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  • Alright, the next area were going to talk about deals with cost equity...do I have good

  • volume there, good volume? Yeah? Very nice. Alright, cost equity. So were talking about

  • investments. Were actually going to talk in two different sections, cost equity and

  • the next section is called marketable securities. So, what I want to do is kind of walk you

  • through the investments that we can make and it basically talks about how much stock do

  • you own in the company. That would distinguish how we account for the investment. So, let�s

  • come on over here, and were going to talk a little bit about some of the different methods.

  • Basically, if I own 0 to 20%, that is called either the cost method or marketable securities.

  • Now what this means is that I own 0 to 20% of the stock outstanding, so that is called

  • the cost method. If I own 20 to 50%, that is called the equity method, and the equity

  • method is also known as the one line consolidation. Now what it means is I�m going to be teaching

  • you this thing called consolidations down the road, but basically it�s similar to

  • consolidations but we consolidate in this one line item called investment. The next

  • one is 50% plus, and that is called consolidations, and the implication here is that you have

  • control. Remember? Back in the �90s? Janet Jackson? Woo...control. Anyway, so that�s

  • control. So, that is the implication, we have control of the entity. So, zero to 20 is cost,

  • 20 to 50 is equity, 50 or more is consolidations. Now, as far as 0 to 20, 20 to 50, 0 to 20,

  • 20 to 50 were called investor/investee. Fifty or more, theyre called, used to be called

  • parent and subsidiary, then we changed it from one fad to 141R, we changed it to acquirer

  • and aquiree. Acquirer, aquiree. So 0 to 20, 20 to 50, 50 or more. Zero to 20, 20 to 50,

  • cost versus equity or marketable security, so in this first chapter, were talking

  • about cost versus equity. The next chapter were going to talk about marketable securities,

  • which means you own 0 to 20, but it has a market value, and in FAR 8, the very last

  • section, were going to talk about consolidations. Why? Because in consolidations, basically,

  • I own you, I control you, so we need to consolidate and put our numbers together. That means we

  • have to reverse a lot of intercompany transactions. Well, I don�t want to show you how to reverse

  • transactions I haven�t taught you yet. So, I�m going to teach you all the transactions,

  • then at the end were going to reverse intercompany inventory, intercompany profit or loss, intercompany

  • PP and E, intercompany gains, intercompany dividends, intercompany bonds and all that

  • fun stuff. So, itll make more sense once I teach you bonds, how to reverse them. So,

  • this is basically where were going. So, gain, 0 to 20 is cost or marketable security,

  • 20 to 50 is equity. What is the difference between these two? Well, if you own 10% of

  • Roger CPA Review, mmm hmm, am I a publicly traded company? Not yet. Therefore, cost.

  • If you own a hundred shares of Microsoft, is it a publicly traded company? Yes. Does

  • it have a fair market value? Yes. Then use marketable securities. So, what I want you

  • to see is the distinction between which topics were going to be covering in which area

  • and how the chapters compare. So, this chapter is cost versus equity. Zero to 20 is cost,

  • 20 to 50 is equity, 50 or more is consolidations. What if youre right at the cusp? 20? What

  • if youre right at the cusp? 50? Well, that�s what well talk about in a minute as well.

  • So let�s look in our notes and well start to see the distinction. At the top of page

  • one there, it says 0 to 20 is cost or marketable securities, cost or marketable securities.

  • The implication is that no influence over the investee exist if the security isn�t

  • marketable, use the cost. Twenty to 50, one line consolidation. The implication is that

  • the investor has significant voting influence. Significant voting influence, which I�ll

  • expand on, and then 50 or more, consolidations, which well cover in FAR 8. Now, here�s

  • what�s happening. The way that a company is organized, and well talk about this

  • in BEC and Auditing and a little bit in FAR as well. Here�s how a company�s organized.

  • Here�s the group called the Board of Directors. They act as a board, they act as a group,

  • and as far as the Board of Directors of the group, they are in charge of hiring the management,

  • theyre in charge of declaring dividends, theyre in charge of buying back treasury

  • stock, which is stock that is authorized, issued, but not outstanding. Now, the management

  • runs the company for the stockholder. The stockholder gets to vote in the Board of Directors.

