Appendix D

Report
Appendix D
Investments in Other Corporations
PowerPoint Authors:
Brandy Mackintosh
Lindsay Heiser
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Why Do Companies Invest?
1. Companies transfer excess cash into investments to
produce higher income. Some companies are set up to
produce income from investments.
2. Companies use investments to even out seasonal
fluctuations in cash. Such investments in securities are
referred to as passive investment.
3. Some companies invest with the purpose of influencing,
but not controlling another company’s policies and
activities.
4. Managers may want to control another company, either by
purchasing it directly or by becoming a majority
shareholder.
App D-2
Passive Investments in Debt and
Equity Securities
Passive investments are made to earn a high rate of
return on funds that may be needed in the future. This
category includes debt securities (bonds and notes) and
equity securities (stock).
Passive Equity Investments
Presumed to be passive if the
investing company owns less
than 20% of the other
company’s outstanding voting
shares.
Measure and report using the
Fair Value Method
Passive Debt Investments
Investments in debt securities
are always considered to be
passive.
No
Hold to
Maturity?
Yes
Measure and report at Amortized
Cost
App D-3
Investments in Stock for Significant
Influence
Active investments are those in which a company owns
enough stock in another business to influence or control
that business. Significant influence is presumed to exist
if the investing company owns from 20 to 50% of the
outstanding voting shares.
The equity method is
used to measure and
report this type of active
investment.
App D-4
Investments in Stock for Control
Control is the ability to determine the operating and
financial policies of another company through
ownership of its voting stock. For all practical purposes,
control is presumed when the investing company owns
more that 50% of the outstanding voting stock.
These investments are accounted for by
combining the two companies using the
acquisition method and preparing
consolidated financial statements.
App D-5
Summary of Investment Types
App D-6
Debt Investments Held to Maturity:
Amortized Cost Method
Assume that on October 1, 2013, Washington Post
Company paid the face value of $100 million for 8% bonds
due to mature on October 1, 2018. The 8% interest is paid
each September 30th. Management plans and has the
ability to hold the bonds for five years, until they mature.
1 Analyze
Assets
=
Liabilities
+
Stockholders’ Equity
Held-to-Maturity
Investments
+100
Cash
-100
2
Record
dr
App D-7
Held-to-Maturity Investments (+A)
cr Cash (-A)
100
100
Debt Investments Held to Maturity:
Amortized Cost Method
On December 31, 2013, Washington Post Company will
prepare an adjusting entry to accrue interest for three
months (since the October 1 purchase)
($100 million × 8% × 3/12 = $2 million).
1 Analyze
Assets
=
Liabilities
Interest Receivable +2
2
Stockholders’ Equity
Interest
Revenue (+R)
+2
Record
dr
App D-8
+
Interest Receivable (+A)
cr Interest Revenue (+R, +SE)
2
2
Debt Investments Held to Maturity:
Amortized Cost Method
On September 30, 2014, Washington Post Company will
receive a full year of interest. Revenue recognized in 2014
is ($100,000,000 × 8% × 9/12).
1 Analyze
Assets
=
Liabilities
Cash
+8
Interest Receivable -2
2
Stockholders’ Equity
Interest
Revenue (+R)
+6
Record
dr
App D-9
+
Cash (+A)
cr Interest Receivable (-A)
cr Interest Revenue (+R, +SE)
8
2
6
Debt Investments Held to Maturity:
Amortized Cost Method
On October 1, 2018, Washington Post Company will
receive the principal amount of the investment as the
bonds mature.
1 Analyze
Assets
=
Liabilities
+
Stockholders’ Equity
Cash
+100
Held-to-Maturity
Investments
-100
2
Record
dr
Cash (+A)
cr Held-to-Maturity Investments (-A)
100
100
If the bond investment were sold before maturity, any difference between
the fair value and the net book value is reported as a gain or loss on sale
in the income statement.
App D-10
Securities Available for Sale: Fair Value
Method
Classifying Passive Investments
Trading Securities
Trading securities are traded
actively, with the objective of
generating short-term profits
on changes in the securities
price. They are classified as
current assets on the balance
sheet.
App D-11
Available-for-Sale Securities
Most companies do not
actively trade the securities of
other companies. They invest
to earn a return on funds they
may need in the near future.
These securities may be
classified as either current
assets or noncurrent assets
depending on the intent of
management to sell them
within one year.
Recording and Reporting
Available-for-Sale Securities
On January 2, 2013, Washington Post purchased
1,000,000 shares of Internet Financial News (IFN)
common stock for $60 per share paying $60,000,000. The
1,000,000 shares represents 10% of the outstanding
shares. This investment would be treated as a passive
investment.
1 Analyze
Assets
=
Liabilities
+
Stockholders’ Equity
Available-for-Sale
Securities
+60
Cash
-60
2
Record
dr
App D-12
Available-for-Sale Securities (+A)
cr Cash (-A)
60
60
Recording and Reporting
Available-for-Sale Securities
Investments in equity securities earn a return from two
sources: (1) increase in the market price and (2)
dividend income. On December 15, 2013, Washington
Post received a $1 per share cash dividend from IFN
totaling $1,000,000.
