Reporting and Interpreting

Investments in Other
Corporations
Chapter 12

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

McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
12-1
 Understanding the Business

A company may invest in the securities

of another company to:

Earn a return Influence the Control the

on idle funds. other other
(Passive company’s company.
investments) policies and
activities.

12-2
 Passive Investments in Debt and
Equity Securities
Passive investments are made to earn a high rate of
return on funds that may be needed for future purposes.

Investments in debt securities are always

considered passive investments.

Equity security investments

The investor is not
are presumed passive if the
interested in controlling
investing company owns less
or influencing the other
than 20% of the outstanding
company.
voting shares.
12-3
 Investments in Stock for Significant
Influence
Investments made with the intent of exerting
significant influence over another corporation.

The ability of the

investing company to Significant
have an important Influence
impact on the 20% - 50%
operating and outstanding shares
financial policies of
another company.

12-4
 Investments in Stock for Control

Investments made with the intent to exert

control over another corporation.

The investing
Control
company has the
ability to determine
>50%
the operating and
outstanding shares
financial policies of
another corporation.

12-5
 Types of Investments and Accounting
Methods
The accounting method depends
on the type of security and the level
of ownership (influence).

Measuring and
Investment Category Reporting Method
Debt Passive, Held-to-maturity Amortized cost
Debt Passive, Not-held-to-maturity Fair value
Stock Passive Fair value
Stock Significant influence Equity
Stock Control Consolidated statement

12-6
 Debt Held To Maturity: Amortized Cost
Method
Record at cost on
acquisition date.

Record interest
received.

Amortize discount
or premium.

Record principal
received at maturity.

12-7
 Debt Held To Maturity: Amortized Cost
Method
On July 1, 2010, Washington Post paid the par value of
$100,000 for 8 percent bonds that mature on June 30, 2015.
The 8 percent interest is paid on each June 30 and
December 31. Management plans to hold the bonds until
maturity. Prepare the journal entry to record the investment.

GENERAL JOURNAL
Date Description Debit Credit
Jul. 1 Held-to-maturity Investments (+A) 100,000
Cash (-A) 100,000

12-8
 Debt Held To Maturity: Amortized Cost
Method
The journal entry to record the receipt of interest on
December 31 of the first year is . . .

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Cash (+A) 4,000
Interest Revenue (+R, +SE) 4,000

$100,000 × 8% × 6/12

12-9
 Debt Held To Maturity: Amortized Cost
Method
The journal entry to record the receipt of
the principal payment at maturity is . . .

GENERAL JOURNAL
Date Description Debit Credit
June 30 Cash (+A) 100,000
Held-to-maturity Investments (-A) 100,000

12-10
 Passive Stock Investments: The Fair
Value Method
Unrealized
Date of holding gains and Future
acquisition losses are measurement date
recorded.

Investment is Investment
initially carrying amount is
recorded at adjusted to current
cost. market value.

12-11
 Classifying Passive Investments at Fair
Value
Effect of Unrealized Holding Gains and
Losses On . . .
Type of Investment
Investment Definition Account Equity Net Income
Actively traded Reported on
Trading Allowance
for potential N/A the Income
Securities Account
profit. Statement
Not actively
Securities Reported
traded, held for Allowance
Available for as part of N/A
investment Account
Sale equity
returns.

NOTE: Realized gains and losses go on the Income Statement.

12-12
 Securities Available for Sale (SAS)

On January 5, 2009, Washington Post acquires 15,000 of the

100,000 outstanding shares of INews on the open market at a
cost of $10 per share. Washington Post has no influence over
INews, and does not plan to sell the shares in the near future.

Should the acquired shares be classified as Trading

Securities or Securities Available for Sale?
Washington Post does not plan to actively trade the shares.
Instead, they will be held to earn a return on invested funds
that may be needed for future operations. The shares
should be classified as Securities Available for Sale.
12-13
 Securities Available for Sale (SAS)

The journal entry to record

the investment is . . .

