2. Motivations for Intercorporate Investments
As a temporary investment of excess cash or part of a long-term risk-adjusted portfolio
Expectations of dividends and gains
As a strategic investment
Develop relationships with suppliers and customers
Gain access to new product or geographic markets
To facilitate activity along its supply chain

3. Investments on the Balance Sheet
Coca-Cola Company reported the following investments at December 31, 2010 and 2009 (in millions):
2010
2009
Investments
Trading securities $
$ 61
Available-for-sale securities
485
398
Held-to-maturity securities
111
199
Equity method investments
6,954
6,217
Other investments, principally bottling companies
631
538

4. Coca-Cola’s Investments
Marketable securities
Includes trading, available-for-sale, and held-to-maturity investments
Equity method investments
Investments for which Coca-Cola exerts significant influence over operations
Coca-Cola’s equity method investments
23% interest in Coca-Cola Hellenic
32% interest in Coca-Cola FEMSA
30% interest in Coca-Cola Amatil

5. Coca-Cola’s Investments continued
Joint ventures
Investments for which Coca-Cola and at least one other company share ownership interest and jointly control a separate entity
Controlling interest
Investments for which Coca-Cola has a controlling interest in another company
2010 acquisition: Coca-Cola Enterprises (CCE)

6. Types of Investments for Reporting Purposes
Trading
Available-for-sale
Held-to-maturity
Equity method
Derivatives (hedges)
Controlling interest

7. This chapter assumes the company did NOT elect the fair value option.
ASC Topic 825 allows companies to elect the fair value option for eligible intercorporate investments
Investments reported at fair value
Value changes reported as part of income
Option available only for noncontrolling investments
This chapter assumes the company did NOT elect the fair value option.

8. Learning Objective 1
Describe the reporting for trading, available-for-sale, and held-to-maturity investments in other companies.

9. Examples of Marketable Debt and Equity Investments
Debt securities
Commercial paper
Corporate bonds
Redeemable preferred stock
Equity securities
Common stock
Preferred stock
Put and call options

10. Investments Under ASC Topic 320
Readily determinable market values
No significant influence over the investee
Three categories:
Trading investments
Available-for-sale investments
Held-to-maturity investments

11. Trading Investments Debt or equity securities
Reported as current assets at fair value
Income statement reporting
Income statement
Other Income/losses:
Unrealized gains/losses on trading investments…………$ xx
Realized gains/losses on trading investments……………..xx
Investment income…………………………………………… xx

12. Accounting for Trading Investments
Securities owned:
Exhibit 1.1
Security
Date Acquired
Cost
December 31, 2012 Value
Date Sold
Selling Price A
10/15/12
$100,000
$125,000
1/15/13
$120,000 B
500,000
485,000
496,000 C
200,000
N/A
12/5/12
214,000
$800,000
To record purchase of trading investments costing $800,000:
2012
Oct. 15
Investment in trading securities
800,000
Cash

13. Accounting for Trading Investments continued
To record the sale of trading security C for $214,000:
2012
Dec. 5
Cash
214,000
Investment in trading securities
200,000
Realized gain on sale of trading securities (income)
14,000
To record the unrealized value change for securities A and B:
Security
Cost
Year-end Value
Unrealized Gain(loss) A
$100,000
$125,000
$25,000 Gain B
500,000
485,000
$15,000 Loss
2012
Dec. 31
Investment in trading securities
25,000
Unrealized gain on trading securities
(income) 
2012
Dec. 31
Unrealized loss on trading securities (income)
15,000
Investment in trading securities

14. Accounting for Trading Investments continued
To record the sale of trading securities A and B:
Exhibit 1.1
Security
Cost
Year-end Value
Date Sold
Selling Price
Realized Gain (Loss) A
$100,000
$125,000
1/15/13
$120,000
($5,000) B
500,000
485,000
496,000
$11,000
2013
Jan. 15
Cash
120,000
Realized loss on sale of trading securities (income)
5,000
Investment in trading securities
125,000
2013
Jan. 15
Cash
496,000
Investment in trading securities
485,000
Realized gain on sale of trading securities
(income)
11,000

15. Accounting for Trading Investments continued
Gains and losses are reported in income as the value of the securities changes
No impairment testing is necessary since all changes in value flow through income
No difference in accounting between a “normal” decline in value and a decline characterized as “impairment.”

