© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-1 CHAPTER 10 Part A Accounting for Long-Term Investments and International Operations

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-2 STOCK INVESTMENTS: A Review Stock Prices –To “quote a stock price” means to state the current market price per share –Stock prices are quoted in one-eighth fractions

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-3 The 52 week high and low prices are $ and $74.125, respectively The annual cash dividend is $1.12 per share During the previous day 10,598 x 100 shares of Boeing common stock were traded The daily high and low were $ and , respectively The day’s closing price of $ was $0.50 lower than the closing price of the preceding day The 52 week high and low prices are $ and $74.125, respectively The annual cash dividend is $1.12 per share During the previous day 10,598 x 100 shares of Boeing common stock were traded The daily high and low were $ and , respectively The day’s closing price of $ was $0.50 lower than the closing price of the preceding day Information for the common stock of The Boeing Company is: 52 Weeks High Low Stock Dividend Sales 100s High Low Close Net Change 114 1/2 74 1/8 Boeing / / /8 - 1/2 52 Weeks High Low Stock Dividend Sales 100s High Low Close Net Change 114 1/2 74 1/8 Boeing / / /8 - 1/2

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-4 The person or company that owns stock in a corporation is the investor The corporation that issued the stock is the investee STOCK INVESTMENTS: A Review

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-5 Short-term investments (marketable securities) are current assets –These investments must be liquid (readily convertible to cash) –The investor must intend either to convert the investments to cash within one year or to use them to pay a current liability STOCK INVESTMENTS: A Review

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-6 Long-term investments include –Stocks and bonds that The investor expects to hold longer than one year Are not readily marketable The next slide shows the position of short-term and long-term investments on the balance sheet STOCK INVESTMENTS: A Review

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-7 Current Assets:$X Cash X Short-term investments X Accounts receivable X Inventories X Prepaid expenses X Total current assets$X Long-term investments (Investments) X Property, plant, and equipment X Intangible assets X Other assets X Current Assets:$X Cash X Short-term investments X Accounts receivable X Inventories X Prepaid expenses X Total current assets$X Long-term investments (Investments) X Property, plant, and equipment X Intangible assets X Other assets X Reporting Investments on the Balance Sheet

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-8 Assets are reported in the order of their liquidity Long-term Investments are less liquid than Current Assets but more liquid than Property, Plant, and Equipment STOCK INVESTMENTS: A Review Reporting Investments on the Balance Sheet

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-9 Trading securities are –Stock investments that will be sold in the near future for short-term profit –Classified as current assets Available-for-sale securities are –All stock investments other than trading securities –Classified as long-term unless they are expected to be sold within one year STOCK INVESTMENTS: A Review

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-10 AVAILABLE-FOR-SALE INVESTMENTS The market value method is used to account for available-for-sale investments in stock –Under the market value method, cost is used only as the initial amount for recording the investments –These investments are reported on the balance sheet at their current market value

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-11 Dade, Inc., purchases 1,000 shares of Hewlett-Packard Company common stock at the market price of 35 3/4. Dade intends to hold this investment for longer than a year. Dade’s entry to record the investment is 20X1 Feb. 23 Long-term Investment (1,000 x$35.75) 35,750 Cash 35,750 Purchased investment 20X1 Feb. 23 Long-term Investment (1,000 x$35.75) 35,750 Cash 35,750 Purchased investment AVAILABLE-FOR-SALE INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-12 If Dade receives a $0.22 per share cash dividend on the Hewlett-Packard stock, the entry to record receipt of the dividend is 20X1 July 14 Cash (1,000 x $.22) 220 Dividend Revenue220 Received cash dividend 20X1 July 14 Cash (1,000 x $.22) 220 Dividend Revenue220 Received cash dividend AVAILABLE-FOR-SALE INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-13 For a stock dividend, the investor –Records no dividend revenue –Makes a memorandum entry in the accounting records to denote the new number of shares of stock held as an investment AVAILABLE-FOR-SALE INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-14 AVAILABLE-FOR-SALE INVESTMENTS Reporting Available-for-Sale Investments at Current Market Value Assume that the market value of Dade’s investment in Hewlett- Packard’s common stock is $36,400 on December 31, 20X1. Dade, Inc., makes the following adjustment: 20X1 Dec. 31 Allowance to Adjust Investment to Market (36,400 - $35,750)650 Unrealized Gain on Investment650 Adjusted investment to market value 20X1 Dec. 31 Allowance to Adjust Investment to Market (36,400 - $35,750)650 Unrealized Gain on Investment650 Adjusted investment to market value

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-15 AVAILABLE-FOR-SALE INVESTMENTS Allowance to Adjust Investment to Market is a companion account that is used in conjunction with the Long-Term Investment account to bring the investment’s carrying amount to current market value Long-Term Investment Allowance to Adjust Investment to Market 35, Investment carrying amount = Market value of $36,400

