Chap 012

Chapter 12
Reporting and Interpreting

Investments in Other
Corporations
12-2
Understanding the Business

A
A company
company may
may invest
invest in
in the
the
securities
securities of
of another
another company
company to:
to:
Earn
Earn aa return
return
on
on idle
idle funds.
funds.
(Passive
(Passive
investments)
investments)
McGraw-Hill/Irwin
Influence
Influence the
the
other
other
companys
companys
policies
policies and
and
activities.
activities.
Control
Control the
the
other
other
company.
company.
2004 The McGraw-Hill Companie
12-3
Types of Investments
Passive investments are made to earn a
high rate of return on funds that may be
needed for future purposes.
Investments
Investmentsin
in debt
debt
securities
securities are
arealways
always
considered
consideredpassive
passive
investments.
investments.
McGraw-Hill/Irwin
12-4
Passive investments are made to earn a
high rate of return on funds that may be
needed for future purposes.
Equity
Equitysecurity
security
investments
investmentsare
are
presumed
presumed passive
passive
ififthe
theinvesting
investing
company
companyowns
owns
less
lessthan
than 20%
20%of
of
the
theoutstanding
outstanding
voting
votingshares.
shares.
McGraw-Hill/Irwin
Investor
Investor is
isnot
not
interested
interestedin
in controlling
controlling
or
or influencing
influencing other
other
company.
company.
12-5
Investments made with the intent of exerting
significant influence over another corporation.
The
Theability
abilityof
ofthe
the
investing
investingcompany
companyto
to
have
havean
animportant
important
impact
impact on
onthe
the
operating
operatingand
and
financial
financialpolicies
policiesof
of
another
another company.
company.
McGraw-Hill/Irwin
Significant
Significant
Influence
Influence
20%
20%-- 50%
50%
outstanding
outstandingshares
shares
12-6
Investments made with the intent to exert
control over another corporation.
The
Theinvesting
investing
company
companyhas
hasthe
the
ability
abilityto
todetermine
determine
the
theoperating
operatingand
and
financial
financialpolicies
policiesof
of
another
another corporation.
corporation.
McGraw-Hill/Irwin
>50%
>50%
outstanding
outstandingshares
shares
Control
Control
12-7
Types of Investments and

Accounting Methods
The
The accounting
accounting method
method depends
depends
on
on the
the type
type of
of security
security and
and the
the level
level
of
of ownership
ownership (influence).
(influence).
McGraw-Hill/Irwin
12-8
Passive Investments in debt

Passive
Passive debt
debt securities
securities (bonds):
(bonds):
Sold
Soldbefore
beforematurity:
maturity:investments
investmentsare
arereported
reportedusing
using
the
theMARKET
MARKETVALUE
VALUEMETHOD
METHOD
the
thesame
sameused
usedfor
forpassive
passiveinvestments
investmentsin
inequity
equity
securities
securities
each
eachyear
year end
endinvestments
investmentsare
are adjusted
adjustedto
to
market
marketvalue
value
Held-to-maturity:
Held-to-maturity: investments
investmentsare
arereported
reportedat
at
AMORTIZED
AMORTIZEDCOST
COSTMETHOD
METHOD
McGraw-Hill/Irwin
12-9
Debt Held To Maturity: Amortized

Cost Method
Record
Recordat
atcost
coston
onacquisition
acquisitiondate
date(Held-to-maturity
(Held-to-maturityInvestment
Investment
account)
account)
Record
Recordinterest
interestreceived
received
Amortize
Amortizepremiums
premiumsor
ordiscounts:
discounts:not
notrecorded
recordedininseparate
separate
accounts
accounts
Record
Recordprincipal
principalreceived
receivedat
atmaturity
maturity
IfIfthe
thedebt
debtinvestment
investmentisissold
soldbefore
beforematurity,
maturity,the
thedifference
difference
between
betweenthe
themarket
marketvalue
valueand
andthe
thebook
bookvalue
valuewould
wouldbe
bereported
reportedas
as
aagain
gainor
orloss
losson
onsale.
sale.
McGraw-Hill/Irwin
12-10
Bonds purchased at par

Record
Recordthe
thepurchase
purchaseon
onJan
Jan2003
2003of
offive
five$1,000,
$1,000,5%,
5%,
3-year
3-yearbonds
bondsat
at par
par ---- interest
interestpayable
payable
semiannually
semiannually
McGraw-Hill/Irwin
12-11

Record
Recordthe
thereceipt
receiptof
of an
aninterest
interest payment
payment on
onJune
June30
30
The same entry is made in the next payment dates!