GENERAL JOURNAL
Date Description Debit Credit
Jan. 5 Investment in SAS (+A) 150,000
Cash (-A) 150,000

The investment may be a current asset or a noncurrent asset,

depending on management’s intended holding period.
12-14
 Securities Available for Sale (SAS)

On July 2, 2009, Washington Post receives

a $15,000 dividend from INews. Prepare
the journal entry to record the dividend.

GENERAL JOURNAL
Date Description Debit Credit
July 2 Cash (+A) 15,000
Dividend Revenue (+R, +SE) 15,000

12-15
 Securities Available for Sale (SAS)

By December 31, 2009, Washington Post’s fiscal year-

end, the market value of INews’ shares has dropped
from $10 to $8 per share. How much has Washington
Post’s portfolio value changed?

Market value ($8 per share × 15,000 shares) $ 120,000

Cost ($10 per share × 15,000 shares) 150,000
Unrealized holding loss on SAS portfolio $ (30,000)

The journal entry to recognize the change in

market value is . . .
12-16
 Securities Available for Sale (SAS)

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Net Unrealized Losses/Gains (-OCI) (-SE) 30,000
Investments in SAS (-A) 30,000

The unrealized holding loss is reported in the stockholders’

equity section of Washington Post’s balance
sheet as Other Comprehensive Income.

12-17
 Securities Available for Sale (SAS)
On December 31, 2010, the market value of INews’
shares is $11 per share, an increase of $3 per share
from December 31, 2009.
December 31, 2010 fair value ($11 per share × 15,000 shares) $ 165,000
December 31, 2009 fair value ($8 per share × 15,000 shares) 120,000
Unrealized holding gain on SAS portfolio $ 45,000

The journal entry to recognize the change in

market value for 2010 is . . .

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Investments in SAS (+A) 45,000
Net Unrealized Losses/Gains (+OCI, +SE) 45,000

12-18
 Securities Available for Sale (SAS)
Near the end of 2011, Washington Post sells all
15,000 shares of INews for $13 per share.

Proceeds from sale $ 195,000

Cost of INews investment 150,000
Gain on sale of INews investment $ 45,000

New Unrealized Losses/Gains (SE)

Beginning of 2009 $ -
2009 Unrealized loss 30,000
12/31/09 Balance $ 30,000
$ 45,000 2010 Unrealized gain
This amount will be
$ 15,000 12/31/10 Balance
removed when the
sale entry is made.
12-19
 Securities Available for Sale (SAS)
The journal entry to record the 2011 sale of the
INews investment is . . .

GENERAL JOURNAL
Date Description Debit Credit
Cash (+A) (15,000 × $13) 195,000
Net Unrealized Losses/Gains (-OCI, -SE) 15,000
Investments in SAS (-A) 165,000
Gain on Sale of Investments (+Gain, +SE) 45,000

$150,000 – $30,000 + $45,000 = $165,000

12-20
 Comparing Trading and Available for
Sale Securities
Income Statement
Trading Securities
Effects Securities Available for Sale
Realized Gains Sales Price > Cost Sales Price > Cost
Realized Losses Sales Price < Cost Sales Price < Cost
Unrealized Gains Adjusted at
N/A
and Losses Year-end
Balance Sheet
Trading Securities
Effects Securities Available for Sale
Unrealized Gains Adjusted at
N/A
and Losses Year-end

12-21
 Key Ratio Analysis

Dividends and Interest Received

Economic Return + Change in Fair Value
=
from Investing Fair Value of Investments
(beginning of period)

The economic return from investing ratio measures how

much a company earns for each dollar of investment for
a period. In general, a higher return indicates
management is doing a better job selecting investments.

For the year 2009, Washington Post received $15,000 in

dividends from INews, and the fair value declined from $150,000
at the beginning of the year to $120,000 at the end of the year.
12-22
 Key Ratio Analysis

Dividends and Interest Received

Economic Return + Change in Fair Value
=
from Investing Fair Value of Investments
(beginning of period)

For 2009
Economic Return $15,000 – $30,000
= = – 10%
from Investing $150,000

12-23
 Investments For Significant Influence:
Equity Method

Used when an investor can exert

significant influence over an investee.
Measuring and
Investment Category Reporting Method
Stock Passive Fair value
Stock Significant influence Equity
Stock Control Consolidated statement

It is presumed that the investment

was made as a long-term investment.
12-24
 Investments For Significant Influence:
Equity Method
Unrealized
Date of holding gains and Future
acquisition losses are not measurement date
recorded.

