ACC hw

1 ©Cambridge Business Publishers, 2014

SAMPLE ACCOUNTING ISSUES MEMO

Memorandum

To: Investor, Inc. Accounting Files

From: Student name

Date: xx/xx/xxxx

Re: Accounting for investment in ABC Corp

Background and Facts

Investor, Inc. (“Investor”) recently purchased 15% of the outstanding common stock of ABC

Corp, a nonpublic company, for $3 million. Along with this purchase, Investor was also given

the ability to appoint five new members (out of ten total members) to ABC Corp's Board of

Directors. Additionally, Investor will be leading a restructuring (such as a refinance) of ABC

Corp's current outstanding debt, as a condition of its equity investment.

Issues

Issue 1: Should Investor account for its investment under the cost method, or under the equity

method?

Background

Investor has evaluated the appropriate accounting treatment for its investment in 15% of ABC

Corp's stock. Because this is a noncontrolling (less than 50%) ownership interest, two

alternatives were considered: 1) Account for the investment under the "cost method", or 2)

Account for the investment under the "equity method".

Conclusion

Investor has the ability to exercise significant influence. The investment should be accounted for

under the equity method.

Research and Analysis

Use of the cost method is addressed in ASC 325-20-05-2 and 05-3 ("Investments - Other, Cost

Method Investments"), as follows:

05-2. Investments are sometimes held in stock of entities other than subsidiaries, namely corporate joint

ventures and other noncontrolled entities. These investments are accounted for by one of three

methods—the cost method (addressed in this Subtopic), the fair value method (addressed in Topic 320),

and the equity method (addressed in Topic 323).

05-3. While practice varies to some extent, the cost method is generally followed for most investments in

noncontrolled corporations, in some corporate joint ventures, and to a lesser extent in unconsolidated

subsidiaries, particularly foreign.

2 Skills for Accounting and Auditing Research, 2nd Edition

The guidance above indicates that the cost method can be used to account for investments in

"noncontrolled corporations." It is true that Investor does not control ABC Corp. However, this

topic (ASC 325-20) does not offer additional interpretive guidance for determining which

transactions are within the scope of the cost method. (Note that the scope guidance for cost

method investments is minimal, and is not on point, and implementation guidance is not

available for this topic). Therefore, it is appropriate to consider what guidance is available

regarding use of the equity method.

ASC 323-10-15-3 (Investments - Equity Method, Scope) identifies investments that fall within

the scope of this topic, as follows:

15-3 The guidance in the Investments—Equity Method and Joint Ventures Topic applies to investments

in common stock or in-substance common stock... that give the investor the ability to exercise significant

influence (see paragraph 323-10-15-6) over operating and financial policies of an investee even though the

investor holds 50% or less of the common stock or in-substance common stock...

Therefore, par. 15-3 states that common stock giving the investor the ability to exercise

significant influence should be accounted for under the equity method. Additional scope

guidance available in par. 15-6 and 15-8 states the following for determining whether

"significant influence" is present:

15-6 Ability to exercise significant influence over operating and financial policies of an investee may be

indicated in several ways, including the following:

a. Representation on the board of directors

b. Participation in policy-making processes

c. Material intra-entity transactions

d. Interchange of managerial personnel

e. Technological dependency

f. Extent of ownership by an investor in relation to the concentration of other shareholdings (but

substantial or majority ownership of the voting stock of an investee by another investor does not

necessarily preclude the ability to exercise significant influence by the investor).

15-8 ...an investment of less than 20 percent of the voting stock of an investee shall lead to a presumption

that an investor does not have the ability to exercise significant influence unless such ability can be

demonstrated...

In this case, Investor purchased 15% of ABC Corp's stock. Therefore, par. 8 indicates that there

is a presumption that Investor does not have significant influence. However, this presumption

can be overcome if other indicators of significant influence are present, such as those listed in

par. 6. Along with Investor's purchase of the stock, Investor was given the ability to appoint five

of ten total members to ABC Corp's Board. Investor will also be leading a restructuring of ABC

Corp's current debt load. As such, indicators (a) and (b) of par. 6 are present, indicating that

Investor does have the ability to exercise significant influence and therefore the investment

should be accounted for under the equity method.

3 ©Cambridge Business Publishers, 2014

Issue 2: How should Investor initially record its investment?

Conclusion Note: In this example, Issue 2 follows from Issue 1 so no additional background

is necessary.

Investor shall record its Investment asset “at cost”. Equity method investments shall be recorded

as assets and initially measured at cost. In cases where cash is paid to acquire the stock, the cash

paid is generally reflective of the investment’s cost (plus any applicable transaction costs).

Investor shall therefore record its investment in an asset account at $3 million, plus any

applicable transaction costs.

Investor shall make the following entry upon purchase of this investment:

Dr. Investment in ABC Corp $3 million

Cr. Cash $3 million

Research and Analysis

Recognition guidance within ASC 323-10 states the following regarding how investors should

initially record an equity method investment:

25-2 An investor shall recognize an investment in the stock of an investee as an asset.

Accordingly, Investor shall record the cost of its investment in an asset account, Investment in

ABC Corp.

ASC 323-10 provides the following initial measurement guidance for equity method

investments:

30-2 …[A]n investor shall measure an investment in the common stock of an investee (including a joint

venture) initially at cost in accordance with the guidance in Section 805-50-30.

ASC 805-50, referenced in the preceding guidance, states the following regarding investments

made in exchange for a cash payment:

30-2 Asset acquisitions in which the consideration given is cash are measured by the amount of cash

paid, which generally includes the transaction costs of the asset acquisition.

Based on the preceding guidance, Investor shall record its Investment asset “at cost”. When cash

is paid to acquire an investment, ASC 805-50 states that cost is generally measured by the

amount of cash paid. Investor shall therefore initially record its investment at $3 million, plus

any applicable transaction costs.

Investor shall also make the disclosures as described in ASC 323-10-50. The extent of these

disclosures shall depend upon the significance of this investment to Investor’s financial position,

as noted in par. 50-2.