CHAPTER 13 INVESTMENTS AND FAIR VALUE ACCOUNTING

Transcription

1 INVESTMENTS AND FAIR VALUE ACCOUNTING DISCUSSION QUESTIONS 1. A company may temporarily have excess cash that is not needed for use in its current operations. Instead of letting excess cash remain idle in a checking account, most companies invest their excess cash in temporary investments. The primary objectives of investing in temporary investments are to: a. earn interest revenue b. receive dividends c. realize gains from increases in the market price of the securities 2. A gain or loss can occur when the selling price of the bond differs from the carrying amount (cost) of the bond. The price of bond investments can change due to changes in the market rate of interest. If the proceeds from the sale exceed the carrying amount (cost) of the bonds, then a gain is recorded. 3. The equity method is used for equity investments representing more than 20% and less than 50% of the outstanding shares of the investee. 4. Under the cost method, a dividend received is treated as dividend revenue. Under the equity method, a dividend received is not treated as dividend revenue, but is treated as a reduction in the carrying amount of the investment. 5. An investment greater than 50% of the investee is considered to be an investment that exerts control. Thus, the financial statements of the investee (subsidiary) are consolidated (combined) with that of the investor (parent company). 6. Both portfolios are reported at fair value. However, changes in the fair value of trading securities during a period are reported as an unrealized gain or loss on the statement of comprehensive income. For available-for-sale securities, changes in the fair value of the securities are reported in equity and, thus, are not recognized as part of net profit. 7. A credit balance in Valuation Allowance for Available-for-Sale Investments is subtracted from Available-for-Sale Investments (at cost). The net reported amount is the available-for-sale securities at fair value. 8. A debit balance in Unrealized Gain (Loss) on Available-for-Sale Investments would be reported as a reduction in the Equity section of the statement of financial position, after Retained Earnings. 9. Current GAAP requires fair value accounting for impaired assets. Current GAAP allows financial assets and liabilities to be reported at fair value. The assets and liabilities reported at fair value are becoming a more significant portion of many companies statement of financial positions. International Financial Reporting Standards are also moving more aggressively toward fair value accounting. As a result of the desire to converge U.S. and international standards, the United States is also moving toward fair value reporting. 10. Fair values may not be readily obtainable for some assets or liabilities, which causes financial statement valuations to become more subjective. In addition, comparability between financial statements among different companies may be hampered by different methods of determining fair value. Lastly, using fair value can result in greater fluctuations in reported results, making predictions of future trends potentially more difficult. 13-1

2 11. IAS 39 classifies investment in financial securities into four categories: (1) fair value through profit and loss (FVTPL), which includes securities held for trading and designed as FVTPL, (2) loans and receivables, (4) securities held to maturity, and securities available for sale. IFRS 9 Financial Instruments reorganizes four categories of classification of financial assets under IAS 39 into two categories. Under IFRS 9, financial assets are measured at either fair value (FV) or amortized cost (AC). 12. A reporting entity should apply amortized cost if both of the following conditions are met: 1. The asset is held within a business model whose objective is to hold assets in order to collect contractual cash flows. 2. The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. 13. Under US GAAP, a short-term investment in financial assets can be a trading securities, available-for sale invesment, or held-to-maturity investment. IAS 39 classifies short-term investment into four categories fair value through profit and loss (FVTPL), which includes securities held for trading and designed as FVTPL, (2) loans and receivables, (4) securities held to maturity, and securities available for sale. IFRS 9 classifies short-term investment in financial assets into two categories according to their valuation: (1) fair value and (2) amortized cost. 14. The accounting for available-for-sale securities is similar to the accounting for trading securities, except for the reporting of changes in fair values. Specifically, changes in the fair values of trading securities are reported as an unrealized gain or loss on the statement of comprehensive income. In contrast, changes in the fair values of available-for-sale securities are reported as part of equity and, thus, excluded from the statement of comprehensive income. Under IFRS 9, trading securities are classified into the category Fair Value through Profit and Loss (FVTPL). Changes in fair value result in a direct write-down of financial assets and financial asset will be restated at fair value. Valuation provision account is not used and gain and loss pass through profit and loss. Under IFRS 9, changes in fair value of available-for-sale (AFS) investment do not pass through profit and loss. Instead, they are recognized in other comprehensive income (OCI). 13-2