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-16 An unrealized gain or loss results from a change in the investment’s market value, not from the sale of the investment AVAILABLE-FOR-SALE INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-17 For available-for-sale investments, the Unrealized Gain account or the Unrealized Loss account is reported in two places in the financial statements: –Other comprehensive income Reported on the income statement in a separate section below net income or Reported in a separate statement of comprehensive income AVAILABLE-FOR-SALE INVESTMENTS Comprehensive Income

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-18 –Accumulated other comprehensive income Reported in a separate section of stockholders’ equity, below retained earnings, on the balance sheet AVAILABLE-FOR-SALE INVESTMENTS Comprehensive Income The following slide shows how Dade, Inc., reported its investment and the related unrealized gain in its financial statements at the end of 20X1:

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-19 Income Statement: Revenues $10,000 Expenses, including income tax 6,000 Net income $ 4,000 Other comprehensive income: Unrealized gains on investment $ 650 Less: Income tax ( 260) 390 Comprehensive income $ 4,390 Balance Sheet: Assets: Total current assets XXX Long -term investments at market value ($35,750 + $650) 36,400 Property, plant, and equipment, net XXX Stockholders’ equity: Common stock $1,000 Retained earnings 2,000 Accumulated other comprehensive income: Unrealized gain on investments $ 390 Total stockholders’ equity $3,390

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-20 Selling an available-for-sale investment can result in a realized gain or loss –Realized gains and losses Measure the difference between the amount received from the sale of the investment and the cost of the investment Are reported as an “Other” item on the income statement AVAILABLE-FOR-SALE INVESTMENTS Available- For-Sale

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-21 Suppose Dade, Inc., sells its investment in Hewlett-Packard stock for $34,000 during 20X2. Dade would record the sale as follows: 20X2 May 19 Cash 34,000 Loss on Sale of Investment 1,750 Long-Term Investment (cost)35,750 Sold investment 20X2 May 19 Cash 34,000 Loss on Sale of Investment 1,750 Long-Term Investment (cost)35,750 Sold investment AVAILABLE-FOR-SALE INVESTMENTS Selling an Available-for-Sale Investment

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-22 ACCOUNTING FOR EQUITY- METHOD INVESTMENTS An investor with a stock holding of between 20 and 50% of the investee’s voting stock may significantly influence how the investee operates the business –Dividend policy –Product lines –Sources of supply, etc.

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-23 The equity method is used to account for investments in which the investor owns % of the investee’s stock These investee companies are referred to as affiliates Investments accounted for by the equity method are recorded initially at cost ACCOUNTING FOR EQUITY- METHOD INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-24 ACCOUNTING FOR EQUITY- METHOD INVESTMENTS Phillips Petroleum Company pays $400,000 for 30% of the common stock of White Rock Corporation. Phillips’s entry to record the purchase of this investment follows: Jan. 6 Long-term Investment400,000 Cash400,000 To purchase equity-method investment Jan. 6 Long-term Investment400,000 Cash400,000 To purchase equity-method investment

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-25 Under the equity method, the investor applies its percentage of ownership in recording its share of the investee’s net income and dividends. If White Rock reports net income of $250,000 for the year, Phillips records 30% of this amount as follows: Dec. 31 Long-Term Investment ($250,000 x.30) 75,000 Equity-Method Investment Revenue 75,000 To record investment revenue Dec. 31 Long-Term Investment ($250,000 x.30) 75,000 Equity-Method Investment Revenue 75,000 To record investment revenue ACCOUNTING FOR EQUITY- METHOD INVESTMENTS The Investor’s Percentage of Investee Income As the investee’s owners’ equity increases, so does the Investment account on the investor’s books

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-26 When White Rock declares and pays a cash dividend of $100,000, Phillips receives 30% of this dividend and records this entry: Dec. 31 Cash ($100,000 x.30) 30,000 Long-Term investment 30,000 To record receipt of cash dividend on equity method investment Dec. 31 Cash ($100,000 x.30) 30,000 Long-Term investment 30,000 To record receipt of cash dividend on equity method investment ACCOUNTING FOR EQUITY- METHOD INVESTMENTS Receiving Dividends Under the Equity Method An investor records its proportionate part of cash dividends received form the investee

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-27 The investment account is decreased for the receipt of a dividend on an equity-method investment because the dividend decreases the investee’s owners’ equity and thus the investor’s investment ACCOUNTING FOR EQUITY- METHOD INVESTMENTS

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-28 After the preceding entries are posted, Phillips’s Investment account reflects its equity in the net asset of White Rock: ACCOUNTING FOR EQUITY- METHOD INVESTMENTS Jan. 6 Purchases 400,000 Dec. 31 Net income 75,000 Dec. 31 Balance 445,000 Dec. 31 Dividends 30,000 Long-Term Investment

