Page 558 - Accounting Principles (A Business Perspective)

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14. Stock investments

Learning objectives

After studying this chapter, you should be able to:
• Report stock investments and distinguish between the cost and equity methods of accounting for stock
investments.
• Prepare journal entries to account for short-term stock investments and for long-term stock
• Prepare journal entries to account for long-term stock investments of 20 per cent to 50 per cent.
• Describe the nature of parent and subsidiary corporations.

• Prepare consolidated financial statements through the use of a consolidated statement work sheet.
• Describe the uses and limitations of consolidated financial statements.
• Analyze and use the financial results—dividend yield on common stock and payout ratio on common stock.
The role of accountants in business acquisitions

The number and size of corporate mergers and acquisitions has accelerated at an amazing pace over the last
decade. The combination of these sometimes mega-giant corporations, involves complex strategic alliance
decisions. The potential rewards of mergers and acquisitions can be enormous-increased market share, broadened
product lines, stability for the overall company, strengthened financial position, captured key executive or technical
talent, and cost savings. In 1999, Exxon and Mobil merged in an USD 82 billion deal. The companies originally
estimated that the merger would save the companies USD 2.8 billion, but by the end of 2002 that number had risen
to nearly USD 7 billion.

Not all mergers and acquisitions turn out this well. In fact, many mergers and acquisitions weaken companies
(for example, the acquisition of Skype by eBay). Beyond the need to record accounting transactions after the
combination, accountants are now being asked to play an increasing role in business valuation before the
combination.
When considering the acquisition of a company, the first question is "Do we really want to go into business with
this company?" Target companies may misrepresent their financial position or conceal suspicious behavior in an
attempt to maximize their purchase price. Accountants are used by acquirers to scope out the full details of a
target's financials, operations, and human assets. Accountants are intimately familiar with accounting practices and
recording procedures and therefore are best trained to find financial statement misrepresentations. Discoveries by

accountants have canceled many giant mergers and acquisitions.
The second question to consider is "What is the target worth?" The acquiring company generally requires the
target company to make available its financial statements. Accounting professionals are asked to interpret the
financial statements and other financial data to determine the value of the target. Accounting professionals also
understand how accounting numbers translate into firm value and which aspects of firm value are not captured by
accounting numbers.

Accounting Principles: A Business Perspective 559 A Global Text