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CORPORATE FINANCIAL REPORTING

13 – Financial Reporting of Investments (revisited). CORPORATE FINANCIAL REPORTING. Reporting investments is a continuum based on some measure of influence over the investee: We can own: 1 share 50% 100% of shares

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CORPORATE FINANCIAL REPORTING

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  1. 13 – Financial Reporting ofInvestments (revisited) CORPORATE FINANCIAL REPORTING Long-Lived Assets

  2. Reporting investments is a continuum based on some measure of influence over the investee: We can own: 1 share 50% 100% of shares passive investoractive investor market equity consolidated value method financial statements INVESTMENT IN THE STOCK OF ANOTHER COMPANY Financial Reporting of Investments

  3. The “theory”. THE EQUITY METHOD Investments

  4. On Jan. 2, 2011, Co. A acquires 25% of Co. B’s stock from B’s stockholders for $28,000 cash. Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities before acquiring B’s assets/liabilities: BookValueMarket Value cash $ 200,000 cash $ 1,000 $ 1,000 acct. rec. 300,000 acct. rec. 8,000 8,000 inventory 500,000 inventory 12,000 15,000 PPE 900,000 PPE 110,000 90,000 accum. deprec (300,000) accum. deprec (30,000) patent 1,000 patent 1,000 0 trademark 3,000trademark - 2,000 $1,604,000$102,000$116,000 liabilities 100,000 liabilities 10,000 $ 10,000 com. stock 300,000 com. stock 30,000 APIC 350,000 APIC 35,000 ret. earnings 854,000ret. earnings 27,000 $1,604,000$102,000 THE EQUITY METHOD Investments

  5. What would appear in Co. A’s financial statements? Then Co. A’s accountant would ask “Why did we pay so much?” THE EQUITY METHOD Investments

  6. A’s balance sheet after acquiring B’s stock: cash $ 172,000 acct. rec. 300,000 inventory 500,000 PPE 900,000 accum. deprec (300,000) Invest. in Co. B 28,000 patent 1,000 trademark 3,000 trade secret - $1,604,000 liabilities 100,000 com. stock 300,000 APIC 350,000 ret. earnings 854,000 $1,604,000 THE EQUITY METHOD Investments

  7. A’s balance sheet after acquiring B’s stock: cash $ 172,000 acct. rec. 300,000 inventory 500,000 25% of B’s OE 23,000 PPE 900,000 trademark 500 accum. deprec (300,000) patent ( 250) Invest. in Co. B 28,000 PPE 2,500 patent 1,000 inventory 750 trademark 3,000 goodwill 1,500 trade secret -28,000 $1,604,000 liabilities 100,000 com. stock 300,000 APIC 350,000 ret. earnings 854,000 $1,604,000 THE EQUITY METHOD Investments

  8. On 12/31/2011, Co. B reports $6,000 of net income and pays $1,500 in dividends. What journal entries will Co. A make? To answer this we need think about the Investment in Co. B account the way an accountant does. THE EQUITY METHOD Investments

  9. Company A wants to expand – two common ways of doing that are: (1) buying Company B’s assets and assuming its liabilities and (2) buying enough stock in Company B (in the U.S. > 50% ownership). TWO COMMON WAYS TO OBTAIN CONTROL Investments

  10. ACCOUNTING METHOD TO USE: ACTIVE INVESTMENT Equity method control (in US) Consolidate 50% 100% of stock | | EQUITY INVESTMENTS Investments

  11. 1. If Co. A buys Co. B’s assets and liabilities, this is what happens: Owners of A Owners of B Co. A Co. B assets/liabilities BUY B’S ASSETS/LIABILITIES Investments

  12. 1. Afterwards, this is what we have: Owners of A Owners of B Co. A Co. B lots oflots of assets liabilities BUY B’S ASSETS/LIABILITIES Investments