  • So, I get to vote in the board, the board hires the management, the management runs

  • the company for me, the shareholder. So, remember since day one I�ve been picking up and saying,

  • Whose statements are these?� And you all yell out, �Whose statements?� Craig?

  • Management�s. Exactly. Management�s statements. So, management is responsible for these statements.

  • So, management runs the company for me, I get to vote in the board, the board hires

  • the management, the board declares the dividend. Let�s say for example I don�t like the

  • management, so I go to the board meeting and I get to vote, I get to vote on the board.

  • I say, �Hey board, I don�t like the president. Please get rid of them.� And the board says,

  • Well, I like the president because he�s my son-in-law.� So, I say, �Fine, I�m

  • going to vote you out,� put a new board in who will then fire the president and hire

  • a new one. So, the question is, how much influence do I have over them to them? If I own 0 to

  • 20%, I have no influence over them, no influence over them. If I have 20 to 50, I have significant

  • voting influence over them and them. If I own 50% or more, I control them. That�s

  • why, what youll see as we go through the accounting, if I own 0 to 20%, I don�t have

  • any control over them, and so I don�t record a dividend until I get it. If I own 20 to

  • 50% of them, that�s equity method, I have influence over them. That means when we make

  • money, I know I�m going to get it in the form of a dividend eventually. Why? Because

  • if they don�t declare a dividend, then what? If they don�t declare a dividend, then what

  • does that say? That says that I�ll vote them out, put people in, I�ll eventually

  • get the money. So that�s why with the equity method, I�m going to record they income

  • as they earn it, not as I receive it. So, were going to have to look through that

  • as we go through the different topics. Alright, youll see that. Now look at equity method.

  • It says equity method ASC 323. The equity method is used when the investor has significant

  • influence over the operating and financial policies of the investee. The method is more

  • consistent with accrual accounting. Even if ownership of less than 20%, one must consider

  • how much influence exists between the two. What are some of the factors? Some of the

  • factors: significant intercompany transactions, officers of one company as officers of another,

  • the investor is a major customer supplier. Circle the next bullet. The investor owns

  • at least 20% of the voting common stock, but not if another person owns the majority. So,

  • even if I own 30%, someone else owns 70, I would still do cost method. The investor has

  • definite plans to acquire the additional stock. These are all implications, so this is again

  • for a multiple choice question, youre right at the cusp of 20, do you do cost or equity?

  • It depends on the implication. Alright. Let�s jump ahead and let�s look at a problem here

  • because what I�d like to do is kind of show you the journal entries that were going

  • to go through. So look on about page four, and well look at a problem together, and

  • this is on? Very good. Testing. It says, �Example of both equity and cost. On 11-X1, we acquire

  • 30% of a company for a thousand dollars. The fair value of the investee is 3000, and the

  • book value is 2500.� What does that mean? Fair value means that�s how much the assets

  • are worth today, book value means that�s how much theyre being carried in the books

  • at. The difference is from property plant equipment with a fair value 500 higher than

  • its book value. During the year, the investee reports income of 120 and pays dividends of

  • 40. P P and E is being d-d-d-d-d-depreciated over 10 years and 10% of initial goodwill

  • is impaired. There�s a lot of stuff in here I haven�t taught you yet. First of all,

  • P P and E is Property Plant Equipment. Were going to have to depreciate that. Weve

  • got goodwill has been impaired which means weve tested annually for impairment. If

  • the value has dropped, then what do we do? We have to write it down. So, that�s basically

  • what theyre telling us as we go through it. But again, what I want you to realize,

  • it�s new in the course, right? Were still in the first section. So, there�s stuff

  • we haven�t covered yet. I want you to understand the concepts of the equity method, and then

  • every week, every class, I�ll give you more, more and more information, and then all the

  • sudden, boom, lights go on, you understand and become a CPA and find out what true happiness

  • really means. Alright. So, what we need to do is go through the journal entries. Now

  • we acquired 30% of the company for a thousand dollars, fair value�s 3000, book value is

  • 2500. So, over here, I�m buying 30% of the company and paying a thousand dollars. Fair

  • market value is 3000, book value is 2500. So, what I need to do, is I�m saying, and

  • it�s called the one line consolidation because in all of these cases, here�s what I�m

  • doing, let�s come back over to this board for a minute. In all of these cases, I�m

  • debiting investment, crediting cash. So, on day one, I debit investment, credit cash.

