The following data are from the annual report of Francisco Company, a specialized packaging manufacturer:

Question:

The following data are from the annual report of Francisco Company, a specialized packaging manufacturer:

 Year 6Year 7Year 8
Sales      $25,000$30,000$35,000
Net income2,0002,2002,500
Dividends paid1,0001,2001,500
Book value per share (year-end) 111213

Note: Francisco had 1,000 common shares outstanding during the entire period. There is no public market for Francisco shares.

Potter Company, a manufacturer of glassware, made the following acquisitions of Francisco com­mon shares:

January 1, Year 6  10 shares at $10 per share

January 1, Year 7  290 shares at $11 per share, increasing ownership to 300 shares

January 1, Year 8  700 shares at $15 per share, yielding 100% ownership of Francisco

Ignore income tax effects and the effect of lost income on funds used to make these investments. Required:

a. Compute the effects of these investments on Potter Company’s reported sales, net income, and cash flows for each of the Years 6 and 7.

b. Calculate the carrying value of Potter Company’s investment in Francisco as of December 31, Year 6, and Dec. 31, December 31, Year 7.

c. Discuss how Potter Company accounts for its investment in Francisco during Year 8. Describe any additional information necessary to calculate the impact of this acquisition on Potter Company’s financial statements for Year 8.

Answer:

Investment in equity security:

Equity securities are which are purchased to gain controlling interest if it exceeds 20% of the total equity capital of the investee and is less than 50%. These are recorded at the purchase cost and is decreased by the dividend income and net proportionate loss earned by the investee company. Investment value is increased proportionately by income earned by the investee company.

If the investor acquires more than 50% equity shares of the investee company then consolidation of the balance sheet is done for the reporting purpose.

Equity security:

Investment in equity security makes an investor an owner of shares held by it. Equity securities are classified as available-for-sale and trading.

Equity security held for trading:

Equity securities are which are purchased to earn short-term benefit due to the pricing difference are classified as equity security bought for trading. These are valued at fair value, not at the amortized cost. The dividend received is treated as an income. Unrealized holding gains or losses are treated as an income or loss for the period in the income statement.

Equity security held as available-for-sale:

Equity securities are which are purchased to earn short-term benefit due to the pricing difference are classified as equity security available for sale. These are valued at the fair value in the balance sheet, but unrealized holding gains or losses are treated as an income or loss for the period as the other comprehensive income statement. Securities fair value adjustment account is shown in the balance sheet as a separate component of shareholders’ equity.

a. For the year 2004, B would record cash dividends only. For the year 2005, it would follow the equity method for recording common stock.

Explanation:

For the year 2004, B has insignificant shareholding which is less than 10% hence it would record only dividend income. The cash dividend would be recorded as a cash inflow from the investing activities.

For the year 2005, it has 30% shareholding hence it would follow the equity method for recording the investment. The cash dividend would be recorded as a cash inflow from the investing activities.

b. Compute the carrying value of F for the year 2007 as follows: –

Therefore, the carrying value for 2007 is $3,600.

Working Note:

Compute the shareholding percentage for 2006 as follows: –

Percentage of Shareholding  = TotalSharePurchased/TotalOutsatandingShare = 10/1000 = 1%

Therefore, the percentage of shareholding during 2006 is 1%.

Compute the shareholding percentage for 2007 as follows: –

Percentage of Shareholding  = TotalSharePurchased/TotalOutsatandingShare = (10+290)/1000 = 30%

Therefore, the percentage of shareholding during 2007 is 30%.

Explanation:

The percentage of shareholding has been computed by dividing the total purchased shares by the total outstanding shares. The total purchased shares have been computed by adding the shares purchased during 2004 and 2005.

The carrying value for 2004 would be $100 as the dividend received would be recorded as an income hence; it would not change the investment value.

The carrying value for the year 2005 has been computed adding the share in net income for 2005 and dividend income received in 2004, and deducting the share in dividend for 2005 from the total purchase cost of the investment.

c. The US GAAP; ASC 805 which mandates business combination and ASC 305 which records the fair value accounting for investment in securities is used for accounting.

The company would have to follow ASC 805 and 305 for recording investment transactions.

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