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17 – Investments. CORPORATE FINANCIAL REPORTING 2. Debt investments Equity investments Preferred stock Common stock. I NVESTMENTS I N O THER C OMPANIES. PASSIVE ACCOUNTING METHOD TO USE: INVESTMENT ACTIVE INVESTMENT Fair value Equity method

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17 – Investments

CORPORATEFINANCIAL

REPORTING 2

Investments


Debt investments

Equity investments

Preferred stock

Common stock

INVESTMENTS IN OTHER COMPANIES

Investments


PASSIVEACCOUNTING METHOD TO USE:

INVESTMENTACTIVE INVESTMENT

Fair valueEquity method

significant control (in US)

influence Consolidate

1 share (20%) 50% 100% of stock

| | | |

EQUITY INVESTMENTSCommon stock

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.

REPORTING “PASSIVE” INVESTMENTS

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.

REPORTING “PASSIVE” INVESTMENTS

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)

REPORTING “PASSIVE” INVESTMENTS

Investments


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%.

REPORTING “PASSIVE” INVESTMENTS

(our company prepares quarterly f/s)

Investments


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%.

REPORTING “PASSIVE” INVESTMENTS

(our company prepares quarterly f/s)

Investments


ACTIVE INVESTMENT

Equity method

significant

influence

(20%?) 50% 100% of stock

| | |

EQUITY INVESTMENTS for voting stock (usually just common)

Investments


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:

BookValueMarket 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 3,000trademark - 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 855,000ret. earnings 27,000

$1,605,000$102,000

THE EQUITY METHOD

Investments


What journal entry would Co. A’s accountant make? B’s stockholders for $28,000 cash.

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

THE EQUITY METHOD

Investments


A’s balance sheet B’s stockholders for $28,000 cash.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

THE EQUITY METHOD

Investments


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.

THE EQUITY METHOD

Investments


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.

TWO COMMON WAYS TO OBTAIN CONTROL

Investments


ACCOUNTING METHOD TO USE: are:

ACTIVE INVESTMENT

Equity method

control (in US)

Consolidate

50% 100% of stock

| |

EQUITY INVESTMENTSfor voting stock (usually just common)

Investments


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:

BookValueMarket 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 3,000trademark - 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 855,000ret. earnings 27,000

$1,605,000$102,000

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


This is what happened: B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.

Owners of A Owners of B

$135,000

90% Co.

Co. A BstockCo. B

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

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


This is “after”: B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.

Owners of A Owners of B

10% owners

Co. A 90% owner

Co. B

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


A’s balance sheet after the transaction: B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.

cash $ 65,000 liabilities 100,000

acct. rec. 300,000

inventory 500,000 com. stock 300,000

Invest. in B stock 135,000 APIC 350,000

PPE 900,000 ret. earnings 855,000

accum. deprec (300,000) $1,605,000

patent 2,000

trademark 3,000

$1,605,000

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


B’s balance sheet after the transaction: B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.

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

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


Then A’s accountant B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.asks:

“Why did A pay so much?”

The answer lies in a previous slide and our previous thought process,but with a modification.

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


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.

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


What FASB also wants: one company controls another company the controlling company needs to do something more than use the equity method.

Owners of A

F/S Co. A consolidated

F/S

F/S Co. B

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


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).

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


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

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


A’s balance sheet after the transaction: A’s balance sheet really represents control of Co. B’s assets and liabilities

cash $ 65,000 liabilities 100,000

acct. rec. 300,000 com. stock 300,000

inventory 500,000 APIC 350,000

Invest. in B stock 135,000 ret. earnings 855,000

PPE 900,000 $1,605,000

accum. deprec (300,000) cash 1,000

patent 2,000 acct. rec. 8,000

trademark 3,000inventory 15,000

PPE 90,000

$1,605,000patent 0

trademark 2,000

goodwill 41,000 liabilities (10,000)

BUYING CO. B’s STOCK – A Consolidation Example


So, Co. A’s A’s balance sheet really represents control of Co. B’s assets and liabilitiesconsolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock.

BUYING CO. B’s STOCK – A Consolidation Example

Consolidated Financial Statements


A’s A’s balance sheet really represents control of Co. B’s assets and liabilitiesconsolidated 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 SUBSIDIARY

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

Consolidated Financial Statements


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)?

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

Consolidated Financial Statements


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

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

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

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

Consolidated Financial Statements


What would appear in A’s B:consolidated Income Statement:

Sales revenue $270,000 COGS (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

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

Consolidated Financial Statements


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

BUYING CO. B’s STOCK

Consolidated Financial Statements


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