Page 577 - Accounting Principles (A Business Perspective)

14. Stock investments

retain more of the funds and use them to attempt to increase future earnings and the market price of the stock. The
formula for the dividend yield on common stock ratio is:

Dividend per share of common stock
Dividend yield oncommon stock ratio=
Current market price per share
For Tyco, the dividend yield on common stock ratios are:
2003: USD 0.05/USD 53.81 =.09 per cent
2002: USD 0.05/USD 50.25 =.10 per cent

To determine the relevance of this ratio, an investor compares these numbers to ratios calculated on other
stocks.
Investors calculate the payout ratio on common stock as follows:
Dividend per share of commonstock
Payout ratiooncommonstock=
Earnings per shareEPS
This ratio indicates whether a company pays out a large percentage of earnings as dividends or reinvests most of
its earnings. When computing the payout ratio, remember that negative earnings per share result in an invalid
calculation. Tyco's payout ratios are:
2003: USD 0.05/USD 2.68 = 1.87 per cent
2002: USD 0.05/USD 0.62 = 8.06 per cent
Now that you have studied consolidated financial statements, you should realize the importance of presenting a
complete picture of the business operations of a company. In Chapter 15 you learn about long-term financing, its

advantages and disadvantages, and how bonds differ from stocks.
Understanding the learning objectives
• Under the cost method, the investor company records its investment at the price paid at acquisition and
does not adjust the investment account balance subsequently. The cost method is used for all short-term
investments, long-term investments of less than 20 per cent where the purchasing company does not exercise
significant influence over the investee company, and may be used for long-term investments of more than 50

per cent.
• Under the equity method, the investment is also initially recorded at acquisition price but is then adjusted
periodically for the investor company's share of the investee's reported income, losses, and dividends. The
equity method is used for all long-term investments of between 20 per cent and 50 per cent and may be used
for investments of more than 50 per cent. This method is also used for investments of less than 20 per cent if
the purchasing company exercises significant influence over the investee company.
• Under the cost method, the initial investment is debited to either Trading Securities or Available-for-Sale

Securities, depending on whether the investment is a near-term or longer-term investment.
• At the end of each accounting period, the company must adjust the carrying value of each investment. The
fair market value method is applied independently to each of these portfolios.
• Under the cost method, dividends received are credited to Dividend Revenue.
• Under the equity method, the initial investment is debited to an Investment in (Company Name) account.
Income, losses, and dividends result in increases or decreases to the investment account.
• The equity method must be used for long-term investments of 20 per cent to 50 per cent and for long-term
investments of less than 20 per cent where significant influence is present.

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