1. · 1 CORPORATE FINANCIAL REPORTING 2 17 – Investments Investments

2. I NVESTMENTS I N O THER C OMPANIES Debt investments Equity investments Preferred stock Common stock 2 Investments

3. E QUITY I NVESTMENTS Common stock PASSIVE ACCOUNTING METHOD TO USE: INVESTMENT ACTIVE INVESTMENT Fair value Equity method significantcontrol (in US) influence Consolidate 1 share (20%) 50% 100% of stock | | || 3 Investments

4. R EPORTING “ P ASSIVE” I NVESTMENTS PASSIVE INVESTMENT Fair value 1 share (20%) | | Trading security or Security available for sale The difference is where the “unrealized” (holding) gains/losses will appear. 4 Investments

5. R EPORTING “ P ASSIVE” I NVESTMENTS 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. 5 Investments

6. R EPORTING “ P ASSIVE” I NVESTMENTS 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) 6 Investments

7. R EPORTING “ P ASSIVE” I NVESTMENTS (our company prepares quarterly f/s) 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%. 7 Investments

8. R EPORTING “ P ASSIVE” I NVESTMENTS (our company prepares quarterly f/s) 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%. 8 Investments

9. E QUITY I NVESTMENTS for voting stock (usually just common) ACTIVE INVESTMENT Equity method significant influence (20%?) 50% 100% of stock | || 9 Investments

10. T HE E QUITY M ETHOD 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: Book Value Market Value cash $ 200,000cash $ 1,000 $ 1,000 acct. rec. 300,000acct. rec. 8,000 8,000 inventory 500,000inventory 12,000 15,000 PPE 900,000PPE 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 100,000liabilities 10,000 $ 10,000 com. stock 300,000com. stock 30,000 APIC 350,000APIC 35,000 ret. earnings 855,000ret. earnings 27,000 $1,605,000 $102,000 10 Investments

11. T HE E QUITY M ETHOD What journal entry would Co. A’s accountant make? Then Co. A’s accountant would ask “Why did we pay so much?” 11 Investments

12. T HE E QUITY M ETHOD A’s balance sheet after acquiring B’s stock: cash $ 172,000 acct. rec. 300,000 inventory 500,00025% of B’s OE 23,000 PPE 900,000trademark 500 accum. deprec (300,000)patent ( 250) Invest. in Co. B 28,000PPE 2,500 patent 1,000inventory 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 12 Investments

13. T HE E QUITY M ETHOD 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. 13 Investments

14. T WO C OMMON W AYS T O O BTAIN C ONTROL 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. 14 Investments

15. E QUITY I NVESTMENTS for voting stock (usually just common) ACCOUNTING METHOD TO USE: ACTIVE INVESTMENT Equity method control (in US) Consolidate 50% 100% of stock || 15 Investments

16. B UYING C O. B ’s S TOCK – A Consolidation Example 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: Book Value Market Value cash $ 200,000cash $ 1,000 $ 1,000 acct. rec. 300,000acct. rec. 8,000 8,000 inventory 500,000inventory 12,000 15,000 PPE 900,000PPE 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 100,000liabilities 10,000 $ 10,000 com. stock 300,000com. stock 30,000 APIC 350,000APIC 35,000 ret. earnings 855,000ret. earnings 27,000 $1,605,000 $102,000 16 Consolidated Financial Statements

17. B UYING C O. B ’s S TOCK – A Consolidation Example This is what happened: Owners of A Owners of B $135,000 90% Co. Co. A B stock Co. B What will Co. A’s journal entry look like? 17 Consolidated Financial Statements

18. B UYING C O. B ’s S TOCK – A Consolidation Example This is “after”: Owners of A Owners of B 10% owners Co. A 90% owner Co. B 18 Consolidated Financial Statements

19. B UYING C O. B ’s S TOCK – A Consolidation Example A’s balance sheet after the transaction: 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 19 Consolidated Financial Statements

20. B UYING C O. B ’s S TOCK – A Consolidation Example B’s balance sheet after the transaction: 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 20 Consolidated Financial Statements

21. B UYING C O. B ’s S TOCK – A Consolidation Example Then A’s accountant asks: “Why did A pay so much?” The answer lies in a previous slide and our previous thought process, but with a modification. 21 Consolidated Financial Statements

22. B UYING C O. B ’s S TOCK – A Consolidation Example 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. 22 Consolidated Financial Statements

23. B UYING C O. B ’s S TOCK – A Consolidation Example What FASB also wants: Owners of A F/S Co. A consolidated F/S F/S Co. B 23 Consolidated Financial Statements

24. B UYING C O. B ’s S TOCK – A Consolidation Example 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). 24 Consolidated Financial Statements

25. B UYING C O. B ’s S TOCK – A Consolidation Example 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 25 Consolidated Financial Statements

26. B UYING C O. B ’s S TOCK – A Consolidation Example A’s balance sheet after the transaction: 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 3,000 inventory 15,000 PPE 90,000 $1,605,000 patent 0 trademark 2,000 goodwill 41,000 liabilities (10,000) 26

27. B UYING C O. B ’s S TOCK – A Consolidation Example So, Co. A’s consolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock. 27 Consolidated Financial Statements

28. B UYING C O. B ’s S TOCK – A Consolidated Balance S heet A’s consolidated Balance Sheet: cash$ 66,000liabilities 110,000 acct. rec. 308,000 inventory 515,000N.C.I. * 12,000 Invest. in B stock -com. stock 300,000 PPE 990,000APIC 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 28 Consolidated Financial Statements

29. B UYING C O. B ’s S TOCK – A Consolidated Income Statement One year later, these were the income statements for A and B: A B Sales revenue$200,000$70,000 COGS( 80,000)( 36,000) Deprec. exp.( 45,000)( 5,500) Pat. amort. exp.( 400)( 200) Other exp.( 14,600)( 7,800) Net income$ 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)? 29 Consolidated Financial Statements

30. B UYING C O. B ’s S TOCK – A Consolidated Income Statement A’s income statement that it would issue to the public (IF it issued a non-consolidated income statement): Sales revenue$200,000 COGS ( 80,000) Deprec. exp. ( 45,000) Pat. amort. exp. ( 400) Other expenses ( 14,600) Equity income 15,030 Net income$ 75,030 30 Consolidated Financial Statements

31. B UYING C O. B ’s S TOCK – A Consolidated Income Statement What would appear in A’s 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 31 Consolidated Financial Statements

32. B UYING C O. B ’s S TOCK Co. A’s accountant also must prepare a consolidated owners’ equity statement and a consol- idated cash flow statement. 32 Consolidated Financial Statements