2024 STUDENT

CASE COMPETITION
DETERMINING HOW
TO CLASSIFY STOCK
INVESTMENTS: THE CASE
OF UNBEKANNT, INC.

A finance team must decide whether to

keep using the fair value method or switch
to the equity method for its stock investment.
BY JASON PORTER, PH.D., AND MICHAEL W. PENN JR., PH.D.

© 2023 by IMA® (Institute of Management Accountants), Montvale, N.J., sfmagazine.com.

1 / STRATEGIC FINANCE / August 2023
 2024 STUDENT CASE
COMPETITION
The Student Case Competition is sponsored annually by
IMA® to provide an opportunity for students to interpret,
analyze, evaluate, synthesize, and communicate a
solution to a management accounting problem.
U
nbekannt, Inc., is a food distributor reporting requirements, and, more recently, investment
that specializes in foreign events. While opportunities. The meetings were led by Azul, the com-
headquartered in the United States, it pany’s CFO, with support from Beslau, the controller, and
does business around the world, ship- Kendi, the director of finance.
ping specialized food, beverages, and Other team members were invited as needed, but
decor from one nation to another in today’s meeting included only the three leaders. They
order to host special events. For example, needed to make some decisions about their recent invest-
it provides German beverages, sausages, ment in Éxito Real, and Azul felt the meeting would be
and costumes to venues in the U.S. as more effective with just the leadership team.
part of Oktoberfest events. The company also ships Mexican “Good afternoon, Beslau,” Kendi said as they entered
foods, horchata, sombreros, and other traditional items to the boardroom for the day’s meeting. “How are you
Japanese hotels wishing to host Cinco de Mayo celebrations. doing?”
Overall, the business has been very successful, espe- “I’m doing well, danke,” Beslau replied, with a light
cially with its respectful focus on sharing cultural tradi- German accent. Beslau was born in Munich but migrated
tions. It has low production costs, since it purchases food, to the U.S. with family at age 11. Most of the time, Beslau’s
beverages, and decorations from established vendors in the accent was barely recognizable, but it did tend to come out
countries where the traditions originate and rents shipping late in the day as he got tired. “And you?”
space from large airlines. Most of its costs are driven by “I’m doing just fine, although I wish this meeting were
labor, since it hires experts in linguistics and local traditions over.” Kendi was an immigrant from the Ivory Coast but
and customs. Because specialty suppliers, not the company, came to the U.S. as a baby. There was no accent to give away
host the events, Unbekannt doesn’t take on much risk. In Kendi’s origin.
other words, it gets paid whether or not the event is a suc- “Really?” Beslau asked. “Why’s that?”
cess. That said, Unbekannt’s employees take pride in their “Because this isn’t going to be a good meeting, and
work and do everything they can to help the different ven- you know it.” Kendi slouched into a chair and looked out
ues around the world plan and execute successful events the window. “It’s going to be all about GAAP [Generally
that will become local traditions, providing Unbekannt with Accepted Accounting Principles] rules as we get ready for
continuing markets for its services. the annual financial statements.”
Unfortunately, the company faced challenges during a Kendi held up a hand. “Don’t tell me. You’re all excited
recent economic downturn as venues closed and shipping about it, but some of us, believe it or not, find it kind of
became more difficult. The company was able to leverage boring.”
its existing connections and continue to operate by mod- Beslau just chuckled and found a seat that also had a
ifying its services. Instead of supplying large gatherings, good view of the nearby lake. “You finance people don’t
Unbekannt would provide party boxes for individuals and know fun when you see it! This is going to be a great
outdoor decorations. The result was a series of small, more meeting.”
reasonably priced events that kept the company solvent and “Of course it is!” Both Kendi and Beslau jumped as Azul
its employees paid. As the downturn continued, Unbekannt came in. Azul was born in south Texas and had a deep
was able to provide some exciting opportunities for clients southern drawl, despite being raised by Mexican parents
looking to host parties and other activities to reinvigorate and speaking Spanish fluently. “We’re gonna have us a great
communities or advertise their products. time this afternoon. I mean, who doesn’t love figuring out
By the end of last year, in fact, Unbekannt’s finance team how to share good news with our investors?”
was in the unusual position of having extra cash and no Kendi sighed. “Can’t you at least pretend to be a finance
readily available investment opportunities. After long consul- person still?”
tations, the team decided that its best option was to purchase Azul laughed. “I’m the CFO, Kendi. I can’t afford to play
stock in some of its suppliers, especially a company named favorites between accounting and finance. I have to work
Éxito Real, Inc. Éxito is headquartered in Mexico City and both sides, so of course I’m excited to be here. Let’s get
provides most of the food and costumes Unbekannt uses for started.”
its popular Cinco de Mayo events. Éxito’s shares on Nasdaq Azul sat down between the two other senior
dropped significantly during the downturn, and Unbekan- members of Unbekannt’s finance department. “I’ll
nt’s finance team felt that purchasing stock in Éxito would keep it quick, since some of you have unreasonable
not only give their company a chance to help support a key prejudices.”
supplier but would also give it a way to ensure that Éxito Kendi sighed. It was going to be one of those meetings.
continued to provide Unbekannt with the same services it “We’re comin’ up on year-end, like Kendi said. How’re
had offered in the past. At the time of its initial investment, our books looking?” Azul asked.
Unbekannt became the largest single shareholder in Éxito Beslau shrugged. “Given what’s going on in the world,
other than the company’s founder, who owned 25%. they look pretty good. Actually, they look much better
than last year. The increases in prices across the board
haven’t helped, so our margins aren’t as good as they were
Finance Leadership Meeting before the economy tanked, but we’re doing okay. I think
During the downturn, Unbekannt’s finance team held we’ll just meet analysts’ forecasts.”
daily meetings to address cash needs, financing options, Kendi smiled. “Excellent. Everything looks good, we’re