1 Analyze
Assets
Cash
2
Liabilities
+
+1
Stockholders’ Equity
Dividend
Revenue (+R)
+1
Record
dr
App D-13
=
Cash (+A)
cr Dividend Revenue (+R, +SE)
1
1
Recording and Reporting
Available-for-Sale Securities
At the end of the accounting period, passive investments
are reported on the balance sheet at their fair value. On
December 31, 2013, IFN stock was trading at $58 per
share in the open market.
1 Analyze
Assets
Available-for-Sale
Securities
-2
2
Liabilities
+
Stockholders’ Equity
Net Unrealized
Losses/Gains
-2
Record
dr
App D-14
=
Net Unrealized Losses/Gains (-SE)
cr Available-for-Sale Securities (-A)
2
2
Recording and Reporting
Available-for-Sale Securities
Now let’s assume that Washington Post held the IFN
securities through the year 2014. At the end of 2014, the
stock had a market value of $61 per share. On December
31, 2014, we must make an adjusting entry to state the
investment at fair value.
1 Analyze
Assets
Available-for-Sale
Securities
+3
2
=
Liabilities
+
Stockholders’ Equity
Net Unrealized
Losses/Gains
Record
dr Available-for-Sale Securities (+A)
cr Net Unrealized Losses/Gains (+SE)
App D-15
+3
3
3
Recording and Reporting
Available-for-Sale Securities
Now let’s assume that on March 17, 2015,Washington Post
sold all of its investment in IFN for $64 per share. The
company receives $64 million in cash ($64 x 1,000,000
shares) for stock purchased at $60 million in 2013 ($60 x
1,000,000 shares).
1 Analyze
Assets
Cash
+64
Available-for-Sale
Securities
-61
2
=
Liabilities
+
Stockholders’ Equity
Net Unrealized
Losses/Gains
Gain on Sale of
Investments (+R)
+4
Record
dr Cash (+A)
64
dr Net Unrealized Losses/Gains (-SE)
1
cr Available-for-Sale Securities (-A)
cr Gain on Sale of Investments(+R, +SE)
App D-16
-1
61
4
Comparing Available-For-Sale and
Trading Securities
The impact of unrealized holding gains or losses on the
financial statements depends on whether an investment is a
trading security or a security available-for-sale.
Available-for-Sale Securities
The unrealized gain (loss) on
investments account is reported
as a separate component of
stockholders’ equity, under
Accumulated Other
Comprehensive Income. It is not
reported on the income
statement and does not affect
net income.
App D-17
Trading Securities
The unrealized gain (loss) is
included in each period’s income
statement. Holding gains
increase income and holding
losses decrease net income. The
unrealized gain (loss) account is
closed to retained earnings at
the end of the period.
Accounting for Influential Investments
Investor Ownership of
Investee Shares
Outstanding
0%
{
Cost or
Fair
Value
Method
Equity
Method
20%
Consolidated Financial
Statements
50%
100%
In some cases, influence or control may exist
with less than 20% ownership.
App D-18
Accounting for Influential Investments
Investor Ownership of
Investee Shares
Outstanding
Cost or
Market
Value
Method
20%
{
0%
Equity
Method
Consolidated Financial
Statements
50%
Significant influence is generally assumed with
20% to 50% ownership.
App D-19
100%
Recording Investments Under the
Equity Method
App D-20
Recording Investments Under the Equity
Method
In 2013, Washington Post purchased 4,000,000
shares of the outstanding voting stock of Internet
Financial News (IFN) for $240 million cash.
Washington Post purchased 40% of the voting stock
of IFN and was presumed to have significant
influence over the affiliate.
1 Analyze
Assets
Investments in
Affiliates
Cash
2
=
Liabilities
+240
-240
Stockholders’ Equity
Net Unrealized
Losses/Gains
+3
Record
dr Investments in Affiliates (+A)
cr Cash (-A)
App D-21
+
240
240
Recording Investments Under the Equity
Method
In 2013, IFN reported net income of $50,000,000.
Washington Post’s share of net income is
$20,000,000 (40% × $50,000,000). The journal
entry is:
1 Analyze
Assets
Investments in
Affiliates
2
=
+20
Liabilities
+
Stockholders’ Equity
Equity In Affiliate
Earnings (+R)
Record
dr Investments in Affiliates (+A)
20
cr Equity in Affiliate Earnings (+R, +SE)
App D-22
+20
20
Investments with Controlling Interests:
Consolidated Statements
Required when investor’s ownership
exceeds 50% of investee.
1.
2.
3.
App D-23
Vertical integration. One company acquires another
company that operates on a different level in the
distribution channel.
Horizontal growth. Companies operate on the same
level of the distribution channel.
Synergy. Two companies operating together may be
more profitable than two companies operating
separately.
What are Consolidated
Statements?
When one company purchases all the assets and liabilities of
another company and the acquired company goes out of existence,
the acquisition is called a merger. When the acquired company
remains in business, the company that gains control over it by
acquiring all or a majority of the voting stock is called the parent
company. The other company is called a subsidiary company.
When one company acquires another, results of their operations
must be reported together, in consolidated statements. Consolidated
financial statements combine the operations of two or more
companies into a single set of statements usually identified by the
term “consolidated” in the statement title.
App D-24
End of Appendix D
App D-25

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