©2008 Pearson Prentice Hall. All rights reserved Long-Term Investments and International Operations Chapter 10

©2008 Pearson Prentice Hall. All rights reserved Stock Investments Investor – entity that owns stock of a corporation Investee – corporation that issued the stock ABC Company purchases 1000 shares of XYZ Corporation: ABC is the investorXYZ is the investee

©2008 Pearson Prentice Hall. All rights reserved Reporting Investments on the Balance Sheet Assets to the investor Short-term investments  Also called marketable securities and often classified as trading securities  Must be liquid  Intended to be converted to cash within one year Long-term investments  Expected to be held longer than one year

©2008 Pearson Prentice Hall. All rights reserved Accounting Methods for Long-Term Investments Percent owned by investorAccounting method Up to 20%Available-for-Sale %Equity Method More than 50%Consolidation

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 1 Account for available-for-sale investments

©2008 Pearson Prentice Hall. All rights reserved Available-for-Sale Investments Can be classified as current or long-term  Based on how long management intends to hold the investment Initially recorded at cost Cash dividends received are recorded as revenue  Stock dividends indicated by memorandum Reported at market value on the balance sheet  Considered more relevant for decision making

©2008 Pearson Prentice Hall. All rights reserved Valuing Investments at Year-End Increase in market valueDecrease in market value Unrealized GainUnrealized Loss Allowance to Adjust Investment to Market is a companion account to Long-Term Investments Debit balance = Market > Cost Credit balance = Market < Cost

©2008 Pearson Prentice Hall. All rights reserved Unrealized Gain or Loss Reported in two places on the financial statements Income Statement  Other comprehensive income – separate section below net income Balance Sheet  Accumulated other comprehensive income – separate section of stockholders’ equity Unrealized gains or losses on available-for-sale investments do not impact net income

©2008 Pearson Prentice Hall. All rights reserved Selling Available-for-Sale Investments Results in a realized gain or loss reported on the income statement Difference between cost and selling price

©2008 Pearson Prentice Hall. All rights reserved E10-13 DateAccountsDebitCredit (a)Long-term Investment (400 x $32)$12,800 Cash $12,800 (b)Cash$400 Dividend revenue $400

©2008 Pearson Prentice Hall. All rights reserved E10-13 Market value at year end 15,200 (400 shares x $38) Balance in LT Investment 12,800 Unrealized gain 2,400 DateAccountsDebitCredit (c)Allowance to Adjust Investment to Market$2,400 Unrealized Gain on Investment $2,400

©2008 Pearson Prentice Hall. All rights reserved E10-13 The investment is sold when the market value is $23 This results in a loss  Cost minus selling price DateAccountsDebitCredit (d)Cash ($23 x $400)$9,200 Loss on sale of investments_______ Long-term Investment (cost from letter a) $12,600 What amount will balance the entry?

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 2 Use the equity method to account for investments

©2008 Pearson Prentice Hall. All rights reserved The Equity Method Investor owns 20 – 50% of investee’s voting stock Investor has significant influence over the investee Investment recorded at cost Investment is increased by investee earnings Investment is decreased by investee dividends

©2008 Pearson Prentice Hall. All rights reserved Long-Term Investment Original Cost Share of Dividends Ending Balance Share of Net Income

©2008 Pearson Prentice Hall. All rights reserved E10-14 DateAccountsDebitCredit (a)Long-term Investments$1,000,000 Cash $1,000,000 (b)Long-term Investments __________ Equity method investment revenue __________ Multiply the percent the investor owns by the investee net income

©2008 Pearson Prentice Hall. All rights reserved E10-14 DateAccountsDebitCredit (c)Cash$105,000 Long-term investments $105,000 Long-Term Investments (a) _________ (b) 160,000 (c)__________ 1,055,000 Enter the amounts from entry (a) and (c)

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 3 Understand consolidated financial statements

©2008 Pearson Prentice Hall. All rights reserved Consolidated Subsidiaries Investor owns more than 50% of voting stock of investee Investor controls investee Investor is called the parent company Investee is called a subsidiary (sub) Financial statements of a parent and its subsidiaries are combined  Consolidated as if one company