3 / STRATEGIC FINANCE / August 2023

 TABLE 1: UNBEKANNT, INC., FINANCIAL STATEMENTS

TABLE 1A: MULTI-STEP INCOME STATEMENT FOR YEAR ENDED DECEMBER 31, 2022

Sales revenue $31,750,000

Cost of goods sold $22,034,500
Gross profit $9,715,500

Operating activities
Selling expenses
Advertising expense $595,313
Bad debt expense $495,000
Sales force salaries expense $1,706,563
Shipping expense $259,953
Total selling expenses $3,056,829
Administrative expenses
Executive salaries expense $2,032,000
Insurance expense $47,625
Depreciation expense $635,000
Miscellaneous admin. expenses $31,750
Rent expense $762,000
Utilities expense $127,000
Total administrative expenses $3,635,375 $6,692,204
Income from operations $3,023,296

Other gains and losses

Interest expense ($202,406) ($202,406)
Income from continuing $2,820,890
operations before taxes
Income tax expense $789,849
Net income $2,031,041

Earnings per share $0.97

going to meet our targets, and everyone’s happy. Meeting “It’s a stock investment, and we’re using the fair value
adjourned!” method. That’s really our only option, since Éxito’s stock is
Azul frowned. “Kendi,” he said reprovingly. publicly traded and the price is easy to find,” Beslau said.
“All right. I’m sorry. What’s up?” Kendi said. “No,” Azul disagreed. “It’s not our only option. We could
“I think we need to decide what to do with our invest- use the equity method.”
ment in Éxito,” Azul answered. “Why would we want to do that?” Beslau asked.
Beslau frowned. “Why? Do you want to buy more “Have you looked at Éxito’s current stock price?” Azul
shares? Or maybe you want to sell a few. I haven’t seen the asked.
current market price for their stock.” “I know it has fluctuated the last few weeks. That’s why
“No, no. I’m happy with our stake,” Azul said. I thought, like Kendi, that you might be thinking of adjust-
Kendi frowned. “Then what do we need to decide?” ing our holdings,” Beslau said.
“How to treat it for accounting purposes,” Azul said. “I don’t want to buy more; we need our cash for other