3 EXERCISES Ex (1) Jan. 1 Financial Assets-Amortized Cost 48,227 Cash 48,227 Jul. 1 Cash ($50,000 8% 1/2) 2,000 Financial Assets-Amortized Cost 411 Interest Revenue($48,227 10% 1/2) 2,411 Oct. 1 Cash ($32,000 + $600 $500) 32,100 Financial Assets-Amortized Cost 29,313 ($48,638 30/50+$130) Interest Revenue 730 [($48,227+$411) 30/50 10% 3/12)] Gain on Sale of Financial Assets 2,057 Dec. ($31,500 $29,313 $130 = $2,057) 31 Interest Receivable 800 (2) Financial Assets-Amortized Cost 173 Interest Revenue 973 [($48,227+$411) 20/50 10% 6/12)] 13-3

4 Ex Jan. Jul. Dec. 1 Financial Assets-Amortized Cost 56,231 Cash 56,231 1 Cash ($50,000 12% 6/12) 3,000 Financial Assets-Amortized Cost 188 Interest Revenue 2,812 ($56,231 10% 6/12) 31 Interest Receivable 3,000 Financial Assets-Amortized Cost 198 Interest Revenue 2,802 [($56,231 $188) 10% 6/12)] 2012 Jan. 1 Cash 3,000 Interest Receivable 3,000 Cash 3,007 Loss on Sale of Financial Assets 33,507 ($55,845 30/50) 13-4

5 Ex (1) Jan. 1 Financial Assets-Amortized Cost 55,367 Cash 55,367 July 1 Cash ($60,000 8% 6/12) 2,400 Financial Assets-Amortized Cost 368 Interest Revenue($55,367 10% 6/12) 2,768 Cash ($18,000 $400) 17,600 Financial Assets-Amortized Cost 13,934 [($55,367+$368) 15/60] Gain on Sale of Financial Assets 3,666 ($31,500 $29,313 $130 = $2,057) (2) Dec. 31 Interest Receivable 1,800 Financial Assets-Amortized Cost 290 Interest Revenue 2,090 [($55,367+$368) 45/60 10% 6/12)] 13-5

6 Ex a. 1. Investment in Larson Corp. Stock 480,000 Income of Larson Corp. 480,000 Record 40% share of Larson Corp. net profit, $1,200,000 (160,000 shares 400,000 shares). 2. Cash* 320,000 Investment in Larson Corp. Stock 320,000 *160,000 shares $2.00 b. Stieg s investment in Larson Corp. represents 40% of the outstanding shares of Larson Corp. An investment amount between 20% and 50% of the outstanding ordinary share of the investee is presumed to represent significant influence. The equity method is appropriate when the investor can exercise significant influence over the investee. 13-6

7 Ex a Jan. June Dec. 6 Investment in Gator Co. Stock 212,000 Cash 212, Cash* 8,160 Investment in Gator Co. Stock 8,160 *$24,000 34% 31 Loss of Gator Co. 19,040 Investment in Gator Co. Stock 19,040 Record 34% share of Gator Co. net loss, $56,000 34%. b. Initial acquisition cost $212,000 Equity loss for 2014 (19,040) Cash dividends received (8,160) Investment in Gator Co. Stock balance, December 31, 2014 $184,

8 Ex (Concluded) c. Under the equity method, the investor will record their proportionate share of the net increase (or decrease) of the carrying amount of the investee resulting from earnings and dividend distributions. The fair value method uses market price information to value the investment in the investee. These two methods result in different valuations because the equity method is based upon book accounting, while the fair value approach uses market information. The two methods need not be related to each other over time. While changes in book value can influence market prices, many other variables can influence the market price of a stock. Ex a. $6,000 $35,000 [from (c)] $29,000 [from (b)] b. $29,000 $17,000 ( $12,000) c. $35,000 $245,000 $210,000 d. $132,000 $144,000 $12,000 e. $39,000 $28,000 + $11,000 f. $185,000 $168,000 + $17,000 g. $6,000 $17,000 $11,000 h. $211,000 $205,000 + $6,000 i. $273,000 $245,000 + $28,

9 Ex (1) Feb. 5 Cash 8,000 Financial Assets-Trading ( $28,000) 7,000 Gain on Sale of Financial Assets 1,000 Mar. 30 Financial Assets-Trading Brokerage Fees Cash 1,000 Sept. 9 Financial Assets-Trading Brokerage Fees Cash 2,100 (2) Stock Number of Shares Cost Fair Value Carey Ordinary Shares 150 $21,000 $23,700 Adler Preference Shares 400 6,000 5,600 Hill Ordinary Shares ,950 9,000 $38,950 $38,300 Unrealized Loss Trading 650 Financial Assets-Trading Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

