1

Baker / Lembke / King

Reporting
Intercorporate
Investments in
Common Stock
Irwin/McGraw-

The McGraw-Hill
The McGraw-Hill
Companies,
Inc., 1999
Companies,

Level of Ownership
0%

20%

Influence not
significant

Irwin/McGraw-

50%
Significant
influence

100%
Control

The McGraw-Hill Companies, Inc., 1999

Level of Ownership
0%

20%

Influence not
significant

Cost
Method
Irwin/McGraw-

50%

100%

Significant
influence

Control

Equity
Method

Consolidation

The McGraw-Hill Companies, Inc., 1999

The Cost Method

ABC
ABCCompany
Companypurchases
purchases20
20percent
percentof
ofXYZ
XYZCompanys
Companys
common
commonstock
stockfor
for$100,000
$100,000at
atthe
thebeginning
beginningof
ofthe
theyear.
year.

Influence determined to
be not significant

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

The Cost Method

ABC
ABCCompany
Companypurchases
purchases20
20percent
percentof
ofXYZ
XYZCompanys
Companys
common
commonstock
stockfor
for$100,000
$100,000at
atthe
thebeginning
beginningof
ofthe
theyear.
year.
During
Duringthe
theyear,
year,XYZ
XYZhas
hasnet
netincome
incomeof
of$50,000
$50,000and
andpays
pays
dividends
dividendsof
of$20,000.
$20,000.
Cash
Dividend Income

4,000
4,000

20% of $20,000

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Liquidating Dividends
Investor
InvestorCompany
Companyowns
owns10
10percent
percentof
ofInvestee
Investee
Companys
Companyscommon
commonstock.
stock. By
Bythe
theend
endof
ofthe
thesecond
second
year,
year,net
netincome
incometotals
totals$200,000
$200,000and
anddividends
dividendsdeclared
declared
total
total$190,000.
$190,000. In
Inthe
thethird
thirdyear,
year,Investees
Investeesnet
netincome
incomeisis
$100,000
$100,000and
anddividends
dividendsare
are$120,000.
$120,000.
Cash
Investment in Investee Company Stock
Dividend Income

12,000
1,000
11,000
10% of
$120,000

Irwin/McGraw-

10% of
$110,000

The McGraw-Hill Companies, Inc., 1999

Liquidating Dividends
Investor
InvestorCompany
Companyowns
owns10
10percent
percentof
ofInvestee
Investee
Companys
Companyscommon
commonstock.
stock. By
Bythe
theend
endof
ofthe
thesecond
second
year,
year,net
netincome
incometotals
totals$200,000
$200,000and
anddividends
dividendsdeclared
declared
total
total$190,000.
$190,000. In
Inthe
thethird
thirdyear,
year,Investees
Investeesnet
netincome
incomeisis
$100,000
$100,000and
anddividends
dividendsare
are$120,000.
$120,000.
Cash
Investment in Investee Company Stock
Dividend Income

12,000
1,000
11,000

($310,000 - $300,000) x 10%

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method
APB
APB18
18requires
requiresthat
thatthe
theequity
equity
method
methodbe
beused
usedfor
forreporting
reporting
investments,
investments,other
otherthan
than
temporary,
temporary,in
incommon
commonstock...
stock...

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method
...of
...ofthe
the
following:
following:

Corporate joint ventures.

Companies in which the

investors voting stock interest

gives the investor the ability to
exercise significant influence
over operating and financial
policies of that company.
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method

10

But,
But, what
what isis
significant
significant
influence?
influence?

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

11

Equity Method

APB
APB 18
18 states,
states, An
An investment
investment (direct
(direct or
or
indirect)
indirect) of
of 20%
20% or
or more
more of
of the
the voting
voting
stock
stock of
of an
an investee
investee should
should lead
lead to
to the
the
presumption
presumption that
that in
in the
the absence
absence of
of
evidence
evidence to
to the
the contrary
contrary an
an investor
investor has
has
the
the ability
ability to
to exercise
exercise significant
significant
influence
influence over
over an
an investor.
investor.

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12

Equity Method
ABC
ABCCompany
Companyacquires
acquiressignificant
significantinfluence
influenceover
overXYZ
XYZ
Company
Companyby
bypurchasing
purchasing20
20percent
percentof
ofthe
thecommon
common
stock
stockof
ofXYZ
XYZat
atthe
thebeginning
beginningof
ofthe
theyear.
year.

XYZ
XYZreports
reportsnet
netincome
incomeof
of$60,000.
$60,000.
Investment in XYZ Common Stock
Income from Investee

12,000
12,000

20% x $60,000
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

13

Equity Method
ABC
ABCCompany
Companyacquires
acquiressignificant
significantinfluence
influenceover
overXYZ
XYZ
Company
Companyby
bypurchasing
purchasing20
20percent
percentof
ofthe
thecommon
common
stock
stockof
ofXYZ
XYZat
atthe
thebeginning
beginningof
ofthe
theyear.
year.

