and they absorb the expected VIE losses or receive expected VIE residual returns. They MUST CONSOLIDATE the VIE.

Question 16

JE to record acquisition for parent common stock

Answer 16

Dr   Investment in sub (FV of stock at date TRANSACTION CLOSES, not announcement date)
Cr       CS (parent at par)
Cr       APIC (plug)

Question 17

Consolidation Adjustments (for external reporting only)

Answer 17

CAR IN BIG

CAR (CS, APIC, RE): removing the subsidiary’s old owners equity
*Need RE at purchase date amount

I (Investment in sub): removing parent’s investment account
N (non-controlling interest): If not 100% of sub is owned
*equal fair value of investment

B (Balance sheet adj. to FV): Like equity method building block box, debit for difference of fair value of identifiable net assets and book value of net assets
I (Identifiable intangible assets to FV): debit any identified intangible assets
G (Goodwill): plug

*Extra costs are expense (legal fees) while stock registration and issuance costs are a reduction to APIC

Question 18

Contingent Consideration

Answer 18

Booked as a liability on the acquisition entry and increases the debit to investment in subsidiary (any change is adjusted in earnings with an expense)

Question 19

Identifiable Intangible assets (Acquisitions)

Answer 19

Examples:

Permits, Patents, copyrights, trademarks, franchises, ***in-process R&D. Amortize or test for impairment

Question 20

Measurement period adjustments for an acquisition

Answer 20

Provisional fair values used. Record adjusting entry when final fair values are known

Question 21

Intercompany Transactions

Answer 21

Eliminate 100% if consolidating!
Includes: all payables, receivable, interest expense and income, gains on intercompany sales, sales / COGS

*Calculate profit on I/C sale of inventory and take out of COGS and Inventory (both credits)

Question 22

Goodwill Impairment

Answer 22

Calculated at the reporting unit level (an operating segment or one level below an operating segment)

Step 1) Qualitative evaluation
Step 2) Quantitative evaluation (if necessary)