10 Ex (1) Jun. 2 Financial Assets-Trading 18,000 Cash 18,000 July 1 Financial Assets-Trading 220,000 Brokerage Fees 1,000 Cash 221, Cash 800 Dividend Revenue 800 Sept. 15 Cash 6,000 Financial Assets-Trading 5,400 Gain on Sale of Financial Assets 600 Dec. 31 Cash 11,000 Interest Revenue 11, Cash 560 Dividend Revenue 560 (2) Portfolio Number Cost Fair Value Dolen Ordinary Shares 280 $12,600 $13,440 Pslo Bonds , ,000 $232,600 $243,440 Financial Assets Trading 10,840 Unrealized Gain Trading 10,

11 Ex (1) Jan. 1 Financial Assets-Trading 9,150 Brokerage Fees 300 Cash 9,450 June 1 Cash (1,500 $.50) 750 Dividend Revenue 750 Sept. 15 Cash ($2,500 $100) 2,400 Loss on Sale of Financial Assets 40 Financial Assets-Trading 2,440 Dec. 1 Cash (1,100 $.50) 550 Dividend Revenue 550 (2) Stock Number of Shares Cost Fair Value Quayle Ordinary Shares 1100 $6,710 $8,800 $6,710 $8,800 Financial Assets Trading 2,090 Unrealized Gain Trading 2,

12 Ex (1) 1) Financial Assets-Non-trading 701,000 Cash 701,000 2) Cash 10,000 Dividend Revenue 10,000 Financial Assets-Non-trading 174,000 Unrealized Gain-Non-trading 174,000 (2) 1) Share Investments 701,000 Cash 701,000 2) Share Investments 60,000 Revenue from Investment ( 300,000 20% = 60,000) 60,000 Cash 20,000 Share Investments ( 100,000 20% = 20,000) 20,

13 Ex (1) 1) Financial Assets-Non-trading 721,000 Cash 721,000 2) Cash 15,000 Dividend Revenue 15,000 Unrealized Gain-Non-trading 21,000 Financial Assets-Non-trading 21,000 (2) 1) Share Investments 721,000 Cash 721,000 2) Share Investments 60,000 Revenue from Investment ( 200,000 30% = 60,000) 60,000 Cash 45,000 Share Investments ( 150,000 30% = 20,000) 45, Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

14 Ex (1) 1) Financial Assets-Non-trading 802,000 Cash 802,000 2) Cash 30,000 Dividend Revenue 30,000 Financial Assets-Non-trading 38,000 Unrealized Gain-Non-trading 38,000 (2) 1) Share Investments 802,000 Cash 802,000 2) Share Investments 80,000 Revenue from Investment ( 400,000 20% = 80,000) 80,000 Cash 40,000 Share Investments ( 200,000 20% = 40,000) 40,

15 Ex Dividend Yield = Cash Dividends per Share of Ordinary Share Market Price per Share of Ordinary Share $2.44 Dividend Yield = = 2.6% $93.49 Ex The investor would receive a return on the investment through share price appreciation as internally generated funds are used to fund growth and earnings opportunities. Thus, investors in ebay would likely approve of this policy, because the company is able to earn superior returns with internally generated earnings beyond what investors could likely earn on their own by investing dividend distributions

16 Appendix Ex CHEWCO CO. For the Year Ended December 31, 2014 Net profit $50,000 Other comprehensive income (loss): Unrealized gain on available-for-sale investments* 24,000 Comprehensive income $74,000 * 2,000 shares ($124 per share $112 per share) 13-16

17 PROBLEMS Prob. 13 1A Mar. 1 Investments Buncombe Co. Bonds 50,000 Interest Receivable 250 Cash 50, Investments French Broad Bonds 84,000 Interest Receivable 175 Cash 84,175 Aug. 1 Cash* 1,500 Interest Receivable 250 Interest Revenue 1,250 *$50,000 6% 1/2 31 Cash* 19,900 Loss on Sale of Investment 200 Interest Revenue 100 Investments Buncombe Co. Bonds 20,000 *($20, ) + $100 Sept. Dec. 1 Cash* 2,100 Interest Receivable 175 Interest Revenue 1,925 *$84,000 5% 1/2 31 Interest Receivable 750 Interest Revenue Interest Receivable 1,400 Interest Revenue 1,

