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

22 Long-Term Investments & the Time Value of Money Chapter 8

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 4 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

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

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

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 9 Accounting for Held-to-Maturity Investments JOURNAL DateAccounts and explanationDebitCredit Apr 1 Long-Term Investment in Bonds9,520 Cash ($10,000 x 0.952)9,520 To purchase bond investments. Oct 1 Cash ($10,000 x 6% x 1/2)300 Interest Revenue300 To receive semi-annual interest. Oct 1 Long-Term Investment in Bonds60 Interest Revenue ([($10,000 – $9,520)/48]x6)60 To amortize bond investment.

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

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

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 14 Accounting for Available-for-Sale Investments JOURNAL DateAccounts and explanationDebitCredit Oct 23 Long-Term Investment (1,000 × $44)44,000 Cash44,000 Purchased investment Nov 14 Cash (1,000 ×$0.2)200 Dividend Revenue200 Received dividends

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 15 The Fair Value Adjustment 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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 16 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 If fair value > cost If fair value < cost

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 19 Exercise 8-13A JOURNAL DateAccounts and explanationDebitCredit (a) Long-Term Investment 14,350 Cash (410 x $35) 14,350 Purchased investment (b) Cash 738 Dividend Revenue (410 X $1.80) 738 Received dividends (c) Allowance to Adjust Investment to Market2,870 Unrealized Gain on Investment2,870 Adjusted investment to market

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 20 Exercise 8-13A JOURNAL DateAccounts and explanationDebitCredit (d) Unrealized Gain on Investment2,870 Allowance to Adjust Investment to Market2,870 Eliminate unrealized gain on investment sold (d) Cash ($27 x 410) 11,070 Loss on Sale of Investment 3,280 Long-Term Investment 14,350 Sold investment

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

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

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 25 Exercise 8-15A JOURNAL DateAccounts and explanationDebitCredit Long-Term Investment1,800,000 Cash1,800,000 To purchase the equity-method investment. Long-Term Investment ($660,000×40%)264,000 Equity-Method Investment revenue264,000 To record investment revenue. Cash ($460,000×40%)184,000 Long-Term Investment184,000 To receive cash on equity-method.

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 26 Long-Term Investment 1,800, ,000184,000 1,880,000 Exercise 8-15A

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 29 Many investors (the stockholders) own The parent corporation who owns The subsidiary

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 30 Consolidation Accounting Method of combining financial statements of all companies controlled by same stockholders Result 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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 31 GoodwillNoncontrolling interest Arises when parent pays more to acquire a subsidiary than the fair value of its net assets Recorded as an intangible asset Arises when parent company owns less than 100% of subsidiary stock Recorded as a separate account in the stockholders’ equity section Goodwill and Noncontrolling Interest

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 32 Summary of Accounting for Investments Type of Long-Term Investment Accounting Method Investor owns less than 20% of investee stock Available-for-sale Investor owns between 20 – 50% of investee stock Equity Investor owns more than 50% of investee stock Consolidation Investor owns a long-term investment in bonds Amortized cost

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

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

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 37 Investment Transactions on the Cash Flow Statement Purchases of available-for-sale investments Outflow Sale of available-for-sale investments Inflow Purchase of equity-method investments Outflow Sale of equity-method investments Inflow

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

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

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

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

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 42 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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Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall. 44