Download Accounts and explanation

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1
Long-Term Investments & the
Time Value of Money
Chapter 8
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2
Key Terms
Investor
• Entity that
owns
corporation’s
stock
Investee
• Corporation
that issues
stock
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3
Investments on the Balance Sheet
Current Assets:
Cash
$X
Short-term investments
X
Accounts receivable
X
Inventories
X
Prepaid expenses
X
Total current assets
$X
Long-term investments
X
Property, plant and equipment
X
Intangible assets
X
Other assets
X
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4
Analyze and report investments in held-tomaturity debt securities
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Bonds
Investor (Bondholder)
Issuing Corporation
Investment in bonds
Bonds payable
Interest revenue
Interest expense
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Held-to-Maturity Investments
•
•
•
•
Recorded at amortized cost
Interest received semi-annually
Issued in $1,000 denominations
Price is quoted as percent of par
▫ Fluctuate with market interest rates
 If market rate > face rate, sell at discount
 If market rate < face rate, sell at premium
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Accounting for held-to-maturity
investments
• Initially recorded at cost
• Interest revenue recorded at semiannual interest
payment date
• Premium or discount is amortized
▫ Carrying value is adjusted towards face value
• Face value received at maturity
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Accounting for Held-to-Maturity
Investments
JOURNAL
Date Accounts and explanation
4-1
Debit
Credit
Long-term investment in bonds
Cash
Purchased bond investments
10-1
Cash
Interest revenue
Received semi-annual interest
10-1
Long-term investment in bonds
Interest revenue
To amortize bond investment
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Amortization of Held-to-Maturity
Investment
Increases LongTerm Investment
account as it
reaches maturity
Records interest
revenue earned
from carrying
amount increase
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10
Analyze and report investments in availablefor-sale securities
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11
Available-for-Sale Investments
• May be debt securities not held to maturity or
equity securities
• Initially record at cost
• Adjusted to current fair value at balance sheet
date
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12
Accounting Methods for Long-Term
Investments
Percentage Ownership
by the Investor
Less than 20%
20 – 50%
Greater than 50%
GAAP Accounting
Method
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Accounting for Available-for-Sale
Investments
JOURNAL
Date Accounts and explanation
Debit
4-1
44,000
Long-term investment
Cash
Credit
44,000
Purchased investment
10-1
Cash
200
Dividend Revenue
200
Received dividends
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14
The Fair Value Adjustment
JOURNAL
Date Accounts and explanation
Debit
Allowance to adjust investment to market
Unrealized gain on investment
Adjusted investment to market
Credit
If market value is
greater than
carrying value
JOURNAL
Date Accounts and explanation
Unrealized loss on investment
Allowance to adjust investment to market
Adjusted investment to market
Debit
Credit
If market value is
less than carrying
value
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Carrying Amount of Investment
Original cost of investment
Debit balance in Allowance to
Adjust Investments to Market
OR
Credit balance in Allowance to
Adjust Investments to Market
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Unrealized Gains and Losses
Fair value
declines
DEBIT
Unrealized loss on
investments
Reported as element
of comprehensive
income
Fair value
increases
CREDIT
Unrealized gain on
investments
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17
Selling an Available-for-Sale
Investment
JOURNAL
Date Accounts and explanation
Debit
Credit
Unrealized gain on investments
Allowance to adjust investment to market
Eliminate unrealized gain on investment sold
Cash
Loss on sale of investment
If cash > cost, “Gain”
would be credited
Long-term investment
Sold investment
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Exercise 8-13A
JOURNAL
Date Accounts and explanation
Debit
Credit
(a)
(b)
(c)
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19
Exercise 8-13A
JOURNAL
Date Accounts and explanation
Debit
Credit
(d)
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20
Analyze and report investments in affiliated
companies using the equity method
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21
Accounting for Equity Method
Investments
• Method used when investors owns between 20 –
50% of investee’s voting stock
▫ Investor has significant influence over investee
operations
• Investment initially recorded at cost
• Investor records its share of investee net income
and dividends
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22
Recording Investee Income and
Dividends
JOURNAL
Date Accounts and explanation
Debit
Credit
Long-term investment
Equity-method investment revenue
To record investment revenue
Cash
Long-term investment
Received cash on equity method investment
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Summary of the Equity Method
Equity-Method Investment
Original cost
Share of income
Share of losses
Share of dividends
Balance
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Exercise 8-15A
JOURNAL
Date Accounts and explanation
Debit
Credit
(a)
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25
Exercise 8-15A
Long-Term Investment
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26
Analyze and report controlling interests in
other corporations using consolidated financial
statements
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Consolidated Subsidiaries
• Investor controls investee
▫ Owns more than 50% of investee’s voting stock
▫ Investor can elect majority of board members
• Investor is called the parent company
• Investee is called the subsidiary
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Many investors (the stockholders)
own
The parent corporation
who
owns
The subsidiary
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Consolidation Accounting
• Method of combining financial statements of all
companies controlled by same stockholders
• Results is a single set of statements as if parent
and its subsidiaries are one company
• Gives better perspective on total operations than
individual statements
• Worksheet is used to combine parent and sub
accounts
▫ Intercompany accounts are eliminated
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Goodwill and Noncontrolling
Interest
Goodwill
• Arises when parent pays
more to acquire a
subsidiary than the fair
value of its net assets
• Recorded as an intangible
asset
Noncontrolling interest
• Arises when parent
company owns less than
100% of subsidiary stock
• Recorded as a separate
account in the
stockholders’ equity
section
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31
Summary of Accounting for
Investments
Type of Long-Term Investment
Accounting
Method
Investor owns less than 20% of investee stock
Investor owns between 20 – 50% of investee stock
Investor owns more than 50% of investee stock
Investor owns a long-term investment in bonds
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32
Foreign Currencies & Exchange
Rates
• International business often results in
companies receiving or paying in a foreign
currency
• Measure of one nation’s currency against
another:
▫ Foreign currency exchange rate
• Conversion of an item in one currency to
another:
▫ Translation
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Factors Affecting Exchange Rates
Ratio of imports to
exports
• If exports exceed
imports, increase in
demand drives up
price of currency
• If imports exceed
exports, supply
increases and
currency price falls
Rate of return on
capital markets
• If high, increases
international
investments and
demand for currency
• Currencies are
described as strong
or weak
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Foreign Currency Translation
Adjustments
• Foreign subsidiaries financial statements are
translated into US dollars
▫ Assets and liabilities at current exchange rates
▫ Stockholders’ equity at historical exchange rates
• Difference cause out-of-balance condition
• Translation adjustment needed to balance
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35
Report investing activities on the statement of
cash flows
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36
Investment Transactions on the
Cash Flow Statement
Purchases of available-for-sale investments
Sale of available-for-sale investments
Purchase of equity method investments
Sale of equity method investments
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37
Explain the impact of the time value of money
on certain types of investments
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38
Time Value of Money
Present value
Future value
1 year
Time = 0
Roll forward (accumulate)
Present value x (1 + interest rate) = Future value
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Future Value
• Value a current investment will be worth at a
specified date in the future
• Due to interest revenue
• Three inputs needed
▫ Amount of initial payment
▫ Length of time
▫ Interest rate
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Present Value
• What amount in the future is worth today
• Often called discounting
• To simplify calculations
▫ Present value tables
▫ Excel software
• Single amount or annuity
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Present Value of Investments in
Bonds
• Market price of bonds equals
▫ Present value of principal received at maturity
 Single amount
▫ Present value of interest payments
 Annuity
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