18 Prob. 13 1A (Concluded) 2015 Feb. 1 Cash* 900 Interest Receivable 750 Interest Revenue 150 *$30,000 6% 1/2 Mar. 1 Cash* 2,100 Interest Receivable 1,400 Interest Revenue 700 *$84,000 5% 1/2 2. If the bonds are classified as available-for-sale securities, then the portfolio of bonds would need to be adjusted to fair value. This would be accomplished by using a valuation provision account and an unrealized gain (loss) account as part of equity. If the fair value were greater than the cost of the bond portfolio, the two accounts would be positive, and thus added to investments and equity, respectively. If the fair value were less than the cost of the bond portfolio, the two accounts would be negative, and thus subtracted from investments and equity, respectively

19 Prob. 13 2A Mar. 14 Investments Wilkomm Inc.* 200,500 Cash 200,500 *(5,000 shares $40 per share) + $500 Apr. June 24 Investments McMarsh Inc.* 90,198 Cash 90,198 *(1,800 shares $50 per share) + $198 1 Cash* 98,700 Loss on Sale of Investments 5,560 Investments Wilkomm Inc.** 104,260 *(2,600 shares $38.00 per share) $100 **2,600 shares ($200,500 5,000 shares) 30 Cash* 840 Dividend Revenue 840 *(5,000 shares 2,600 shares) $0.35 Dec. 31 Unrealized Loss on Trading Investments 7,038 Valuation Allowance for Trading Investments* 7,038 * $179,400 $186,438, in table below Number of Cost per Fair Value Fair Shares Share per Share Cost Value Wilkomm Inc. 2,400 1 $40.10 $38 $ 96,240 $ 91,200 McMarsh Inc. 1,800 $ $49 90,198 88,200 Total $186,438 $179,400 1 $200,500 5,000 shares = $40.10 per share 2 $90,198 1,800 shares = $50.11 per share 13-19

20 Prob. 13 2A (Concluded) 2015 Apr. 4 Investments Daley Inc.* 105,175 Cash 105,175 *(3,500 shares $30 per share) + $175 June Sept. Dec. 28 Cash* 960 Dividend Revenue 960 *2,400 shares $0.40 per share 9 Cash* 22,350 Gain on Sale of Investments 1,315 Investments Daley Inc.** 21,035 *(700 shares $32 per share) $50 **700 shares ($105,175 3,500 shares) 31 Valuation Allowance for Trading Investments* 86,460 Unrealized Gain on Trading Investments 86,460 *$7,038 + $79, SCOFIELD FINANCIAL CO. Statement of Financial Position (selected items) December 31, 2015 Current assets: Trading investments (at cost) $270,578 Plus valuation allowance for trading investments 79,422 Trading investments (at fair value) $350, Unrealized gains or losses are reported on the statement of comprehensive income, often as Other Income (Losses). For 2014, Scofield Financial Co. would have reported an unrealized loss of $7,038 as Other Losses. For 2015, Scofield Financial Co. would have reported an unrealized gain of $86,460 as Other Income. If unrealized gains and losses were significant for Scofield Financial, then they would be separately disclosed on the statement of comprehensive income

21 Prob. 13 3A Feb. 1 Investments Acuity Inc.* 324,000 Cash 324,000 *12,000 shares $27 per share Mar. Sept. 18 Cash* 2,160 Dividend Revenue 2,160 *12,000 shares $0.18 per share 12 Cash* 2,880 Dividend Revenue 2,880 *12,000 shares $0.24 per share 28 Cash* 20,950 Loss on Sale of Investments 6,050 Investments Acuity Inc.** 27,000 *(1,000 shares $21.00) $50 **1,000 shares $27 per share Dec Jan. Mar. 31 Valuation Allowance for Available-for- Sale Investments 66,000 Unrealized Gain (Loss) on Available-for- Sale Investments 66,000 11,000 shares ($33.00 $27.00). 23 Investment in Shouse Inc. Stock 376,000 Cash 376, Cash* 2,640 Dividend Revenue 2,640 *(12,000 shares 1,000 shares) $0.24 per share 13-21

