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CORPORATEFINANCIAL REPORTING 2

17 – Investments

Investments

INVESTMENTS IN OTHER COMPANIES

Debt investments

Equity investments

Preferred stock

Common stock

2Investments

EQUITY INVESTMENTSCommon stock

PASSIVE ACCOUNTING METHOD TO USE: INVESTMENT ACTIVE INVESTMENT

Fair value Equity method significant control (in US)

influence Consolidate 1 share (20%) 50% 100% of

stock

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3Investments

REPORTING “PASSIVE” INVESTMENTS

PASSIVE

INVESTMENT

Fair value

1 share (20%) | |

Trading security orSecurity available for sale

The difference is where the “unrealized” (holding) gains/losses will appear.

4Investments

REPORTING “PASSIVE” INVESTMENTS

International rules differ slightly, but in general:

Trading Securities are meant to be held for short periods of time and are part of a company’s “operating activity.”

Securities Available for Sale are not part of a company’s “operating activity” rather they are investments made as a short or long term investment to generate financing (not operating) profits.

Held to maturity securities – investments in bonds payable.

5Investments

REPORTING “PASSIVE” INVESTMENTS

A brief aside - a visit to the “hidden” income statement - Other Comprehensive Income

and a kind of 2nd Retained Earnings account –

Additional Comprehensive Income.

(see ASU 220)6Investments

REPORTING “PASSIVE” INVESTMENTS

(our company prepares quarterly f/s)In Feb. 2013, our company buys shares of X Company common

stock for $10,000 (includes broker charges).

On Mar. 31, 2013, our X stock has a fair value of $9,000.

On June 30, 2013, our X stock has a fair value of $12,000.

In July, 2013, our company buys shares of Y company for $14,000.

On Sep. 30, 2013, our X stock is worth $12,200; Y is worth $13,300.

In Oct. 2013, we sell our X stock for $12,700,

On Dec. 31, 2013, our Y stock is worth $13,000

Scenario A: IF TRADING SECURITY (unrealized gains and losses on the income statement). The tax rate is 40%.

7Investments

REPORTING “PASSIVE” INVESTMENTS

(our company prepares quarterly f/s)In Feb. 2013, our company buys shares of X Company common

stock for $10,000 (includes broker charges).

On Mar. 31, 2013, our X stock has a fair value of $9,000.

On June 30, 2013, our X stock has a fair value of $12,000.

In July, 2013, our company buys shares of Y company for $14,000.

On Sep. 30, 2013, our X stock is worth $12,200; Y is worth $13,300.

In Oct. 2013, we sell our X stock for $12,700,

On Dec. 31, 2013, our Y stock is worth $13,000

Scenario B: IF SEC. AVAIL. FOR SALE (unrealized gains and losses in Other Comprehensive Income). The tax rate is 40%.

8Investments

EQUITY INVESTMENTS for voting stock (usually just common)

ACTIVE INVESTMENT

Equity method significant

influence

(20%?) 50% 100% of stock

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9Investments

THE EQUITY METHOD

On Jan. 2, 2013, Co. A acquires 25% of Co. B’s stock from B’s stockholders for $28,000 cash.

Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities

before acquiring B’s stock:

Book Value Market Value

cash $ 200,000 cash $ 1,000 $ 1,000

acct. rec. 300,000 acct. rec. 8,000 8,000

inventory 500,000 inventory 12,000 15,000

PPE 900,000 PPE 110,000 90,000

accum. deprec (300,000) accum. deprec (30,000)

patent 2,000 patent 1,000 0

trademark 3,000 trademark - 2,000

$1,605,000 $102,000 $116,000

liabilities 100,000 liabilities 10,000 $ 10,000

com. stock 300,000 com. stock 30,000

APIC 350,000 APIC 35,000

ret. earnings 855,000 ret. earnings 27,000

$1,605,000 $102,000

10Investments

THE EQUITY METHOD

What journal entry would Co. A’s accountant make?

Then Co. A’s accountant would ask “Why did we pay so much?”

11Investments

THE EQUITY METHOD

A’s balance sheet after acquiring B’s stock:

cash $ 172,000

acct. rec. 300,000

inventory 500,000 25% of B’s OE 23,000

PPE 900,000 trademark 500

accum. deprec (300,000) patent ( 250)

Invest. in Co. B 28,000 PPE 2,500

patent 1,000 inventory 750

trademark 3,000 goodwill 1,500

trade secret - 28,000

$1,604,000

liabilities 100,000

com. stock 300,000

APIC 350,000

ret. earnings 854,000

$1,604,000

12Investments

THE EQUITY METHOD

On 12/31/2013, Co. B reports $20,500 of net income and pays $10,000 in dividends.

What journal entries will Co. A make?

To answer this we need think about the Investment in Co. B account the way an accountant does.

