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MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS. JOIN KHALID AZIZ. ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM. FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA. COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA. CONTACT: 0322-3385752 - PowerPoint PPT Presentation
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MANAGEMENT DECISIONS AND FINANCIAL ACCOUNTING REPORTS
JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK
19,F.B.AREA, KARACHI, PAKISTAN.
TopicsMethods of accounting for investments in
common stock“Mark-to-Market accounting” for certain
investments in equity securitiesOpportunity for gains tradingLegal forms of business combinationsAccounting methods for business
combinationsConsolidated financial statements
Methods of Accounting for Investments in Common Stock
Cost MethodInvestor has no significant influence over
increase• Presumed to be ownership of < 20% of
investee’s outstanding common stock Equity method
Investor has significant influence, but does not have control over investee• Presumed to be ownership of 20% - 50%
of investee’s outstanding common stock
FAQ?
When should a corporation consider consolidation, i.e., consolidated financial statements?
When the investor is “in control” which is clearly the case when over 50% of the investee’s outstanding common shares are owned. Effective control can often take somewhat less than 50%!
Cost Method
An investor uses the cost method if it has no significant influence over investeeInvestment is recorded at the cost of acquiring
the shares If marketable, securities are classified as
either trading or available-for-sale (in accordance with SFAS No. 115).
The investee’s pro rata share of dividends declared by investee is recorded as dividend incomeDividend income is shown in the
other income section of the income statement.
Dividends received are shown as an operating activity in the SCF.
Equity Method
An investor uses the equity method if it has significant influence over the investee, but it does not have controlThe investment is initially recorded at the
cost of acquiring the shares.The investor’s pro rata share of investee net
income is recorded as (1) an increase in the investment, and (2) investment income (reported in the “other income” section of the income statement; not dependent on cash flows).
Equity Method & Dividend Collections
The investor’s pro rata share of dividends declared by investee is recorded as a reduction of the investor’s investment
Under the equity method, the investment is not marked-to-market
Example: Compare and Contrast Cost and Equity Methods (for long-term investments)
Facts: On January 1, the O’Brien Co. purchased 100,000 shares of Gilly Co.’s common stock for $18 per share (or 15% of Gilly’s outstanding common stock).
For the year, Gilly reported net income of $5,000,000 and declared and paid dividends of $800,000.
Illustration of cost and equity methods
Assumption 1: The investment (15%) does not give O’Brien significant influence
Assumption 2: The investment (15%) does give O’Brien significant influence
The effects on O’Brien’s current year financial statements are as follows:
O’Brien: Cost Method
Balance Sheet
Investment in common stock (1) $1,800,000
Income Statement
Other income: Dividend income (2) 120,000
(1) 100,000 shares × $18(2) $800,000 × 15%
Cost Method, continued
Statement of Cash Flows
Operating Activities
Dividends received $ 120,000
Investing Activities
Purchase of investment (1,800,000)
O’Brien: Equity Method
Balance Sheet
Investment in common stock (1) $2,430,000
Income Statement
Other income: Equity in subsidiary earnings (2) $750,000
(1) ($100,000 shares × $18) + ($5,000,000 × 15%) – ($800,000 × 15%)
(2) $5,000,000 × 15%
Statement of Cash Flows
Operating Activities
Dividends Received
Adjust for non-cash revenue
120,000
(750,000)
Investing Activities
Purchase of investment $(1,800,000)
Equity Method, continued
Compare and Contrast Effect of Cost and Equity Methods
Balance sheet: Investment account is differentCost: carry at historical costEquity: carry at historical cost adjusted for
Income statement: Revenue is differentCost: dividendsEquity: pro-rata share of investee’s Net Income
Statement of cash flows is differentCost: no adjustment required for non-cash revenueEquity: remove non-cash revenue from net income
“Mark-to-Market Accounting” for Investments in Equity Securities SFAS No. 115 classifies certain
securities as trading, available-for-sale, or held-to-maturity.
Equity securities can only be classified as trading or available-for-sale.
Only debt securities can be classified as held-to-maturity.
FMV
To be classified as trading or available-for-sale, the securities must have readily determinable FMVs.
Types of equity securities that qualify for trading or available-for-sale classificationCommon stock (accounted for under the cost
method)Preferred stockStock rights, warrants, options
SFAS No. 115: Trading and Available-for-Sale Securities
TradingMarked-to-Market at balance sheet
dateUnrealized gain/loss is reported in the
other income (expenses) section of the income statement
Unrealized gain/loss is a noncash event that requires adjustment in the operating section of the SCF
Available-For-SaleMarked-to-Market at balance sheet dateUnrealized gain/loss is reported in the other
comprehensive income section of the statement of comprehensive income• Other comprehensive income is closed to
the accumulated other comprehensive income section of stockholders’ equity
Unrealized gain does not impact net income so no adjustment is required on the SCF
Example: Compare and Contrast Trading and Available-For-Sale Classifications
Facts: On January 1, the O’Brien Co. purchased 100,000 shares of Gilly Co.’s common stock for $18 per share (15% of Gilly’s outstanding common stock).
