1. 12-1 Copyright 2004 The McGraw-Hill Companies, Inc. Permission required for reproduction or display. PowerPoint Presentation Materials For Financial Accounting: A New Perspective by Paul Solomon

2. 2 CHAPTER 12 How Investing Activities Affect Financial Statements

3. 12-3 PERFORMANCE OBJECTIVES 1 PO43: Determine which costs should be capitalized, expensed at acquisition PO44: Describe, calculate depreciation under Straight line Double-declining balance Sum-of-the-years’ digits

4. 12-4 PERFORMANCE OBJECTIVES 2 PO45: Describe how depletion calculated with units-of-production Present financial statement effects PO46: Describe how amortization calculated with straight-line Present financial statement effects

5. 12-5 PERFORMANCE OBJECTIVES 3 PO47: Determine valuation for current, noncurrent debt, equity securities Record investments Present financial statements effects PO48: Distinguish between cost/fair value & equity method to account for minority investments in equity securities

6. 12-6 INSIGHTS Why is useful life critical? Real world complications of accounting for investment securities

7. 12-7 WHY ENGAGE IN INVESTING ACTIVITIES? Noncurrent assets on balance sheet Without noncurrent assets, entities unable to generate revenues

8. 12-8 INVESTING ACTIVITY TRANSACTIONS Transaction C1EC1E Acquired equipment Paid lease security deposit C2HC2H Paid for equipment Investment in savings LRLR Bought equipment with note Sold some equipment

9. 12-9 EFFECTS OF INVESTING ACTIVITIES: Balance Sheet Transaction C1LC1L Store equipment account Security deposit receivable

10. 12-10 EFFECTS OF INVESTING ACTIVITIES: Income Statement Transaction RLoss on sale of store equipment

11. 12-11 EFFECTS OF INVESTING ACTIVITIES: Cash Flow Effects Transaction EC2LREC2LR Paid lease security deposit Paid for equipment Bought equipment with note Sold some equipment

12. 12-12 CMU Balance Sheet 12/31 Investments: Security deposit receivable$2,000 Property, Plant, Equipment Store Equipment19,000

13. 12-13 CMU Income Statement for Year Ended 12/31 Revenues Sales Service Interest Expenses Cost of goods sold Other Loss on sale equipment Net income $86,600 600 300 $30,000 27,150 350 $87,500 57,500 $30,000

14. 12-14 CMU Statement of Cash Flows for Year Ended 12/31 Cash flows from investing Proceeds, sale equipment Payment security deposit Acquisition equipment $1,350 Supplemental: noncash investing, financing Exchanged 2-year promissory note for computer equipment

15. 12-15 ACCOUNTING FOR PROPERTY, PLANT, EQUIPMENT Noncurrent Tangible Use in operation of business Examples Depreciable property, plant, equipment Natural resources Non-depreciable property (land)

16. 12-16 COST MEASUREMENT General rule All costs to bring asset to condition, location for its intended use Historical cost = Purchase price-cash discounts + shipping, storage, taxes, insurance, legal fees, installation

17. 12-17 DEPRECIATION: Transaction Analysis AccountAssets =Liabilities +Equity Depreciation expense Accumulated depreciation

18. 12-18 DEPRECIATION: Journal Entry AccountDebitCredit Depreciation expense Accumulated depreciation 2,000

19. 12-19 DEPRECIATION EXPENSE: Straight-line Historical cost – salvage Life $10,000 - $0 5 = $2,000

20. 12-20 INSIGHT: Useful Life Why is estimated useful life critical to accurate income measurement? Estimate, not actual amount Changes in useful life affect pretax income Subject to manipulation of unethical management

21. 12-21 ACCELERATED DEPRECIATION METHODS Matching concept Assets expected to generate most revenues in earliest years Greatest depreciation taken in earliest years Examples Double-declining balance Sum-of-the-years’ digits

22. 12-22 DEPRECIATION EXPENSE: Double-declining Balance 2 * 1/life(historical cost – accumulated depreciation) Assume salvage = $400ExpenseBalance Y 1 Y 2 Y 3 2*1/5(10,000 – 0) = 2*1/5(10,000 – 4,000) = 2*1/5(10,000 – 6,400) = $4,000 2,400 1,440 $6,000 3,600 2,160 Y 4 Y 5 2/1/5(10,000 – 7,440) = 10,000 – 8736 – 400 = 864 894 778 400

23. 12-23 DEPRECIATION EXPENSE: Sum-of-the-years’ Digits Last unused year * Sum of years (Historical cost – Salvage) Y1 Y2 Y3 5/15 * (10,000 – 400) = 4/15 * (10,000 – 400) = 3/15 * (10,000 – 400) = $3,200 2,560 1,920 Y4 Y5 2/15 * (10,000 – 400) = 1/15 * (10,000 – 400) = 1,280 640

24. 12-24 GAINS & LOSSES 1: Transaction Analysis AccountAssets =Liabilities +Equity Cash Accumulated depr. Store equipment Gain on sale 800 9,600 400 Store equipment sold for $800

25. 12-25 GAINS & LOSSES 1: Journal Entry AccountDebitCredit Cash Accumulated depr. Store equipment Gain on sale 800 9,600 10,000 400

26. 12-26 GAINS & LOSSES 2: Transaction Analysis AccountAssets =Liabilities +Equity Cash Accumulated depr. Store equipment 400 9,600 Store equipment sold for $400

27. 12-27 GAINS & LOSSES 2: Journal Entry AccountDebitCredit Cash Accumulated depr. Store equipment 400 9,600 10,000