McGraw-Hill/Irwin
12-12

Record
Recordthe
theredemption
redemptionof
ofbond
bondinvestment
investmentat
at maturity
maturity
on
on12/31/2005
12/31/2005
McGraw-Hill/Irwin
12-13
Bonds purchased at premium

Record
Recordthe
thepurchase
purchaseon
on Jan
Jan2003
2003of
of five
five$1,000,
$1,000,
5%,
5%, 3-year
3-yearbonds
bondsat
at premium
premium (5,300$)
(5,300$)----interest
interest
payable
payablesemiannually
semiannually
Remember that only 5,000$ will be repaid at maturity! The

premium is 300$.
McGraw-Hill/Irwin
12-14

Record
Recordthe
thereceipt
receipt of
ofan
aninterest
interest payment
paymenton
onJune
June
30
30and
andthe
theamortization
amortizationof
ofthe
thepremium
premium
After 3 years, Held-to-maturity investment is reduced to

5,000$
McGraw-Hill/Irwin
12-15

Record
Recordthe
theredemption
redemption of
of bond
bond investment
investmentat
at
maturity
maturityon
on 12/31/2005
12/31/2005
McGraw-Hill/Irwin
12-16

The company paid initially 5,300$
It received at maturity 5,000$
It received cash interest every 6 months for 3
years of 125$, for a total of 750$
It means that it received cash for 5,750$
(5,000+750$)
The difference between what it received and what
it paid is 450$ (5,750$-5,300$)
450$ is the interest income recognized before (75$
every 6 months, for 3 years)
McGraw-Hill/Irwin
12-17
Bonds purchased at discount

Record
Recordthe
thepurchase
purchaseon
on Jan
Jan2003
2003of
of five
five$1,000,
$1,000,
5%,
5%, 3-year
3-yearbonds
bondsat
at discount
discount (4,850$)
(4,850$) ---- interest
interest
payable
payablesemiannually
semiannually
Remember that 5,000$ will be repaid at maturity! The

disocunt is 150$.
McGraw-Hill/Irwin
12-18

Record
Recordthe
thereceipt
receipt of
ofan
aninterest
interest payment
paymenton
onJune
June
30
30and
andthe
theamortization
amortizationof
ofthe
thediscount
discount
After 3 years, Held-to-maturity investment is increased to

5,000$
McGraw-Hill/Irwin
12-19

Record
Recordthe
theredemption
redemption of
of bond
bond investment
investmentat
at
maturity
maturityon
on 12/31/2005
12/31/2005
McGraw-Hill/Irwin
12-20

The company paid initially 4,850$
It received at maturity 5,000$
It received cash interest every 6 months for 3
years of 125$, for a total of 750$
It means that it received cash for 5,750$
(5,000+750$)
The difference between what it received and what
it paid is 900$ (5,750$-4,850$)
900$ is the interest income recognized before
(150$ every 6 months, for 3 years)
McGraw-Hill/Irwin
12-21
Passive Investments in equity