August 2023 / STRATEGIC FINANCE / 4

 TABLE 1B: BALANCE SHEET AS OF DECEMBER 31, 2022

2022 2021
Assets
Current assets
Cash $476,250 $603,250
Accounts receivable $1,349,375 $952,500
Allowance for bad debts ($158,750) ($476,250)
Inventory $4,127,500 $4,445,000
Total current assets $5,794,375 $5,524,500
Long-term assets
Expansion fund $72,000 $0
Land $3,492,500 $2,222,500
Building $2,540,000 $2,540,000
Equipment $8,890,000 $4,127,500
Accumulated depreciation ($3,810,000) ($3,175,000)
Total property, plant, and equipment $11,184,500 $5,715,000
Total assets $16,978,875 $11,239,500

Liabilities and Stockholders’ Equity

Current liabilities
Accounts payable $1,930,334 $1,905,000
Salaries payable $555,625 $317,500
Unearned revenue $793,750 $476,250
Total current liabilities $3,279,709 $2,698,750
Long-term debt
Loan payable $2,540,000 $952,500
Notes payable $4,445,000 $2,540,000
Total long-term debt $6,985,000 $3,492,500
Total liabilities $10,264,709 $6,191,250

Stockholders’ equity
Common stock $2,100,000 $2,100,000
($ par, 5,300,000 authorized, 2,100,000 outstanding)
Additional paid-in capital $952,500 $952,500
Retained earnings $3,661,666 $1,995,750
Total stockholders’ equity $6,714,166 $5,048,250
Total liabilities and stockholders’ equity $16,978,875 $11,239,500

things right now,” Azul said. now and year-end, but what if something happens in this
“It’s not a big change in value, so it won’t have a big last week, or what if, heaven forbid, the auditors find some-
effect on our financials. I mean, our EPS [earnings per thing in our financials that has to be corrected? Wouldn’t it
share] is going to meet analysts’ expectations regard- be better to use the equity method for the investment? That
less of what happens with Exito’s stock price,” Beslau will give us an income effect that’s easier to forecast than
replied. market prices.”
Azul nodded. “As long as there isn’t a big bump between “What are you talking about?” Kendi asked. “I don’t

5 / STRATEGIC FINANCE / August 2023

 TABLE 1C: STATEMENT OF CASH FLOWS FOR YEAR ENDED DECEMBER 31, 2022

Cash flow from operations

Net income $2,031,041
Adjustments:
Depreciation $635,000
Change in working capital accounts
Change in accounts receivable ($714,375)
Change in inventory $317,500
Change in accounts payable $25,334
Change in salaries payable $238,125
Change in unearned revenue $317,500 $819,084
Net cash flow from operations $2,850,125

Cash flow from investments

Purchase of securities ($72,000)
Purchase of land ($1,270,000)
Purchase of equipment ($4,762,500)
Net cash flow from investments ($6,104,500)

Cash flow from financing

Repayment of loans $1,587,500
Issuance of notes payable $1,905,000
Payments of dividends ($365,125)
Net cash flow from financing $3,127,375

Net increase (decrease) in cash ($127,000)