  13. Co. A pays $135,000 to Co. B’s owners to buy 90% of Co. B’s stock; the fair value of the remaining 10% of Co. B’s stock is $12,000.Assume the following is A’s balance sheet Assume the following values for B’s assets/liabilities before acquiring B’s stock: BookValueMarket Value cash $ 200,000 cash $ 1,000 $ 1,000 acct. rec. 300,000 acct. rec. 8,000 8,000 inventory 500,000 inventory 12,000 15,000 PPE 900,000 PPE 110,000 90,000 accum. deprec (300,000) accum. deprec (30,000) patent 2,000 patent 1,000 0 trademark 3,000trademark - 2,000 $1,605,000$102,000$116,000 liabilities 100,000 liabilities 10,000 $ 10,000 com. stock 300,000 com. stock 30,000 APIC 350,000 APIC 35,000 ret. earnings 855,000ret. earnings 27,000 $1,605,000$102,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  14. This is what happened: Owners of A Owners of B $135,000 90% Co. Co. A BstockCo. B What will Co. A’s journal entry look like? BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  15. This is “after”: Owners of A Owners of B 10% owners Co. A 90% owner Co. B BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  16. A’s balance sheet after the transaction: cash $ 65,000 liabilities 100,000 acct. rec. 300,000 inventory 500,000 com. stock 300,000 Invest. in B stock 135,000 APIC 350,000 PPE 900,000 ret. earnings 855,000 accum. deprec (300,000) $1,605,000 patent 2,000 trademark 3,000 $1,605,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  17. B’s balance sheet after the transaction: cash $ 1,000 acct. rec. 8,000 inventory 12,000 PPE 110,000 accum. deprec (30,000) patent 1,000 trademark - $102,000 liabilities 10,000 com. stock 30,000 APIC 35,000 ret. earnings 27,000 $102,000 BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  18. Then A’s accountant asks a similar question: “Why is Co. B valued so highly?” The answer lies in a previous slide and our previous thought process,but with a modification. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  19. FASB (and International Accounting Standards) says that if one company controls another company the controlling company needs to do something more than use the equity method. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  20. What we have: Owners of A F/S Co. A “Old” Owners of B 90% 10% F/S Co. B BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  21. What FASB also wants: Owners of A F/S Co. A consolidated F/S F/S Co. B BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  22. What appears in the consolidated balance sheet are the assets and liabilities that Co. A controls, directly and indirectly (which would include Co. B’s assets and liabilities). BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  23. And the key is - the Investment in B Stock account on Co. A’s balance sheet really represents control of Co. B’s assets and liabilities BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  24. A’s balance sheet after the transaction: cash $ 65,000 liabilities 100,000 acct. rec. 300,000 com. stock 300,000 inventory 500,000 APIC 350,000 Invest. in B stock 135,000 ret. earnings 855,000 PPE 900,000 $1,605,000 accum. deprec (300,000) cash 1,000 patent 2,000 acct. rec. 8,000 trademark 3,000inventory 15,000 PPE 90,000 $1,605,000patent 0 trademark 2,000 goodwill 41,000 liabilities (10,000) BUYING CO. B’s STOCK – A Consolidation Example

  25. So, Co. A’s consolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock. BUYING CO. B’s STOCK – A Consolidation Example Consolidated Financial Statements

  26. A’s consolidated Balance Sheet: cash $ 66,000 liabilities 110,000 acct. rec. 308,000 inventory 515,000 Invest. in B stock - com. stock 300,000 PPE 990,000 APIC 350,000 accum. deprec. (300,000) ret. earnings 855,000 patent 2,000 $1,615,000 trademark 5,000 goodwill 41,000 $1,627,000 BUYING CO. B’s STOCK – A Consolidated Balance Sheet Consolidated Financial Statements

  27. A’s consolidated Balance Sheet: cash $ 66,000 liabilities 110,000 acct. rec. 308,000 inventory 515,000 Invest. in B stock - com. stock 300,000 PPE 990,000 APIC 350,000 accum. deprec. (300,000) ret. earnings 855,000 patent 2,000 $1,615,000 trademark 5,000 WHAT?? goodwill 41,000 $1,627,000 BUYING CO. B’s STOCK – A Consolidated Balance Sheet Consolidated Financial Statements

  28. A’s consolidated Balance Sheet: cash $ 66,000 liabilities 110,000 acct. rec. 308,000 inventory 515,000 N.C.I. * 12,000 Invest. in B stock - com. stock 300,000 PPE 990,000 APIC 350,000 accum. deprec. (300,000) ret. earnings 855,000 patent 2,000 $1,627,000 trademark 5,000 WHEW! goodwill 41,000 $1,627,000 * NONCONTROLLING INTEREST IN NET ASSETS OF SUBSIDIARY BUYING CO. B’s STOCK – A Consolidated Balance Sheet Consolidated Financial Statements

  29. One year later, these were the income statements for A and B: A B Sales revenue $200,000 $70,000COGS ( 80,000) ( 36,000)Deprec. exp. ( 45,000) ( 5,500)Pat. amort. exp. ( 400) ( 200)Other exp. ( 14,600)( 7,800)Net income $ 60,000$20,500 and B paid $10,000 in cash dividends. What entries would A’s accountant make (assuming A uses the equity method)? BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  30. A’s income statement that it would issue to thepublic (IF it issued a non-consolidated income statement): Sales revenue $200,000 COGS ( 80,000) Deprec. exp. ( 45,000) Pat. amort. exp. ( 400)Other expenses ( 14,600)Equity income 15,030Net income $ 75,030 BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  31. What would appear in A’sconsolidated Income Statement: Sales revenue $270,000 COGS (119,000) Deprec. exp. ( 51,500) Pat. amort. exp. ( 400) Other exp. ( 22,400)Equity income --Consol. net income $ 76,700 Net income to N.C.I ( 1,670) Net income to Co. A $ 75,030 BUYING CO. B’s STOCK – A Consolidated Income Statement Consolidated Financial Statements

  32. Co. A’s accountant also must prepare a consolidated owners’ equity statement and a consol-idated cash flow statement. BUYING CO. B’s STOCK – An Example Consolidated Financial Statements

  33. ? QUESTIONS Consolidated Financial Statements

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