16. Available-for-Sale Investments
Debt or equity securities
Balance sheet
Reported as current or noncurrent assets at fair value
Unrealized gains/losses reported in accumulated other comprehensive income
Income statement reporting
Realized gains/losses on available-for-sale investments
Investment income
Other comprehensive income
Unrealized gains/losses on available-for-sale investments

17. Journal Entries for Available-for-Sale Investments
AFS investments:
Exhibit 1.1
Security
Date Acquired
Cost
December 31, 2012 Value
Date Sold
Selling Price A
10/15/12
$100,000
$125,000
1/15/13
$120,000 B
500,000
485,000
496,000 C
200,000
N/A
12/5/12
214,000
$800,000
To record the purchase of investments costing $800,000:
2012
Oct. 15
Investment in AFS securities
800,000
Cash

18. Journal Entries for Available-for-Sale Investments continued
To record the sale of AFS security C for $214,000:
2012
Dec. 5
Cash
214,000
Investment in AFS securities
200,000
Realized gain on sale of AFS
securities (income)
14,000
To record the unrealized value change for securities A and B:
Security
Cost
Year-end Value
Unrealized Gain(loss) A
$100,000
$125,000
$25,000 Gain B
500,000
485,000
$15,000 Loss
2012
Dec. 31
Investment in AFS securities
25,000
Unrealized gain on AFS securities (OCI)
2012
Dec. 31
Unrealized loss on AFS securities (OCI)
15,000
Investment in AFS securities

19. Journal Entries for Available-for-Sale Investments continued
Security
Cost
2013 Year-end Value
Date Sold
Selling Price
Realized Gain (Loss) A
$100,000
$125,000
1/15/13
$120,000
$20,000 B
500,000
485,000
496,000
$(4,000)
To record the sale of AFS security A:
2013
Jan. 15
Cash
120,000
Other comprehensive income
25,000
Investment in AFS securities
125,000
Realized gain on sale (income)
20,000
To record the sale of AFS security B:
2013
Jan. 15
Cash
496,000
Realized loss on sale (income)
4,000
Investment in AFS securities
485,000
Other comprehensive income
15,000

20. Impairment Testing for AFS Securities
Required because impairment losses go through income but “normal” declines are reported in OCI
Is the security’s fair value below its cost?
If so, is the decline other than temporary?
Common indicator: security will be sold before value can be recovered
To record the $15,000 decline in value of AFS security B at December 31, 2012 as impairment:
2012
Dec. 31
Loss on security B (income)
15,000
Investment in AFS securities

21. Impairment Testing of AFS Securities continued
After recognition of impairment, Security B’s “cost” is $485,000.
Subsequent value increases are not reported
Example of loss recognition when unrealized gains/losses previously reported:
AFS security, book value $200,000, original cost $160,000, fair value $90,000

22. Impairment Testing of AFS Securities continued
Fair value ($90,000) < cost ($160,000)
If the decline in value is other than temporary:
Record the decline in value of the AFS security from cost to fair value as impairment loss, in income, reclassify the unrealized gain out of AOCI, and write the investment down from book value to fair value:
Unrealized loss on AFS securities (OCI)
40,000
Impairment loss on AFS securities (income)
70,000
Investment in AFS securities
110,000

23. Held-to-Maturity Investments
Debt securities only
Reported at amortized cost
Discount or premium amortized over time
No gains or losses unless sold prior to maturity
Early sale requires extreme circumstances
Income Statement
Other income/losses:
Interest income…………………………………………………… $xx

24. Journal Entries for HTM Investments
A company invested in a $1 million face value, 5% corporate bond on January 1, 2012 for $965,349, yielding 6%. Interest is paid annually on December 31. Maturity is December 31, 2015.
To record the purchase of HTM securities:
2012
Jan. 1
Investment in HTM securities
965,349
Cash
To record the receipt of interest income for 2012:
$1,000,000 × 5%
2012
Dec. 31
Cash
50,000
Investment in HTM securities
7,921
Interest income
57,921
$57,921 – $50,000
$965,349 × 6%

