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© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
Chapter 12
Reporting and Interpreting Investments in Other Companies
© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
Business Background
Passive InvestmentsMade 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.
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
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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.
The ability of the investing company to
have an important impact on the operating and
financial policies of another company.
20% - 50%outstanding shares
SignificantInfluence
20% - 50%outstanding shares
SignificantInfluence
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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.
The investing company has the
ability to determine the operating and
financial policies of another corporation.
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Accounting for Investments in Securities
The degree of influence and control a company has affects how the investment is accounted for.
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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.
Unrealized holding gains may be recognized and
losses are recognized.
Investment carrying amount is adjusted to current
market value
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Classifying Passive Investments
NOTE: Realized gains and losses go on the Income Statement.
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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.
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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 . . .
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Recording Investments at Market Value
Long Term Investments in securities are classified as
noncurrent assets.
Long Term Investments in securities are classified as
noncurrent assets.
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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 = $40,00020,000 shares × $2 / share = $40,00020,000 shares × $2 / share = $40,00020,000 shares × $2 / share = $40,000
The journal entry to recognize the change in market value is . . .
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Recording Investments at Market Value
The unrealized holding loss would be reported in the shareholders’ equity section of Dow
Jones’ balance sheet.
The unrealized holding loss would be reported in the shareholders’ equity section of Dow
Jones’ balance sheet.
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Selling Short or Long Term Investments
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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.
© McGraw-Hill Ryerson Limited, 2003McGraw-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.
Unrealized holding gains and
losses are not recognized.
Investment carrying amount is adjusted for
dividends received, a % share of the income of
the investee.
© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
Securities Held For Significant Influence
Adjusting Effect onItem Investment Account
Reduce investmentfor dividends received.
Investee Increase investmentNet Income by our proportionate
share.Investee Decrease investmentNet Loss by our proportionate
share.
Dividends
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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.
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.
© McGraw-Hill Ryerson Limited, 2003McGraw-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.
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.
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.
© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
Recording Investments Under the Equity Method
TeleCom credits Equity in Earnings of Sports.com for its share of Sports.com’s earnings.
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.
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.
© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
Focus on Cash Flows
Investing activities: Purchase of investment (cash outflow) Sale of investment (cash inflow)
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)
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)
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Achieving Control
Off and running with less than 20% . . .
Clearing the 20% hurdle to gain influence . . .
Vaulting over the 50% mark
to gain control!
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Securities Held For Control
Horizontal integration
Horizontal integration
Vertical integration
Vertical integration
SynergySynergy
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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.
Any transactions between the parent and
subsidiary must be eliminated
when preparing consolidated
financial statements.
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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 Bank A purchases purchases
Bank B.Bank B.
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Methods of Acquiring a Controlling Interest
A purchase occurs when one company acquires the voting shares of another company.
Bank A
Bank B is Bank B is absorbed absorbed
into Bank A.into Bank A.
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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.
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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.
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.
© McGraw-Hill Ryerson Limited, 2003McGraw-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.
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 $20 million. Goodwill is only decreased
when there is a permanent decline in its value.
Let’s look at the consolidated financial statements.
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Consolidated Balance SheetDow Jones IFN Eliminations Consolidated
ASSETSCurrent assets 342$ 15$ 357$ I nvestment in I FN 100 (100)$ - Plant and property (net) 602 30 632 Other assets 447 45 492 Goodwill 20 20 Total assets 1,491$ 90$ 1,501$
LIABILITI ES & EQUITYCurrent liabilities 600$ 10$ 610$ Noncurrent liabilities 382 382 Stockholders' equity 509 80 (80) 509 Total liabilities & equity 1,491$ 90$ 1,501$
Eliminate the Investment against the Equity of IFN and establish the goodwill.
Eliminate the Investment against the Equity of IFN and establish the goodwill.
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Consolidated Income Statement
Dow Jones IFN Eliminations Consolidated
Revenues 2,158$ 120$ 2,278$ Expenses (2,150) (106) (2,256) Goodwill (2) (2) I ncome 8$ 14$ 20$
Writedown of goodwill created during the acquisition.
Writedown of goodwill created during the acquisition.
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Key Ratio Analysis
Return onAssets =
Net IncomeAverage 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.
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.
© McGraw-Hill Ryerson Limited, 2003McGraw-Hill Ryerson
End of Chapter 12