Cash, January 1, 2022 $603,250
Cash, December 31, 2022 $476,250

remember much about the equity method from my col- “But we don’t have a seat on the board,” Kendi
lege accounting classes, but I do remember you can’t use it countered.
unless you own at least 20% of the outstanding stock, and “But they did offer us one,” Beslau said with a slight
we aren’t even close.” frown. “We just didn’t like the conditions they put on us.”
“Wait,” Beslau objected. “Azul might be right. We “Oh, yeah,” Kendi nodded. “Didn’t they say that
might have a case for using the equity method. I haven’t we couldn’t buy any more stock for like 12 months or
looked at the rules in a while since we don’t own any something?”
other investees, but I believe the term the FASB [Finan- Azul nodded. “Which suggests that they’re afraid that we
cial Accounting Standards Board] uses is ‘significant own too much of the stock and supports us having a signif-
influence’ over the investee company to switch to the icant influence.”
equity method, and the FASB presumes that you have “And we’re one of their biggest customers,” Beslau
significant influence once you own at least 20% of the added. “That also indicates some influence.”
outstanding stock.” “I don’t know,” Kendi said. “Aren’t we pushing here?
“But we don’t own 20% of the outstanding stock,” Kendi And for what? Just to switch from a market-based
started to say, but Azul jumped in. adjustment to an investee profit-based adjustment? That
“No, but we’re the second biggest stockholder, and the doesn’t seem worth the hassle. And we aren’t even sure
founder doesn’t have a controlling vote.” about the rule. For all we know, GAAP may require that

August 2023 / STRATEGIC FINANCE / 6

 TABLE 2: INVESTMENT IN ÉXITO REAL, INC.

Number of shares
Éxito Real, Inc.’s total shares outstanding 150,000
Number of shares owned by Unbekannt 18,000

Stock price
Purchase price $4.00
Market price on 12/31/2022 $7.25

Financial results
Éxito Real, Inc.’s reported net profit (loss) ($20,000)
Dividends paid by Éxito Real during 2022 $35,000

Other Important Numbers

Tax rate 28%

we do have to own a full 20%. We need to find out.” 3. Make the necessary adjusting entries to account for
“That’s a good point,” Beslau agreed. “This can’t be about Unbekannt, Inc.’s investment in Éxito Real, Inc., at the
our projections. It needs to be about following GAAP. That’s end of the fiscal year, assuming that Unbekannt’s finance
what our investors expect and what the auditors are look- team decides to use the equity method to account for the
ing for. I agree that a more stable prediction would be nice, investment.
especially since we’re having a good year. But it isn’t worth 4. Update Unbekannt, Inc.’s financial statements to
a fight with the auditors.” incorporate the effects of the adjusting entries for the equity
Azul nodded. “Which means we should switch.” method.
“Which means,” Beslau disagreed, “that we need to dig 5. Find the financial accounting standards that a com-
a little deeper, reread the rules, look at the entries, and see pany should use to determine when to use the equity
which option would provide the best information for our method of accounting. If you’re studying in the U.S., please
investors and other stakeholders.” use U.S. GAAP, available at FASB.org, for your research.
“Oh, sure,” Azul said, “and I’m sure that will be to use If you’re studying outside of the U.S., please use Interna-
the equity method.” tional Financial Reporting Standards (IFRS), available at
Kendi sighed. “I’m sure you do feel that way. But for IFRS.org, for your research. Note: You’ll need to register
now, maybe Beslau and the accounting team can run some for a free account to access the IFRS database if you don’t
numbers and do some more research for us.” already have one.
“Good idea. Let’s meet again in two days,” Azul 6. Using your answers to the previous questions,
decided. “Beslau, please bring the information about both determine the correct classification for Unbekannt’s
options and a recommendation so we can get the change investment in Éxito Real, Inc. Defend your answer
made.” sufficiently to convince the finance team to follow your
recommendation. SF

Case Questions
1. Make the necessary adjusting entries to account for Jason Porter, Ph.D., is a scholarly associate professor of accounting at
Unbekannt, Inc.’s investment in Éxito Real, Inc., at the end the Carson College of Business at Washington State University. He can be
of the fiscal year, assuming that Unbekannt’s finance team reached at jason.porter@wsu.edu.
decides to use the fair value method to account for the
investment.
2. Update Unbekannt, Inc.’s financial statements to Michael W. Penn Jr., Ph.D., is a senior lecturer of accountancy at the
incorporate the effects of the adjusting entries for the fair Gies College of Business at the University of Illinois Urbana-Champaign. He
value method. can be reached at mpenn@illinois.edu.

7 / STRATEGIC FINANCE / August 2023