28. 12-28 GAINS & LOSSES 3: Transaction Analysis AccountAssets =Liabilities +Equity Cash Accumulated depr. Loss on sale Store equipment 800 9,600 200 Store equipment sold for $200

29. 12-29 GAINS & LOSSES 3: Journal Entry AccountDebitCredit Cash Accumulated depr. Loss on sale Store equipment 200 9,600 200 10,000

30. 12-30 NATURAL RESOURCES Examples Timber Mineral deposits Oil fields Cost matched to revenue by depletion

31. 12-31 DEPLETION Total depletion cost = Acquisition + Exploration & development costs Units of production (straight line) Cost per unit = Total cost/Discovered units Depletion expense = Cost per unit * Units sold

32. 12-32 PROPERTY NOT SUBJECT TO DEPRECIATION Land Unlimited life No depreciation, depletion

33. 12-33 INTANGIBLE ASSETS Value derived from rights that possession conveys to owners Examples Copyrights Patents Trademarks Franchises Leases

34. 12-34 INTANGIBLE ASSETS: Amortization Transaction Analysis Straight-line method over legal life Goodwill not subject to amortization AccountAssets =Liabilities +Equity Patent amortization exp. Patent

35. 12-35 INTANGIBLE ASSETS: Amortization Journal Entry AccountDebitCredit Patent amortization exp. Patent 2,000

36. 12-36 INTANGIBLE ASSETS: After Acquisition When book value exceeds fair value Asset is impaired Value must be written down to fair value Book value: goodwill Fair value: goodwill Impairment $330,000 295,000 $35,000

37. 12-37 IMPAIRED ASSET: Transactional Analysis AccountAssets =Liabilities +Equity Loss on goodwill impairment Goodwill

38. 12-38 IMPAIRED ASSET: Journal Entry AccountDebitCredit Loss on goodwill impairment Goodwill 35,000

39. 12-39 DEBT & EQUITY SECURITIES Debt securities Treasury bill Note Bond Equity securities Common stock Preferred stock

40. 12-40 SECURITIES: Distinguishing Characteristics 3 categories Cash equivalents Marketable securities Investments 3 characteristics Nature Maturity Management’s intention

41. 12-41 INVESTMENTS: 3 Distinguishing Characteristics 1 Nature of security Liquidity Expected maturity date Investments: greater than 1 year

42. 12-42 INVESTMENTS: 3 Distinguishing Characteristics 2 ( cont.) Management’s intention to hold Trading securities: Actively traded for profit Available for sale: Intention to sell; Not actively traded Held-to-maturity: Intent & ability to hold

43. 12-43 ACQUISITION DEBT SECURITY: Transactional Analysis AccountAssets =Liabilities +Equity Investment in bonds Cash 101,000

44. 12-44 ACQUISITION DEBT SECURITY: Journal Entry AccountDebitCredit Investment in bonds Cash 101,000

45. 12-45 INTEREST REVENUE FROM DEBT SECURITY: Transactional Analysis AccountAssets =Liabilities +Equity Interest receivable Interest revenue 2,500 Cash Interest revenue 2,500

46. 12-46 INTEREST REVENUE FROM DEBT SECURITY: Journal Entry AccountDebitCredit Interest receivable Interest revenue 2,500 Cash Interest receivable 2,500

47. 12-47 ADJUSTMENT TO FAIR VALUE FOR HOLDING GAIN: Transactional Analysis AccountAssets =Liabilities +Equity Investment in bonds Unrealized holding gain 200

48. 12-48 ADJUSTMENT TO FAIR VALUE FOR HOLDING GAIN: Journal Entry AccountDebitCredit Investment in bonds Unrealized holding gain 200

49. 12-49 ADJUSTMENT TO FAIR VALUE FOR HOLDING LOSS: Transactional Analysis AccountAssets =Liabilities +Equity Unrealized holding loss Investment in bonds

50. 12-50 ADJUSTMENT TO FAIR VALUE FOR HOLDING LOSS: Journal Entry AccountDebitCredit Unrealized holding loss Investment in bonds 300

51. 12-51 SALE OF DEBT SECURITY: Transactional Analysis AccountAssets =Liabilities +Equity Cash Investment in bonds Realized gain on sale 101,900 900

52. 12-52 SALE OF DEBT SECURITY: Journal Entry AccountDebitCredit Cash Investment in bonds Realized gain on sale 101,900 101,000 900

53. 12-53 STOCK OWNERSHIP: Levels of Ownership OwnershipInfluenceType <20% 20% < x < 50% > 50% Insignificant Significant Control Minority (passive) Minority (active) Majority

54. 12-54 ACCOUNTING FOR EQUITY SECURITIES: Minority Passive Cost/fair value method Dividends increase revenue No recognition of investee income Year-end adjustments Unrealized gains, losses recognized on trading, available- for-sale securities Realized gain, loss on sale

55. 12-55 ACCOUNTING FOR EQUITY SECURITIES: Minority Active Equity method Dividends reduce investment Share of investee net income/loss increases investment Realized gain, loss on sale

56. 12-56 COMPARING COST & EQUITY METHODS: Equity Investments Cost/fair valueEquity Minority, passive Unrelated businesses Minority, activity Significant influence Standard revenue recognition Dividends as revenue Proportionate share investee income, loss Dividends as decrease in investment

57. 12-57 INSIGHT: Real World Complications 4 valuation methods for security investments Held-to-maturity: amortized cost Trading, available for sale (debt & equity) Cost fair value Minority active stock investments: equity method Majority active stock investments: consolidation