Module 7: Intercorporate Investments

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Module 7Intercorporate Investments

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Investment in Marketable Equity Securities -
Overview

• Equity investments represent ownership of another
  companys outstanding common stock.
• Marketable equity investments are actively traded
  on a public stock exchange.
• By owning shares of common stock, the investor
  owns a part of the company, represented by the
  percentage ownership.
• There are different accounting rules for
• (1) less than 20 percent ownership (passive).
• (2) between 20 and 50 percent ownership
• (significant influence).
• (3) greater than 50 percent ownership (control).

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(1) Less than 20 ownership.

• If marketable securities, use the mark-to market
  method.
• Carries securities on balance sheet at market
  value.
• Revaluation at the end of each period based on
  new market price
• Unrealized gains (or losses) are recognized as
  the investment is valued up (or down).
• Treatment of the Unrealized G/L depends on
  classification of security
• (a) Trading securities.
• (b) Available-for-sale securities.

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(a) Trading Securities

• Trading securities held for the short term, with
  purpose of selling securities for profit.
• At purchase - record at cost to acquire.
• Activity during the year - record
  declaration/receipt of cash dividends, and
  recognize Dividend Income on the Income
  Statement.

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(a) Trading Securities

• For securities on hand at the end of the
  accounting period - revalue to market value and
  record Unrealized Gain/Loss on Income
  Statement.
• When sold - recognize Gain/Loss on Sale on
  Income Statement for any balance since the last
  revaluation.

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(b) Available-for-sale Securities

• Available-for-sale (AFS) securities may be held
  for the short term or for long term, depending on
  managements intentions.
• At purchase - record at cost to acquire.
• Activity during the year - record
  declaration/recept of cash dividends, and
  recognize Dividend Income on the Income
  Statement.

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(b) Available-for-sale Securities

• For securities on hand at the end of the
  accounting period - revalue to market value and
  record Unrealized Gain/Loss on Balance Sheet,
  as part of Other Comprehensive Income in
  Stockholders Equity (more on OCI in Module 9).
• When sold - recognize Gain/Loss on Sale on
  Income Statement for total difference between
  original cost and selling price.

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(2) From 20 to 50 Investment

• Because investment represents significant
  influence of investor, we cannot account for
  investments the same way as Trading or AFS.
• Specifically, we cannot recognize Dividend
  Income as dividends are declared, because the
  investor can control dividend payout, and
  therefore control the creation of income.

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(2) From 20 to 50 Investment

• The equity method increases the investment
  account and recognizes investors portion of
  income as investee earns it (as investee reports
  income to investor).
• The equity method decreases the investment
  account as investee declares dividends to the
  investor.
• Note additional complications from equity method
  from cost exceeding fair value of investment
  (e.g., goodwill) are not addressed here for
  unconsolidated investments.

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Cautions Regarding Equity Method

• The equity ignores market value for the
  investment account. Instead the investment
  account fluctuates as the investees equity
  fluctuates (income in excess of dividends).
• 20-50 percent is not always a valid indication of
  significant influence.
• It generates off-balance sheet financing - one
  line on the balance sheet may actually represent
  a percentage ownership in a number of assets and
  liabilities. (Consolidated investments show all
  the detail of assets and liabilities, where
  unconsolidated investments show only a net asset
  amount).

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(3)Greater than 50 Investment

• If an investor has majority control, the
  investment is recorded using the equity method,
  and a parent/subsidiary relationship is
  established.
• At the end of the period, the financials of the
  parent and subsidiary must be combined, or
  consolidated, for external financial reporting.
• Goodwill is recognized as a separate asset in the
  consolidation.