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Module 7

Module 7. Reporting and Analyzing Intercorporate Investments. Intercorporate Investments. Accounting Treatment and Financial Statement Effects. Passive Investments -Market Method. Initially record at purchase price (fair market value on purchase date)

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Module 7

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  1. Module 7 Reporting and Analyzing Intercorporate Investments

  2. Intercorporate Investments

  3. Accounting Treatment and Financial Statement Effects

  4. Passive Investments -Market Method • Initially record at purchase price (fair market value on purchase date) • Gain (loss) on sale = Proceeds – Book value of investment • During holding period, investment is recorded at current market value (“marked-to-market”)

  5. Are Changes in Asset Value Income? • Changes in the carrying amount of the investment (asset) has a corresponding effect on equity: Assets  = Liabilities + Equity  • Is the change in equity is income? • The answer depends on the investment classification.

  6. Financial Statement Effects

  7. Google’s Footnote

  8. Cisco’s Footnote Investments are reported on Cisco’s balance sheet at $14,517 million.

  9. Held To Maturity Investments

  10. Equity Method Investments • Investments are recorded at their purchase cost. • Dividends received are treated as a recovery of the investment. • The investor reports income equal to its percentage share of the investee’s reported income. • Changes in market value do not affect the investment’s carrying value.

  11. Equity Method Accounting Following are the balance sheet and income statement impacts for the preceding transactions:

  12. Investments with Control — Consolidation Accounting • Google’s footnote on consolidated entities: • Consolidation accounting replaces the investment balance with the assets and liabilities to which it relates, and it replaces the equity income reported by the investor company with the sales and expenses of the investee company to which it relates.

  13. Consolidation Accounting

  14. GE’s Consolidating Balance Sheet

  15. CAT’s Consolidating Balance Sheet

  16. 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.

  17. 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. Further assume that 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:

  18. 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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