After completing this chapter you should be able to: Distinguish between debt and equity securities and between short-term and long-term investments, describe how to report equity securities with controlling influence, compute and analyze the components of return on total assets,...
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 McGrawHill/Irwin Copyright © 2011 by The McGrawHill Companies, Inc. All rights reserved 15 2 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 15 3 C1 Short-Term Investments Short-term investments are securities that: • Management intends to convert to cash within one year or the operating cycle, whichever is longer • Are readily convertible to cash Short-term investments not include cash equivalents Cash equivalents are investments that are both readily converted to known amounts of cash and mature within three months 15 4 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 15 5 C1 Debt Securities versus Equity Securities 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 6 C1 Classification and Reporting Accounting Accounting for for Investments Investments depends depends on on some some or or all all of of the the following following factors: factors: 11 purpose, purpose, e.g e.g trading trading or or long-term long-term investment, investment, the the company’s company’s intent intent to to hold hold the the security security either either short-term short-term or or long-term, long-term, 2 its its contractual contractual characteristics, characteristics, e.g e.g debt debt or or equity, equity, 3 whether whether itit is is listed listed on on an an exchange, exchange, 4 the the industry industry in in which which the the reporting reporting entity entity operates, operates, and and 5 the the accounting accounting policy policy choice choice of of the the reporting reporting entity entity 15 7 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 15 8 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 15 9 P1 Held-for-Trading Securities When Nestlé’s fiscal year ends on December 31, 2010, 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 15 10 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 15 20 P4 Investments in Equity with significant influence 15 21 C2 INVESTMENTS IN EQUITY WITH CONTROL equired when investor’s ownership exceeds 50% of 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 15 22 C1 Accounting Summary for Investments in Securities 15 23 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 15 24 A1 Components of Return on Total Assets Return on total assets Net income Average total assets = = Profit margin Net income Net sales Total asset turnover × × Net sales Average total assets 15 25 A1 Return on Total Assets Here are the returns on total assets and its components for Gap, Inc for the years 2005 through 2009: 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 15 26 C3 Appendix15A: Investments in International Operations Two major accounting challenges arise when companies have international operations: Accounting Accounting for for sales sales and and purchases purchases listed listed in in aa foreign foreign currency currency Preparing Preparing consolidated consolidated financial financial statements statements with with international international subsidiaries subsidiaries 15 27 C3 Exchange Rates Between Currencies Each country uses its own currency for internal economic transactions To make transactions in another country, units of that country’s currency must be acquired The cost of those currencies is called the exchange rate 15 28 C3 Sales in a Foreign Currency Boston Company, a U.S.-based manufacturer makes a credit sale to London Outfitters, a British retail company On December 12, 2010, Boston sells £10,000 with payment due on February 10, 2011 Boston keeps its record in U.S dollars At the date of sale, the British pound is valued at $1.80 £10,000 × $1.80 = $18,000 15 29 C3 Sales in a Foreign Currency Boston Company is a December 31, year-end company On December 31, 2010, the British pound has an exchange rate of $1.84 The dollar value of the account receivable from London is $18,400 on this date The receivable is to valued on the balance sheet at it current dollar amount Accounts Receivable – London Outfitters Date 12/12/10 Sale 12/31/10 Explanation Adjustment for foreign currency Debit Credit Balance 18,000 18,000 400 18,400 15 30 C3 Sales in a Foreign Currency On February 10, 2011, Boston receives London Outfitters’ payment of £10,000 Boston immediately exchanges the pounds for U.S dollars The exchange rate on this date is $1.78 per pound, so Boston receives $17,800 for the £10,000 received in settlement Accounts Receivable – London Outfitters Date Explanation 12/12/10 Sale 12/31/10 Adjustment for foreign currency Debit Credit 18,000 400 Balance 18,000 18,400 15 31 C3 Purchases in a Foreign Currency NC Imports, a U.S company, purchases products costing €20,000 from Hamburg Brewing on January 15, when the exchange rate is $1.20 per euro €20,000 × $1.20 = $24,000 15 32 C3 Purchases in a Foreign Currency NC Imports makes payment in full on February 14 when the exchange rate is $1.25 per euro €€20,000 20,000 ×× $1.25 $1.25 == $25,000 $25,000 15 33 C3 Consolidated Statements with International Subsidiaries Consider a U.S.-based company that owns a controlling interest in a French company The reporting currency of the U.S company is the dollar The French company maintains its books in Euros Before preparing consolidated statements, the U.S company must translate the French company’s statements into dollars The process requires the parent company to select appropriate foreign exchange rates and to apply those rates to the foreign subsidiary’s account balances Translate Account Balances 15 34 End of Chapter 15 ... Short-term investments not include cash equivalents Cash equivalents are investments that are both readily converted to known amounts of cash and mature within three months 15 4 C1 Long-Term Investments. .. 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... longer than a year and decided to treat it as an available-for-sale (AFS) investment 15 13 P2 Available-for-Sale Securities Assume that at year-end, the fair market value of Y Corp’s shares