22 Prob. 13 3A (Concluded) Sept. 16 Cash* 3,300 Dividend Revenue 3,300 *11,000 shares ($ $0.06) Dec. 31 Cash 30,100 Investment in Shouse Inc. Stock 30, Investment in Shouse Inc. Stock 53,200 Income of Shouse Inc. 53,200 To record 28% of Shouse Inc. income $190,000 (70,000 shares 250,000 shares). 31 Unrealized Gain (Loss) on Available-for- Sale Investments 33,000 Valuation Allowance for Available-for- Sale Investments* 33,000 *($30.00 $33.00) 11,000 shares 2. DAFFITAR INC. Statement of Financial Position (selected items) December 31, 2015 Current assets: Available-for-sale investments (at cost) 1 $297,000 Plus valuation allowance for available-forsale investments 33,000 Available-for-sale investments (at fair value) 2 $330,000 Investments: Investment in Shouse Inc. stock 3 $399,100 Equity: Retained earnings $465,000 Unrealized gain (loss) on available-for-sale investments 33, ,000 shares $27 per share 2 11,000 shares $30 per share 3 $376,000 + $53,200 $30,

23 Prob. 13 4A a. $236,170 (see table below) b. $(5,800) ($230,370 $236,170, from table) c. $230,370 (from table) Market Cost per Value per No. of Share (or Share (or Shares (or $100 of $100 of Total Fair Investments face amount) face amount) face amount) Cost Value Bernard Co. stock 2,250 $17.00 $15.40 $ 38,250 $ 34,650 Chadwick Co. stock 1, ,520 57,960 Gozar Inc. stock 3, ,400 98,560 Nightline Co. bonds $40, ,000 39,200 $236,170 $230,370 d. $600 ($40,000 6% 3/12) e. $98,100 [$77,000 + ($112,000 30%) $12,500] f. $813,960 ($233,000 + $136,530 + $230,730 + $600 + $98,100 + $115,000) g. $454,930 ($308,700 + $146,230) h. $(5,800) [same as (b)] i. $843,530 ($69,400 + $70,000 + $255,000 + $454,930 $5,800) 13-23

24 Prob. 13 4A (Continued) The completed comparative unclassified statement of financial positions are as follows: O'BRIEN INDUSTRIES, INC. Statement of Financial Position December 31, 2015 and 2014 Dec. 31, Dec. 31, Office equipment (net) $115,000 $130,000 Investment in Jolly Roger Co. stock Note 2 98,100 77,000 Interest receivable 600 Available-for-sale investments (at cost) Note 1 $236,170 $103,770 Less valuation allowance for available-for-sale investments 5,800 2,500 Available-for-sale investments (fair value) $230,370 $101,270 Accounts receivable (net) 136,530 $138,000 Cash $233,000 $220,000 Total assets $813,600 $666,270 Accounts payable $ 69,400 $ 60,000 Share Capital Ordinary 70,000 70,000 Excess of issue price over par 225, ,000 Retained earnings 455, ,770 Unrealized gain (loss) on available-for-sale investments (5,800) 2,500 Total liabilities and equity $813,600 $666,270 Note 1. Investments are classified as available for sale. The investments at cost and fair value on December 31, 2014, are as follows: No. of Cost per Total Total Fair Shares Share Cost Value Bernard Co. stock 2,250 $17.00 $ 38,250 $ 37,500 Chadwick Co. stock 1, ,520 63,770 $103,770 $101,

25 Prob. 13 4A (Concluded) For December 31, 2015: Market Cost per Value per No. of Share (or Share (or Shares (or $100 of $100 of Total Fair face amount) face amount) face amount) Cost Value Bernard Co. stock 2,250 $17.00 $15.40 $ 38,250 $ 34,650 Chadwick Co. stock 1, ,520 57,960 Gozar Inc. stock 3, ,400 98,560 Nightline Co. bonds $40, ,000 39,200 $236,170 $230,370 Note 2. The investment in Jolly Roger Co. stock is an equity method investment representing 30% of the outstanding shares of Jolly Roger Co

26 Prob. 13 1B Jan. 18 Investments Malmo Inc.* 360,000 Cash 360,000 *9,000 shares $40 per share July Oct. Dec. 22 Cash* 27,000 Dividend Revenue 27,000 *9,000 shares $3.00 per share 5 Cash* 28,900 Gain on Sale of Investments 8,900 Investments Malmo Inc.** 20,000 *(500 shares $58.00) $100 **500 shares $40 per share 18 Cash* 25,500 Dividend Revenue 25,500 *(9,000 shares 500 shares) $ Unrealized Gain (Loss) on Available-for- Sale Investments 34,000 Valuation Allowance for Available-for- Sale Investments 34,000 8,500 shares ($36.00 $40) Jan. July 25 Investment in Helsi Co. Stock 800,000 Cash 800, Cash* 25,500 Dividend Revenue 25,500 *8,500 shares $3.00 per share 13-26

