12-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA

12-1

PowerPoint Authors:Susan Coomer Galbreath, Ph.D., CPACharles W. Caldwell, D.B.A., CMAJon A. Booker, Ph.D., CPA, CIACynthia J. Rooney, Ph.D., CPA

Reporting and InterpretingInvestments in Other

CorporationsChapter 12

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

12-2

Understanding the Business

A company may invest in the securities of another company to:

A company may invest in the securities of another company to:

Earn a return on idle funds.

(Passive investments)

Earn a return on idle funds.

(Passive investments)

Control the other

company.

Control the other

company.

Influence the other

company’s policies and

activities.

Influence the other

company’s policies and

activities.

12-3

Passive Investments in Debt and Equity Securities

Investments in debt securities are alwaysconsidered passive investments.

Investments in debt securities are alwaysconsidered passive investments.

Passive investments are made to earn a high rate of return on funds that may be needed for future purposes.

Passive investments are made to earn a high rate of return on funds that may be needed for future purposes.

Equity security investments are presumed passive if the

investing company owns less than 20% of the outstanding

voting shares.

Equity security investments are presumed passive if the

investing company owns less than 20% of the outstanding

voting shares.

The investor is notThe investor is notinterested in controllinginterested in controllingor influencing the otheror influencing the other

company.company.

The investor is notThe investor is notinterested in controllinginterested in controllingor influencing the otheror influencing the other

company.company.

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Investments made with the intent of exerting significant influence over another corporation.

The ability of the investing company to

have an important impact on the operating and

financial policies of another company.

The ability of the investing company to

have an important impact on the operating and

financial policies of another company.

SignificantInfluence

20% - 50%outstanding shares

SignificantInfluence

20% - 50%outstanding shares

Investments in Stock for Significant Influence

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Investments made with the intent to exertcontrol over another corporation.

Control

>50%outstanding shares

Control

>50%outstanding shares

The investing company has the

ability to determine the operating and

financial policies of another corporation.

The investing company has the

ability to determine the operating and

financial policies of another corporation.

Investments in Stock for Control

12-6

Types of Investments and AccountingMethods

Measuring andInvestment Category Reporting Method

Debt Passive, Held-to-maturity Amortized costDebt Passive, Not-held-to-maturity Fair valueStock Passive Fair valueStock Significant influence EquityStock Control Consolidated statement


Debt Passive, Held-to-maturity Amortized costDebt Passive, Not-held-to-maturity Fair valueStock Passive Fair valueStock Significant influence EquityStock Control Consolidated statement

The accounting method depends on the type of security and the level

of ownership (influence).

The accounting method depends on the type of security and the level

of ownership (influence).

12-7

Debt Held To Maturity: Amortized CostMethod

Record at cost on acquisition date.

Record at cost on acquisition date.

Amortize discount or premium.

Amortize discount or premium.

Record interest received.

Record interest received.

Record principal received at maturity.

Record principal received at maturity.

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On July 1, 2010, Washington Post paid the par value of $100,000 for 8 percent bonds that mature on June 30, 2015.

The 8 percent interest is paid on each June 30 and December 31. Management plans to hold the bonds until maturity.

Prepare the journal entry to record the investment.

On July 1, 2010, Washington Post paid the par value of $100,000 for 8 percent bonds that mature on June 30, 2015.

The 8 percent interest is paid on each June 30 and December 31. Management plans to hold the bonds until maturity.

Prepare the journal entry to record the investment.

Date Description Debit Credit

Jul. 1 Held-to-maturity Investments (+A) 100,000

Cash (-A) 100,000

GENERAL JOURNAL

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The journal entry to record the receipt of interest on December 31 of the first year is . . .


Dec. 31 Cash (+A) 4,000

Interest Revenue (+R, +SE) 4,000

GENERAL JOURNAL

$100,000 × 8% × 6/12

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June 30 Cash (+A) 100,000

Held-to-maturity Investments (-A) 100,000

GENERAL JOURNAL

The journal entry to record the receipt ofthe principal payment at maturity is . . .