Investment is Investment carrying

initially amount is adjusted for
recorded at dividends received, and
cost. a percentage share of
the investee’s income.

12-25
 Investments For Significant Influence:
Equity Method

Adjusting Effect on
Item Investment Account
Reduce investment
Dividends
for dividends received.
Investee Increase investment
Net Income by our proportionate
share.
Investee Decrease investment
Net Loss by our proportionate
share.

12-26
 Recording Investments under the
Equity Method
On January 2, 2010 Washington Post a 40%
interest in INews at a cost of $400,000.
Prepare the journal entry to record
Washington Post’s investment.

GENERAL JOURNAL
Date Description Debit Credit
Jan. 2 Investments in Affiliates (+A) 400,000
Cash (-A) 400,000

12-27
 Earnings of Affiliates
INews net income for 2010 is $500,000.
Washington Post’s 40% share is $200,000. Record
Washington Post’s share of the INews income.

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Investments in Affiliates (+A) 200,000
Equity in Affiliate Earnings (+R, +SE) 200,000

Washington Post credits Equity in Affiliate Earnings (an

income statement account) for its share of INews earnings.
12-28
 Dividends Received
On March 31 of the next year, INews pays $100,000 in
dividends, $40,000 (40%) of which goes to
Washington Post. Record Washington Post’s receipt
of the dividend.

GENERAL JOURNAL
Date Description Debit Credit
Mar. 31 Cash (+A) 40,000
Investments in Affiliates (-A) 40,000

Dividends are not revenue under the equity method. They

are treated as a reduction of the investment account.
12-29
 Reporting Investments under the Equity
Method
Reported on the balance sheet as a long-term asset,
originally at cost.
Account is increased by the proportional share of affiliate’s income.

Account is decreased by proportional share of affiliate’s losses and

by dividends received from the affiliate.

If sold, any
No adjustment to
gain or loss is
fair value at the end
reported in the
of the accounting
income statement
period.
as other income.
12-30
 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)

12-31
 Controlling Interests: Mergers and
Acquisitions
Clearing the 20%
hurdle to gain
influence . . .
Vaulting over
the 50% mark
to gain control!
Off and running
with less than 20%.
..

12-32
 Controlling Interests: Mergers and
Acquisitions

Horizontal Vertical
growth integration

Synergy

12-33
 What Are Consolidated Statements?

• The acquiring company is the Any transactions

parent. between the
• The company acquired is the parent and
subsidiary. subsidiary must
• Consolidated statements be eliminated
combine two or more when preparing
companies into a single set of consolidated
statements. financial
statements.

12-34
 Recording a Merger

Goodwill
Occurs when one Only purchased
company buys goodwill is an
another company. intangible asset.

The amount by which the

purchase price exceeds the fair
market value of net assets acquired.

12-35
 Recording a Merger
Washington Post paid $1,000,000 in cash to
purchase all the stock of INews. Washington Post
merged INews’ operations into its own operations,
and INews ceased to exist as a separate entity.
The following information is available at the date
of acquisition:
Fair value of equipment $ 350,000
Fair value of patents 600,000
Total fair value of assets 950,000
INews note payable 100,000
Fair value of net assets $ 850,000

Should Washington Post record goodwill?

12-36
 Recording a Merger

Purchase price for INews $ 1,000,000

Fair value of net assets acquired 850,000
Purchased goodwill $ 150,000

The journal entry to record the

acquisition of INews is . . .

12-37
 Recording a Merger

GENERAL JOURNAL
Date Description Debit Credit
Equipment (+A) 350,000
Patents (+A) 600,000
Goodwill (+A) 150,000
Note Payable (+L) 100,000
Cash (-A) 1,000,000

12-38
 Recording a Merger

Goodwill
Subject to assessment
for impairment of
Not amortized.
value and may be
written down.

12-39
 End of Chapter 12

12-40