CORPORATE FINANCIAL REPORTING 11 – Financial

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CORPORATE FINANCIAL REPORTING

11 – Financial Reporting of Investments

Long-Lived Assets

Financial Reporting of Investments

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INVESTMENT IN THE STOCK OF

ANOTHER COMPANY

Reporting investments is a continuum based on

some measure of influence over the investee:

We can own: 1 share 100% of

shares


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ANOTHER COMPANY

Reporting investments is a continuum based on

some measure of influence over the investee:

We can own: 1 share 50% 100% of

shares

passive

investor active investor


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ANOTHER COMPANY

Reporting investments is a continuum based on some measure of influence over the investee:We can own: 1 share 50% 100% of

shares

passive investor active investor

market equity consolidated value method financial statements


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ANOTHER COMPANY

Marketable security orTrading security

or

1 share Security available for sale

The difference is where the

passive “unrealized” gains or losses

investor will appear

market value


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Reporting Trading Securities vs.

Securities Available for Sale

International rules differ slightly, but in general:

Trading Securities are meant to be held for short periods of time and are part of a company’s “operating activity.”

Securities Available for Sale are not part of a company’s “operating activity” rather they are investments made as a short or long term investment to generate financing (not operating) profits.

Held to maturity securities - later


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A brief aside - a visit to the “hidden” income statement - Other Comprehensive Income

and a bizarre new account.


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On April 2nd, our company buys shares of X Company common stock for $10,000 (includes broker charges); our company prepares quarterly financial statements.

On June 30th, the stock has a fair value of $9,000.

On Sept. 30th, the stock has a fair value of $12,000.

On Dec. 21st, we sell the stock for $12,200 (net).

Scenario A: IF TRADING SECURITY (unrealized gains and losses on the income statement)


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On April 2nd, our company buys shares of X Company common stock for $10,000 (includes broker charges); our company prepares quarterly financial statements.

On June 30th, the stock has a fair value of $9,000.

On Sept. 30th, the stock has a fair value of $12,000.

On Dec. 21st, we sell the stock for $12,200 (net).

Scenario B: IF AVAILABLE-FOR-SALE (unrealized gains and losses in Other Comprehensive Income)


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IF YOU HAD A CHOICE, WHICH WOULD YOU CHOOSE AS A CEO OF A COMPANY?

WHY?


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ANOTHER COMPANY

50% 100% of

shares

active investor

equity consolidated method financial

statements


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The Equity Method - General Idea

Owners Owners of Co. A of Co. B

Co. A Co. B


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Owners Owners of Co. A of Co. B

$ shares of B

Co. A Co. B


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some former Owners Owners Owners

of Co. A of Co. B of Co. B

$

Co. A Co. B


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Brief example:(1) In January 2008, A pays $100,000 for 30% of B’sstock (which gives A “significant influence” over B).

In December 2008: (2) B reports $20,000 of net income and (3) pays $10,000 of cash dividends.

What will appear in A’s financial statements when those three things occur?


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In practice it is a little morecomplicated (of course).

I know you can’t wait to find out more.


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The Equity Method - Practice

On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash. The following relate to Sonn:

Balance sheet Fair values

ASSETS

Cash $ 10 $ 10

Inventory * 40 50

Other current assets 100 100

P P &E. ** 200 240

TOTAL $ 350

LIAB & O. E.

Liabilities $ 220 220

Common stock 50

Retained Earnings 80

TOTAL $ 350


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Popp’s accountant immediately asks:

“Why did we pay so much?”


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On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash. The following relate to Sonn:

Balance sheet Fair values

ASSETS

Cash $ 10 $ 10

Inventory * 40 50

Other current assets 100 100

P P &E. ** 200 240

TOTAL $ 350

LIAB & O. E.

Liabilities $ 220 220

Common stock 50

Retained Earnings 80

TOTAL $ 350


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Here’s the complicating part:

the inventory will be sold 2007

and 1/6th of the PPE’s services will be used up in 2007.


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Sonn’s Income Statement for 2008

Sales $1,540

COGS expense ( 840)

Deprec. expense ( 300)

Other expenses ( 100)

Net income $ 300

Sonn’s COGS and depreciation are based on Sonn’s cost of inventory and PP&E.


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What will appear in Popp’s financial statements when:

1. Popp paid the $262 on January 2, 3008? 2. Sonn sends Popp its income statement at

Dec. 31, 2008?

3. Popp’s accountant remembers what a previous slide said about Sonn’s inventory and PP&E?


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Popp’s Income Statement for 2008

Sales $ 4,000

COGS expense ( 1,300)



Income before equity income 1,200

Equity in earnings of affiliate

Net income $


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Popp’s Income Statement for 2008

Sales $ 4,000

COGS expense ( 1,300)



Income before equity income 1,200

Equity in earnings of affiliate 255

Net income $ 1,455


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Popp’s Balance Sheet December 31, 2007

Investment in Sonn $ 517 (262 + 270 - 15)


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ANOTHER COMPANY

50% 100% of

shares

consolidated financial

statements


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Consolidated Financial Statements-Theory

Theory behind consolidated financial statements;If one company controls another company, then they are “economically” one company and should “consolidate.”

Co. A F/S As separate legal entities A and B must prepare their

own financial statements.

Co. B F/S .


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Consolidated Financial Statements-Theory

Theory behind consolidated financial statements;If one company controls another company, then they are “economically” one company and should “consolidate.”

Co. A F/S As separate legal entities A and B must prepare their

F/S own financial statements.And A must also prepare Co. B F/S a set of financial statementsCONSOLIDATED - as if A

and B were one company.


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Consolidated Financial Statements - Illustration

On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash to the shareholders of Sonn Corporation.


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(some former) Owners Owners Owners of Popp of Sonn of Co. B

10%

Popp $

90% Sonn


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(some former) Owners Owners Owners of Popp of Sonn of Co. B

10%

Popp $

90% Sonn a little complicated by

the noncontrolling (10%)

interest


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Now we have two things going on: Popp uses the equity method to report “investment in Sonn” in its financial statements and Popp prepares consolidated financial statements.

We’ve already discussed Popp’s use of the equity method - Popp does the same thing now.


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And also prepares the additional set of financial statements -as if Popp and Sonn are one company.


P’s balance sheet after the transaction:cash $ 282 liabilities $ 350inventory 70 com. stock 260other current assets 110 ret. earnings 252PPE 400 $ 862Invest. in Sonn 262

$ 862 cash 10

inventory 49 acct. rec. 100

PPE 236liabilities 220 goodwill 100

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INVESTMENTS IN THE STOCKOF ANOTHER COMPANY

How do you think managers try to “manage” earnings prior to acquiring other companies?

Before the acquisition, they manage earnings upward if they are giving

shares to acquire another company, but not if giving cash.


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INVESTMENTS IN THE STOCK OF ANOTHER COMPANY

QUESTIONS?

Business

CORPORATE FINANCIAL REPORTING 11 – Financial