INVESTMENTS AND INTERNATIONAL OPERATIONS

1. INVESTMENTS ANDINTERNATIONAL OPERATIONS Chapter 15 Chapter 15: Investments and International OperationsChapter 15: Investments and International Operations

2. Basics of Investments There are several reasons for a company to make investments. Some companies may wish to invest idle cash to receive a higher rate of return on money. Investment companies are established to seek returns through investing in other companies. Many companies make investments for strategic or competitive reasons. There are several reasons for a company to make investments. Some companies may wish to invest idle cash to receive a higher rate of return on money. Investment companies are established to seek returns through investing in other companies. Many companies make investments for strategic or competitive reasons.

3. Investments of Selected Companies This chart shows the relative proportion of short-term and long-term investments for four different corporations. Notice the difference between the investments as a percent of total assets between Gap and Microsoft.This chart shows the relative proportion of short-term and long-term investments for four different corporations. Notice the difference between the investments as a percent of total assets between Gap and Microsoft.

4. Short-Term versus Long-Term Investments Part I When making an investment decision, the first thing a manager must do is decide on the investment horizon. Short-term investments may usually be converted into cash quickly. The rate of return received on the investment is generally higher for longer term investments.Part IILong-term investing is usually based on a strategic plan. In most cases, it is difficult to convert a long-term investment into cash within a short period of time.Short-term investments are usually classified in the current asset section of the balance sheet and long-term investments are shown in a separate category called investments. Part I When making an investment decision, the first thing a manager must do is decide on the investment horizon. Short-term investments may usually be converted into cash quickly. The rate of return received on the investment is generally higher for longer term investments.

5. Classification and Reporting Investments are placed in one of several categories. Held-to-maturity investments represent investment in debt instruments of another company. On the balance sheet, held-to-maturity investments are shown at amortized cost. Amortized cost is the purchase price less any unamortized discount or plus any unamortized premium.Trading securities are investments that management wants to sell immediately. Available-for-sale investments are those investments that cannot be classified as held-to-maturity or trading. Both trading and available-for-sale securities are shown on the balance sheet at market value rather than historical cost.A company that owns between 20 and 50 percent of the voting common stock of another company is assumed to have significant influence over the operating policies of that company. When a company has significant influence over another company, the equity method of accounting for the investment is considered proper.When a company owns more than 50 percent of the voting common stock of another company, it has control over that company. In this case, consolidation is the proper accounting treatment. In essence, we combine the assets, liabilities, and income of the two companies. Investments are placed in one of several categories. Held-to-maturity investments represent investment in debt instruments of another company. On the balance sheet, held-to-maturity investments are shown at amortized cost. Amortized cost is the purchase price less any unamortized discount or plus any unamortized premium.

6. Accounting Basics for Equity Securities Investments in equity securities are recorded at cost. Any dividends received from the investee are recognized as dividend revenue. When the investment is sold we may record a gain or loss. If the proceeds from the sale exceed the cost of the investment, we will recognize a gain. When the proceeds are less than cost, a loss is recognized. Investments in equity securities are recorded at cost. Any dividends received from the investee are recognized as dividend revenue. When the investment is sold we may record a gain or loss. If the proceeds from the sale exceed the cost of the investment, we will recognize a gain. When the proceeds are less than cost, a loss is recognized.

7. The entire portfolio of trading securities is reported at its market value; this requires a �market adjustment� from the cost of the portfolio of securities. Any unrealized gain or loss from a change in the market value of the portfolio of trading securities is reported in the income statement. Reporting of Noninfluential Investments Trading securities are debt and equity securities that the company intends to actively manage and trade for profit. Frequent purchases and sales are expected. The entire portfolio of trading securities is reported at its market value; this requires a �market adjustment� from the cost of the portfolio of securities. Any unrealized gain or loss from a change in the market value of the portfolio of trading securities is reported in the income statement. Trading securities are debt and equity securities that the company intends to actively manage and trade for profit. Frequent purchases and sales are expected. The entire portfolio of trading securities is reported at its market value; this requires a �market adjustment� from the cost of the portfolio of securities. Any unrealized gain or loss from a change in the market value of the portfolio of trading securities is reported in the income statement.