12-11

Passive Stock Investments: The FairValue Method

Date of acquisition

Investment is initially

recorded at cost.

Future measurement date

Unrealized holding gains and

losses are recorded.


losses are recorded.

Investment carrying amount is adjusted to current

market value.

12-12

Classifying Passive Investments at Fair Value

NOTE: Realized gains and losses go on the Income Statement.

12-13

Securities Available for Sale (SAS)

On January 5, 2009, Washington Post acquires 15,000 of the 100,000 outstanding shares of INews on the open market at a cost of $10 per share. Washington Post has no influence over INews, and does not plan to sell the shares in the near future.

On January 5, 2009, Washington Post acquires 15,000 of the 100,000 outstanding shares of INews on the open market at a cost of $10 per share. Washington Post has no influence over INews, and does not plan to sell the shares in the near future.

Should the acquired shares be classified as Trading Securities or Securities Available for Sale?

Should the acquired shares be classified as Trading Securities or Securities Available for Sale?

Washington Post does not plan to actively trade the shares. Instead, they will be held to earn a return on invested

funds that may be needed for future operations. The shares should be classified as Securities Available for Sale.

12-14


Jan. 5 Investment in SAS (+A) 150,000

Cash (-A) 150,000

GENERAL JOURNAL

The investment may be a current asset or a noncurrent asset, depending on management’s intended holding period.

The investment may be a current asset or a noncurrent asset, depending on management’s intended holding period.


The journal entry to record the investment is . . .

12-15


On July 2, 2009, Washington Post receives a $15,000 dividend from INews. Prepare the journal entry to record the dividend.

On July 2, 2009, Washington Post receives a $15,000 dividend from INews. Prepare the journal entry to record the dividend.


July 2 Cash (+A) 15,000

Dividend Revenue (+R, +SE) 15,000

GENERAL JOURNAL

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By December 31, 2009, Washington Post’s fiscal year-end, the market value of INews’ shares has dropped

from $10 to $8 per share. How much has Washington Post’s portfolio value changed?

By December 31, 2009, Washington Post’s fiscal year-end, the market value of INews’ shares has dropped

from $10 to $8 per share. How much has Washington Post’s portfolio value changed?

The journal entry to recognize the change in market value is . . .

Market value ($8 per share × 15,000 shares) 120,000$ Cost ($10 per share × 15,000 shares) 150,000 Unrealized holding loss on SAS portfolio (30,000)$

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Dec. 31 Net Unrealized Losses/Gains (-OCI) (-SE) 30,000

Investments in SAS (-A) 30,000

GENERAL JOURNAL


The The unrealized holding lossunrealized holding loss is reported in the stockholders’ is reported in the stockholders’ equity section of Washington Post’s balanceequity section of Washington Post’s balance

sheet as Other Comprehensive Income.sheet as Other Comprehensive Income.

The The unrealized holding lossunrealized holding loss is reported in the stockholders’ is reported in the stockholders’ equity section of Washington Post’s balanceequity section of Washington Post’s balance

sheet as Other Comprehensive Income.sheet as Other Comprehensive Income.

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Dec. 31 Investments in SAS (+A) 45,000

Net Unrealized Losses/Gains (+OCI, +SE) 45,000

GENERAL JOURNAL

Securities Available for Sale (SAS)On December 31, 2010, the market value of INews’ shares is $11 per share, an increase of $3 per share

from December 31, 2009.

On December 31, 2010, the market value of INews’ shares is $11 per share, an increase of $3 per share

from December 31, 2009.

The journal entry to recognize the change in market value for 2010 is . . .

December 31, 2010 fair value ($11 per share × 15,000 shares) 165,000$ December 31, 2009 fair value ($8 per share × 15,000 shares) 120,000 Unrealized holding gain on SAS portfolio 45,000$

12-19

Securities Available for Sale (SAS)Near the end of 2011, Washington Post sells all

15,000 shares of INews for $13 per share.Near the end of 2011, Washington Post sells all

15,000 shares of INews for $13 per share.

