1 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Long-Term Investments & the Time Value of Money Chapter 8 2 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Key Terms Investor Entity that owns corporation’s stock Investee Corporation that issues stock 3 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Investments on the Balance Sheet Current Assets: Cash$X Short-term investmentsX Accounts receivableX InventoriesX Prepaid expensesX Total current assets$X Long-term investmentsX Property, plant and equipmentX Intangible assetsX Other assetsX 4 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Analyze and report investments in held-to- maturity debt securities 5 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Bonds Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 6 Investor (Bondholder) Investment in bonds Interest revenue Issuing Corporation Bonds payable Interest expense

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 7 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 8 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Accounting for Held-to-Maturity Investments Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 9 JOURNAL DateAccounts and explanationDebitCredit 4-1 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

Amortization of Held-to-Maturity Investment Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 10 Increases Long- Term Investment account as it reaches maturity Records interest revenue earned from carrying amount increase

Analyze and report investments in available- for-sale securities 11 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 12 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Accounting Methods for Long-Term Investments Percentage Ownership by the Investor GAAP Accounting Method Less than 20% 20 – 50% Greater than 50% 13 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Accounting for Available-for-Sale Investments Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 14 JOURNAL DateAccounts and explanationDebitCredit 4-1 Long-term investment44,000 Cash44,000 Purchased investment 10-1 Cash200 Dividend Revenue200 Received dividends

The Fair Value Adjustment Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 15 JOURNAL DateAccounts and explanationDebitCredit Allowance to adjust investment to market Unrealized gain on investment Adjusted investment to market JOURNAL DateAccounts and explanationDebitCredit Unrealized loss on investment Allowance to adjust investment to market Adjusted investment to market If market value is greater than carrying value If market value is less than carrying value

Carrying Amount of Investment Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 16 Original cost of investment Debit balance in Allowance to Adjust Investments to Market OR Credit balance in Allowance to Adjust Investments to Market

Unrealized Gains and Losses Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 17 Fair value declines DEBIT Unrealized loss on investments Fair value increases CREDIT Unrealized gain on investments Reported as element of comprehensive income

Selling an Available-for-Sale Investment Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 18 JOURNAL DateAccounts and explanationDebitCredit Unrealized gain on investments Allowance to adjust investment to market Eliminate unrealized gain on investment sold Cash Loss on sale of investment Long-term investment Sold investment If cash > cost, “Gain” would be credited

Exercise 8-13A Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 19 JOURNAL DateAccounts and explanationDebitCredit (a) (b) (c)

Exercise 8-13A Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 20 JOURNAL DateAccounts and explanationDebitCredit (d)

Analyze and report investments in affiliated companies using the equity method 21 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 22 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Recording Investee Income and Dividends Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 23 JOURNAL DateAccounts and explanationDebitCredit Long-term investment Equity-method investment revenue To record investment revenue Cash Long-term investment Received cash on equity method investment

Summary of the Equity Method Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 24 Equity-Method Investment Original cost Share of incomeShare of dividends Share of losses Balance

Exercise 8-15A Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 25 JOURNAL DateAccounts and explanationDebitCredit (a)

Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 26 Long-Term Investment Exercise 8-15A

Analyze and report controlling interests in other corporations using consolidated financial statements 27 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 28 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

29 Many investors (the stockholders) own The parent corporation who owns The subsidiary

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 30 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 31 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Summary of Accounting for Investments Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 32 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

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 33 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 34 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 35 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Report investing activities on the statement of cash flows 36 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 37 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Explain the impact of the time value of money on certain types of investments 38 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

Time Value of Money Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall. 39 Present valueFuture value Roll forward (accumulate) Present value x(1 + interest rate) = Future value Time = 0 1 year

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 40 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 41 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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 42 Copyright © 2012 Pearson Education Inc. Publishing as Prentice Hall.

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