27 Prob. 13 1B (Concluded) Dec. 16 Cash* 27,200 Dividend Revenue 27,200 *8,500 shares ($ $0.20) 31 Cash 38,000 Investment in Helsi Co. Stock 38, Investment in Helsi Co. Stock 51,000 Income of Helsi Co. 51,000 To record 30% of Helsi Co. income $170,000 (75,000 shares 250,000 shares). 31 Valuation Allowance for Available-for- Sale Investments* 68,000 Unrealized Gain (Loss) on Available-for- Sale Investments 68,000 *8,500 ($44 $36.00) 2. GLACIER PRODUCTS, INC. Statement of Financial Position (selected items) December 31, 2015 Current assets: Available-for-sale investments (at cost) 1 $340,000 Plus valuation allowance for available-forsale investments 8,500 Available-for-sale investments (at fair value) 2 $374,000 Investments: Investment in Helsi Co. stock 3 $813,000 Equity: Retained earnings $700,000 Unrealized gain (loss) on available-for-sale investments 34, ,500 shares $40 per share 2 8,500 shares $44 per share 3 $800,000 + $51,000 $38,

28 1. a. Cash 450,000 Share Capital Ordinary 300,000 Share Premium Ordinary 150,000 b. Cash 400,000 Share Capital Preference 320,000 Share Premium Preference 80,000 c. Cash* 520,000 Bonds Payable 500,000 Premium on Bonds Payable 20,000 *$500, d. Cash Dividends* 50,000 Cash Dividends Payable 50,000 *100,000 shares $0.50 per share Cash Dividends* 20,000 Cash Dividends Payable 20,000 *20,000 shares $1.00 per share e. Cash Dividends Payable 70,000 Cash 70,000 f. Investments Solstice Corp.* 300,150 Cash 300,150 *(7,500 shares $40 per share) + $150 g. Treasury Share* 264,000 Cash 264,000 *8,000 shares $33 per share h. Investment in Pinkberry Co. Stock* 960,000 Cash 960,000 *40,000 shares $24 per share COMPREHENSIVE PROBLEM

29 Comp. Prob. 4 (Continued) i. Cash Dividends 20,000 Cash Dividends Payable 20,000 j. Cash Dividends Payable 20,000 Cash 20,000 k. Cash 27,500 Investment in Pinkberry Co. Stock 27,500 l. Investments Dream Inc. Bonds 90,000 Interest Receivable 375 Cash 90,375 m. Cash* 98,800 Treasury Share** 85,800 Share Premium from Sale of Treasury Share 13,000 * 2,600 shares $38 per share ** 2,600 shares $33 per share n. Cash* 4,500 Dividend Revenue 4,500 * 7,500 shares $0.60 per share o. Cash* 45,000 Gain on Sale of Investment 4,980 Investments Solstice Corp.** 40,020 * 1,000 shares $45.00 per share ** 1,000 shares ($300,150 7,500 shares) 13-29

30 Comp. Prob. 4 (Continued) p. Interest Expense 11,500 Premium on Bonds Payable 1,000 Cash 12,500 Computations: Semiannual interest payment ($500,000 5% 1/2) $12,500 Less amortization premium [($20, years) 1/2] 1,000 Interest expense $11,500 q. Interest Receivable 1,125 Interest Revenue 1,125 Interest accrued for three months. Computation: $90,000 5% 3/12 = $1,125 r. Investment in Pinkberry Co. Stock* 76,800 Income from Pinkberry Co. 76,800 Recorded 32% share of Pinkberry Co. net profit. * $240,000 32%, 32% = 40,000 shares 125,000 shares s. Unrealized Gain (Loss) on Available-for-Sale Investments 6,500 Valuation Allowance for Available-for-Sale Investments 6,500 6,500 shares ($39.02 $40.02*). * $40.02 = $300,150 7,500 shares 13-30

31 Comp. Prob. 4 (Continued) 2. a. EQUINOX PRODUCTS INC. Statement of Comprehensive Income For the Year Ended December 31, 2014 Sales $5,254,000 Cost of goods sold 3,700,000 Gross profit $1,554,000 Operating expenses: Selling expenses: Sales salaries expense $385,000 Sales commissions 185,000 Advertising expense 150,000 Depreciation expense store buildings and equipment 100,000 Delivery expense 30,000 Store supplies expense 21,000 Miscellaneous selling expense 14,000 $885,000 Administrative expenses: Office salaries expense $170,000 Office rent expense 50,000 Depreciation expense office buildings and equipment 30,000 Office supplies expense 10,000 Miscellaneous administrative expense 7, ,500 Total operating expenses 1,152,500 Operating profit $ 401,500 Other expenses and income: Dividend revenue $ 4,500 Interest revenue 2,720 Income from Pinkberry Co. investment 76,800 Gain on sale of investment 4,980 Interest expense -21,000 68,000 Profit before income tax $ 469,500 Income tax 140,500 Net profit $ 329,000 Earnings per common share: Net profit* $2.29 * ($329,000 $100,000 preferred dividends) 100,000 common shares, rounded 13-31

