1. Intercorporate Entities
Module 9
Intercorporate Entities

2. Describe and illustrate accounting for passive investments.
Learning Objective 1
Describe and illustrate accounting for passive investments.
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3. Intercorporate Investments
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4. Accounting Treatment and Financial Statement Effects
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5. Passive Investments – Market Method
Initially record at purchase price (fair market value on purchase date)
Gain (loss) on sale:
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6. Are Changes in Asset Value During the Holding Period Income?
During holding period, investment is recorded at current market value (“marked-to-market”).
Changes in the carrying amount of the investment (asset) has a corresponding effect on equity:
Is the change in equity is income?
The answer depends on the investment classification.
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7. Financial Statement Effects
Available-for-sale (AFS). These are securities that management intends to hold for capital gains and dividend revenue; although, they might be sold if the price is right.
Trading (T). These are investments that management intends to actively buy and sell for trading profits as market prices fluctuate.
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8. Fair Value Adjustments During Holding Period
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9. Google’s Footnote
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10. Google’s Disclosure of Fair Value Gains and Losses
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11. Google’s Disclosure of Fair Value Gains and Losses
Google’s net unrealized gain of $810 million ($840 million - $30 million) is reported net of tax in the accumulated other comprehensive income (AOCI) section of its stockholders’ equity as follows ($ millions):
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12. Google’s Disclosure of Fair Value Gains and Losses
Google identifies the components of its 2012 accumulated other comprehensive income of $538 million in the following footnote disclosure:
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13. Cisco’s Disclosure of Fair Value Gains and Losses
Investments are reported on Cisco’s balance sheet at $38,917 million.
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14. Bond Investment Classifications
Available-for-sale
Trading
Held-to-maturity
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15. Google’s Investments Reported at Cost
Google uses historical cost to account for investments in non-marketable securities.
Google monitors the value of these investments and writes them down to market value if they suffer a permanent decline in value.
If such an investee company ever goes public, Google will change its accounting method.
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16. Explain and illustrate accounting for equity method investments.
Learning Objective 2
Explain and illustrate accounting for equity method investments.
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17. Equity Method Investments
Investments are recorded at their purchase cost.
Dividends received are treated as a recovery of the investment and, thus, reduce the investment balance (dividends are not reported as income).
The investor reports income equal to its percentage share of the investee’s reported net income;
the investment account is increased by the percentage share of the investee’s income or is decreased by the percentage share of any loss.
Changes in fair value do not affect the investment’s carrying value.
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18. Equity Method Accounting Mechanics
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19. Equity Method Accounting Mechanics
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20. Effects of Equity Method Investments on ROE
Net operating profit margin (NOPM = NOPAT/Sales). Most analysts include equity income (sales less expenses) in NOPAT since it relates to operating investments. However, investee’s sales are not included in the NOPM denominator. The reported NOPM is, thus, overstated.
Net operating asset turnover (NOAT = Sales/Average NOA). Investee’s sales are excluded from the NOAT numerator, and net operating assets in excess of the investment balance are excluded from the denominator. This means the impact on NOAT is indeterminate.
Financial leverage (FLEV = Net nonoperating obligations / Average equity). Financial leverage is understated due to the absence of investee liabilities in the numerator.
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21. Describe and illustrate accounting for consolidations.
Learning Objective 3
Describe and illustrate accounting for consolidations.
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22. Investments with Control: Consolidation
Google’s footnote on consolidated entities:
Consolidation replaces…
the equity investment balance with the assets and liabilities to which it relates, and
the equity income reported by the investor company with the sales and expenses of the investee company to which it relates.
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23. Consolidation – 100% owned, purchased at book value
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24. Consolidation - Less than wholly-Owned
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25. Consolidation – 100% owned, purchased at more than book value
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26. CAT’s Consolidating Balance Sheet
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27. Acquired Intangible Assets
The purchase price is allocated to acquired identifiable intangible assets, which include the following:
Marketing-related assets like trademarks and internet domain names
Customer-related assets like customer lists, production backlog, and customer contracts
Artistic-related assets like plays, books, and video
Contract-based assets like licensing and royalty agreements, lease agreements, franchise agreements, and servicing contracts
Technology-based assets like patents, computer software, databases and trade secrets
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28. Kellogg’s Allocation of Pringles Purchase
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29. Oracle’s Acquisition of Siebel Systems, Inc.
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30. Impairment of Goodwill
The impairment test is a two-step process.
First, if the market value of the investee company is less than the investment balance, the investment is deemed impaired.
Second, the investor estimates the goodwill value as if the subsidiary were acquired at current market value, and the imputed balance for goodwill becomes the balance in the goodwill account.
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31. Goodwill Impairment Example
Assume that
an investment currently reported on the investor's balance sheet in the amount of $1 million has a current fair market value of $900,000.
the fair market value of the net assets of the investee company is $700,000 and
the current value of goodwill on the consolidated balance sheet is 300,000.
This indicates an impairment loss of $100,000, which is computed as follows:
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32. Hewlett-Packard’s Goodwill Write-Off
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33. Zoetis’ IPO
Pfizer’s equity method investment account increased by $2.3 billion.
Pfizer recognized a corresponding $2.3 billion increase in the additional paid-in capital account of stockholders’ equity.
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34. Sales of Subsidiaries – Discontinued Operations
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35. P&G’s Divestiture of Pringles
Once P&G decided to sell its snacks business, it accounted for the business unit as a discontinued operation with the following financial statement effects:
It removed from the consolidated income statement, the revenues and expense relating to the snacks business and reported only the net profit after tax of the snacks business unit in a separate section below income from continuing operations.
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36. P&G’s Divestiture of Pringles (continued)
In the year of sale, P&G reported a $1.4 billion gain on the sale of the snacks business unit (sales proceeds of $2.7 billion less book value of the snacks business unit of $1.3 on the date of sale).
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37. Limitations of Consolidated Financial Statements
Consolidation income does not imply that cash is received by the parent company.
Comparisons across companies are often complicated by the mix of subsidiaries included in the financial statements.
Segment profitability can be affected by intercorporate transfer pricing and allocation of overhead.
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38. Global Accounting: Passive Investments
Under both U.S. GAAP and IFRS, companies classify financial (passive) instruments as trading, available-for-sale, or held-to-maturity.
Under IFRS the definition of financial instrument is much broader.
Under IFRS, unlisted securities can be valued at fair value, if it can be reliably measured.
Under IFRS, reclassifications to and from the trading portfolio is prohibited.
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39. Global Accounting: Consolidation
Consolidation accounting standards were developed jointly by the FASB and the IASB.
Yes, a few differences remain:
Under IFRS, companies can measure noncontrolling interests either at fair value (full goodwill approach) or at the proportionate share of the identifiable net assets acquired (purchased goodwill approach). U.S. GAAP permits fair value only.
Contrary to US GAAP, under IFRS, parent and subsidiaries’ accounting policies must conform.
Contrary to US GAAP, under IFRS, fair-value impairments for intangible assets, excluding goodwill, can be later reversed (that is, written back up after being written down).
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