Proceeds from sale 195,000$ Cost of INews investment 150,000 Gain on sale of INews investment 45,000$

Beginning of 2009 -$ 2009 Unrealized loss 30,000

12/31/09 Balance 30,000$ 45,000$ 2010 Unrealized gain15,000$ 12/31/10 Balance

New Unrealized Losses/Gains (SE)

This amount will beremoved when thesale entry is made.

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Cash (+A) (15,000 × $13) 195,000

Net Unrealized Losses/Gains (-OCI, -SE) 15,000

Investments in SAS (-A) 165,000

Gain on Sale of Investments (+Gain, +SE) 45,000

GENERAL JOURNAL


The journal entry to record the 2011 sale of the INews investment is . . .

$150,000 – $30,000 + $45,000 = $165,000

12-21

Comparing Trading and Available for Sale Securities

12-22

Key Ratio Analysis

The economic return from investing ratio measures how The economic return from investing ratio measures how much a company earns for each dollar of investment for much a company earns for each dollar of investment for

a period. In general, a higher return indicates a period. In general, a higher return indicates management is doing a better job selecting investments.management is doing a better job selecting investments.

The economic return from investing ratio measures how The economic return from investing ratio measures how much a company earns for each dollar of investment for much a company earns for each dollar of investment for

a period. In general, a higher return indicates a period. In general, a higher return indicates management is doing a better job selecting investments.management is doing a better job selecting investments.

For the year 2009, Washington Post received $15,000 individends from INews, and the fair value declined from $150,000at the beginning of the year to $120,000 at the end of the year.

For the year 2009, Washington Post received $15,000 individends from INews, and the fair value declined from $150,000at the beginning of the year to $120,000 at the end of the year.

Economic Return

from Investing

Dividends and Interest Received

+ Change in Fair Value

Fair Value of Investments

(beginning of period)

=

12-23

Key Ratio Analysis

Economic Return

from Investing

Dividends and Interest Received

+ Change in Fair Value

Fair Value of Investments

(beginning of period)

=

Economic Return

from Investing$15,000 – $30,000

$150,000= = – 10%

For 2009

12-24

Investments For Significant Influence:Equity Method

Used when an investor can exertsignificant influence over an investee.

It is presumed that the investmentwas made as a long-term investment.


Stock Passive Fair valueStock Significant influence EquityStock Control Consolidated statement


Stock Passive Fair valueStock Significant influence EquityStock Control Consolidated statement

12-25

Date of acquisition

Investment is initially

recorded at cost.

Future measurement date


losses are not recorded.


losses are not recorded.

Investment carrying amount is adjusted for

dividends received, and a percentage share of the investee’s income.


12-26

Adjusting Effect onItem Investment Account

Reduce investmentfor dividends received.

Investee Increase investmentNet Income by our proportionate

share.Investee Decrease investmentNet Loss by our proportionate

share.

Dividends


12-27


Jan. 2 Investments in Affiliates (+A) 400,000

Cash (-A) 400,000

GENERAL JOURNAL

Recording Investments under the Equity Method

On January 2, 2010 Washington Post a 40% interest in INews at a cost of $400,000.

Prepare the journal entry to record Washington Post’s investment.

On January 2, 2010 Washington Post a 40% interest in INews at a cost of $400,000.

Prepare the journal entry to record Washington Post’s investment.

12-28


Dec. 31 Investments in Affiliates (+A) 200,000

Equity in Affiliate Earnings (+R, +SE) 200,000

GENERAL JOURNAL

Washington Post credits Equity in Affiliate Earnings (an income statement account) for its share of INews earnings.

Washington Post credits Equity in Affiliate Earnings (an income statement account) for its share of INews earnings.

Earnings of Affiliates INews net income for 2010 is $500,000.

Washington Post’s 40% share is $200,000. Record Washington Post’s share of the INews income.

INews net income for 2010 is $500,000. Washington Post’s 40% share is $200,000. Record

Washington Post’s share of the INews income.

12-29


Mar. 31 Cash (+A) 40,000

Investments in Affiliates (-A) 40,000

GENERAL JOURNAL

Dividends are Dividends are notnot revenue under the equity method. They revenue under the equity method. They are treated as a reduction of the investment account.are treated as a reduction of the investment account.