8. TechCom�s portfolio of trading securities had a total cost of $11,500, and a market value of $13,000, on December 31, 2008, the first year the securities were held. The $1,500 difference between cost of $11,500 and market value of $13,000 is an unrealized gain. Valuing and Reporting Trading Securities Part I TechCom�s portfolio of trading securities had a total cost of $11,500, and a market value of $13,000, on December 31, 2008, the first year the securities were held. The $1,500 difference between cost of $11,500 and market value of $13,000 is an unrealized gain. The adjusting journal entry on December 31st is to debit Market Adjustment � Trading for $1,500, and credit Unrealized Gain � Trading for the same amount. Let�s look at how these two new accounts appear on the financial statements. Part II The Market Adjustment � Trading account has a debit balance and is an adjunct assets account that will increase the Short-Term Investment � Trading account on the balance sheet. The Unrealized Gain � Trading will appear on the income statement, usually listed under other income and expense towards the bottom of the statement. Part I TechCom�s portfolio of trading securities had a total cost of $11,500, and a market value of $13,000, on December 31, 2008, the first year the securities were held. The $1,500 difference between cost of $11,500 and market value of $13,000 is an unrealized gain. The adjusting journal entry on December 31st is to debit Market Adjustment � Trading for $1,500, and credit Unrealized Gain � Trading for the same amount. Let�s look at how these two new accounts appear on the financial statements. Part II The Market Adjustment � Trading account has a debit balance and is an adjunct assets account that will increase the Short-Term Investment � Trading account on the balance sheet. The Unrealized Gain � Trading will appear on the income statement, usually listed under other income and expense towards the bottom of the statement.

9. Held-to-Maturity Securities Held-to-maturity (HTM) securities are debt securities a company intends and is able to hold until maturity. They are reported in the current assets if their maturity dates are within one year or the operating cycle, whichever is longer. The securities are classified as noncurrent investments if their maturity dates are longer than one year or the normal operating cycle, whichever is longer. The portfolio of HTM securities is reported at amortized cost. There is no market adjustment to the portfolio. Held-to-maturity (HTM) securities are debt securities a company intends and is able to hold until maturity. They are reported in the current assets if their maturity dates are within one year or the operating cycle, whichever is longer. The securities are classified as noncurrent investments if their maturity dates are longer than one year or the normal operating cycle, whichever is longer. The portfolio of HTM securities is reported at amortized cost. There is no market adjustment to the portfolio.

10. Available-for-Sale Securities Available-for-sale (AFS) securities are debt and equity securities not classified as trading or held-to-maturity. They are not actively managed like trading securities. If the intent is to sell the securities within the longer of one year or the normal operating cycle, the securities are classified as short-term investment. Otherwise, they are classified as long-term investments. Like trading securities, the AFS securities portfolio is valued at market value. This is done with a market adjustment to the total portfolio cost. Any unrealized gain or loss is reported in the equity section of the balance sheet as part of comprehensive income. Available-for-sale (AFS) securities are debt and equity securities not classified as trading or held-to-maturity. They are not actively managed like trading securities. If the intent is to sell the securities within the longer of one year or the normal operating cycle, the securities are classified as short-term investment. Otherwise, they are classified as long-term investments. Like trading securities, the AFS securities portfolio is valued at market value. This is done with a market adjustment to the total portfolio cost. Any unrealized gain or loss is reported in the equity section of the balance sheet as part of comprehensive income.

11. Accounting for Influential Investments So far we have studied the accounting for debt and equity securities where the investor lacks significant influence or control over the investee. So far we have studied the accounting for debt and equity securities where the investor lacks significant influence or control over the investee.

12. Accounting for Influential Investments It is now time to look at accounting under the equity method where a company has significant influence over the operating policies of the investee. Generally, we associate significant influence with ownership of between 20 and 50 percent of the voting common stock of another company. It is now time to look at accounting under the equity method where a company has significant influence over the operating policies of the investee. Generally, we associate significant influence with ownership of between 20 and 50 percent of the voting common stock of another company.

13. Investment in Equity Securities with Controlling Influence Required when investor�s ownership exceeds 50% of investee. 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. When we own more that 50 percent of the voting common stock of another company, we control that company. We refer to the investor as the parent company and the investee as a subsidiary company. We continue to use the equity method of accounting, but at the end of the year we consolidate the financial statements of both companies. The procedures for preparing consolidated financial statements are covered in advanced accounting courses. When we own more that 50 percent of the voting common stock of another company, we control that company. We refer to the investor as the parent company and the investee as a subsidiary company. We continue to use the equity method of accounting, but at the end of the year we consolidate the financial statements of both companies. The procedures for preparing consolidated financial statements are covered in advanced accounting courses.

14. Accounting Summary for Investments in Securities We have prepared this summary of the accounting discussed on the previous slides to help with your homework and study for your next exam. Take a few minutes to review this summary in detail and make sure you understand the implications of the related accounting. We have prepared this summary of the accounting discussed on the previous slides to help with your homework and study for your next exam. Take a few minutes to review this summary in detail and make sure you understand the implications of the related accounting.

15. Components of Return on Total Assets Part IReturn on total assets is calculated by multiplying the company�s profit margin times its total asset turnover. We can break the equation into its constituent parts.Part IIProfit margin is defined as net income divided by net sales. Total asset turnover is equal to net sales divided by average total assets. You can see that net sales is common to both profit margin and total asset turnover. As a result, return on assets may be defined as net income divided by average total assets. Part IReturn on total assets is calculated by multiplying the company�s profit margin times its total asset turnover. We can break the equation into its constituent parts.

16. END OF CHAPTER 15 End of Chapter 15.End of Chapter 15.