Chapter 14 “Stock Investments” from Accounting Principles: A Business Perspective, FinancialAccounting (Chapters 9-18) by Hermanson, Edwards, and Maher is available under a Creative CommonsAttribution-Noncommercial-Share Alike 3.0 license. © Textbook Equity (2011)14 Stock investments14.1 Learning objectivesAfter studying this chapter, you should be able to:•Report stock investments and distinguish between the cost and equity methodsof accounting for stock investments.•Prepare journal entries to account for short-term stock investments and forlong-term stock•Prepare journal entries to account for long-term stock investments of 20percent to 50 percent.•Describe the nature of parent and subsidiary corporations.•Prepare consolidated financial statements through the use of a consolidatedstatement work sheet.•Describe the uses and limitations of consolidated financial statements.•Analyze and use the financial results—dividend yield on common stock andpayout ratio on common stock.14.2 The role of accountants in business acquisitionsThe number and size of corporate mergers and acquisitions has accelerated at anamazing pace over the last decade. The combination of these sometimes mega-giantcorporations, involves complex strategic alliance decisions. The potential rewards ofmergers and acquisitions can be enormous-increased market share, broadenedproduct lines, stability for the overall company, strengthened financial position,captured key executive or technical talent, and cost savings. In 1999, Exxon andMobil merged in an USD 82 billion deal. The companies originally estimated that themerger would save the companies USD 2.8 billion, but by the end of 2002 thatnumber had risen to nearly USD 7 billion.Not all mergers and acquisitions turn out this well. In fact, many mergers andacquisitions weaken companies (for example, the acquisition of Skype by eBay).Beyond the need to record accounting transactions after the combination,288accountants are now being asked to play an increasing role in business valuationbefore the combination.When considering the acquisition of a company, the first question is "Do we reallywant to go into business with this company?" Target companies may misrepresenttheir financial position or conceal suspicious behavior in an attempt to maximizetheir purchase price. Accountants are used by acquirers to scope out the full detailsof a target's financials, operations, and human assets. Accountants are intimatelyfamiliar with accounting practices and recording procedures and therefore are besttrained to find financial statement misrepresentations. Discoveries by accountantshave canceled many giant mergers and acquisitions.The second question to consider is "What is the target worth?" The acquiringcompany generally requires the target company to make available its financialstatements. Accounting professionals are asked to interpret the financial statementsand other financial data to determine the value of the target. Accountingprofessionals also understand how accounting numbers translate into firm value andwhich aspects of firm value are not captured by accounting numbers.Business acquisitions are commonplace in every industry.