XYZ
XYZdeclares
declaresand
andpays
paysaa$20,000
$20,000dividend.
dividend.
Cash
Investment in XYZ Company Stock

4,000
4,000

20% x $20,000
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method--Cost Exceeds Book Value

14

Ajax
AjaxCorporation
Corporationpurchases
purchases40
40percent
percentof
ofthe
thecommon
common
stock
stockof
ofBarclay
BarclayCompany
Companyon
onJanuary
January1,1,19X1,
19X1,for
for
$200,000.
$200,000. Barclay
Barclayhas
hasnet
netassets
assetswith
withaabook
bookvalue
value
of
of$400,000
$400,000and
andaafair
fairvalue
valueof
of$465,000.
$465,000.
Cost of investment to Ajax
Book value of Ajaxs share of Barclays net
assets (.40 x $400,000)
Differential

Irwin/McGraw-

$200,000
(160,000)
$ 40,000

The McGraw-Hill Companies, Inc., 1999

Equity Method--Cost Exceeds Book Value

15

Barclay
Barclayreports
reportsnet
netincome
incomeof
of$80,000
$80,000in
in19X1.
19X1.
Investment in Barclay Stock
Income from Investee

32,000
32,000

40% x $80,000

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method--Cost Exceeds Book Value

16

Barclay
Barclayreports
reportsnet
netincome
incomeof
of$80,000
$80,000in
in19X1.
19X1.
Investment in Barclay Stock
Income from Investee

32,000
32,000

Barclay
Barclaydeclares
declaresaadividend
dividendof
of$20,000
$20,000in
in19X1.
19X1.
Cash
Investment in Barclay Stock

8,000
8,000

40% x $20,000
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Equity Method--Cost Exceeds Book Value

17

The
The$40,000
$40,000excess
excesspaid
paidby
byAjax
Ajaxisisassigned
assignedto
toLand,
Land,$6,000,
$6,000,
Equipment,
Equipment,$20,000,
$20,000,and
andGoodwill,
Goodwill,$14,000.
$14,000. Because
Becauseland
land
has
hasunlimited
unlimitedlife,
life,only
onlyequipment
equipmentand
andgoodwill
goodwillare
areamortized.
amortized.
Equipment ($20,000/5 years)
Goodwill ($14,000/7 years)
Total Amortization
Income from Investee
Investment in Barclay Stock

Irwin/McGraw-

$4,000
2,000
$6,000
6,000
6,000

The McGraw-Hill Companies, Inc., 1999

Equity Method--Purchase Additional Shares

18

ABC
ABCCompany
Companypurchases
purchases20
20percent
percentof
ofXYZs
XYZscommon
commonstock
stock
on
onJanuary
January2,2,19X1,
19X1,and
andanother
another10
10percent
percenton
onJuly
July1,1,19X1,
19X1,
and
andthe
thestock
stockpurchases
purchasesare
areat
atbook
bookvalue.
value.
XYZ
XYZCompany
Companyearns
earnsincome
incomeof
of$20,000
$20,000from
fromJanuary
January22
to
toJune
June30
30and
andearns
earns$30,000
$30,000from
fromJuly
July11to
toDecember
December31.
31.
Income, January 2 to June 30: $20,000 x .20
Income, July 1 to December 31: $30,000 x .30
Income from Investment, 19X1

Irwin/McGraw-

$ 4,000
9,000
$13,000

The McGraw-Hill Companies, Inc., 1999

Equity Method--Purchase Additional Shares

19

XYZ
XYZdeclares
declaresand
andpays
paysaa$10,000
$10,000dividend
dividendon
onJanuary
January15
15
and
andagain
againon
onJuly
July15.
15.
January 15 dividend: $10,000 x .20
July 15 dividend: $10,000 x .30
Reduction in Investment, 19X1

$2,000
3,000
$5,000

January 15, 19X1

Cash
Investment in XYZ Stock

2,000

July 15, 19X1

Cash
Investment in XYZ Stock

3,000

Irwin/McGraw-

2,000

3,000
The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

20

Recorded amount of investment

at date of acquisition.
Cost
CostMethod
Method
Original cost

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Cost and Equity Methods Compared

21

Recorded amount of investment

at date of acquisition.
Equity
EquityMethod
Method
Original cost

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

22

Usual carrying amount of

investment subsequent to acquisition
Cost
CostMethod
Method
Original cost

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

23

Usual carrying amount of

investment subsequent to acquisition
Equity
EquityMethod
Method
Original cost increased (decreased) by investors share of
investee's income (loss) and decreased by investors share of
investees dividends and by amortization of the differential.
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

24

Differential
Cost
CostMethod
Method
Not amortized

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Cost and Equity Methods Compared

25

Differential
Equity
EquityMethod
Method
Amortized if related to limited-life or
intangible assets of investee
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

26

Income recognized by investor

Cost
CostMethod
Method
Investors share of investees dividends
declared from earnings since acquisition
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

27

Income recognized by investor

Equity
EquityMethod
Method
Investors share of investees earnings since
acquisition, whether distributed or not,
reduced by any amortization of the
differential
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

28

Investee dividends from earnings

since acquisition by investor
Cost
CostMethod
Method
Income

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

29

Investee dividends from earnings

since acquisition by investor
Equity
EquityMethod
Method
Reduction of investment

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

30

Investee dividends in excess of

earnings since acquisition by investor
Cost
CostMethod
Method
Reduction of investment

Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

Cost and Equity Methods Compared

31

Investee dividends in excess of

earnings since acquisition by investor
Equity
EquityMethod
Method
Reduction of investment

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The McGraw-Hill Companies, Inc., 1999

FASB Interpretation No. 35

32

Evidence that an investor is unable to exercise significant

influence over the investee:

Opposition
Opposition by
by the
the investee
investee

Investor
Investor and
and investee
investee sign
sign an
an agreement
agreement under
under

which
which the
the investor
investor surrenders
surrenders significant
significant rights
rights
as
as aa shareholder
shareholder

Investor
Investor tries
tries and
and fails
fails to
to obtain
obtain more
more financial
financial
information
information than
than available
available to
to other
other
shareholders
shareholders

Investor
Investor tries
tries and
and fails
fails to
to obtain
obtain representation
representation
on
on the
the investees
investeesboard
board of
of directors
directors
Irwin/McGraw-

The McGraw-Hill Companies, Inc., 1999

33

Chapter Two

The
The
End
End

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The McGraw-Hill Companies, Inc., 1999