Download Short-term investments - McGraw Hill Higher Education

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
Copyright © 2015 by McGraw-Hill Education (Asia). All rights reserved.
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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.
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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.
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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.
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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
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CLASSIFICATION AND REPORTING
Accounting for Investments depends on some or all of the following factors:
1. purpose, e.g. trading or long-term investment, the company’s intent to hold the security either
short-term or long-term,
2. its contractual characteristics, e.g. debt or equity,
3. whether it is listed on an exchange,
4. the industry in which the reporting entity operates, and
5. the accounting policy choice of the reporting entity.
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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.
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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.
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HELD-FOR-TRADING SECURITIES
When Nestlé’s fiscal year ends on December 31, 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.
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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.
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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.
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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.
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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:
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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, 2014, 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 31st and February 28th. Music City
plans to hold the bonds until they mature (HTM securities).
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HELD-TO-MATURITY DEBT
Interest earned but not received must be
accrued on December 31, 2014.
$30,000 par value × 7% × 4/12 = $700 interest earned.
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INVESTMENTS IN EQUITY WITH
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SIGNIFICANT INFLUENCE
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%
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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.
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INVESTMENTS IN EQUITY WITH
SIGNIFICANT INFLUENCE
On January 1, 2014, Micron Co. records the
purchase of 3,000 shares (30%) of Star Co.
ordinary shares at a total cost of $70,650 cash.
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INVESTMENTS IN EQUITY WITH
SIGNIFICANT INFLUENCE
For 2014, Star reports net income of $20,000,
and pays total cash dividends of $10,000 on
January 9, 2015.
$20,000 × 30% = $6,000
$10,000 × 30% = $3,000
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INVESTMENTS IN EQUITY WITH
SIGNIFICANT INFLUENCE
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INVESTMENTS IN EQUITY WITH CONTROL
Required when investor has control over the
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.
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ACCOUNTING SUMMARY FOR
INVESTMENTS IN SECURITIES
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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.
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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
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RETURN ON TOTAL ASSETS
Here are the returns on total assets and its components
for Gap, Inc. for the years 2012 through 2008:
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.
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APPENDIX15A: INVESTMENTS IN
INTERNATIONAL OPERATIONS
Two major accounting challenges arise when
companies have international operations:
Accounting for sales
and purchases listed in
a foreign currency.
Preparing consolidated
financial statements
with international
subsidiaries.
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EXCHANGE RATES BETWEEN CURRENCIES
 Each
country uses its own
currency for internal economic
transactions.
 To make transactions in another
country, units of that country’s
currency must be acquired.
 The cost of those currencies is
called the exchange rate.
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SALES IN A FOREIGN CURRENCY
Boston Company, a U.S.-based manufacturer makes a credit
sale to London Outfitters, a British retail company. On
December 12, 2014, Boston sells £10,000 with payment due
on February 10, 2015. Boston keeps its record in U.S. dollars.
At the date of sale, the British pound is valued at $1.80.
£10,000 × $1.80 = $18,000
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SALES IN A FOREIGN CURRENCY
Boston Company is a December 31, year-end company. On
December 31, 2014, the British pound has an exchange rate of
$1.84. The dollar value of the account receivable from London is
$18,400 on this date. The receivable is to valued on the balance
sheet at it current dollar amount.
Accounts Receivable – London Outfitters
Date
Explanation
12/12/14 Sale
12/31/14 Adjustment for foreign currency
Debit
18,000
400
Credit
Balance
18,000
18,400
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SALES IN A FOREIGN CURRENCY
On February 10, 2015, Boston receives London Outfitters’
payment of £10,000. Boston immediately exchanges the
pounds for U.S. dollars. The exchange rate on this date is
$1.78 per pound, so Boston receives $17,800 for the £10,000
received in settlement.
Accounts Receivable – London Outfitters
Date
Explanation
12/12/10 Sale
12/31/10 Adjustment for foreign currency
2/10/11 Payment received
Debit
Credit Balance
18,000
18,000
400
18,400
18,400
-0-
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PURCHASES IN A FOREIGN CURRENCY
NC Imports, a U.S. company, purchases
products costing €20,000 from Hamburg
Brewing on January 15, when the exchange
rate is $1.20 per euro.
€20,000 × $1.20 = $24,000
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PURCHASES IN A FOREIGN CURRENCY
NC Imports makes payment in full on February
14 when the exchange rate is $1.25 per euro.
€20,000 × $1.25 = $25,000
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CONSOLIDATED STATEMENTS WITH
INTERNATIONAL SUBSIDIARIES
Consider a U.S.-based company that owns a controlling
interest in a French company. The reporting currency of
the U.S. company is the dollar. The French company
maintains its books in Euros. Before preparing
consolidated statements, the U.S. company must translate
the French company’s statements into dollars. The
process requires the parent company to select appropriate
foreign exchange rates and to apply those rates to the
foreign subsidiary’s account balances.
Translate
Account Balances
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APPENDIX15B: NEW REQUIREMENTS
UNDER IFRS 9
IFRS 9 classifies financial instruments into two categories:
1. at amortied cost; or
2. at fair value.
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CLASSIFICATION AND REPORTING
IFRS 9 uses two criteria to determine how financial assets
should be classified and measured:
 (a) the entity’s business model for managing the financial
assets (the “business model approach”); and
 (b) the contractual cash flow characteristics of the financial
assets.
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PROCESS FOR DETERMINING THE
CLASSIFICATION AND MEASUREMENT
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FVTOCI SECURITIES
 FVTOCI is a new category under IFRS 9.
 Unlike AFS securities, IFRS 9 prohibits
subsequent transfer (‘recycling’) of fair value
changes to profit or loss on sale of the
investments for FVTOCI.
 In other words, both realized and unrealized
changes in carrying amount (gains or losses)
“by pass” the P&L and are reported in the OCI.
 Only dividend income is recognized in profit or
loss.
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END OF CHAPTER 15