1. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Chapter 12 Reporting and Interpreting Investments in Other Companies

2. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Business Background Passive Investments Made to earn a high rate of return on funds that may be needed in the future Equity security investments are presumed passive if the investing company owns less than 20% of the outstanding voting share. <20% outstanding shares Passive <20% outstanding shares Passive

3. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Business Background 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. 20% - 50% outstanding shares Significant Influence 20% - 50% outstanding shares Significant Influence

4. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Business Background Investments made with the intent to exert control over another corporation. >50% outstanding shares Control >50% outstanding shares Control The investing company has the ability to determine the operating and financial policies of another corporation.

5. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Accounting for Investments in Securities The degree of influence and control a company has affects how the investment is accounted for.

6. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Securities Held For Passive Investment Date of acquisition Investment is initially recorded at cost. Future measurement date Unrealized holding gains may be recognized and losses are recognized. Investment carrying amount is adjusted to current market value

7. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Classifying Passive Investments NOTE: Realized gains and losses go on the Income Statement.

8. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments at Market Value IFN and Dow Jones both produce film. Dow Jones wants to acquire an ownership interest in IFN. On 6/30/02, Dow Jones acquires 2% of IFNs’ 1,000,000 shares on the open market at a cost of $18 per share. Dow Jones has no influence over IFN, and does not plan to sell the shares in the near future. IFN and Dow Jones both produce film. Dow Jones wants to acquire an ownership interest in IFN. On 6/30/02, Dow Jones acquires 2% of IFNs’ 1,000,000 shares on the open market at a cost of $18 per share. Dow Jones has no influence over IFN, and does not plan to sell the shares in the near future.

9. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments at Market Value Should the acquired shares be classified as Short Term or Lon Term? Dow Jones does not plan to sell the shares, so they should be classified as Long Term securities. Should the acquired shares be classified as Short Term or Lon Term? Dow Jones does not plan to sell the shares, so they should be classified as Long Term securities. The journal entry to record the investment is...

10. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments at Market Value Long Term Investments in securities are classified as noncurrent assets.

11. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments at Market Value By December 31, 2002, Dow Jones’ fiscal year-end, the market value of Images’ shares has dropped to $16 per share. How much has Dow Jones’ portfolio value changed? By December 31, 2002, Dow Jones’ fiscal year-end, the market value of Images’ shares has dropped to $16 per share. How much has Dow Jones’ portfolio value changed? 20,000 shares × $2 / share = $40,000 The journal entry to recognize the change in market value is...

12. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments at Market Value The unrealized holding loss would be reported in the shareholders’ equity section of Dow Jones’ balance sheet.

13. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Selling Short or Long Term Investments

14. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Securities Held For Significant Influence Used when an investor can exert significant influence over an investee. It is presumed that the investment was made as a long-term investment.

15. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Securities Held For Significant Influence Date of acquisition Investment is initially recorded at cost. Future measurement date Unrealized holding gains and losses are not recognized. Investment carrying amount is adjusted for dividends received, a % share of the income of the investee.

16. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Securities Held For Significant Influence

17. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments Under the Equity Method On 1/1/02, TeleCom, Inc. acquires a 30% interest in Sports.com at a cost of $2,000,000. Prepare the journal entry to record TeleCom’s investment.

18. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments Under the Equity Method Dividends are not revenue under the equity method. They are treated as a reduction of the investment account. On 3/31/02, Sports.com pays $200,000 in dividends, $60,000 (30%) of which goes to TeleCom. Record TeleCom’s receipt of the dividend.

19. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Recording Investments Under the Equity Method TeleCom credits Equity in Earnings of Sports.com for its share of Sports.com’s earnings. Sports.com net income for the year ending 12/31/02 is $1,600,000. TeleCom’s 30% share is $480,000. Record TeleCom’s share of Sports.com’s income.

20. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Focus on Cash Flows 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)

21. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Achieving Control Off and running with less than 20%... Clearing the 20% hurdle to gain influence... Vaulting over the 50% mark to gain control!

22. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Securities Held For Control Horizontal integration Vertical integration Synergy

23. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson 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.

24. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Methods of Acquiring a Controlling Interest A purchase occurs when one company acquires the voting shares of another company. Bank A Bank B Bank A purchases Bank B.

25. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Methods of Acquiring a Controlling Interest A purchase occurs when one company acquires the voting shares of another company. Bank A Bank B is absorbed into Bank A.

26. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Goodwill The excess of the purchase price of a company over the fair market value of the net assets. Goodwill is only recorded in a purchase transaction. The excess of the purchase price of a company over the fair market value of the net assets. Goodwill is only recorded in a purchase transaction.

27. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Goodwill On 1/1/02, WebTech acquired 100% of the voting stock of TD Systems for $6,200,000 cash. At the time, TD System’s net assets had an FMV of $6,000,000.

28. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Consolidated Financial Statements Dow Jones purchases all the stock of IFN for $100 million. IFN’s net assets (assets less liabilities) are $80 million at the date of purchase. The transaction results in goodwill of $20 million. Goodwill is only decreased when there is a permanent decline in its value. Let’s look at the consolidated financial statements.

29. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Consolidated Balance Sheet Eliminate the Investment against the Equity of IFN and establish the goodwill.

30. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Consolidated Income Statement Writedown of goodwill created during the acquisition.

31. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson Key Ratio Analysis Return on Assets = Net Income Average Total Assets Measures how much the firm earned for each dollar of investment. In general, a higher return indicates management is doing a better job selecting investments.

32. © McGraw-Hill Ryerson Limited, 2003 McGraw-Hill Ryerson End of Chapter 12