2. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 1 Long-Term Investments and International Operations Chapter 10

3. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 2 Stock Prices, Investors, and Investees Common Stock Information for General Electric Company: 52-week Hi Lo Stock SymbolDividend Volume 100sClose Net Change $53.55 $28.50GE$.72195,960$33.70–$.10

4. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 3 Reporting Investments on the Balance Sheet Current Assets:$X Cash X Short-term investments X Accounts receivable X Inventories X Prepaid expenses X Total current assets$X Long-term investments (Investments) X Property, plant, and equipment X Intangible assets X Other assets X

5. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 4 Trading investments are investments to be sold in the very near future with the intent of generating profits on the sale. Trading investments are investments to be sold in the very near future with the intent of generating profits on the sale. Available-for-sale investments are stock investments other than trading securities. Available-for-sale investments are stock investments other than trading securities. Trading and Available-For-Sale Investments Short-term Long-term

6. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 5 Learning Objective 1 Account for available- for-sale investments

7. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 6 Available-for-Sale Investments The market value method is used. Cost is used only as the initial amount for recording the investments. These investments are reported on the balance sheet at their current market value.

8. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 7 Accounting for Available-for-Sale Investments Suppose that on February 23, 2004, GE purchases 1,000 shares of Hewlett-Packard common stock for $35,750. GE intends to hold this stock for longer than one year.

9. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 8 Accounting for Available-for-Sale Investments 2004 February 23 Long-term Investment (1,000 × $35.75)35,750 Cash35,750 Purchased investment 2004 February 23 Long-term Investment (1,000 × $35.75)35,750 Cash35,750 Purchased investment

10. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 9 Accounting for Available-for-Sale Investments Assume that GE receives a $0.22 per share cash dividend on this investment. Assume that GE receives a $0.22 per share cash dividend on this investment. 2004 July 14Cash (1,000 × $.22) 220 Dividend Revenue220 Received cash dividend 2004 July 14Cash (1,000 × $.22) 220 Dividend Revenue220 Received cash dividend

11. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 10 What Value of an Investment Is Most Relevant? Assume that the market value of GE’s investment in Hewlett-Packard is $36,400 on December 31, 2004. Assume that the market value of GE’s investment in Hewlett-Packard is $36,400 on December 31, 2004. 2004 December 31 Allowance to Adjust Investment to Market ($36,400 – $35,750)650 Unrealized Gain on Investment650 Adjusted investment to market value 2004 December 31 Allowance to Adjust Investment to Market ($36,400 – $35,750)650 Unrealized Gain on Investment650 Adjusted investment to market value

12. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 11 What Value of an Investment Is Most Relevant? Long-Term Investment Allowance to Adjust Investment to Market 35,750650 Investment carrying amount = Market value of $36,400

13. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 12 What Value of an Investment Is Most Relevant? Unrealized Gain account or the Unrealized Loss account is reported in two places in the financial statements: Unrealized Gain account or the Unrealized Loss account is reported in two places in the financial statements: Other comprehensive income Accumulated other comprehensive income

14. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 13 What Value of an Investment Is Most Relevant? Income statement: Revenues$10,000 Expenses, including income tax 6,000 Net income$ 4,000 Other comprehensive income: Unrealized gain on investment$ 650 Less: Income tax (40%)– 260 390 Comprehensive income$ 4,390 Income statement: Revenues$10,000 Expenses, including income tax 6,000 Net income$ 4,000 Other comprehensive income: Unrealized gain on investment$ 650 Less: Income tax (40%)– 260 390 Comprehensive income$ 4,390

15. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 14 What Value of an Investment Is Most Relevant? Balance sheet: Assets: Total current assets$ XXX Long-term investments – at market value ($35,750 + $650) 36,400 Property, plant, and equipment, net XXX Stockholders’ equity: Common stock$ 1,000 Retained earnings 2,000 Accumulated other comprehensive income: Unrealized gain on investments$ 390 Total stockholders’ equity$ 3,390 Balance sheet: Assets: Total current assets$ XXX Long-term investments – at market value ($35,750 + $650) 36,400 Property, plant, and equipment, net XXX Stockholders’ equity: Common stock$ 1,000 Retained earnings 2,000 Accumulated other comprehensive income: Unrealized gain on investments$ 390 Total stockholders’ equity$ 3,390

16. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 15 Selling an Available- for-Sale Investment Suppose GE sells its investment in Hewlett-Packard stock for $34,000 during 2006. Suppose GE sells its investment in Hewlett-Packard stock for $34,000 during 2006. 2006 May 19 Cash34,000 Loss on Sale of Investment 1,750 Long-Term Investment (cost)35,750 Sold investment 2006 May 19 Cash34,000 Loss on Sale of Investment 1,750 Long-Term Investment (cost)35,750 Sold investment

17. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 16 Learning Objective 2 Use the equity method for investments.

18. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 17 Equity Method Investments The equity method is used to account for investments in which the investor owns 20 to 50% of the investee’s stock. Investments accounted for by the equity method are recorded initially at cost.

19. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 18 Equity Method Investments Owns between 20% and 50% of another company

20. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 19 Equity Method Investments Phillips Petroleum Company pays $400 million for 30% of the common stock of White Rock Natural Gas Corporation. January 6 Long-Term Investment 400 Cash 400 To purchase equity-method investment

21. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 20 Investor’s Percentage of Investee Income White Rock Natural Gas Corporation reports net income of $250 million for the year. December 31 (in millions) Long-term Investment ($250 × 0.30)75 Equity-Method Investment Revenue75 To record investment revenue Phillips records 30% of this amount as follows:

22. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 21 Receiving Dividends Under the Equity Method White Rock declares and pays a cash dividend of $100 million. December 31 (in millions) Cash ($100 × 0.30)30 Long-Term Investment30 To receive cash dividend on equity-method investment Phillips records 30% of this amount as follows:

23. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 22 Investment Account Long-Term Investment Jan. 6Purchases400 Dec. 31Net income 75 Dec. 31Balance445 Dec. 31Dividends30 After the preceding entries are posted, Phillip’s Investment account reflects its equity in the net assets of White Rock (in millions):

24. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 23 Financial Statements Balance sheet (partial): millions Assets Total current assets$XXX Long-term investments, at equity 445 Property, plant, and equipment, net XXX Income statement (partial): millions Income from operations$XXX Other revenue: Equity-method investment revenue 75 Net income$XXX

25. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 24 Learning Objective 3 Understand consolidated financial statements.

26. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 25 Consolidated Subsidiaries Parent Company Subsidiary A 100% ownership Subsidiary B 85% ownership

27. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 26 Consolidated Subsidiaries Subsidiary Financial Statements _____ Consolidated Financial Statements _____ Parent Financial Statements _____

28. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 27 Accounting Methods for Stock Investment 50% or more Consolidation Method 20%–50% Equity Method Less than 20% Market Value Method The percentage of ownership determines the accounting method to be used.

29. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 28 Consolidation Accounting It is a method of combining the financial statements of two or more companies that are controlled by the same owners. The assets, liabilities, revenues, and expenses of each subsidiary are added to the parent company’s accounts.

30. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 29 Work Sheet for Consolidated Balance Sheet ParentSubsidiary Eliminations DebitCredit Consolidated Amounts Assets Cash Note rec. from Sub. Inventory Investment in Sub. Other assets Total Liabilities and Stockholders’ Equity Accounts payable Notes payable Common stock Retained earnings Total 12,000 80,000 104,000 150,000 218,000 564,000 43,000 190,000 176,000 155,000 564,000 18,000 — 91,000 — 138,000 247,000 17,000 80,000 100,000 50,000 247,000 (b) 80,000 (a) 100,000 (a) 50,000 230,000 (b) 80,000 (a) 150,000 230,000 30,000 — 195,000 — 356,000 581,000 60,000 190,000 176,000 155,000 581,000

31. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 30 Goodwill and Minority Interest Goodwill is the intangible asset that represents the parent company’s excess payment to acquire the subsidiary. Minority interest arises when a parent company purchases less than 100% of the stock of a subsidiary company.

32. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 31 Income of a Consolidated Entity Net Income (Net loss) of Each Company Parent’s Ownership of Each Company Parent’s Consolidated Net Income (Net Loss) Parent Company Subsidiary S-1 Subsidiary S-2 Consolidated net income $330,000 150,000 (100,000) xxxxxx 100% 60% ====== $330,000 150,000 (60,000) $420,000

33. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 32 Learning Objective 4 Account for long-term investments in bonds.

34. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 33 Long-Term Investments in Bonds and Notes Investor (Bondholder) Investment in bonds Interest revenue Held-to-maturity investments are long-term investments in bonds and notes. Issuing Corporation Bonds payable Interest expense

35. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 34 Long-Term Investments in Bonds and Notes Suppose an investor purchases $10,000 of 6% CBS bonds at a price of 95.2 on April 1, 20X5. Interest dates are April 1 and October 1. The investor intends to hold the bonds as a long-term investment until their maturity. Assuming amortization of the discount by the straight-line method, following are the entries for this long-term investment.

36. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 35 Long-Term Investments in Bonds and Notes April 1 Long-Term Investment in Bonds ($10,000 × 0.952)9,520 Cash9,520 To purchase bond investment April 1 Long-Term Investment in Bonds ($10,000 × 0.952)9,520 Cash9,520 To purchase bond investment October 1 Cash ($10,000 × 0.06 × 6 / 12 ) 300 Interest Revenue 300 To receive semiannual interest October 1 Cash ($10,000 × 0.06 × 6 / 12 ) 300 Interest Revenue 300 To receive semiannual interest

37. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 36 Long-Term Investments in Bonds and Notes October 1 Long-Term Investment in Bonds [($10,000 – $9,520) ÷ 48] × 660 Interest Revenue60 To amortize bond investment October 1 Long-Term Investment in Bonds [($10,000 – $9,520) ÷ 48] × 660 Interest Revenue60 To amortize bond investment

38. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 37 Long-Term Investments in Bonds and Notes December 31 Long-Term Investment in Bonds [($10,000 – $9,520) ÷ 48] × 3 30 Interest Revenue 30 To amortize bond investment December 31 Long-Term Investment in Bonds [($10,000 – $9,520) ÷ 48] × 3 30 Interest Revenue 30 To amortize bond investment December 31 Interest Receivable ($10,000 × 0.06 × 3 / 12 )150 Interest Revenue150 To accrue interest revenue December 31 Interest Receivable ($10,000 × 0.06 × 3 / 12 )150 Interest Revenue150 To accrue interest revenue

39. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 38 Long-Term Investments in Bonds and Notes Long-Term Investment in Bonds 4/19,520 10/1 60 12/31 30 9,610

40. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 39 Learning Objective 5 Account for international operations.

41. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 40 Accounting for business activities across national boundaries is called international accounting. Extent of International Business Company Percent of International Sales Coca-Cola 62% Intel 56% General Electric 29%

42. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 41 Foreign Currencies and Exchange Rates The measure of one currency against another is called the foreign-currency exchange rate. Using an exchange rate to convert the cost of an item given in one currency to its cost in a second currency is called a translation. € £ $¥

43. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 42 Foreign Currencies and Exchange Rates Country Monetary Unit U.S. Dollar Value Brazil Canada France Germany United Kingdom Italy Japan Mexico Real (R) Dollar ($) Euro (€) Pound (£) Euro (€) Yen (¥) Peso (P) 0.43 0.64 0.89 1.45 0.89 0.0077 0.108

44. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 43 Foreign Currencies and Exchange Rates Two main factors determine the supply and demand for a particular currency: 1. The ratio of a country’s imports to its exports 2. The rate of return available in the country’s capital market

45. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 44 Managing Cash in International Transactions D. E. Shipp Belting sells goods to Artes de Mexico for a price of 1 million pesos on July 28. On that date, a peso was worth $0.107. On August 28, when the peso is worth only $0.104, Shipp receives 1 million pesos from Artes, but the dollar value of Shipp’s cash receipt is $3,000 less than expected.

46. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 45 Managing Cash in International Transactions July 28 Accounts Receivable – Artes (1,000,000 pesos × $0.107)107,000 Sales Revenue107,000 Sale on account August 28 Cash (1,000,000 pesos × $0.104)104,000 Foreign Currency Transaction Loss 3,000 Accounts Receivable – Artes107,000 Collection on account

47. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 46 Managing Cash in International Transactions Assume Shipp Belting buys inventory from Gesellschaft Ltd., a Swiss company. They decide on a price of 20,000 Swiss francs. On September 15, when Shipp receives the goods, the Swiss franc is quoted at $0.7999. When Shipp pays on September 29, the Swiss franc has decreased in value to $0.7810.

48. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 47 Managing Cash in International Transactions September 15 Inventory (20,000 Swiss francs × $0.799)15,980 Accounts Payable – Gesellschaft Ltd.15,980 Purchase on account September 29 Accounts Payable – Gesellschaft Ltd.15,980 Cash (20,000 Swiss francs × $0.781)15,620 Foreign-Currency Transaction Gain 360 Payment on account

49. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 48 Managing Cash in International Transactions The company reports the net amount of foreign currency transaction gains and losses on the income statement as “Other Revenues and Gains” or “Other Expenses and Losses.” The company reports the net amount of foreign currency transaction gains and losses on the income statement as “Other Revenues and Gains” or “Other Expenses and Losses.” Foreign-currency transaction loss3,000 Foreign-currency transaction gain– 360 Foreign-currency transaction loss, net2,640 Foreign-currency transaction loss3,000 Foreign-currency transaction gain– 360 Foreign-currency transaction loss, net2,640

50. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 49 Managing Cash in International Transactions Hedging means to protect oneself from losing money in one transaction by engaging in counterbalancing transactions. Hedging means to protect oneself from losing money in one transaction by engaging in counterbalancing transactions. Losses on the receipt of one currency may be offset by gains of the payment on another currency. Losses on the receipt of one currency may be offset by gains of the payment on another currency.

51. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 50 Consolidation of Foreign Subsidiaries Accountants must first bring the subsidiary’s statements into conformity with American GAAP. When the subsidiary statements are expressed in foreign currency, they must be translated into dollars.

52. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 51 Consolidation of Foreign Subsidiaries The foreign-currency translation adjustment is the balancing amount that brings the dollar amount of the total liabilities and stockholders’ equity of a foreign subsidiary into agreement with the dollar amount of its total assets.

53. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 52 Translation of Foreign-Currency Balance Sheet Into Dollars Italian Imports, Inc. Amounts Assets Liabilities Stockholders’ equity Common stock Retained earnings Accumulated other comprehensive income: Foreign-currency translation adjustment $0.89 0.89 1.04 0.92 $712,000 $445,000 104,000 184,000 (21,000) $712,000 800,000 500,000 100,000 200,000 800,000 Euros Exchange RateDollars

54. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 53 International Accounting Standards A company that sells its stock through a foreign stock exchange must follow the accounting principles of the foreign country. The primary organization working to achieve worldwide harmony of accounting standards is the International Accounting Standards Committee (IASC).

55. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 54 Learning Objective 6 Report investing transactions on the statement of cash flows.

56. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 55 Using the Statement of Cash Flows Cash flows from investing activities: Addition to property and equipment$(15) Disposition of PP&E 7 Loans to others (14) Payments for other companies (12) All other investing activities (6) Cash used for investing activities$(40) General Electric Statement of Cash Flows Year Ended December 31, 2001 (In Millions)

57. ©2004 Prentice Hall Business Publishing Financial Accounting, 5/e Harrison/Horngren 10 - 56 End of Chapter 10