Passive
Passive stock
stock investments:
investments:
TRADING
TRADINGSECURITIES:
SECURITIES:securities
securitiesheld
heldprimarily
primarilyfor
for
resale
resalefor
for short-term
short-term profits
profits
the
theinvestment
investment asset
assetaccount
account isisreflected
reflectedat
at fair
fair value
value
the
thechanges
changesin
invalue
value are
are recorded
recorded under
underoperating
operating
income
income
SECURITIES
SECURITIESAVAILABLE
AVAILABLEFOR
FORSALE:
SALE: not
notheld
heldprimarily
primarily
for
for resale
resale
the
theinvestment
investment asset
assetaccount
account isisreflected
reflectedat
at fair
fair value
value
the
thechanges
changesin
invalue
value go
gointo
intoaaspecial
specialaccount:
account:
Unrealized
UnrealizedGain/LossGain/Loss-part
partOther
Other Comprehensive
Comprehensive
Income."
Income."
McGraw-Hill/Irwin
12-22
Trading securities
TRADING
TRADINGSECURITIES:
SECURITIES:securities
securitiesheld
held primarily
primarily for
forresale
resale
for
for short-term
short-term profits
profits
Investments
Investmentsin
intrading
tradingsecurities
securitiesare
areclassified
classifiedas
as
current
current assets
assetson
onthe
thebalance
balancesheet
sheet
Initially
Initiallyrecorded
recordedat
atcost
cost but
buttheir
theirvalue
valuecan
canfluctuate
fluctuate
rapidly
rapidly
subsequently
subsequently the
the investment
investment asset
asset account
account isis
adjusted
adjustedto
toreflect
reflectthe
thefair
fair value
value
the
thechanges
changesin
invalue
value are
are recorded
recorded under
underoperating
operating
income
income
McGraw-Hill/Irwin
12-23
Trading securities
Record
Recordthe
thepurchase
purchasefrom
fromWebster
Webstercompany
companyon
onMarch
March3,
3,
2006
2006of
of5,000
5,000shares
sharesof
ofMerriam
Merriamstock
stockat
at$10
$10per
pershare.
share.
The
Thecompany
companywants
wantsto
tosell
sellthe
theshares
sharesin
inthe
thenear
nearfuture
future
for
foraaquick
quickprofit.
profit.
McGraw-Hill/Irwin
12-24
Trading securities
Assume
Assumethe
thestock
stockprice
pricedeclined
declinedto
to9$
9$per
pershare
shareby
byMarch
March31.
31.
Assume
Assumethe
thecompany
companyis
ispreparing
preparingmid-term
mid-termfinancial
financial
statements
statementson
onMarch
March31
31and
andis
isstill
stillholding
holdingthe
the5,000
5,000
shares.
shares.
The investment must be written down to current value. The

Allowance account is subtracted from the investment account.
McGraw-Hill/Irwin
12-25
Trading securities
Assume
Assumethe
thestock
stockprice
priceincreased
increasedto
to12$
12$per
pershare
shareby
byApril
April
30(3$
30(3$increase
increasefrom
from9$).
9$). The
Thecompany
companyis
isstill
stillholding
holdingthe
the
5,000
5,000shares.
shares.
McGraw-Hill/Irwin
12-26
Trading securities
Cumulatively, the income statements show a total gain of

$10,000 ($5,000 loss + $15,000 gain).
The adjusted amount of unrealized holding gains or
losses is included in each period income statement. It
increases or decreases net income.
When trading securities are sold a net realized gain or
loss is recorded.
McGraw-Hill/Irwin
12-27
Securities available for sale

(SAS)
SECURITIES
SECURITIESAVAILABLE
AVAILABLEFOR
FORSALE:
SALE: not
notheld
heldprimarily
primarily
for
for resale
resale
Classified
Classifiedas
ascurrent
current or
ornon
noncurrent
current assets,
assets, depending
depending
when
whenare
areintended
intendedto
tobe
besold
sold
Initially
Initiallyrecorded
recordedat
at cost
cost but
buttheir
theirvalue
value can
can
fluctuate
fluctuaterapidly
rapidly
subsequently
subsequently the
the investment
investment asset
asset account
account
isisadjusted
adjustedto
toreflect
reflectthe
thefair
fair value
value
the
thechanges
changesin
invalue
value go
gointo
intoaaspecial
special
account:
account:Unrealized
UnrealizedGain/LossGain/Loss- part
part Other
Other
Comprehensive
ComprehensiveIncome."
Income."
McGraw-Hill/Irwin
12-28

Record
Recordthe
thepurchase
purchasefrom
fromWebster
Webstercompany
companyon
onMarch
March3,
3,
2006
2006of
of5,000
5,000shares
sharesof
ofMerriam
Merriamstock
stockat
at$10
$10per
pershare.
share.
The
Thecompany
companydoes
doesnot
notwant
wantto
tosell
sellthe
theshares
sharesin
inthe
thenear
near
future
futurefor
foraaquick
quickprofit.
profit.
McGraw-Hill/Irwin
12-29

