Question

Watson Company has several investments in the securities of other companies. The following information regarding these investments is available at December 31, 2019.

1. Watson holds bonds issued by Fowler Corp. The bonds have an amortized cost of $600,000, and their fair value at December 31, 2019, is $700,000. Watson intends to hold the bonds until they mature on December 31, 2022.

2. Watson has invested idle cash in the equity securities of several publicly traded companies. Watson intends to sell these securities during the first quarter of 2020, when it will need the cash to acquire seasonal inventory. These equity securities have a cost basis of $500,000 and a fair value of $620,000 at December 31, 2019.

3. Watson has a significant ownership stake in one of the companies that supplies Watson with various components Watson uses in its products. Watson owns 5% of the common stock of the supplier, does not have any representation on the supplier’s board of directors, does not exchange any personnel with the supplier, and does not consult with the supplier on any of the supplier’s operating, financial, or strategic decisions. The cost basis of the investment in the supplier is $1,400,000, and the fair value of the investment at December 31, 2019, is $1,800,000. Watson does not intend to sell the investment in the foreseeable future. The supplier reported net income of $200,000 for 2019 and paid no dividends.

4. Watson owns some common stock of Stein Corp. The cost basis of the investment in Stein is $300,000, and the fair value at December 31, 2019, is $250,000. Watson believes the decline in the value of its investment in Stein is other than temporary, but Watson does not intend to sell its investment in Stein in the foreseeable future.

5. Watson purchased 25% of the stock of Love Co. for $500,000. Watson has significant influence over the operating activities of Love Co. During 2019, Love Co. reported net income of $200,000 and paid a dividend of $50,000.
Required:

Determine whether each of the investments described should be accounted for as fair value securities, held-to-maturity securities, or equity method securities.

Answer 1

1. Bonds issued by Fowler Corp.

As the intension of Watson Company is clearly stated that they want to hold these bonds till maturity. These should be accounted for as held to maturity securities. So as at year end they should be valued at Amortized cost i.e $ 600,000.

2. Equity securities of several publicly traded companies

As the intension of Watcon Company is to maintain liquidity and sell these securities at the start of the next quarter, these should be accounted for as Fair Value securities. So as at the year they should be valued at the fair value i.e. $ 620,000.

3. Ownership stake in supplier company

As per the information in the question it is clear that Watson Company does not hold any controlling interest as the holding is less than 20% and no decision making power is in the hands of Watson Company. Hence it shall be accounted as Fair Value securities. So as at the year they should be valued at the fair value i.e. $ 1,800,000.

4. Common stock of Stein Corp.

As the intension of Watson Company is not to sell these stock in the foreseeable future, these shall be accounted for as a held to maturity. However as there is other than temporary decline in the value of the Stock. It shall be valued at its current fair value i.e. $ 250,000.

5. 25% Stock of Love Co

As Watson Co has a significant influence over the operating activites of Love Co. for the previous year and also holds a share of greater than 20%. The stock shall be accounted as per equity method.

Particulars	Amount in $
Carrying amount of investment at the beginning of the year	500,000
Add: share in profit of associate                (25% of $200,000)	50,000
Less: dividends received from associate (25% of $50,000)	12,500
Carrying amount of investment at the year-end	537,500