Lecture Principles of financial accouting - Chapter 15: Investments and international operations

Chapter 15

Investments and International
Operations

PowerPoint Authors:
Susan Coomer Galbreath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
Winston Kwok, Ph.D., CPA
McGraw­Hill/Irwin

        Copyright © 2011 by The McGraw­Hill Companies, Inc. All rights reserved.


15 ­ 2

C1

Basics of Investments
Motivation for Investments
1.Companies transfer excess cash into
investments to produce higher income.
2.Some companies are set up to
produce income from investments.
3.Companies make investments for
strategic reasons.


15 ­ 3

C1

Short-Term Investments
Short-term investments are securities that:
• Management intends to convert to cash
within one year or the operating cycle,
whichever is longer.
• Are readily convertible to cash.
Short-term investments do not include cash
equivalents. Cash equivalents are investments
that are both readily converted to known
amounts of cash and mature within three
months.


15 ­ 4

C1

Long-Term Investments
Long-term investments:
• are not readily convertible to cash.
• are not intended to be converted to cash in
the short term.
• are reported in the noncurrent section of
the balance sheet, often in its own
category.

15 ­ 5

C1

Debt Securities versus
Equity Securities
Debt Securities
• Reflect a creditor relationship
• Examples: Investments in notes, bonds,
and CDs
• May be issued by governments,
companies, or individuals
Equity Securities
• Reflect an owner relationship
• Examples: Investments in ordinary shares
Issued by other companies


15 ­ 6

C1

Classification and Reporting
Accounting
Accounting for
for Investments
Investments depends
depends on
on some
some or

or all
all of
of the
the following
following
factors:
factors:

11.. purpose,
purpose, e.g.
e.g. trading
trading or
or long-term
long-term investment,
investment, the
the company’s
company’s intent
intent to
to hold
hold the
the security
security either
either
short-term
short-term or
or long-term,
long-term,
2.
2. its
its contractual

contractual characteristics,
characteristics, e.g.
e.g. debt
debt or
or equity,
equity,
3.
3. whether
whether itit is
is listed
listed on
on an
an exchange,
exchange,
4.
4. the
the industry
industry in
in which
which the
the reporting
reporting entity
entity operates,
operates, and
and
5.
5. the
the accounting
accounting policy
policy choice

choice of
of the
the reporting
reporting entity.
entity.


15 ­ 7

P1

Held-for-Trading Securities
 Acquired principally for the purpose of selling or
repurchasing them in the near term, with a
pattern of short-term profit-taking.
 Such investments are accounted for by the fair
value approach, in contrast to the historical cost
approach generally used for other assets like
land, buildings, and equipment. Fair value is the
amount for which an asset could be exchanged
between knowledgeable and willing parties, in
an arm’s length transaction.


15 ­ 8

P1

Held-for-Trading Securities

Assume that Nestlé buys X Corp’s shares on October 1, with
the intention to sell within a few months. The journal entry at
purchase is as follows.


15 ­ 9

P1

Held-for-Trading Securities
When Nestlé’s fiscal year ends on December 31, 2010, the
share price of X Corp has risen in value and the total market
value is CHF 55,000. The CHF 5,000 value on top of the
original cost is an unrealized gain on the investment. The
year-end journal entry to record this gain is as follows.


15 ­ 10

P1

Held-for-Trading Securities
When Nestlé sells X Corp’s shares, it records a realized gain
or loss. If Nestlé sells at CHF 60,000, which is higher than
the carrying amount of CHF 55,000, then the journal entry is
as follows.


15 ­ 11

P2

Available-for-Sale Securities
Purchased to yield dividends or increases in fair value.
Not actively managed like held-for-trading securities.
If the intent is to sell available-for-sale securities within the
longer of one year or operating cycle, they are classified
as short-term investments. Otherwise, they are classified
as long-term.
 Adjust the cost of available-for-sale securities to reflect
changes in fair value. This is done with a fair value
adjustment to its total portfolio cost.
 Any unrealized gain or loss is not reported as part of profit
or loss but as part of other comprehensive income.





15 ­ 12

P2

Available-for-Sale Securities
Assume that Nestlé buys Y Corp’s shares at CHF
100,000. Nestlé intends to hold this investment for
longer than a year and decided to treat it as an
available-for-sale (AFS) investment.

15 ­ 13

P2

Available-for-Sale Securities
Assume that at year-end, the fair market value of Y Corp’s
shares is CHF 120,000. The journal entry is as follows.

Upon sale at CHF 10,000, the journal entry is:


15 ­ 14

P3

Held-to-Maturity Debt
Debt securities are recorded at cost when
purchased. Interest revenue for investments in debt
securities is recorded when earned.
On September 1, 2010, Music City paid $29,500 plus a
$500 brokerage fee to buy Dell’s 7%, 2-year bonds payable
with a $30,000 par value. The bonds pay interest
semiannually on August 31stst and February 28thth. Music City
plans to hold the bonds until they mature (HTM securities).


15 ­ 15

P3

Held-to-Maturity Debt
Interest earned but not received must be
accrued on December 31, 2010.
$30,000 par value × 7% × 4/12 = $700 interest earned.


15 ­ 16

Investments in Equity with
significant influence

P4

Investor Ownership of Investee Shares Outstanding
Cost or
Fair
Value
Method
0%

Equity
Method
20%

Consolidated Financial
Statements
50%

Significant influence is generally assumed with
20% to 50% ownership.

100%


15 ­ 17

P4

Investments in Equity with
significant influence
 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.


15 ­ 18

P4

Investments in Equity with
significant influence
On January 1, 2010, Micron Co. records the
purchase of 3,000 shares (30%) of Star Co.
ordinary shares at a total cost of $70,650 cash.

15 ­ 19

P4

Investments in Equity with
significant influence
For 2010, Star reports net income of $20,000,
and pays total cash dividends of $10,000 on
January 9, 2011.

$20,000
$20,000 × 30% == $6,000

$10,000 × 30% = $3,000
$3,000


15 ­ 20

P4

Investments in Equity with
significant influence


15 ­ 21

C2

INVESTMENTS IN EQUITY WITH CONTROL

equired when investor’s ownership exceeds
50% of investee.
 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.


15 ­ 22

C1

Accounting Summary for
Investments in Securities


15 ­ 23

C1

Comprehensive Income
Comprehensive Income: all changes in equity
during a period except those from owners’
investments and dividends.
Example: Fair value adjustments on available-for-sale
investments are shown in the statement of comprehensive
income.

15 ­ 24

A1

Components of
Return on Total Assets
Return on
total assets

Net income
Average total assets

=

=

Profit
margin

Net income
Net sales

Total asset
turnover

×

×

Net sales
Average total assets


15 ­ 25

A1

Return on Total Assets
Here are the returns on total assets and its components
for Gap, Inc. for the years 2005 through 2009:

All companies desire a high return on total assets. To improve the
return, the company must meet any decline in profit margin or
total asset turnover with an increase in the other. Companies
consider these components in planning strategies.