Assume
Assumethe
thestock
stockprice
pricedeclined
declinedto
to9$
9$per
pershare
shareby
byMarch
March31.
31.
Assume
Assumethe
thecompany
companyis
ispreparing
preparingmid-term
mid-termfinancial
financial
statements
statementson
onMarch
March31
31and
andis
isstill
stillholding
holdingthe
the5,000
5,000
shares.
shares.
The investment must be written down to current value, with

a corresponding charge to Other Comprehensive Income. The
Allowance account is subtracted from the investment account.
McGraw-Hill/Irwin
12-30

(SAS)
This
This charge
charge against
against Other
Other Comprehensive
Comprehensive
Income
Income will
will reduce
reduce stockholders'
stockholders' equity.
equity.
But,
But, net
net income
income is
is not
not reduced,
reduced, as
as there
there is
is no
no
charge
charge to
to an
an operating
operating income
income statement
statement account.
account.
The
The rationale
rationale is
is that,
that, since
since the
the intent
intent is
is to
to hold
hold
the
the investment
investment for
for aa longer
longer term
term period,
period, net
net
income
income must
must not
not be
be affected
affected by
by temporary
temporary
fluctuations
fluctuations in
in market
market value.
value.
McGraw-Hill/Irwin
12-31

Assume
Assumethe
thestock
stockprice
priceincreased
increasedto
to12$
12$per
pershare
shareby
byApril
April
30(3$
30(3$increase
increasefrom
from9$).
9$). The
Thecompany
companyis
isstill
stillholding
holdingthe
the
5,000
5,000shares.
shares.
McGraw-Hill/Irwin
12-32
The Other Comprehensive Income has been adjusted for a

total of $10,000 credit ($5,000 debit and $15,000 credit).
This cumulative credit corresponds to the total increase in
value of the original $50,000 investment.
The adjusted amount of unrealized holding gains or losses
are reported under Other Comprehensive Income, as a
separate component of Stockholders equity.
When SAS are sold a net realized gain or loss is recorded.
McGraw-Hill/Irwin
12-33
McGraw-Hill/Irwin
12-34
McGraw-Hill/Irwin
12-35

When
Whensecurities
securitiesare
aresold
soldfor
for13$,
13$,proceeds
proceedsfrom
fromsale
saleare
are
recorded
recordedas
asgains
gainsor
orlosses.
losses.Unrealized
Unrealizedgain/loss
gain/lossand
and
Allowance
Allowanceto
tovalue
valueat
atmarket
marketare
areeliminated.
eliminated.
McGraw-Hill/Irwin
12-36
Investments For Significant

Influence: Equity Method
Used when an investor can exert
significant influence over an investee.
It is presumed that the investment

was made as a long-term investment.
McGraw-Hill/Irwin
12-37
Investments for significant

influence
With
Withthe
the equity
equity method,
method, the
theaccounting
accounting for
for an
aninvestment
investment
isisset
set to
totrack
trackthe
the"equity"
"equity"of
of the
the investee.
investee.
That
Thatis,
is,when
whenthe
theinvestee
investeemakes
makesmoney
money(and
(andexperiences
experiencesaa
corresponding
correspondingincrease
increaseininequity),
equity),the
theinvestor
investorwill
willsimilarly
similarlyrecord
record
its
itsshare
shareof
ofthat
thatprofit
profit(and
(andvice-versa
vice-versafor
foraaloss).
loss).
The
Theinvestment
investment isisinitially
initially recorded
recordedat
atcost
cost
Unrealized holding gains and losses are not
Unrealized holding gains and losses are not recognized

recognized
Investment
Investmentcarrying
carryingamount
amountisisadjusted
adjusted for
for dividends
dividends
received
receivedand
andaapercentage
percentageshare
shareof
ofthe
theinvestees
investeesincome
income
On
Onthe
thebalance
balancesheet
sheet classified
classifiedas
aslong-term
long-term investments
investments
Investments
Investments in
inassociated
associatedCompanies
Companies
McGraw-Hill/Irwin
12-38

Investee
Effects on the investment account of

the investor
Dividend payments Reduction in the investment account.

