McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investments and International Operations Chapter 15

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Investments 1.Companies transfer excess cash into investments to produce higher income. 2.Some companies are setup to produce income from investments. 3.Companies make investments for strategic reasons. Motivation for Investments

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Investments Short-Term versus Long-Term Investments Short-term investments: are securities that management intends to convert to cash with one year or the operating cycle, whichever is longer. are readily convertible to cash. Short-term investments: are securities that management intends to convert to cash with one year or the operating cycle, whichever is longer. are readily convertible to cash. Long-term investments: are not readily convertible to cash. are not intended to be converted to cash. are reported in the noncurrent section of the balance sheet, often in its own category. Long-term investments: are not readily convertible to cash. are not intended to be converted to cash. are reported in the noncurrent section of the balance sheet, often in its own category.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Classes of and Reporting for Investments Held-To- Maturity Available- For-Sale Significant Influence Controlling Influence Consolidate Equity Method Market Value Method Trading Amortized Cost Class of Investment Reporting

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Accounting for Investments Accounting Basics for Debt Securities Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. On January 1, 2005, Matrix, Inc. purchased $1,000,000 in bonds of Debt, Inc. Matrix paid $975,000 for the bonds and $25,000 in brokerage fees. The two-year bonds have a stated rate of 6% annually. Interest is paid semi-annually on June 30 and December 31.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Accounting for Investments Accounting Basics for Debt Securities Held-to-maturity (HTM) debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Accounting for Investments Accounting Basics for Debt Securities Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. The same entry would be made on December 31, 2005.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Basics of Accounting for Investments Accounting Basics for Debt Securities On January 1, 2007, the bonds mature and Matrix would make the following entry:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Accounting Basics for Equity Securities Equity securities are recorded at cost when acquired, including commissions or brokerage fees paid. Any cash dividends received are credited to Dividend Revenue and reported in the income statement. When the securities are sold, sales proceeds are compared with cost, and any gain or loss is recorded.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Accounting Basics for Equity Securities On May 6, 2005, Matrix, Inc. purchased 10,000 shares of Apex, Inc. common stock for $250,000 in the open market. The securities are classified by manager of Matrix as “available-for-sale” (AFS).

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Accounting Basics for Equity Securities On June 30, Apex pays a quarterly dividend to Matrix, Inc. of $0.50 per share. Matrix receives a dividend check for $5,000.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Accounting Basics for Equity Securities On December 18, Matrix, Inc. sells 1,000 shares of Apex, Inc. in the open market for $30 per share. $250,000 ÷ 10,000 shares = $25 per share cost

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006  Recorded at cost at acquisition  Interest revenue recorded as accrued (debt securities)  Dividends recorded as revenue (equity securities)  Carrying amount is adjusted to Market Value each period.  Recorded at cost at acquisition  Interest revenue recorded as accrued (debt securities)  Dividends recorded as revenue (equity securities)  Carrying amount is adjusted to Market Value each period. Available-for-Sale Securities Debt and equity securities that a company intends to sell in the future, before maturity.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Matrix, Inc. purchased 1,000 shares of Apex, Inc. at $5 per share during At December 31, 2005, the shares had increased in value to $9.50 per share. Valuing and Reporting Available-for- Sale Securities

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 { In some cases, influence or control may exist with less than 20% ownership. Investor Ownership of Investee Shares Outstanding 0%20%50%100% Cost or Market Value Method Equity Method Consolidated Financial Statements Accounting for Influential Investments

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 { Significant influence is generally assumed with 20% to 50% ownership. Investor Ownership of Investee Shares Outstanding 0%20%50%100% Equity Method Consolidated Financial Statements Accounting for Influential Investments Cost or Market Value Method

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006  Original investment is recorded at cost.  The investment account is increased by a proportionate share of investee’s earnings.  The investment account is decreased by dividends received.  Original investment is recorded at cost.  The investment account is increased by a proportionate share of investee’s earnings.  The investment account is decreased by dividends received. Investments in Equity Securities with Significant Influence

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investment in Equity Securities with Significant Influence On January 1, 2005, Matrix, Inc. buys 20% of the voting common stock of Apex, Inc. for $2,000,000 cash. 2,000,000 Long-Term Investment - Apex 2,000,000 Cash

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investment in Equity Securities with Significant Influence On December 31, 2005, Apex reports net income for the year of $300,000, and pays total cash dividends of $50,000. $300,000 × 20% = $60,000 $50,000 × 20% = $10,000

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investment in Equity Securities with Significant Influence Investment Earnings Dividends Balance

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investment in Equity Securities with Controlling Influence oRequired when investor’s ownership exceeds 50% of investee. oEquity Method is used. oConsolidated financial statements show the financial position, results of operations, and cash flows of all entities under the parent’s control.

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Accounting Summary for Investments in Securities

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Components of Return on Total Assets Return on total assets = Profit Margin × Total asset turnover Net income Average total assets =× Net income Net sales Net sales Average total assets

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Investments in International Operations (1) Accounting for sales and purchases listed in a foreign currency. (2) Preparing consolidated financial statements with international subsidiaries. Two major accounting challenges arise when companies have international operations:

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006  Each country uses its own currency for internal economic transactions.  To make transactions in another country, units of that country’s currency must be acquired.  The cost of those currencies is called the exchange rate.  Each country uses its own currency for internal economic transactions.  To make transactions in another country, units of that country’s currency must be acquired.  The cost of those currencies is called the exchange rate. Exchange Rates Between Currencies

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 Homework for Chapter 15  Ex 15-4

McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., 2006 End of Chapter 15