32 Comp. Prob. 4 (Continued) b. EQUINOX PRODUCTS INC. Retained Earnings Statement For the Year Ended December 31, 2014 Retained earnings, January 1, 2014 $9,319,725 Net profit for year $329,000 Less cash dividends: Common $155,120 Preferred 100, ,120 Increase in retained earnings 73,880 Retained earnings, December 31, 2014 $9,393,605 c. EQUINOX PRODUCTS INC. Statement of Financial Position For the Year Ended December 31, 2014 Assets Current assets: Available-for-sale investments $ 260,130 Less valuation allowance for available-for-sale investment 6,500 $ 253,630 Accounts receivable $ 545,000 Less provision for doubtful accounts 8, ,550 Inventory, at lower of cost (FIFO) or market 778,000 Interest receivable 1,125 Prepaid expenses 27,400 Cash 246,000 Total current assets $ 1,842,705 Investments: Investment in Pinkberry Co. stock 1,009,300 Investment in Dream Inc. bonds 90,000 Property, plant, and equipment: Store buildings and equipment $12,560,000 Less accumulated depreciation 4,126,000 $8,434,000 Office buildings and equipment $ 4,320,000 Less accumulated depreciation 1,580,000 2,740,000 Total property, plant, and equipment 11,174,000 Intangible assets: Goodwill 500,000 Total assets $14,616,

33 Comp. Prob. 4 (Concluded) EQUINOX PRODUCTS INC. Statement of Financial Position For the Year Ended December 31, 2014 Equity Share Capital: Share capital Preference 5%, $80 par (30,000 shares authorized; 20,000 shares issued) $1,600,000 Excess of issue price over par 150,000 $ 1,750,000 Share Capital Ordinary, $20 par (400,000 shares authorized; 100,000 shares issued, 94,600 shares outstanding) $2,000,000 Excess of issue price over par 886,800 2,886,800 From sale of treasury share 13,000 Total paid-in capital $ 4,649,800 Retained earnings 9,393,605 Unrealized gain (loss) on availablefor-sale investments -6,500 Total $14,036,905 Deduct treasury Share Capital Ordinary (5,400 shares at cost) 178,200 Total equity 13,858,705 Liabilities Non-current liabilities: Bonds payable, 5%, due 2022 $ 500,000 Add premium on bonds payable 19, ,000 Current liabilities: Accounts payable $ 194,300 Income tax payable 44,000 Total current liabilities $ 238,300 Total liabilities $ 757,300 Total liabilities and equity $14,616,

34 CASES & PROJECTS CP Under generally accepted accounting principles, the land would be reported at $350,000 for Wyatt Corp. and $2,000,000 for TexoPete Inc. These valuations reflect their historical costs. 2. The historical cost valuation reduces the ability to compare the two companies. In this scenario, both companies have nearly identical land holdings. Wyatt Corp. purchased its land in 1996; thus, the land is valued according to a 1996 valuation. TexoPete Inc., purchased its land in 2014, reflecting a more current valuation. Thus, both companies have a similar asset; however, the balance sheet reports very different valuations (Wyatt s valuation is approximately 17.5% of TexoPete s). Therefore, comparability is reduced. If the land were valued at fair value, then both companies would report the land at nearly identical valuations, which is a better reflection of reality. CP There is an emerging trend toward more uniform accounting standards worldwide. This is caused by companies participating in multiple capital markets. For example, many companies not only have their stock trade on the New York Stock Exchange, but might also have their stock trade in London or Japan. In these cases, companies must provide financial reports that conform to the laws of the country in which their stock trades. Lack of accounting uniformity causes unnecessary reporting expenses for companies that wish to broaden the market for their stock worldwide, while making financial statements less comparable for users around the world. Thus, the United States and the European Union are working to align their financial accounting standards. When the International Accounting Standards Board (IASB, European Union) releases a standard such as IAS No. 16, it influences U.S. GAAP. In this case, the United States does not embrace IAS No. 16, so it is not U.S. GAAP. However, as the United States and Europe work to converge standards, we might see the substance of IAS No. 16 reflected in a future FASB pronouncement. 2. Fair value reporting for property, plant, and equipment is a very aggressive fair value position. This is because property, plant, and equipment fair values are usually very subjective. Given this subjectivity, there is concern that the reported statement of financial position amounts for property, plant, and equipment would be subject to manipulation and possible abuse. Moreover, the lack of objective fair values for these types of assets could reduce the comparability of financial statements across companies, depending on the subjective assumptions selected in the valuation

