© The McGraw-Hill Companies, Inc., 2002 Slide 16-1 McGraw-Hill/Irwin 16 Long-Term Investments and International Transactions

© The McGraw-Hill Companies, Inc., 2002 Slide 16-2 McGraw-Hill/Irwin Classes of Long-Term Investments Held-To- Maturity Cost Method Available- For-Sale Market Value Method Significant Influence Equity Method Controlling Influence Consolidatio n Accounting Method Exh. 16.3

© The McGraw-Hill Companies, Inc., 2002 Slide 16-3 McGraw-Hill/Irwin Accounting Recorded at cost at acquisition Interest revenue recorded as accrued Difference between cost and maturity value is amortized over the remaining life of the security Accounting Recorded at cost at acquisition Interest revenue recorded as accrued Difference between cost and maturity value is amortized over the remaining life of the security Held-to-Maturity Securities Debt securities that a company intends to hold until maturity.

© The McGraw-Hill Companies, Inc., 2002 Slide 16-4 McGraw-Hill/Irwin Accounting 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. Accounting 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.

© The McGraw-Hill Companies, Inc., 2002 Slide 16-5 McGraw-Hill/Irwin Unrealized holding gains and losses from available-for- sale securities are reported in the equity section of the balance sheet. Available-for-Sale Securities

© The McGraw-Hill Companies, Inc., 2002 Slide 16-6 McGraw-Hill/Irwin Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at Dec. 31, Foot, Inc. purchased 1,000 shares of General Boots at $5 per shares during At December 31, 2001, the shares had increased in value to $9.50 per share. Available-for-Sale Securities Example

© The McGraw-Hill Companies, Inc., 2002 Slide 16-7 McGraw-Hill/Irwin Foot, Inc. purchased 1,000 shares of General Boots at $5 per shares during At December 31, 2001, the shares had increased in value to $9.50 per share. Available-for-Sale Securities Example The Unrealized Holding Gain is reported in the equity section of the Balance Sheet.

© The McGraw-Hill Companies, Inc., 2002 Slide 16-8 McGraw-Hill/Irwin { 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 The Significance of the Size of the Investment

© The McGraw-Hill Companies, Inc., 2002 Slide 16-9 McGraw-Hill/Irwin { 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 The Significance of the Size of the Investment Cost or Market Value Method

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin 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. Equity Method

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin The investment account is reported on the balance sheet as a single amount. The investor’s share of the investee’s earnings is reported as a single item on the investor’s income statement.  The account is called “Earnings from Long-Term Investment” The investment account is reported on the balance sheet as a single amount. The investor’s share of the investee’s earnings is reported as a single item on the investor’s income statement.  The account is called “Earnings from Long-Term Investment” Equity Method

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Let’s do an equity method example.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Equity Method Example On January 1, 2001, Big Corp. buys 20% of Small Inc. for $2,000,000 cash. Record Big’s journal entry.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Equity Method Example On December 31, 2001, Small reports net income for the year of $300,000. Record Big’s journal entry.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Equity Method Example 60,000 Big owns 20% of Small and gets credit for 20% of Small’s income. 20% × $300,000 = $60,000 60,000

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Equity Method Example On December 31, 2001, Big received a $25,000 dividend check from Small. Record Big’s journal entry. 25,000 60,00025,000

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Consolidation of Financial Statements Required when investor’s ownership exceeds 50% of investee.  Control is presumed to exist. Equity Method is used. Consolidated Financial Statements show the financial position, results of operations, and cash flows of all entities under the parent’s control.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin 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:

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin 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

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin As the relative strength of a country’s economy changes the exchange rate of the local currency relative to other currencies also fluctuates. ¥ = $? Foreign Exchange Markets

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin ? When a transaction occurs on one date (for example a credit sale) but the cash flow is at a later date fluctuating exchange rates can result in exchange rate gains or losses. Foreign Exchange Markets

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days. The current exchange rate is $1 =.6093 £. Prepare BobCo’s journal entry. On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days. The current exchange rate is $1 =.6093 £. Prepare BobCo’s journal entry. Foreign Exchange Transaction Example

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days. The current exchange rate is $1 =.6093 £. Prepare BobCo’s journal entry. On 12/1/01, BobCo sells inventory to Coventry Corp. on credit. Coventry will pay BobCo 10,000 British pounds in 90 days. The current exchange rate is $1 =.6093 £. Prepare BobCo’s journal entry. Foreign Exchange Transaction Example

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Record the adjusting entry. Any resulting gain or loss should be reported on the income statement. Foreign Exchange Transaction Example On December 31, 2001, the foreign exchange rate was $1 =.6250 £. Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date. On December 31, 2001, the foreign exchange rate was $1 =.6250 £. Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Foreign Exchange Transaction Example On December 31, 2001, the foreign exchange rate was $1 =.6250 £. Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date. On December 31, 2001, the foreign exchange rate was $1 =.6250 £. Accounting rules require that the foreign currency receivable be adjusted based on the exchange rate on the reporting date.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Foreign Exchange Transaction Example On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale. The exchange rate on 3/1/02, was $1 =.6115 £. Record BobCo’s receipt of Coventry’s payment. On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale. The exchange rate on 3/1/02, was $1 =.6115 £. Record BobCo’s receipt of Coventry’s payment.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Foreign Exchange Transaction Example On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale. The exchange rate on 3/1/02, was $1 =.6115 £. Record BobCo’s receipt of Coventry’s payment. On 3/1/02, Coventry Corp. pays BobCo the 10,000 £ for the 12/1/01 sale. The exchange rate on 3/1/02, was $1 =.6115 £. Record BobCo’s receipt of Coventry’s payment.

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin GAAP excludes some unrealized items from income, such as the change in market value of available-for-sale debt and equity investments. Comprehensive Income

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Comprehensive Income

© The McGraw-Hill Companies, Inc., 2002 Slide McGraw-Hill/Irwin Let’s close this chapter! End of Chapter 16