©2008 Pearson Prentice Hall. All rights reserved Consolidated Worksheet Tool to combine parent and subsidiary financial statements at year-end Parent and subsidiary accounts are placed side-by-side in columns Worksheet entries are made to eliminate reciprocal accounts  Parent’s investment and Sub’s equity  Receivables and payables between parent and sub

©2008 Pearson Prentice Hall. All rights reserved

©2008 Pearson Prentice Hall. All rights reserved Goodwill and Minority Interest Goodwill  Recorded in consolidation process as an intangible asset  Occurs when parent purchases sub for more than the fair value of its net assets Minority Interest  Recorded in consolidation process and can be included in liabilities  Occurs when parent owns less than 100% of sub

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 4 Account for long-term investments in bonds

©2008 Pearson Prentice Hall. All rights reserved Long-Term Bond Investments Major investors  Financial institutions  Insurance companies Called held-to-maturity investments Reported at amortized cost  Bonds carrying amount is amortized to face value at maturity value

©2008 Pearson Prentice Hall. All rights reserved Bonds Issuing Corporation Investor (Bondholder) Investment in bondsBonds payable Interest revenue Interest expense

©2008 Pearson Prentice Hall. All rights reserved E10-19 Skoda should use the amortized cost method to account for the bond investment The investment is recorded at cost  $20,000 x.97

©2008 Pearson Prentice Hall. All rights reserved E10-19 On December 31, interest earned on the bond investments is accrued  ___________________________ Amortization is recorded  $20,000 – 19,400 = $600  $600/60 months = $10 per month  $10 per month x 3 months = $30 Face value x interest rate x months/12

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 5 Account for international operations

©2008 Pearson Prentice Hall. All rights reserved International Accounting Most corporations operate in multiple countries  Most use their own currency  Several European countries use the euro

©2008 Pearson Prentice Hall. All rights reserved Foreign Currency Terms Price of one currency stated in terms of another currency Translation Converting the cost of an item stated in one currency into another currency Import/Export Ratio Relationship of a country’s imports to exports Strong Currency Exchange rate of currency is rising relative to other nations Exchange rate Weak Currency Exchange rate of currency is falling relative to other nations

©2008 Pearson Prentice Hall. All rights reserved Accounting for Foreign Currency Transactions Export  Sales in which payments will be made in a foreign currency Import  Purchases that will be paid in a foreign currency Changes in exchange rates between sale or purchase and payment will result in a foreign currency gain or loss

©2008 Pearson Prentice Hall. All rights reserved Export Entries A U.S. company sells goods to a Mexican company for one million pesos when the exchange rate is $0.086 When payment is received the exchange rate is $0.083

©2008 Pearson Prentice Hall. All rights reserved Import Entries A U.S. company buys inventory from a supplier in Switzerland for 20,000 Swiss francs when the exchange rate is $0.80 They make payment when the exchange rate is $0.78

©2008 Pearson Prentice Hall. All rights reserved Consolidation of Foreign Subsidiaries Two challenges: (1) Foreign accounting practices differ from American GAAP (2) Subsidiary statements may be in foreign currency and need translation  Results in a foreign currency translation adjustment

©2008 Pearson Prentice Hall. All rights reserved Translation Adjustment Assets and liabilities are translated into dollars at current exchange rate on financial statement date Stockholders’ equity is translated into dollars at older, historical exchange rates Differing rates creates out-of-balance condition Foreign currency translation adjustment is the balancing amount

©2008 Pearson Prentice Hall. All rights reserved International Standards Most accounting methods are consistent throughout the world Differences do exist for:  Inventory – LIFO method of inventory not used in the U.K.  Goodwill – In Germany and Japan, the account is amortized; not in the U.S.  Research & Development costs – Capitalized in Japan; expensed in the U.S.

©2008 Pearson Prentice Hall. All rights reserved Learning Objective 6 Report investing transactions on the statement of cash flows

©2008 Pearson Prentice Hall. All rights reserved Investing Activities on the Cash Flow Statement Purchases and sales of long-term investments are investing activities Investing inflow  Proceeds from sales of long-term investments (available-for-sale, equity method and held-to- maturity) Investing outflow  Purchases of all categories of long-term investments

©2008 Pearson Prentice Hall. All rights reserved End of Chapter 10