Increase in cash when it receives its
share of dividends.
Positive net
income
Increase in the investment account by

proportionate share
Net Loss
Decrease in the investment account by

proportionate share
McGraw-Hill/Irwin
12-39

Influence:
Equity
Method
On 1/1/03, TeleCom, Inc. acquires a 30%

interest
interest in
in Sports.com
Sports.com at
at aa cost
cost of
of $2,000,000.
$2,000,000.
Prepare
Prepare the
the journal
journal entry
entry to
to record
record TeleComs
TeleComs
investment.
investment.
GENERAL JOURNAL
Date
Description
Page 2
Debit
Credit
Jan. 1
McGraw-Hill/Irwin
12-40

Influence:
Equity
Method

interest
interest in
in Sports.com
Sports.com at
at aa cost
cost of
of $2,000,000.
$2,000,000.
Prepare
Prepare the
the journal
journal entry
entry to
to record
record TeleComs
TeleComs
investment.
investment.
GENERAL JOURNAL
Date
Description
Jan. 1 Investments in Associated Co.

Cash
McGraw-Hill/Irwin
Page 2
Debit
Credit
2,000,000
2,000,000
12-41

Influence:
Equity
Method
On
3/31/03,
Sports.com
On 3/31/03, Sports.com pays
pays $200,000
$200,000 in
in
dividends,
dividends, $60,000
$60,000 (30%)
(30%) of
of which
which goes
goes to
to
TeleCom.
TeleCom. Record
Record TeleComs
TeleComs receipt
receipt of
of the
the
dividend.
dividend.
GENERAL JOURNAL
Date
Description
Page 46
Debit
Credit
Mar. 31
McGraw-Hill/Irwin
12-42

Influence:
Equity
Method
On
3/31/03,
Sports.com
On 3/31/03, Sports.com pays
pays $200,000
$200,000 in
in
dividends,
dividends, $60,000
$60,000 (30%)
(30%) of
of which
which goes
goes to
to
TeleCom.
TeleCom. Record
Record TeleComs
TeleComs receipt
receipt of
of the
the
dividend.
dividend.
GENERAL JOURNAL
Date
Description
Mar. 31 Cash
Investments in Associated Co.
Page 46
Debit
Credit
60,000
60,000
Dividends
Dividends are
are not
not revenue
revenue under
under the
the equity
equity method.
method. They
They
are
are treated
treated as
as aa reduction
reduction of
of the
the investment
investment account.
account.
McGraw-Hill/Irwin
12-43

Influence:
Equity
Method
Sports.com net income for the year ending

12/31/03
12/31/03 is
is $1,600,000.
$1,600,000. TeleComs
TeleComs 30%
30%
share
share is
is $480,000.
$480,000. Record
Record TeleComs
TeleComs
share
share of
of Sports.coms
Sports.coms income.
income.
GENERAL JOURNAL
Date
Description
Page 86
Debit
Credit
Dec. 31
McGraw-Hill/Irwin
12-44

Influence:
Equity
Method

12/31/03
12/31/03 is
is $1,600,000.
TeleComs 30%
30%
share
share is
is $480,000.
$480,000. Record
Record TeleComs
TeleComs
share
share of
of Sports.coms
Sports.coms income.
income.
TeleCom
TeleComcredits
credits Equity
Equityin
inInvestee
Investee Earnings
Earnings (an
(anincome
income
statement
statement account)
account) for
forits
itsshare
shareof
ofSports.coms
Sports.comsearnings.
earnings.
McGraw-Hill/Irwin
12-45

Influence:
Equity
Method
Sports.com net loss for the year ending
Sports.com net loss for the year ending

12/31/03
12/31/03 is
is $1,600,000.
TeleComs 30%
30%
share
share is
is $480,000.
$480,000. Record
Record TeleComs
TeleComs
share
share of
of Sports.coms
Sports.coms loss.
loss.
TeleCom
TeleComdebits
debits Equity
Equityin
in Investee
InvesteeLoss
Loss (an
(anincome
income
statement
statement account)
account) for
forits
itsshare
shareof
ofSports.coms
Sports.comsloss.
loss.
McGraw-Hill/Irwin
12-46

Equity in investee earnings or loss (a type of
Investment Income) is reported in Other Items

section of the income statement (together with
interest revenue, expense, gains and losses on
sales of assets)
At the end of the accounting period, this account
is not adjusted to reflect changes in the market
value of the shares.
When securities are sold, the difference
between cash received and the book value of
the investment is recorded as a gain or loss.
McGraw-Hill/Irwin
Controlling Interests: Mergers

and Acquisitions
Horizontal
Horizontal
integration
integration
12-47
Vertical
Vertical
integration
integration
Synergy
Synergy
McGraw-Hill/Irwin
12-48
What Are Consolidated