13Investments

TWO COMMON WAYS TO OBTAIN CONTROL

Company A wants to expand – two common ways of doing that are:

(1) buying Company B’s assets and assuming its liabilities and

(2) buying enough stock in Company B to control Company B. 14Investments

EQUITY INVESTMENTSfor voting stock (usually just common)

ACCOUNTING METHOD TO USE: ACTIVE INVESTMENT

Equity method control (in US)

Consolidate 50% 100% of

stock

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15Investments

BUYING CO. B’s STOCK – A Consolidation Example

Co. A pays $135,000 to Co. B’s owners to buy 90% of Co. B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities

before acquiring B’s stock:

Book Value Market Value

cash $ 200,000 cash $ 1,000 $ 1,000

acct. rec. 300,000 acct. rec. 8,000 8,000

inventory 500,000 inventory 12,000 15,000

PPE 900,000 PPE 110,000 90,000

accum. deprec (300,000) accum. deprec (30,000)

patent 2,000 patent 1,000 0

trademark 3,000 trademark - 2,000

$1,605,000 $102,000 $116,000

liabilities 100,000 liabilities 10,000 $ 10,000

com. stock 300,000 com. stock 30,000

APIC 350,000 APIC 35,000

ret. earnings 855,000 ret. earnings 27,000

$1,605,000 $102,000

16Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

This is what happened:

Owners of A Owners of B

$135,000

90% Co.

Co. A B stock Co. B

What will Co. A’s journal entry look like?

17Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

This is “after”:

Owners of A Owners of B

10% owners

Co. A 90% owner

Co. B

18Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

A’s balance sheet after the transaction:cash $ 65,000 liabilities 100,000acct. rec. 300,000inventory 500,000 com. stock 300,000Invest. in B stock 135,000 APIC 350,000PPE 900,000 ret. earnings 855,000accum. deprec (300,000) $1,605,000patent 2,000trademark 3,000

$1,605,000

19Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

B’s balance sheet after the transaction:cash $ 1,000

acct. rec. 8,000

inventory 12,000

PPE 110,000

accum. deprec (30,000)

patent 1,000

trademark -

$102,000

liabilities 10,000

com. stock 30,000

APIC 35,000

ret. earnings 27,000

$102,000

20Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

Then A’s accountant asks:

“Why did A pay so much?”

The answer lies in a previous slide and our previous thought process,

but with a modification.

21Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

FASB (and International Accounting Standards) says that if one company controls another company the controlling company needs to do something more than use the equity method.

22Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

What FASB also wants:

Owners of A

F/S Co. A consolidated

F/S

F/S Co. B

23Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

What appears in the consolidated balance sheet are the assets and liabilities that Co. A controls, directly and indirectly (which would include Co. B’s assets and liabilities).

24Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

And the key is - the Investment in B Stock account on Co. A’s balance sheet really represents control of Co. B’s assets and liabilities

25Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidation Example

A’s balance sheet after the transaction:cash $ 65,000 liabilities 100,000acct. rec. 300,000 com. stock 300,000inventory 500,000 APIC 350,000Invest. in B stock 135,000 ret. earnings 855,000PPE 900,000 $1,605,000accum. deprec (300,000) cash 1,000

patent 2,000 acct. rec. 8,000

trademark 3,000 inventory 15,000PPE 90,000

$1,605,000 patent 0

trademark 2,000goodwill 41,000liabilities (10,000)

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BUYING CO. B’s STOCK – A Consolidation Example

So, Co. A’s consolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock.

27Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidated Balance Sheet

A’s consolidated Balance Sheet:cash $ 66,000 liabilities 110,000

acct. rec. 308,000

inventory 515,000 N.C.I. * 12,000

Invest. in B stock - com. stock 300,000

PPE 990,000 APIC 350,000

accum. deprec. (300,000) ret. earnings 855,000

patent 2,000 $1,627,000

trademark 5,000 WHEW!

goodwill 41,000

$1,627,000 * NONCONTROLLING INTEREST IN NET ASSETS OF

SUBSIDIARY28Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidated Income Statement

One year later, these were the income statements for A and B:

A B

Sales revenue $200,000 $70,000COGS ( 80,000) ( 36,000)Deprec. exp. ( 45,000) ( 5,500)Pat. amort. exp. ( 400) ( 200)Other exp. ( 14,600) ( 7,800)Net income $ 60,000 $20,500

and B paid $10,000 in cash dividends.

What entries would A’s accountant make (assuming A uses the equity method)?

29Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidated Income Statement

A’s income statement that it would issue to thepublic (IF it issued a non-consolidated income statement):

Sales revenue $200,000COGS ( 80,000) Deprec. exp. ( 45,000)

Pat. amort. exp. ( 400)Other expenses ( 14,600)Equity income 15,030Net income $ 75,030

30Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidated Income Statement

What would appear in A’s consolidated Income Statement:

Sales revenue $270,000COGS (119,000) Deprec. exp. ( 51,500)

Pat. amort. exp. ( 400) Other exp. ( 22,400)Equity income --Consol. net income $ 76,700

Net income to N.C.I ( 1,670)

Net income to Co. A $ 75,030

31Consolidated Financial Statements

BUYING CO. B’s STOCK

Co. A’s accountant also must prepare a consolidated owners’ equity statement and a consol-idated cash flow statement.

32Consolidated Financial Statements