For the year, O’Gill reported net income of $5,000,000 and declared and paid dividends of $800,000.
The investment (15%) does not give O’Brien significant influence therefore the cost method is used.Gilly’s year-end common stock FMV is $20 per share.
Illustration of cost and equity methods
Assumption 1: The investment is classified as trading.
Assumption 2: The investment is classified as available-for-sale.
O’Brien’s current year financial statement effects for the investments are as follows:
O’Brien: Trading Classification
Balance Sheet
Investment in common stock (1) $2,000,000
Income Statement
Other income:
Dividend income (2) $120,000
Unrealized gain (loss) on trading securities (3) 200,000
(1) 100,000 shares × $20(2) $800,000 × 15%(3) 100,000 × ($20 - $18 )
Statement of Comprehensive Income
Other comprehensive income $0
Statement of Cash Flows
Operating Activities
Purchase of investments $(1,800,000)
Dividends received
Adjustment for noncash revenue
120,000
(200,000)
Trading Classification, continued
JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK
19,F.B.AREA, KARACHI, PAKISTAN.
O’Brien: Available-for-Sale Classification
Balance Sheet
Investment in common stock (1) $2,000,000
Income Statement
Other income: Dividend income (2) $120,000
(1) 100,000 shares × $20(2) $5,000,000 × 15%
Statement of Comprehensive Income
Other comprehensive income(3) $ 200,000
Statement of Cash Flows
Operating Activities
Dividends received $120,000
Investing Activities
Purchase of investments $(1,800,000)
(3)100,000 × ($20 - $18 )
Available-for-Sale Classification, continued
Compare and Contrast Effects of Trading and Available-for-Sale Classifications
Balance sheet investment account is the same Income statement amounts are different Statement of comprehensive income amounts are
different Cash flows on the SCF different; classification
affects ‘type’ of cash flow; Trading’s noncash revenue from mark-to-market requires adjustment
Opportunity for “Gains Trading”
A company with available-for-sale securities has unrealized gains/losses associated with the securities
“Gains trading” is the strategic planning of sales of available-for-sale securities in such a manner as to create eitherprofits (sell securities with unrealized
gains)losses (sell securities with unrealized
losses)
BUSINESS COMBINATIONS
Legal Forms of Business Combinations
Three general forms (types) of business combinations occurMerger: One entity retains its identity.Consolidation: New entity identity is
created.Parent/Subsidiary Relationship: All
entities maintain identity.
• Merger: A + B = AOne company acquires a second company and the second company ceases to exist.
• Consolidation: A + B = CTwo companies form a third company and the original two companies cease to exist.
• Parent & Subsidiaries: A + B = A + BOne company acquires the common stock of a second company, and after the transaction both companies continue to exist.
Accounting Methods forBusiness Combinations: “Purchase”
The transaction is recorded at the fair market value of the consideration
given by the acquiring company The net assets of the acquired company
are written up or down to fair market value
Any excess of the value paid over the sum of the fair market values of the net assets acquired is recorded as goodwill
Accounting Methods for Business Combinations: “Poolings”
FASB eliminated ‘pooling’ for all combinations after June 30, 2001
Historically, many combinations were recorded as poolingNet assets acquired recorded at their book valueNo goodwill was recognized
Goodwill
Goodwill reported on a balance sheet can only result from a business combination accounted for as a purchase.
Goodwill is tested annually for impairment
Goodwill Impairment Procedure
1) Compare fair value of the reporting unit to the unit’s book value including goodwill
• If FV > carrying amount, no impairment• If FV < carrying amount, proceed to second
step
2) Compare GW’s bookvalue to its implied fair value
• If BV > Implied FV recognizeimpairment equal to the excess
Consolidated Financial Statements
Note: The use of the term consolidation in the next slide is different than when used to refer to the legal form of a type of business combination (i.e., consolidation: A + B = C)
Consolidated Financial Statements
Companies that reflect a parent/subsidiary relationship prepare consolidated financial statements
The financial statements of the parent company are combined with those of the subsidiary company(s) into one set of consolidated financial statements
Intercompany amounts are eliminated in the consolidation process
JOIN KHALID AZIZ
ECONOMICS OF ICMAP, ICAP, MA-ECONOMICS, B.COM.
FINANCIAL ACCOUNTING OF ICMAP STAGE 1,3,4 ICAP MODULE B, B.COM, BBA, MBA & PIPFA.
COST ACCOUNTING OF ICMAP STAGE 2,3 ICAP MODULE D, BBA, MBA & PIPFA.
CONTACT: 0322-3385752 0312-2302870 R-1173,ALNOOR SOCIETY, BLOCK
19,F.B.AREA, KARACHI, PAKISTAN.