Statements?
The
The acquiring
acquiring company
company is
is the
the
parent.
parent.
The
The company
company acquired
acquired is
is the
the
subsidiary.
subsidiary.
Consolidated
Consolidated statements
statements
combine
combine two
two or
or more
more
companies
companies into
into aa single
single set
set of
of
statements.
statements.
McGraw-Hill/Irwin
Any
Any
transactions
transactions
between
betweenthe
the
parent
parentand
and
subsidiary
subsidiarymust
must
be
be eliminated
eliminated
when
whenpreparing
preparing
consolidated
consolidated
financial
financial
statements.
statements.
12-49
Accounting for Goodwill
Goodwill
Occurs when one
company buys
another company.
Only purchased
goodwill is an
intangible asset.
The amount by which the

purchase price exceeds the fair
market value of net assets acquired.
McGraw-Hill/Irwin
12-50
Accounting for Goodwill
Goodwill
Not
Not amortized.
amortized.
McGraw-Hill/Irwin
Subject
Subject to
to assessment
assessment
for
for impairment
impairment of
of
value
value and
and may
may be
be
written
written down.
down.
12-51
Consolidated Financial
Statements
Dow Jones uses $100 million of its $368 million in
current assets to purchase all the stock of IFNews
for $100 million (merger). IFNews net assets
(assets less liabilities) are $80 million at the date
of purchase, but have a fair market value of $85
million.
Goodwill = ?
Goodwill = $100 million $85 million = $15 million
Fair Value Adjustment = ?
Fair Value Adjustment = $85 million - $80 million
Fair Value Adjustment = $ 5 million
McGraw-Hill/Irwin
12-52
Consolidated Balance Sheet

Dow Jones
ASSETS
Current assets
Investment in IFN
Plant and property (net)
Other assets
Goodwill
Total assets
LIABILITIES & EQUITY
Current liabilities
Noncurrent liabilities
Stockholders' equity
Total liabilities & equity
McGraw-Hill/Irwin
268
100
761
233
IFN
Eliminations &
Adjustments Consolidated
$
$
$ 30
60
(100)
5
15
$ 1,362
$ 90
$ 10
587
608
167
$ 1,362
80
$ 90
(80)
$
268
796
293
15
1,372
597
608
167
1,372
12-53
Consolidated Income Statement

Dow Jones
Revenues
Expenses
Income
2,158
(2,150)
$
8
IFN
$ 120
(106)
$ 14
Adjustments Consolidated
$
(1)
(1)
2,278
(2,257)
21
$1
$1million
millionadditional
additional
depreciation
depreciation on
on the
the$5
$5
million
millionadditional
additionalfair
fair value
value
of
of assets
assetsacquired.
acquired.
McGraw-Hill/Irwin
12-54
End of Chapter 12
McGraw-Hill/Irwin

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Chapter 12

Reporting and Interpreting

Understanding the Business

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Types of Investments and

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Passive Investments in debt

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Debt Held To Maturity: Amortized

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Bonds purchased at par

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Bonds purchased at par

The same entry is made in the next payment dates!

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Bonds purchased at par

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Bonds purchased at premium

Remember that only 5,000$ will be repaid at maturity! The

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Bonds purchased at premium

After 3 years, Held-to-maturity investment is reduced to

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Bonds purchased at premium

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Bonds purchased at premium

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Bonds purchased at discount

Remember that 5,000$ will be repaid at maturity! The

2004 The McGraw-Hill Companie

Bonds purchased at discount

After 3 years, Held-to-maturity investment is increased to

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Bonds purchased at discount

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Bonds purchased at discount

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Passive Investments in equity

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The investment must be written down to current value. The

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Cumulatively, the income statements show a total gain of

2004 The McGraw-Hill Companie

Securities available for sale

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Securities available for sale

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Securities available for sale

The investment must be written down to current value, with

2004 The McGraw-Hill Companie

Securities available for sale

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Securities available for sale

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Securities available for sale

The Other Comprehensive Income has been adjusted for a

2004 The McGraw-Hill Companie