  • Here�s the deal, at the end of the year under cost, I still have an investment, under

  • market I still have an investment, under equity, and I still have an investment. Under consolidations

  • I can�t have an investment myself because I control you. The whole process of consolidating

  • is eliminating the investment. So, in all these cases I�m going to debit the investment,

  • debit the investment at the beginning. At the end of the year, still have it, still

  • have it. Consolidations, I get rid of it. I eliminate it. So, in this case I�m going

  • to set up the investment. Then what I have to show you is what the difference is between

  • if it�s counted for this way, or this way, or this way. First were going to do this,

  • equity method, which is the one line consolidation. It�s going to be comparable to this, but

  • its data owning a hundred or 90 or 80. I only own 30% or 40%. Alright, so back over here.

  • Nice and slow, weve got boom, boom, and boom. So, here�s what I�ve got to keep

  • track of...the difference between the purchase price, the fair market value of investees

  • net assets and the book value of investees net assets. So, I�m going to keep track

  • of what I paid, what its worth, what it�s in their books for. So, that�s what I paid,

  • that�s the fair value of it and the book value. So in this particular case, I paid

  • how much? A thousand dollars. So, I paid a thousand dollars. Now, what is this worth?

  • It said over here the fair value is three million or 300,000 or 3000. I own 30% of that

  • 3000, and that�s what? 900 bucks. So, really, I should have paid 900 dollars. They charged

  • me a thousand. They charged me more. Were going to call that goodwill. I bought 30%.

  • What is their book value? Now, what is book value? The difference between these two means

  • property plant equipment. They bought it and here's how much it's in their books for historical

  • cost, but went up in value. That's fair value. So it went up in value by what? 500 bucks

  • and they said that was called PP and E which is property plant equipment. So, if I were

  • to take 30% of my 2500, 30% of the book value is...what do we have...750? So that's what

  • I have to compare. I've got to compare these numbers to see what did I pay, what is it

  • worth, what is it in their books for? So, here's, I paid a thousand, it's worth 900,

  • and it's in their books for 750. What does this represent? This represents 30% of what

  • I paid, with what I paid, 30% of what they're worth, 30% of the book value. Now, I have

  • to keep track of these differences. The difference between what I paid what its worth is called

  • goodwill. Now goodwill I�ll define next time in FAR 3. Actually, two times from now

  • in FAR 3 in intangible assets. Goodwill is the unidentifiable asset that makes a business

  • worth more than the sum of all its identifiable assets. In other words, you go to the store

  • you go, �Man, I'm thirsty. I need caffeine. I�m going to have a Mountain Dew. Mmm.�

  • Now they have all these other sodas, but you like the Mountain Dew commercials, and so

  • on and so forth. That�s called goodwill. So you go in...So if I were to buy Mountain

  • Dew, the corporation's assets are worth a billion dollars. That's like their buildings,

  • their sugar, the cans, their leases, their trade, but the difference is theyre going

  • to charge me three billion. Why? Because that goodwill. Because people go, �I like Mountain

  • Dew better than Sprite and everything else. I like the commercials.� So, that�s called

  • goodwill. It�s the unidentifiable asset that makes a business worth more than the

  • sum of all its identifiable assets, so well define that in intangibles. What do we do

  • every year? You test the value. If it's been impaired, you write it down, you never recover

  • it. So that's called goodwill, in this case its a hundred bucks. Come on over this way

  • a little bit. Thee we go. A hundred bucks. Now we got here 150. What is this 150? About

  • 150 I'm going to call fair market value write-up. It's more of a generic term, fair market value