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-29 Phillips would report the long-term investment on the balance sheet and the equity-method investment revenue on the income statement as follows: Balance sheet (partial): Assets Total current assets$ XXX Property, plant, and equipment, net XXX Income statement (partial): Income from operations$ XXX Other revenue Net income$ XXX Balance sheet (partial): Assets Total current assets$ XXX Property, plant, and equipment, net XXX Income statement (partial): Income from operations$ XXX Other revenue Net income$ XXX Long-term investments, at equity 445,000 Equity-method investment revenue 75,000

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-30 Sale of one-tenth of the White Rock common stock for $41,000 would be recorded as follows: Feb. 13 Cash 41,000 Loss on Sale of Investment 3,500 Long Term Investment ($445,000 x 1/10) 44,500 Feb. 13 Cash 41,000 Loss on Sale of Investment 3,500 Long Term Investment ($445,000 x 1/10) 44,500 ACCOUNTING FOR EQUITY- METHOD INVESTMENTS Gain or loss on the sale of an equity-method investment is measured as the difference between the sale proceeds and the carrying amount of the investment

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-31 ACCOUNTING FOR EQUITY- METHOD INVESTMENTS Original cost Share of income Share of losses Share of dividends Equity-Method Investment Balance

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-32 ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES A controlling (majority) interest is the ownership of more than 50% of the investee’s voting stock The investor is called the parent company The investee is called the subsidiary

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-33 For example, because Saturn Corporation is a subsidiary of General Motors, the parent, the stockholders of GM control Saturn, as diagrammed below: Many individuals and institutional investors (The stockholders) General Motors Corporation (Parent) Saturn Corporation (Subsidiary) owns which owns

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-34 The exhibit below shows some of the more interesting subsidiaries of the “Big Two” U. S. automakers: General Motors Corporation Total assets: $257 Billion Saturn Corporation Hughes Aircraft Company General Motors Acceptance Corporation (GM’s financing subsidiary, which makes up 44% of GM’s total assets) Ford Aerospace Corporation Jaguar, Ltd. Ford Motor Credit Company (Ford’s financing subsidiary, which makes up 70% of Ford’s total assets) Ford Motor Company Total assets: $238 billion Parent Company Selected Subsidiaries

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-35 Consolidation accounting –Is a method of combining the financial statements of two or more companies that are controlled by the same stockholders –Reports a single set of financial statements for the consolidated entity, which carries the name of the parent company ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-36 Accounting Methods for Stock Investment by Percentage of Ownership

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-37 The assets, liabilities, revenues, and expenses of each subsidiary are added to the parent’s accounts ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-38 Consolidated balance sheet –Suppose that Parent Corporation has Purchased all (100%) of the outstanding common stock of Subsidiary Corporation at its book value of $150,000 and Loaned Subsidiary Corporation $80,000 ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-39 –The consolidated statements cannot show both the investment amount plus the amounts for the subsidiary’s assets and liabilities –This would count the same resources twice ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-40 Entry (a) –Credits the parent’s Investment account to eliminate its debit balance and –Debits the subsidiary stockholders’ equity accounts to eliminate their credit balances ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES The following exhibit shows the work sheet for consolidating the balance sheet

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-41 Entry (b) eliminates the parent’s receivable and the subsidiary's payable because they represent the same resources After the work sheet is complete, the consolidated amount for each account represents the Parent Company’s asset or liability or equity amounts ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-42 Cash Notes receivable from Subsidiary Inventory Investment in Subsidiary Other assets Total Accounts payable Notes payable Common stock Retained earnings Total 12,000 80, , , , ,000 43, , , , ,000 (b) 80,000 (a)100,000 (a) 50, ,000 18,000 91, , ,000 17,000 80, ,000 50, ,000 (b) 80,000 (a)150, ,000 30, , , ,000 60, , , , ,000 Parent Corporation Subsidiary Corporation Debit Credit Consolidated Amounts Eliminations Assets Liabilities and Stockholders’ Equity

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-43 Goodwill –Arises when a parent company pays more to acquire a subsidiary company than the market value of the subsidiary’s net assets –Is the intangible asset that represents the parent company’s excess payment to acquire the subsidiary ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-44 Minority interest –Arises when a parent company purchases less than 100% of the stock of a subsidiary company –Is reported among the liabilities on the balance sheet of the parent company The income of a consolidated entity is the net income of the parent plus the parent’s proportion of all subsidiaries’ net income ACCOUNTING FOR CONSOLIDATED SUBSIDIARIES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-45 Suppose Parent Company owns all the stock of Subsidiary S-1 and 60% of the stock of Subsidiary S-2. During the year just ended, Parent earned net income of $330,000, S-1 earned $150,000, and S-2 had a net loss of $100,000. Parent Company would report net income computed as follows: Net Income (Net loss) of each Company Parent’s Ownership of each Company Parent’s Consolidated Net Income (Net Loss) Parent Company Subsidiary S-1 Subsidiary S-2 Consolidated net income $330, ,000 (100,000) 100% 60% $330, ,000 (60,000) $420,000 ====== xxxxxx

