Financial Accounting John J. Wild Sixth Edition John J. Wild Sixth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Appendix C Investments and International Operations

Conceptual Learning Objectives C1: Distinguish between debt and equity securities and between short-term and long-term investments. C2: Describe how to report equity securities with controlling influence. C3: Appendix – Explain foreign exchange rates and record transactions listed in a foreign currency. APPC-3

A1: Compute and analyze the components of return on total assets. Analytical Learning Objectives APPC-4

P1: Account for trading securities. P2: Account for held-to-maturity securities. P3: Account for available-for-sale securities. P4: Account for equity securities with significant influence. Procedural Learning Objectives APPC-5

Basics of 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. Motivation for Investments C1 APPC-6

Basics of Investments Short-Term versus Long-Term Investments Short-term investments are securities that can be converted to cash within one year or the operating cycle, whichever is longer. They are reported under current assets and serve a purpose similar to cash equivalents. Long-term investments are not readily convertible to cash or intended to be converted to cash in the short term. They are reported in the noncurrent section of the balance sheet, often in their own category. C1 APPC-7

Classes of and Reporting for Investments Held-To- Maturity Available- For-Sale Significant Influence Controlling Influence Consolidate Equity Method Market Value Method Trading Amortized Cost Class of Investment Reporting C1 APPC-8

Accounting Basics for Debt Securities Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. On January 1, 2011, Matrix, Inc. paid Debt Inc. $975,000 plus a $25,000 brokers fee to purchase Debt’s bonds. The two-year bonds have a $1 million par value with a stated rate of 6% annually. Interest is paid semiannually on June 30 and December 31. C2 APPC-9

Held-to-maturity (HTM) debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. C1 APPC-10 Accounting Basics for Debt Securities

Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. The same entry would be made on December 31, C1 APPC-11 Accounting Basics for Debt Securities

On January 1, 2013, the bonds mature and Matrix would make the following entry: C1 APPC-12 Accounting Basics for Debt Securities

Accounting Basics for Equity Securities Equity securities are recorded at cost when acquired, including commissions or brokerage fees paid. Any cash dividends received are credited to Dividend Revenue and reported in the income statement. When the securities are sold, sales proceeds are compared with cost, and any gain or loss is recorded. C1 APPC-13

Accounting Basics for Equity Securities On May 6, 2011, Matrix, Inc. purchased 10,000 shares of Apex, Inc. common stock for $250,000 in the open market. The securities are classified by manager of Matrix as “available-for-sale” (AFS). C1 APPC-14

Accounting Basics for Equity Securities On June 30, Apex pays a quarterly dividend to Matrix, Inc. of $0.50 per share. Matrix receives a dividend check for $5,000. C1 APPC-15

Accounting Basics for Equity Securities On December 18, Matrix, Inc. sells 1,000 shares of Apex, Inc. in the open market for $30 per share. $250,000 ÷ 10,000 shares = $25 per share cost C1 APPC-16

Recorded at cost at acquisition. Interest revenue recorded as accrued (debt securities). Dividends recorded as revenue (equity securities). Carrying amount is adjusted to Market Value each period. Recorded at cost at acquisition. Interest revenue recorded as accrued (debt securities). Dividends recorded as revenue (equity securities). Carrying amount is adjusted to Market Value each period. Financial Reporting Available-for-Sale Securities Debt and equity securities that a company intends to sell in the future, before maturity. P3 APPC-17

Matrix, Inc. purchased 1,000 shares of Apex, Inc. at $5 per share during At December 31, 2011, the shares had increased in value to $9.50 per share. Valuing and Reporting of Available-for-Sale Securities P3 APPC-18

{ In some cases, influence or control may exist with less than 20% ownership. Investor Ownership of Investee Shares Outstanding 0%20%50%100% Cost or Market Value Method Equity Method Consolidated Financial Statements Accounting for Influential Investments P4 APPC-19

{ Significant influence is generally assumed with 20% to 50% ownership. Investor Ownership of Investee Shares Outstanding 0%20%50%100% Equity Method Consolidated Financial Statements Accounting for Influential Investments Cost or Market Value Method P4 APPC-20

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. 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. Investments in Equity Securities with Significant Influence P4 APPC-21

Investment in Equity Securities with Significant Influence On January 1, 2011, Matrix, Inc. buys 20% of the voting common stock of Apex, Inc. for $2,000,000 cash. 2,000,000 Long-Term Investment - Apex 2,000,000 Cash P4 APPC-22

Investment in Equity Securities with Significant Influence On December 31, 2011, Apex reports net income for the year of $300,000, and pays total cash dividends of $50,000. $300,000 × 20% = $60,000 $50,000 × 20% = $10,000 P4 APPC-23

Investment in Equity Securities with Significant Influence Investment Earnings Dividends Balance P4 APPC-24

Investment in Equity Securities with Controlling Influence o Required when investor’s ownership exceeds 50% of investee. o Equity Method is used. o Consolidated financial statements show the financial position, results of operations, and cash flows of all entities under the parent’s control. C2 APPC-25

Accounting Summary for Investments in Securities C2 APPC-26

Comprehensive Income Includes: 1)Revenues, gains, expenses, and losses reported on the income statement, and 2)Gains and losses that bypass net income but affect equity. Includes: 1)Revenues, gains, expenses, and losses reported on the income statement, and 2)Gains and losses that bypass net income but affect equity. Accumulated Other Comprehensive Income appears in the equity section of the balance sheet. C2 APPC-27

Components of Return on Total Assets Return on total assets = Profit Margin × Total asset turnover Net income Average total assets =× Net income Net sales Net sales Average total assets A1 APPC-28

Investments in International Operations (1) Accounting for sales and purchases listed in a foreign currency. (2) Preparing consolidated financial statements with international subsidiaries. Two major accounting challenges arise when companies have international operations: C3 APPC-29

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. 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. Exchange Rates Between Currencies C3 APPC-30

As the relative strength of a country’s economy changes the exchange rate of the local currency relative to other currencies also fluctuates. Foreign Exchange Markets C3 APPC-31

End of Appendix C APPC-32