Dividends are Dividends are notnot revenue under the equity method. They revenue under the equity method. They are treated as a reduction of the investment account.are treated as a reduction of the investment account.

Dividends ReceivedOn March 31 of the next year, INews pays $100,000 in

dividends, $40,000 (40%) of which goes to Washington Post. Record Washington Post’s receipt

of the dividend.

On March 31 of the next year, INews pays $100,000 in dividends, $40,000 (40%) of which goes to

Washington Post. Record Washington Post’s receipt of the dividend.

12-30

Reporting Investments under the Equity Method

Reported on the balance sheet as a long-term asset,originally at cost.

Account is increased by the proportional share of affiliate’s income.

Account is decreased by proportional share of affiliate’s losses andby dividends received from the affiliate.

No adjustment to fair value at the end

of the accounting period.

If sold, anygain or loss is reported in the

income statement as other income.

12-31

Focus on Cash FlowsInvesting activities:• Purchase of investment (cash outflow)• Sale of investment (cash inflow)

Investing activities:• Purchase of investment (cash outflow)• Sale of investment (cash inflow)

Operating activities:• Gain on sale of investment (subtract from net income)• Loss on sale of investment (add to net income)• Equity in earnings of investee (subtract from net income)• Dividends from investee (add to net income)• Unrealized holding gains trading securities (subtract from net income)• Unrealized holding losses trading securities (add to net income)

Operating activities:• Gain on sale of investment (subtract from net income)• Loss on sale of investment (add to net income)• Equity in earnings of investee (subtract from net income)• Dividends from investee (add to net income)• Unrealized holding gains trading securities (subtract from net income)• Unrealized holding losses trading securities (add to net income)

12-32

Controlling Interests: Mergers andAcquisitions

Off and running with less than

20%. . .

Clearing the 20% hurdle to gain influence . . .

Vaulting over the 50% mark

to gain control!

12-33

Horizontal Horizontal growthgrowth

Horizontal Horizontal growthgrowth

Vertical Vertical integrationintegration

Vertical Vertical integrationintegration

Controlling Interests: Mergers andAcquisitions

SynergySynergySynergySynergy

12-34

What Are Consolidated Statements?

• The acquiring company is the parent.

• The company acquired is the subsidiary.

• Consolidated statements combine two or more companies into a single set of statements.

• The acquiring company is the parent.

• The company acquired is the subsidiary.

• Consolidated statements combine two or more companies into a single set of statements.

Any transactions between the parent and

subsidiary must be eliminated

when preparing consolidated

financial statements.

Any transactions between the parent and

subsidiary must be eliminated

when preparing consolidated

financial statements.

12-35

Occurs when onecompany buys

another company.

The amount by which thepurchase price exceeds the fair

market value of net assets acquired.

Only purchased goodwill is an

intangible asset.

Goodwill

Recording a Merger

12-36

Recording a MergerWashington Post paid $1,000,000 in cash to

purchase all the stock of INews. Washington Post merged INews’ operations into its own operations, and INews ceased to exist as a separate entity. The following information is available at the date

of acquisition:

Fair value of equipment 350,000$ Fair value of patents 600,000 Total fair value of assets 950,000 INews note payable 100,000 Fair value of net assets 850,000$

Should Washington Post record goodwill?Should Washington Post record goodwill?

12-37

Recording a Merger

Purchase price for INews 1,000,000$ Fair value of net assets acquired 850,000 Purchased goodwill 150,000$

The journal entry to record the acquisition of INews is . . .

12-38

Recording a Merger


Equipment (+A) 350,000

Patents (+A) 600,000

Goodwill (+A) 150,000

Note Payable (+L) 100,000

Cash (-A) 1,000,000

GENERAL JOURNAL

12-39

Not amortized.Not amortized.Subject to assessment

for impairment ofvalue and may be

written down.

Subject to assessment for impairment ofvalue and may be

written down.

Goodwill

Recording a Merger

12-40

End of Chapter 12

Documents

12-1 PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA