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16. Long-Term Investments and International Transactions. Exh. 16.3. Classes of Long-Term Investments. Held-To-Maturity. Available-For-Sale. Significant Influence. Controlling Influence. Equity Method. Cost Method. Market Value Method. Consolidation. Accounting Method. Accounting

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Long-Term Investments and International Transactions

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Long term investments and international transactions

16

Long-Term Investments and International Transactions


Classes of long term investments

Exh.

16.3

Classes of Long-Term Investments

Held-To-Maturity

Available-For-Sale

Significant Influence

Controlling Influence

Equity Method

Cost Method

Market Value Method

Consolidation

Accounting Method


Held to maturity securities

Accounting

Recorded at cost at acquisition

Interest revenue recorded as accrued

Difference between cost and maturity value is amortized over the remaining life of the security

Held-to-Maturity Securities

Debt securities that a company intends to hold until maturity.


Available for sale securities

Accounting

Recorded at cost at acquisition

Interest revenue recorded as accrued (debt securities)

Dividends recorded as revenue (equity securities)

Carrying amount is adjusted to Market Value each period.

Available-for-Sale Securities

Debt and equity securities that a company intends to sell in the future, before maturity.


Available for sale securities1

Available-for-Sale Securities

Unrealized holding gains and losses from available-for-sale securities are reported in the equity section of the balance sheet.


Available for sale securities example

Foot, Inc. purchased 1,000 shares of General Boots at $5 per shares during 2001. At December 31, 2001, the shares had increased in value to $9.50 per share.

Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at Dec. 31, 2001.

Available-for-Sale Securities Example


Available for sale securities example1

Foot, Inc. purchased 1,000 shares of General Boots at $5 per shares during 2001. At December 31, 2001, the shares had increased in value to $9.50 per share.

Available-for-Sale Securities Example

The Unrealized Holding Gain is reported in the equity section of the Balance Sheet.


The significance of the size of the investment

Investor Ownership of Investee Shares Outstanding

The Significance of the Size of the Investment

Cost or Market Value Method

Equity Method

Consolidated Financial Statements

{

0%

20%

50%

100%

In some cases, influence or control may exist with less than 20% ownership.


The significance of the size of the investment1

Investor Ownership of Investee Shares Outstanding

The Significance of the Size of the Investment

Cost or Market Value Method

Equity Method

Consolidated Financial Statements

{

0%

20%

50%

100%

Significant influence is generally assumed with 20% to 50% ownership.


Equity method

Original investment is recorded at cost.

The investment account is increased by a proportionate share of investee’s earnings.

The investment account is decreased by dividends received.

Equity Method


Equity method1

The investment account is reported on the balance sheet as a singleamount.

The investor’s share of the investee’s earnings is reported as a single item on the investor’s income statement.

The account is called “Earnings from Long-Term Investment”

Equity Method


Long term investments and international transactions

Let’s do an equity method example.


Equity method example

Equity Method Example

On January 1, 2001, Big Corp. buys 20% of Small Inc. for $2,000,000 cash.

Record Big’s journal entry.


Equity method example1

Equity Method Example

On December 31, 2001, Small reports net income for the year of $300,000.

Record Big’s journal entry.


Equity method example2

Equity Method Example

Big owns 20% of Small and gets credit for 20% of Small’s income.

20% × $300,000 = $60,000

60,000

60,000


Equity method example3

Equity Method Example

On December 31, 2001, Big received a $25,000 dividend check from Small.

Record Big’s journal entry.

25,000

60,000

25,000


Consolidation of financial statements

Consolidation of Financial Statements

  • Required when investor’s ownership exceeds 50% of investee.

    • Control is presumed to exist.

  • Equity Method is used.

  • Consolidated Financial Statements show the financial position, results of operations, and cash flows of all entities under the parent’s control.


Investments in international operations

(1) Accounting for sales and purchases listed in a foreign currency.

(2) Preparing consolidated financial statements with international subsidiaries.

Investments in International Operations

Two major accounting challenges arise when companies have international operations:


Exchange rates between currencies

Each country uses its own currency for internal economic transactions.

To make transactions in another country, units of that country’s currency must be acquired.

The cost of those currencies is called the exchange rate.

Exchange Rates Between Currencies


Foreign exchange markets

Foreign Exchange Markets

As the relative strength of a country’s economy changes . . .

. . . the exchange rate of the local currency relative to other currencies also fluctuates.

¥ = $?


Foreign exchange markets1

When a transaction occurs on one date (for example a credit sale) . . .

Foreign Exchange Markets

?

. . . but the cash flow is at a later date . . .

. . . fluctuating exchange rates can result in exchange rate gains or losses.


Foreign exchange transaction example

On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days.

The current exchange rate is $1 = .6093 £.

Prepare BobCo’s journal entry.

Foreign Exchange Transaction Example


Foreign exchange transaction example1

On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days.

The current exchange rate is $1 = .6093 £.

Prepare BobCo’s journal entry.

Foreign Exchange Transaction Example


Foreign exchange transaction example2

Record the adjusting entry. Any resulting gain or loss should be reported on the income statement.

Foreign Exchange Transaction Example

On December 31, 2001, the foreign exchange rate was $1 = .6250 £.

Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date.


Foreign exchange transaction example3

Foreign Exchange Transaction Example

On December 31, 2001, the foreign exchange rate was $1 = .6250 £.

Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date.


Foreign exchange transaction example4

Foreign Exchange Transaction Example

On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale.

The exchange rate on 3/1/02, was $1 = .6115 £.

Record BobCo’s receipt of Coventry’s payment.


Foreign exchange transaction example5

Foreign Exchange Transaction Example

On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale.

The exchange rate on 3/1/02, was $1 = .6115 £.

Record BobCo’s receipt of Coventry’s payment.


Comprehensive income

Comprehensive Income

GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments.


Comprehensive income1

Comprehensive Income


End of chapter 16

End of Chapter 16

Let’s close this chapter!


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