1. PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Chapter 15 I NVESTMENTS AND I NTERNATIONAL O PERATIONS McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.

2. 15 - 2 B ASICS OF I NVESTMENTS 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. 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

3. 15 - 3 I NVESTMENTS OF S ELECTED C OMPANIES Short-Term (S-T) and Long-Term (L-T) Investments as a Percent of Total Assets C1

4. 15 - 4 S HORT -T ERM I NVESTMENTS C1 Short-term investments are securities that: Management intends to convert to cash within one year or the operating cycle, whichever is longer. Are readily convertible to cash. Short-term investments are securities that: Management intends to convert to cash within one year or the operating cycle, whichever is longer. Are readily convertible to cash. Short-term investments do not include cash equivalents. Cash equivalents are investments that are both readily converted to known amounts of cash and mature within three months.

5. 15 - 5 L ONG -T ERM I NVESTMENTS Long-term investments: are not readily convertible to cash. are not intended to be converted to cash in the short term. are reported in the noncurrent section of the balance sheet, often in its own category. Long-term investments: are not readily convertible to cash. are not intended to be converted to cash in the short term. are reported in the noncurrent section of the balance sheet, often in its own category. C1

6. 15 - 6 D EBT S ECURITIES VERSUS E QUITY S ECURITIES Debt Securities Reflect a creditor relationship Examples: Investments in notes, bonds, and CDs May be issued by governments, companies, or individuals Debt Securities Reflect a creditor relationship Examples: Investments in notes, bonds, and CDs May be issued by governments, companies, or individuals C1 Equity Securities Reflect an owner relationship Examples: Investments in shares of stock Issued by companies Equity Securities Reflect an owner relationship Examples: Investments in shares of stock Issued by companies

7. 15 - 7 C LASSIFICATION AND R EPORTING C1 Accounting for Investments depends on three factors: 1.Security type: debt or equity 2.Intent to hold the security short or long term 3.Percentage ownership in another company’s equity securities Accounting for Investments depends on three factors: 1.Security type: debt or equity 2.Intent to hold the security short or long term 3.Percentage ownership in another company’s equity securities

8. 15 - 8 D EBT S ECURITIES : A CCOUNTING B ASICS Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. On September 1, 2010, Music City paid $29,500 plus a $500 brokerage fee to buy Dell’s 7%, 2-year bonds payable with a $30,000 par value. The bonds pay interest semiannually on August 31 st and February 28 th. Music City plans to hold the bonds until they mature (HTM securities). P2

9. 15 - 9 D EBT S ECURITIES : A CCOUNTING B ASICS Interest earned but not received must be accrued on December 31, 2010. $30,000 par value × 7% × 4/12 = $700 interest earned. P2

10. 15 - 10 D EBT S ECURITIES : A CCOUNTING B ASICS On February 28, 2011, Music City will record the receipt of the semiannual interest. The company’s accountants will make the following entry. $30,000 par value × 7% × 6/12 = $1,050 (Interest received) P2 $30,000 par value × 7% × 4/12 = $700 (Interest earned in 2010) $30,000 par value × 7% × 2/12 = $350 (Interest earned in 2011) $30,000 par value × 7% × 4/12 = $700 (Interest earned in 2010) $30,000 par value × 7% × 2/12 = $350 (Interest earned in 2011)

11. 15 - 11 D EBT S ECURITIES : A CCOUNTING B ASICS When the bonds mature, Music City will receive the amount of the par value in cash. The bonds have now been retired. P2

12. 15 - 12 EQUITY SECURITIES: ACCOUNTING BASICS 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. P1

13. 15 - 13 EQUITY SECURITIES: ACCOUNTING BASICS On October 10, 2010, Music City purchases 1,000 shares of Intex common stock for $86,000 in the open market. The securities are classified by management of Music City as “available-for-sale” (AFS) securities. P3

14. 15 - 14 EQUITY SECURITIES: ACCOUNTING BASICS On November 2, Music City receives a $1,720 quarterly dividend on its investment in Intex. P3

15. 15 - 15 EQUITY SECURITIES: ACCOUNTING BASICS On December 20, Music City sells 500 shares of Intex in the open market for $45,000. Calculate original cost per share $86,000 ÷ 1,000 shares = $86.00 per share cost Calculate cost of shares sold 500 shares × $86 = $43,000 Calculate original cost per share $86,000 ÷ 1,000 shares = $86.00 per share cost Calculate cost of shares sold 500 shares × $86 = $43,000 P3