35 CP 13 2 (Concluded) 3. The accounting treatment for increases in fair value for property, plant, and equipment under International Accounting Standards is similar to the treatment for unrealized gains and losses from available-for-sale investments. Increases in fair value bypass the statement of comprehensive income and are reported directly in equity. Thus, increases in property, plant, and equipment fair values would not be reported in earnings. Decreases in fair value are reported on the Statement of comprehensive income as an expense. Statement of comprehensive income treatment is similar to the treatment for unrealized gains and losses from trading securities. If the property, plant, and equipment fair value declines, the statement of comprehensive income impact of this decline is fully disclosed. CP 13 3 Since many complex and exotic investment vehicles do not have ready market values, management must value these investments using mathematical models, subjective inputs, and risk assessments. These mathematically determined valuations are subject to wide variation, depending on the assumptions. Therein lies the ethical challenge. Since the valuation is subjective, it is possible for managers to over- or underestimate fair values to meet their personal objectives. Moreover, the ability for auditors to verify these values independently is difficult, since there is a lack of agreed-upon objectivity. CP Look-through earnings is a Warren Buffett term. It is the GAAP net profit plus an adjustment for the equity earnings (the forgotten-but-not-gone" earnings) in investments where less than 20% of the outstanding shares are owned. Thus, look-through earnings would be significantly greater than GAAP net profit for a company that held a large portfolio of these types of investments (which Berkshire does). These are supplemental disclosures that Buffet provides his shareholders in addition to GAAP disclosures. Essentially, he is treating these investments as if they were being accounted for under the equity method. 2. Buffett makes the case that there is no reason for the equity method to be used only for 20% 50% investees, but that the rationale for the equity method applies equally well for investments of less than 20%. Thus, Berkshire Hathaway provides an additional non-gaap disclosure to its investors, which essentially adds the after-tax equity earnings of its less than 20% investees to its net profit. In so doing, Buffett argues that the earning power of all of his investments is properly disclosed in look-through earnings. He argues that the dividends that he receives from his less than 20%-owned investees do not reflect the earning power of his investment, even though that is what is required by GAAP

36 CP 13 5 The following are portions of Notes 3 and 4 from the financial statements dated June 30, 2011, for Microsoft. Investment Components, Including Associated Derivatives NOTE 4 INVESTMENTS Cash Equity and Cost Unrealized Unrealized Recorded and Cash Short-Term Other (In millions) Basis Gains Losses Basis Equivalents Investments Investments June 30, 2011 Cash $ 1,648 $ $ $ 1,648 $1,648 $ $ Mutual funds 1,752 1,752 1,752 Commercial paper Certificates of deposit U.S. Government and Agency securities 33, (7) 33,762 2,049 31,713 Foreign government bonds (2) Mortgage-backed securities 2, (4) 2,424 2,424 Corporate notes and bonds 10, (11) 10,824 3,375 7,449 Municipal securities (2) Ordinary and preference share 7,925 2,483 (193) 10,215 10,215 Other investments Total $60,804 $3,052 $(219) $63,637 $9,610 $43,162 $10,

37 CP 13 5 (Concluded) NOTE 3 OTHER INCOME (EXPENSE) The components of other income (expense) were as follows: (In millions) Year Ended June 30, Dividends and interest $ 900 $ 843 $ 744 Net recognized gains (losses) on investments (295) (151) (38) Net gains (losses) on derivatives (125) Net gains (losses) on foreign currency (77) (140) (558) remeasurements (26) 1 (509) Other (31) 14 (56) Total $ 910 $ 915 $(542) Note to Instructors: This solution is provided as a guide. Students may have different numbers, depending on the date of the financial statements. Answers in millions. 1. $60, $63,637 (termed, recorded basis by Microsoft) $3,052 ($219) 5. a. $9,610 $63,637 = 15.1% b. $43,162 $63,637 = 67.8% c. $10,865 $63,637 = 17.1% 6. $ ($295) 13-37