25. Journal Entries for HTM Investments continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%. Carrying value at December 31, 2012: $965,349 + $7,921 = $973,270
To record the receipt of interest income for 2013:
$1,000,000 × 5%
2013
Dec. 31
Cash
50,000
Investment in HTM securities
8,396
Interest income
58,396
$58,396 – $50,000
$973,270 × 6%
Carrying value at December 31, 2013: $973,270 + $8,396 = $981,666
To record the receipt of interest income for 2014:
$1,000,000 × 5%
2014
Dec. 31
Cash
50,000
Investment in HTM securities
8,900
Interest income
58,900
$58,900 – $50,000
$981,666 × 6%

26. Journal Entries for HTM Investments continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2014: $981,666 + $8,900 = $990,566
To record the receipt of interest income for 2015:
$1,000,000 × 5%
2015
Dec. 31
Cash
50,000
Investment in HTM securities
9,434
Interest income
59,434
$59,434 – $50,000
$990,566 × 6%
Carrying value at December 31, 2015: $990,566 + $9,434 = $1,000,000
To record receipt of face value of bonds at maturity:
2015
Dec. 31
Cash
1,000,000
Investment in HTM securities

27. Impairment Testing for HTM Investments
Required because normally HTM investments are carried at amortized cost
Two criteria, same as for AFS securities
Fair value declines below amortized cost, and
Decline is judged to be other than temporary
If judged to be impaired
Write down the security to fair value
Report the decline as an impairment loss on the income statement
Ignore subsequent increases in fair value

28. Recording an Impairment Loss
Example: An investor owns an HTM security with a current amortized cost of $981,666. At the end of 2013, the investor determines that it is probable that all amounts due according to the contractual terms of a debt security will not be collected. The current market value is $500,000.
To record the impairment:
2013
Dec. 31
Impairment loss on HTM securities (income)
481,666
Investment in HTM securities

29. Explain the reporting for equity method intercorporate investments.
Learning Objective 2
Explain the reporting for equity method intercorporate investments.

30. Investments with Significant Influence
Two accounting options exist
Elect to use the ASC Topic 825 fair value option, or
Apply the equity method (ASC Topic 323)
Investor must exert significant influence over operating and financing decisions of the investee

31. When is Significant Influence Present?
Representation on the investee’s board
Involvement in investee operating and financial policies
Significant transactions between investor and investee
Guideline: 20% to 50% ownership
BUT significant influence can exist with less than 20% ownership

32. Accounting Using the Equity Method
Investment performance reflects the investee’s performance
Equity method investment
Cost of investment
Investor's share of investee's income and OCI gains
Investor's share of investee's losses and OCI losses
Dividends declared by investee
Ending balance
Increases
Decreases
Investment changes in proportion to the investee’s retained earnings and AOCI accounts

33. Equity Method Example To record the purchase of equity investment:
Investment cost = $2,000,000 for 30% of the investee’s stock. During the first year, the investee reports net income of $800,000, declares and pays dividends of $300,000, and has $50,000 in unrealized losses on AFS securities.
To record the purchase of equity investment:
Equity method investment
2,000,000
Cash
To record dividends declared and paid:
Cash
90,000
Equity method investment
To accrue earnings of investee:
Equity method investment
240,000
Equity in income of investee

34. Equity method example continued
Investment cost = $2,000,000 for 30% of the investee’s stock. During the first year, the investee reports net income of $800,000, declares and pays dividends of $300,000, and has $50,000 in unrealized losses on AFS securities.
To record investee’s OCI:
Other comprehensive income
15,000
Equity method investment
Change in investee’s equity = $800,000 - $300,000 - $50,000 = $450,000
Change in equity method investment = $240,000 - $90,000 - $15,000 = $135,000, or 30% of the change in the investee’s equity

35. Equity Method Example continued
Investment cost = $2,000,000 for 30% of the investee’s stock. During the first year, the investee reports net income of $800,000, declares and pays dividends of $300,000, and has $50,000 in unrealized losses on AFS securities.
Equity method investment
2,000,000
 240,000
90,000
15,000
2,135,000
Equity in income
of investee
240,000
Balance Sheet as long-term asset
Income Statement

36. Equity in Net Income
Adjustments to reported net income may be required
If investment cost differs from investee’s book value
Adjustment required: Amortize investment cost in excess of book value acquired
If investor and investee transact business with each other
Adjustment required: Remove intercompany profit that is not yet earned

37. Adjustments to Equity in Net Income
Adjustments should be made for depreciation and amortization on revaluations of
Tangible assets, and
Limited life intangible assets
Exceptions
No adjustments for goodwill impairment or impairment of other indefinite life intangibles

