Session 5

Question 1

Two things to keep in mind relating to intercorporate investments

Answer 1

% of ownership (% of outstanding stock)

Management’s intent

Question 2

If a company owns more than 50% of a company’s stock, what is that called and how is it accounted?

Answer 2

Majority, has control.

Consolidates the balance sheet

Question 3

If a company owns 50% or less of a company’s stock, what is that called?

Answer 3

Minority

Question 4

If a Minority investment is less than or equal to 20%, what is it called and how is it accounted for?

Answer 4

Passive (market method)

Accounted via Available-for-sale or Trading

Question 5

If a Minority investment is for > 20% what is it called and how is it accounted for?

Answer 5

Significant Influence

Accounted using the equity method

Question 6

Passive level of investment

Answer 6

Merely an investor and cannot exert any influence over the investee company.

Generally presumed if investor owns less than 20% of the oustanding voting stock.

The only investments that we Mark to Market.

Question 7

Significant influence level of investment

Answer 7

Significant influence, but not control of a company. Generally if the investor owns 20-50% of the voting stock

Question 8

Control influence level of investment

Answer 8

If investor owns more than 50%.

Has ability to elect a majority of the board of directors. As a result, the ability to affect its strategic direction and hiring of executive management.

Question 9

Passive Investments - Market Method

Answer 9

Initially recorded at purchase price

During holding period, investment is recorded at current market value (Marked to Market)

Question 10

What are the two investment classifications for passive investments?

Answer 10

Available for Sale

Trading

Question 11

Available-for-sale

Answer 11

Investments that management intends to hold for capital gains and dividends, although it may sell if the price is right.

Market value changes initially bypass the income statement and are reported directly in Other Comprehensive Income.

Question 12

Trading

Answer 12

Investments that management intends to actively trade (buy and sell) for trading profits as market prices fluctuate.

Market value changes are immediately reported in the income statement and impact retained earnings.

Question 13

Mark-to-market uncertainty levels

Answer 13

Level 1 - Use market quotations

Level 2 - Use market quotations for similar assets

Level 3 - Use a valuation model

Question 14

How are debt securities handled

Answer 14

Generally treated as passive with zero control.

Use mark to market to account for them.

Question 15

How investing in bonds works

Answer 15

Treated as passive. And classified as either available-for-sale or trading.

Another category exists - held to maturity - which will mirror the firm’s treatment of its own long-term debt and will not be marked to market.

Question 16

Equity Method Investments

Answer 16

Required for investements which investor can exert significant influence

Generally 20-50%

Question 17

Accounting for Equity Method

Answer 17

Initially recoreded at their purchase cost

Dividends received are treated as recovery of investment.

Investor reports income equal to its percentage share of the reported income.

Investment is increased (decreased) in amount of income recorded

Question 18

Consolidation accounting

Answer 18

Replaces the investment balance with the assets and liabilities to which it relates.

And replaces the equity income reported by the investor company with the sales and expenses.

Question 19

What’s the first thing you do during negotiations?

Answer 19

Get an appraisal done

Question 20

Good will calculation

Answer 20

Purchase price

- FMV of Net Assets Aquired

Question 21

During aquisition, the purchase price goes into what categories?

Answer 21

Market value of specifically identifiable assets

MV of specifically identifiable liabilities

The remaining amount goes into goodwill.

Question 22

Problem with the Equity Method (pre-consolidated balance sheet)

Answer 22

The equity method balance sheet understates assets and liabilities for the parent company.

Question 23

Steps to determine impairment of goodwill

Answer 23

1. The estimated market value of the investee company is compared with its book value. If market value is less than book value, the investment is deemed impaired.
2. Then must estimtate the goodwill value as if it were acquired for its current market value. If market value of goodwill is less than its book value, the goodwill must be marked down to the market value, resulting in an impairment loss that is recognized on the I/S. Otherwise goodwill account is not changed.

Question 24

Goodwill impairment calculation

Answer 24

Fair value of investee company
- Fair value of net assets (absent goodwill)
= Implied goodwill
- Current Goodwill balance
= Impairment loss

Question 25

Another name for Noncontrolling Interest

Answer 25

Minority Interest

Question 26

Noncontrolling interest

Answer 26

Representation of outsiders equity corresponding to their share of assets/liabilities.

Question 27

Effect of Ownership > 50% (but less than 100%)

Answer 27

All of subsidiary assets and liabilities on it’s balance sheet (instead of just the % they control)

To reconcile this, a noncontrolling interest equity component is added.

Question 28

Accounting equation when noncontrolling interest is involved

Answer 28

Assets = Liabilities + Equity + Minority Interest

Question 29

Income statement ‘issues’ when Ownership > 50% (but less than 100%)

Answer 29

Revenues and expenses are (over)stated in full and an adjustment can be seen for the minority interest, so that net income represents that portion attributable to the parent only.

“I/S shows the pice that is mine”