Reporting and Interpreting Investments in Other Corporations Chapter 12 McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

McGraw-Hill/Irwin Slide 2 Understanding the Business A company may invest in the securities of another company to: Earn a return on idle funds. (Passive investments) Control the other company. Influence the other company’s policies and activities.

McGraw-Hill/Irwin Slide 3 Passive Investments in Debt and Equity Securities Investments in debt securities are always considered passive investments. Passive investments are made to earn a high rate of return on funds that may be needed for future purposes. Equity security investments are presumed passive if the investing company owns less than 20% of the outstanding voting shares. The investor is not interested in controlling or influencing the other company.

McGraw-Hill/Irwin Slide 4 Investments made with the intent of exerting significant influence over another corporation. The ability of the investing company to have an important impact on the operating and financial policies of another company. Significant Influence 20% - 50% outstanding shares Significant Influence 20% - 50% outstanding shares Investments in Stock for Significant Influence

McGraw-Hill/Irwin Slide 5 Investments made with the intent to exert control over another corporation. Control >50% outstanding shares Control >50% outstanding shares The investing company has the ability to determine the operating and financial policies of another corporation. Investments in Stock for Control

McGraw-Hill/Irwin Slide 6 Types of Investments and Accounting Methods The accounting method depends on the type of security and the level of ownership (influence).

McGraw-Hill/Irwin Slide 7 Debt Held To Maturity: Amortized Cost Method Record at cost on acquisition date. Amortize discount or premium. Record interest received. Record principal received at maturity.

McGraw-Hill/Irwin Slide 8 Passive Stock Investments: The Market Value Method Date of acquisition Investment is initially recorded at cost. Future measurement date Unrealized holding gains and losses are recorded. Investment carrying amount is adjusted to current market value.

McGraw-Hill/Irwin Slide 9 Classifying Passive Stock Investments NOTE: Realized gains and losses go on the Income Statement.

McGraw-Hill/Irwin Slide 10 Comparing Trading and Available for Sale Securities

McGraw-Hill/Irwin Slide 11 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.

Slide 12 McGraw-Hill/Irwin Date of acquisition Investment is initially recorded at cost. Future measurement date Unrealized holding gains and losses are not recorded. Investment carrying amount is adjusted for dividends received, and a percentage share of the investee’s income. Investments For Significant Influence: Equity Method

McGraw-Hill/Irwin Slide 13 Investments For Significant Influence: Equity Method

McGraw-Hill/Irwin Slide 14 Focus on Cash Flows Investing activities: Purchase of investment (cash outflow) Sale of investment (cash inflow) Investing activities: Purchase of investment (cash outflow) Sale of investment (cash inflow) Operating activities: Gain on sale of investment (subtract from net income) Loss on sale of investment (add to net income) Equity in earnings of investee (subtract from net income) Dividends from investee (add to net income) Unrealized holding gains trading securities (subtract from net income) Unrealized holding losses trading securities (add to net income) Operating activities: Gain on sale of investment (subtract from net income) Loss on sale of investment (add to net income) Equity in earnings of investee (subtract from net income) Dividends from investee (add to net income) Unrealized holding gains trading securities (subtract from net income) Unrealized holding losses trading securities (add to net income)

McGraw-Hill/Irwin Slide 15 Controlling Interests: Mergers and Acquisitions Off and running with less than 20%... Clearing the 20% hurdle to gain influence... Vaulting over the 50% mark to gain control!

McGraw-Hill/Irwin Slide 16 What Are Consolidated Statements? The acquiring company is the parent. The company acquired is the subsidiary. Consolidated statements combine two or more companies into a single set of statements. The acquiring company is the parent. The company acquired is the subsidiary. Consolidated statements combine two or more companies into a single set of statements. Any transactions between the parent and subsidiary must be eliminated when preparing consolidated financial statements.