[Anonymous]

Company purchases 80% of 100,000 shares or 80K shares year 1. They sell 50,000 shares five years later and are left with 30% ownership or 30k out of 100K shares outstanding. The question from Becker then asks me what is their gain reported in P/L statement in year 5. The fair value of the company being traded went up $5 per share in value. So I answered that the gain was the gain from the 50k of shares sold and their increase in value of the stock, and made no mention of the remaining shares since at 30% the company would then need to use the equity method and the equity method does not account for increases and decreases of fair value.

For times sake I got it wrong. They told me that I need to also include the gain from the $5 increase of value for the remaining 30,000 shares they held on to. As I said though, this would leave them at 30% and on the equity method and so mark to market accounting would be a violation of GAAP. The only thing I can think of is that in the beginning of the case or question they tell me that they are going to account for the initial 80% stake internally by using the cost method or mark to market, but they are still required to consolidate under GAAP at 80% so why then would I need to mark the remaining 30% to market and record the associated gain after and with the gain from the sale? Did Becker make a mistake writing this one? Should they have had them sell a larger interest off to get them below the 20% mark in this case or am I missing something critical here?

[greg2015]

Based on what you stated, it seems like the question maybe doesn't provide enough information to answer. On the acquiring company's non-consolidated financials, the initial investment would increase (decrease) based on 80% of the GAAP income of the acquired entity each year, adjusted for any acquisition basis differences. Therefore, without information on yearly net income, you don't have enought information to calculate the gain/loss recognized upon the sale.

However, you mentioned that it stated internally the company was using cost method or mark to market. Does it specify which one? If it's mark to market, then they would be recognizing the gain/loss each year based on share price (for their internal purposes only). If it's cost, nothing would be recognized until sold. If the correct answer is to recognize the gain on the full number of shares in year 5, then it appears they used cost method initially and switched to mark to market in year 5 (again, for internal purposes only). Doesn't seem to make sense.

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Licensed Illinois CPA

[Author]

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