16. 15 - 16 T RADING S ECURITIES 1.Debt and equity securities 2.Actively managed and traded for profit 3.Frequent purchases and sales expected 4.Reported at fair value 5.Unrealized gain or loss reported in the income statement 1.Debt and equity securities 2.Actively managed and traded for profit 3.Frequent purchases and sales expected 4.Reported at fair value 5.Unrealized gain or loss reported in the income statement P1

17. 15 - 17 TechCom’s portfolio of trading securities had a total cost of $11,500, and a fair value of $13,000, on December 31, 2010, the first year the securities were held. The $1,500 difference between cost of $11,500 and fair value of $13,000 is an unrealized gain. T RADING S ECURITIES P1

18. 15 - 18 Assume TechCom sells trading securities that had cost $1,000 for $1,200 cash, on January 9, 2011. T RADING S ECURITIES The gain is reported in the Other Revenues and Gains section of the Income Statement. A loss would be reported in Other Expenses and Losses section. P1

19. 15 - 19 H ELD - TO -M ATURITY S ECURITIES 1.Debt securities 2.Intent and ability to hold until maturity 3.Reported as a)Current assets if their maturity dates are within one year or the operating cycle, whichever is longer. b)Noncurrent investments if their maturity dates are longer than one year or the normal operating cycle, whichever is longer. 1.Debt securities 2.Intent and ability to hold until maturity 3.Reported as a)Current assets if their maturity dates are within one year or the operating cycle, whichever is longer. b)Noncurrent investments if their maturity dates are longer than one year or the normal operating cycle, whichever is longer. The portfolio of HTM securities is reported at amortized cost. There is no fair value adjustment to the portfolio. P2

20. 15 - 20 A VAILABLE - FOR -S ALE S ECURITIES 1.Debt and equity securities not classified as trading or held-to-maturity 2.Not actively managed 3.Report as a)Short-term investments if the intent is to sell the securities within one year or the normal operating cycle, whichever is longer. b)Long-term investments if securities do not meet short-term investment criteria. 4.Valued at fair value 5.Unrealized gains or loss reported in the equity section of the balance sheet as part of comprehensive income 1.Debt and equity securities not classified as trading or held-to-maturity 2.Not actively managed 3.Report as a)Short-term investments if the intent is to sell the securities within one year or the normal operating cycle, whichever is longer. b)Long-term investments if securities do not meet short-term investment criteria. 4.Valued at fair value 5.Unrealized gains or loss reported in the equity section of the balance sheet as part of comprehensive income P3

21. 15 - 21 A VAILABLE - FOR -S ALE S ECURITIES Music City had no prior investments. In the current period, it acquired two available-for-sale securities. At December 31, 2010, the following information is provided. P3

22. 15 - 22 A VAILABLE - FOR -S ALE S ECURITIES Music City Partial Balance Sheet December 31, 2010 Assets Long-term investments‒AFS (at cost) $ 73,000 Fair value adjustment–AFS 1,550 Long-term investments‒AFS (at fair value) $ 74,550 Equity Add unrealized gain on AFS securities $ 1,550 P3

23. 15 - 23 A VAILABLE - FOR -S ALE S ECURITIES Let’s extend our example and assume that at Dec. 31, 2011, the portfolio of long-term AFS securities has an $81,000 cost and an $82,000 fair value. P3

24. 15 - 24 G LOBAL V IEW Fair Value Option for Reporting Financial Assets Both U.S. GAAP and IFRS permit companies to use fair value in reporting financial assets. This option allows companies to report any financial asset at fair value and recognize value changes in income. This method was previously reserved only for trading securities, but now is an option for available-for-sale and held-to- maturity securities.

25. 15 - 25 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 A CCOUNTING F OR I NFLUENTIAL I NVESTMENTS P4

26. 15 - 26 Significant influence is generally assumed with 20% to 50% ownership. 0%20%50%100% Cost or Market Value Method Equity Method Consolidated Financial Statements P4 Investor Ownership of Investee Shares Outstanding A CCOUNTING F OR I NFLUENTIAL I NVESTMENTS

27. 15 - 27  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. P4 I NVESTMENTS IN E QUITY S ECURITIES WITH S IGNIFICANT I NFLUENCE

28. 15 - 28 On January 1, 2010, Micron Co. records the purchase of 3,000 shares (30%) of Star Co. common stock at a total cost of $70,650 cash. P4 I NVESTMENTS IN E QUITY S ECURITIES WITH S IGNIFICANT I NFLUENCE

29. 15 - 29 For 2010, Star reports net income of $20,000, and pays total cash dividends of $10,000 on January 9, 2011. P4 $10,000 × 30% = $3,000 $20,000 × 30% = $6,000 I NVESTMENTS IN E QUITY S ECURITIES WITH S IGNIFICANT I NFLUENCE

