INVESTMENTS AND INTERNATIONAL OPERATIONS

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2 Chapter 15 INVESTMENTS AND INTERNATIONAL OPERATIONS 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 Winston Kwok, Ph.D., CPA Copyright 2015 by McGraw-Hill Education (Asia). All rights reserved.

3 15-3 C1 BASICS OF INVESTMENTS Motivation for Investments 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.

4 15-4 C1 SHORT-TERM INVESTMENTS Short-term investments are securities that: Management intends to convert to cash within one yearor 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 C1 LONG-TERM INVESTMENTS 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.

6 C1 DEBT SECURITIES VERSUS EQUITY SECURITIES 15-6 Debt Securities Reflect a creditor relationship Examples: Investments in notes, bonds, and CDs May be issued by governments, companies, or individuals Equity Securities Reflect an owner relationship Examples: Investments in ordinary shares Issued by other companies

15-7 C1 CLASSIFICATION AND REPORTING Accounting for Investments depends on some or all of the following factors: 1. purpose, e.g. trading or long-term investment, the company s intent to hold the security either short-term or long-term, 2.

7 15-7 C1 CLASSIFICATION AND REPORTING Accounting for Investments depends on some or all of the following factors: 1. purpose, e.g. trading or long-term investment, the company s intent to hold the security either short-term or long-term, 2. its contractual characteristics, e.g. debt or equity, 3. whether it is listed on an exchange, 4. the industry in which the reporting entity operates, and 5. the accounting policy choice of the reporting entity.

8 15-8 P1 HELD-FOR-TRADING SECURITIES Acquired principally for the purpose of selling or repurchasing them in the near term, with a pattern of short-term profit-taking. Such investments are accounted for by the fair value approach, in contrast to the historical cost approach generally used for other assets like land, buildings, and equipment. Fair value is the amount for which an asset could be exchanged between knowledgeable and willing parties, in an arm s length transaction.

9 15-9 P1 HELD-FOR-TRADING SECURITIES Assume that Nestlé buys X Corp s shares on October 1, with the intention to sell within a few months. The journal entry at purchase is as follows.

10 15-10 P1 HELD-FOR-TRADING SECURITIES When Nestlé s fiscal year ends on December 31, the share price of X Corp has risen in value and the total market value is CHF 55,000. The CHF 5,000 value on top of the original cost is an unrealized gain on the investment. The year-end journal entry to record this gain is as follows.

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13 15-13 P1 HELD-FOR-TRADING SECURITIES When Nestlé sells X Corp s shares, it records a realized gain or loss. If Nestlé sells at CHF 60,000, which is higher than the carrying amount of CHF 55,000, then the journal entry is as follows.

14 15-14 P2 AVAILABLE-FOR-SALE SECURITIES Purchased to yield dividends or increases in fair value. Not actively managed like held-for-trading securities. If the intent is to sell available-for-sale securities within the longer of one year or operating cycle, they are classified as short-term investments. Otherwise, they are classified as long-term. Adjust the cost of available-for-sale securities to reflect changes in fair value. This is done with a fair value adjustment to its total portfolio cost. Any unrealized gain or loss is not reported as part of profit or loss but as part of other comprehensive income.

15 15-15 P2 AVAILABLE-FOR-SALE SECURITIES Assume that Nestlé buys Y Corp s shares at CHF 100,000. Nestlé intends to hold this investment for longer than a year and decided to treat it as an available-for-sale (AFS) investment.

16 15-16 P2 AVAILABLE-FOR-SALE SECURITIES Assume that at year-end, the fair market value of Y Corp s shares is CHF 120,000. The journal entry is as follows. Upon sale at CHF 10,000, the journal entry is:

17 15-17 P3 HELD-TO-MATURITY DEBT Debt securities are recorded at cost when purchased. Interest revenue for investments in debt securities is recorded when earned. On September 1, 2014, 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).

18 15-18 P3 HELD-TO-MATURITY DEBT Interest earned but not received must be accrued on December 31, $30,000 par value 7% 4/12 = $700 interest earned.

19 P4 INVESTMENTS IN EQUITY WITH SIGNIFICANT INFLUENCE Investor Ownership of Investee Shares Outstanding Cost or Fair Value Method Equity Method Consolidated Financial Statements 0% 20% 50% 100% Significant influence is generally assumed with 20% to 50% ownership.

20 15-20 P4 INVESTMENTS IN EQUITY WITH SIGNIFICANT INFLUENCE 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.

21 15-21 P4 INVESTMENTS IN EQUITY WITH SIGNIFICANT INFLUENCE On January 1, 2014, Micron Co. records the purchase of 3,000 shares (30%) of Star Co. ordinary shares at a total cost of $70,650 cash.

22 15-22 P4 INVESTMENTS IN EQUITY WITH SIGNIFICANT INFLUENCE For 2014, Star reports net income of $20,000, and pays total cash dividends of $10,000 on January 9, $20,000 30% = $6,000 $10,000 30% = $3,000

23 15-23 P4 INVESTMENTS IN EQUITY WITH SIGNIFICANT INFLUENCE

24 15-24 C2 INVESTMENTS IN EQUITY WITH CONTROL Required when investor has control overthe 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.

25 15-25 C1 ACCOUNTING SUMMARY FOR INVESTMENTS IN SECURITIES

26 15-26 C1 COMPREHENSIVE INCOME Comprehensive Income: all changes in equity during a period except those from owners investments and dividends. Example: Fair value adjustments on available-for-sale investments are shown in the statement of comprehensive income.

27 15-27 A1 COMPONENTS OF RETURN ON TOTAL ASSETS Return on total assets = Profit margin Total asset turnover Net income Average total assets Net income = Net sales Net sales Average total assets

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15-30 A1 RETURN ON TOTAL ASSETS Here are the returns on total assets and its components for Gap, Inc. for the years 2012 through 2008: All companies desire a high return on total assets.

30 15-30 A1 RETURN ON TOTAL ASSETS Here are the returns on total assets and its components for Gap, Inc. for the years 2012 through 2008: 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.

STATEMENT OF CASH FLOWS

Chapter 16 STATEMENT OF CASH FLOWS 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 Winston Kwok, Ph.D.,