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-46 LONG-TERM INVESTMENTS IN BONDS AND NOTES The relationship between a corporation issuing bonds and the investor (bondholder) may be diagrammed as follows: Issuing Corporation Investor (Bondholder) Bonds payable Investment in bonds Interest expense Interest revenue Issuing Corporation Investor (Bondholder) Bonds payable Investment in bonds Interest expense Interest revenue

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-47 Held-to-maturity investments are long- term investments in bonds and notes that the investor intends to hold until the bonds mature Bond investments are recorded at cost LONG-TERM INVESTMENTS IN BONDS AND NOTES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-48 Held-to-maturity investments in bonds are reported at their amortized cost, which determines the carrying amount A discount or premium is amortized to account more precisely for interest revenue over the period the bonds will be held LONG-TERM INVESTMENTS IN BONDS AND NOTES

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-49 Suppose an investor purchases $10,000 of 6% CBS bonds at a price of 95.2 on April 1, 20X2. The investor intends to hold the bonds as a long-term investment until their maturity. Interest dates are April 1 and October 1. Assuming amortization of the discount by the straight-line method the entries for this investment are as follows: Apr. 1 Long-Term Investment in Bonds ($10,000 x 0.952) 9,520 Cash 9,520 To purchase bond investment Oct. 1 Cash ($10,000 x 0.06 x 6/12) 300 Interest Revenue 300 To receive semiannual interest Oct. 1 Long-Term investment in Bonds [($10,000 - $9,520)/48] x6 60 Interest Revenue 60 To amortize discount on bond investment for six months Apr. 1 Long-Term Investment in Bonds ($10,000 x 0.952) 9,520 Cash 9,520 To purchase bond investment Oct. 1 Cash ($10,000 x 0.06 x 6/12) 300 Interest Revenue 300 To receive semiannual interest Oct. 1 Long-Term investment in Bonds [($10,000 - $9,520)/48] x6 60 Interest Revenue 60 To amortize discount on bond investment for six months

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-50 At December 31, the year end-adjustments are Dec. 31 Interest Receivable ($10,000 x 0.06 x 3/12) 150 Interest Revenue 150 To accrue interest revenue for three months Dec. 31 Long-Term Investment in Bonds [($10,000 - (9,520)/48] x 3 30 Interest Revenue 30 To amortize discount on bond investment for three months Dec. 31 Interest Receivable ($10,000 x 0.06 x 3/12) 150 Interest Revenue 150 To accrue interest revenue for three months Dec. 31 Long-Term Investment in Bonds [($10,000 - (9,520)/48] x 3 30 Interest Revenue 30 To amortize discount on bond investment for three months

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-51 The financial statements at December 31, 20X2, report the following effects of this investment in bonds (assume that the market price is 102): Balance sheet at December 31, 20X2: Current assets: Interest receivable $ 150 Total current assets X,XXX Long-Term investments in bonds ($9,520 + $60 + $30) - Note 6 9,610 Property, plant, and equipment X,XXX Note 6: Long-term investments: Bond investments that will be held to maturity are reported at amortized cost. At December 31, 20X2, the market value of long-term investments in bonds was $10,200 ($10,000 x 1.02) Income statement (multiple-step) for the year ended December 31, 20x2: Other revenues: Interest revenue ($300 + $60 + $150 + $30) $ 540 Balance sheet at December 31, 20X2: Current assets: Interest receivable $ 150 Total current assets X,XXX Long-Term investments in bonds ($9,520 + $60 + $30) - Note 6 9,610 Property, plant, and equipment X,XXX Note 6: Long-term investments: Bond investments that will be held to maturity are reported at amortized cost. At December 31, 20X2, the market value of long-term investments in bonds was $10,200 ($10,000 x 1.02) Income statement (multiple-step) for the year ended December 31, 20x2: Other revenues: Interest revenue ($300 + $60 + $150 + $30) $ 540

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-52 Accounting Method to Use for Each Type of Long-Term Investment Accounting Method to Use for Each Type of Long-Term Investment Accounting Type of Long-Term Investment Method Accounting Type of Long-Term Investment Method Investor owns less than 20% of investee stock (Available-for- sale investment classified as noncurrent asset) Investor owns between 20 and 50% of investee/affiliate stock Investor owns more than 50% of investee stock Long-term investment in bonds (Held-to-maturity investment) Market value Equity Consolidation Amortized cost

© 2001 Prentice Hall Business Publishing Financial Accounting, 4/e Harrison and Horngren 10A-53 END OF CHAPTER 10 Part A Harrison & Horngren