30. 15 - 30 P4 I NVESTMENTS IN E QUITY S ECURITIES WITH S IGNIFICANT I NFLUENCE

31. 15 - 31 Required when investor’s ownership exceeds 50% of investee.  Equity Method is used.  Consolidated financial statements show the financial position, results of operations, and cash flows of all entities under the parent’s control. C2 I NVESTMENTS IN S ECURITIES WITH C ONTROLLING I NFLUENCE

32. 15 - 32 A CCOUNTING S UMMARY FOR I NVESTMENTS IN S ECURITIES C1

33. 15 - 33 C OMPREHENSIVE I NCOME C1 Comprehensive Income: all changes in equity during a period except those from owners’ investments and dividends. Examples of items not included in Net Income but which are part of Comprehensive Income include: Unrealized gains and losses on available-for-sale securities Foreign currency adjustments Pension adjustments

34. 15 - 34 G LOBAL V IEW Accounting for Influential Securities The accounting for influential securities is broadly similar between U.S. GAAP and IFRS. There are a couple of minor differences in terminology. Accounting for Noninfluential Securities The accounting for noninfluential securities is broadly similar between U.S. GAAP and IFRS. There are a couple of differences in terminology. Trading securities are referred to in IFRS as financial assets at fair value though profit and loss, and available- for-sale securities are referred to as available-for-sale financial assets.

35. 15 - 35 C OMPONENTS OF R ETURN ON T OTAL A SSETS Return on total assets = Profit margin × Total asset turnover Net income Average total assets =× Net income Net sales Net sales Average total assets A1

36. 15 - 36 R ETURN ON T OTAL A SSETS Here are the returns on total assets and its components for Gap, Inc. for the years 2005 through 2009: All companies desire a high return on total assets. To improve the return, the company must meet any decline in profit margin or total asset turnover with an increase in the other. Companies consider these components in planning strategies. A1

37. 15 - 37 A PPENDIX 15A: I NVESTMENTS IN I NTERNATIONAL O PERATIONS Two major accounting challenges arise when companies have international operations: C3 Accounting for sales and purchases listed in a foreign currency. Preparing consolidated financial statements with international subsidiaries.

38. 15 - 38  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. E XCHANGE R ATES B ETWEEN C URRENCIES C3

39. 15 - 39 S ALES IN A F OREIGN C URRENCY Boston Company, a U.S.-based manufacturer makes a credit sale to London Outfitters, a British retail company. On December 12, 2010, Boston sells £10,000 with payment due on February 10, 2011. Boston keeps its record in U.S. dollars. At the date of sale, the British pound is valued at $1.80. £10,000 × $1.80 = $18,000 C3

40. 15 - 40 S ALES IN A F OREIGN C URRENCY Boston Company is a December 31, year-end company. On December 31, 2010, the British pound has an exchange rate of $1.84. The dollar value of the account receivable from London is $18,400 on this date. The receivable is to valued on the balance sheet at it current dollar amount. Accounts Receivable – London Outfitters DateExplanationDebitCreditBalance 12/12/10 Sale 18,000 12/31/10 Adjustment for foreign currency400 18,400 C3

41. 15 - 41 S ALES IN A F OREIGN C URRENCY On February 10, 2011, Boston receives London Outfitters’ payment of £10,000. Boston immediately exchanges the pounds for U.S. dollars. The exchange rate on this date is $1.78 per pound, so Boston receives $17,800 for the £10,000 received in settlement. Accounts Receivable – London Outfitters DateExplanationDebitCreditBalance 12/12/10 Sale 18,000 12/31/10 Adjustment for foreign currency400 18,400 2/10/11 Payment received 18,400-0- C3

42. 15 - 42 P URCHASES IN A F OREIGN C URRENCY NC Imports, a U.S. company, purchases products costing €20,000 from Hamburg Brewing on January 15, when the exchange rate is $1.20 per euro. €20,000 × $1.20 = $24,000 C3

43. 15 - 43 P URCHASES IN A F OREIGN C URRENCY NC Imports makes payment in full on February 14 when the exchange rate is $1.25 per euro. €20,000 × $1.25 = $25,000 C3

44. 15 - 44 C ONSOLIDATED S TATEMENTS WITH I NTERNATIONAL S UBSIDIARIES Consider a U.S.-based company that owns a controlling interest in a French company. The reporting currency of the U.S. company is the dollar. The French company maintains its books in Euros. Before preparing consolidated statements, the U.S. company must translate the French company’s statements into dollars. The process requires the parent company to select appropriate foreign exchange rates and to apply those rates to the foreign subsidiary’s account balances. Translate Account Balances C3

45. 15 - 45 E ND OF C HAPTER 15