38. Inventory Sales Between Investee and Investor
Downstream sales Investor sells inventory to investee
Upstream sales
Investee sells inventory to investor
Both companies record sales as if selling to outside customers
Both report gross margin as part of income
Results in
If inventory not sold to unrelated outside party at year-end, gross margin is not yet earned
Investor must remove when calculating equity in net income of investee

39. Example: Revaluations
On January 1, 2013, Rocky Mountain reports total assets of $80 million and total liabilities of $50 million, for a net book value of $30 million. Coca-Cola paid $12 million for 30% of Rocky Mountain’s shares. Analysis indicates that Rocky Mountain has unreported technology valued at $5 million and its plant and equipment is undervalued by $1 million. Plant and equipment has a remaining life of 10 years as of January 2, 2013 and uses straight-line depreciation. The previously unreported technology is a limited life intangible asset with a 5-year life.
Price paid
$12,000,000
Share of Rocky Mountain's net assets acquired:
Book value (30% x $30,000,000)
$9,000,000
Revaluation of plant and equipment
(30% x $1,000,000)
300,000
Unreported technology (30% x $5,000,000)
1,500,000
10,800,000
Additional investment cost (goodwill)
$1,200,000

40. Example: Unconfirmed Inventory Profits
Suppose Rocky Mountain sells canned beverages to Coca-Cola upstream for $800,000 at a 20% markup on cost. Coca-Cola holds $210,000 of this inventory at year-end. Coca-Cola sells finished products to Rocky Mountain downstream for $500,000 at a 25% markup on cost. Rocky Mountain holds $100,000 of this inventory at year-end. How much is unconfirmed profit?
Unconfirmed gross profit on $210,000 upstream sales:
$210,000 –[ $210,000 ÷ 1.20] = $35,000
Unconfirmed gross profit on $100,000 downstream sales:
$100,000 – [$100,000 ÷ 1.25] = $20,000

41. Recognition of Adjusted Equity in Net Income for 2013
$300,000
÷ 10
Coca-Cola's share of Rocky Mountain's reported
2013 income (30% x $2,000,000)
$600,000
Adjustments for revaluation write-offs:
Plant and equipment
(30,000)
Previously unreported technology
(300,000)
Adjustments for unconfirmed inventory profits:
Upstream sales
(10,500)
Downstream sales
(6,000)
Equity in net income of Rocky Mountain
$253,500
$1,500,000
÷ 5
30% × $20,000
30% × $35,000
2013
Dec. 31
Investment in Rocky Mountain Bottlers
253,500
Equity in income of Rocky Mountain Bottlers

42. Impairment Testing: Equity Method Investments
Impairment testing required for equity method investments (ASC Topic 323)
Criteria
Fair value of the investment declines below its carrying value, and
The decline is other than temporary
Accounting requirements
Investment is written down and a loss is recognized on the investor’s income statement
Subsequent increases are ignored

43. U.S. companies use the equity method for joint ventures.
An entity formed by a group of individuals or firms that contribute resources and jointly share in managing and controlling the venture
Often established for a short-term, single business transaction or activity
Enables expertise, special technology, capital, market access to be combined
U.S. companies use the equity method for joint ventures.

44. Describe the reporting for controlling interests in other companies.
Learning Objective 3
Describe the reporting for controlling interests in other companies.

45. Controlling Investments
The investor has control over the operating and financial decisions of the investee
Three forms
Statutory merger, statutory consolidation, or asset acquisition
Stock acquisition
Variable interest entity
Assets, liabilities, revenues, and expenses are combined with those of the investor for financial statement reporting

46. Statutory Mergers, Statutory Consolidations, and Asset Acquisitions
Investor directly acquires the assets and liabilities of the investee
Assets and liabilities recorded directly on investor’s balance sheet at fair value
Statutory merger
Occurs when the investor acquires the investee and becomes the remaining legal entity
Statutory consolidation
Occurs when a new entity is formed to acquire both the investor and the investee
Asset acquisition
Occurs when an investor acquires a subset of the investee’s assets

