CM2 purchased some shares of one of its suppliers, Infrared Co., as an investment. CM2 paid $140,186 for the shares. Although management plans to hold this investment for the long-term, the company may need to sell it in the future for liquidity purposes. Conner and Martin also think that making investments in some of their other suppliers can be a good way to ensure quality and consistency in the components they buy from these suppliers. Because many of its suppliers are public companies, it should be fairly easy for CM2 to buy shares on the open market.

Conner and Martin mention that they might go so far as to buy 1015% of the common stock of one of their main suppliers and up to 30% of the common stock of another supplier of routers, which are critical pieces in the CM2 system. They want you to help them understand whether it makes a difference if they buy just 1015% or if they buy 30% of these suppliers shares. Both these suppliers have been around for some time and, with very few exceptions, the parts ordered from them have been of high quality and delivered on time; Conner and Martin tell you that if they do buy these stocks, they anticipate holding them for a long time.

Action

1. Use the investment in Infrared Co. to illustrate the accounting and financial reporting implications of an equity investment in a supplier. While the growth prospects for Infrared are quite good, in the current year it reported a net loss of $120,000 and paid cash dividends of $24,000. The fair value of the Infrared shares is $150,000 at year-end. Prepare journal entries for the Infrared investment, assuming:

(a) CM2s investment represents 10% of Infrared shares. (b) CM2s investment represents 30% of Infrared shares.

Indicate the differential effect on income between the accounting for the conditions under assumptions 1 and 2.

2. Conner and Martin have heard that as long as they do not hold more than 20% of the shares of one of these suppliers, they are able to recognize the unrealized gains on these equity investments in income. Prepare a memorandum to Conner and Martin with references to the authoritative literature on the accounting for equity investments of less than 20% ownership. Discuss other factors beyond the percentage of shares owned that should be considered in determining the accounting for investments if they hold at least 20% but less than or equal to 50% of the stock of another company.