47. Statutory Merger Example
Coca-Cola acquires all of Rocky Mountain’s assets and liabilities in a statutory merger by paying $40 million in cash on Jan. 2, Fair values in millions are: Current assets, $20; plant and equipment, $61; current liabilities, $15; and long-term liabilities, $35. Coca-Cola identified and valued Rocky Mountain’s previously unreported intangibles asset, technology, at $5 million.
Price paid
$40,000,000
Fair value of identifiable net assets acquired:
Current assets
$20,000,000
Plant and equipment
61,000,000
Technology
5,000,000
Current liabilities
(15,000,000)
Long-term debt
(35,000,000)
36,000,000
Goodwill
$4,000,000

48. Statutory Merger Example continued
To record the acquisition of Rocky Mountain Bottlers:
Current assets
20,000,000
Plant and equipment
61,000,000
Technology
5,000,000
Goodwill
4,000,000
Current liabilities
15,000,000
Long-term debt
35,000,000
Cash
40,000,000

49. Stock Acquisitions
Occurs when an investor obtains control over another company by investing in its voting stock
Investee remains a separate legal entity
Parent
the investor
Subsidiary
the acquired company
The separate financial records are consolidated at the end of each reporting period.

50. Stock Acquisition Example
Assume Coca-Cola acquires and holds all of the voting stock of Rocky Mountain Bottlers, paying the former stockholders of Rocky Mountain $40 million cash.
Investment in Rocky Mountain Bottlers
40,000,000
Cash
This is the entry Coca-Cola makes on its own books, but its annual report shows Coca-Cola and Rocky Mountain’s combined accounts as if Coca-Cola recorded the acquisition as a statutory merger.

51. Variable Interest Entities (VIEs)
Investee is a separate legal entity controlled by another company
Control occurs through legal relationships rather than stock ownership
Entity is considered to be a VIE if:
The entity must obtain guarantees from other parties in order to obtain financing, or
The equity holders do not have the usual rights and responsibilities of equity ownership, such as voting and residual return rights

52. Issue of Control with VIEs
Consequences of control
Must have the power to direct the VIE’s activities
Must absorb the majority of the VIE’s risks and rewards
Reporting is the same as for stock investments
Voting rights are not an indicator of controlling a VIE

53. Learning Objective 4
Discuss International Financial Reporting Standards (IFRS) for intercorporate investments.

54. IFRS for Marketable Debt and Equity Investments
Currently accounted for the same as U.S. GAAP (IAS 39)
IFRS 9 (effective 2015):
Default: FV-NI
Option for equity investments not held for trading: FV-OCI, never reclassified to income
Option for debt securities held for principal and interest payments: amortized cost

55. IFRS for Marketable Debt and Equity Investments continued
Impairment losses
Focus on observance of ‘loss events’ related to the decline in value
Such as decline in credit rating, or
Investee misses scheduled debt payments
New standards for impairment testing under consideration

56. IFRS for Significant Influence Investments
Investee is defined as an associate
Principles-oriented view to significant influence
Representation on the investee’s board
Participation in policy-making process
Material transactions between the investor and the investee
Interchange of managerial personnel
Provision of essential technical information

57. IFRS for Significant Influence Investments continued
Equity method required
Similar to U.S. GAAP procedures
Impairment testing
Compare the investment carrying value with the higher of its market value or value-in-use
Value-in-use is the present value of the investment’s future expected cash flows
Possible differences in impairment loss recognition between IFRS and U.S. GAAP

58. IFRS and Joint Ventures
IFRS 11, effective 2013
Two kinds of joint arrangements:
Joint operations (rights to entity’s assets and liabilities)
Joint ventures (rights to entity’s returns and disposal value)
Joint ventures are most common
Reported using the equity method

59. IFRS and Joint Ventures continued
Until 2013, joint ventures may be reported using proportionate consolidation
Investor includes proportionate share of JV’s assets and liabilities on its balance sheet
Affects investor’s leverage
No effect on investor’s equity or income

60. IFRS and Controlling Investments
IFRS 10: When should an entity be consolidated: all of the following
Power to direct the activities that significantly affect the investee’s returns
Exposure to variable returns from investee
Ability to use power to affect the amount of investor’s returns

61. IFRS and Controlling Investments continued
IFRS 10 applies to all control relationships
Investments in stock of a company
Control achieved through financial relationships
Variable interest entities
Should an entity controlled through a financial relationship be consolidated? Possible differences between IFRS and U.S. GAAP

62. End of Chapter 1