Motivations for Intercorporate
Investments
 As a temporary investment of excess cash
 As part of a long-term risk-adjusted
portfolio
 Expectations of dividends and gains
 As a strategic investment
 To develop relationships with suppliers and
customers
 To gain access to new product or geographic
markets
 To facilitate activity along a supply chain
©Cambridge Business Publishing, 2010
1
2
Investments on the Balance Sheet
Coca-Cola Company reported the following investments at
December 31, 2007 and 2008 (in millions):
Assets
Current Assets
Cash and cash equivalents
Marketable securities
Trade accounts receivable, less allowances of $51 and
$56, respectively
Inventories
Prepaid expenses and other assets
Total Current Assets
Investments
Equity method investments:
Coca-Cola Hellenic Bottling Company, S.A.
Coca-Cola FEMSA, S.A.B. de C.V.
Coca-Cola Amatil Limited
Coca-Cola Enterprises, Inc.
Other, principally bottling companies and joint ventures
Other investments,,principally bottling companies
Total Investments
©Cambridge Business Publishing, 2010
2008
2007
$4,701
278
$4,093
215
3,090
2,187
1,920
$12,176
3,317
2,220
2,260
$12,105
$1,487
877
638
2,314
463
$5,779
$1,549
996
806
1,637
2,301
488
$7,777
3
Note Disclosure of Investments
Coca-Cola Company reported the following in Footnote 10
of its 2008 annual report:
The Coca-Cola Company, Footnote 10, 2008 Annual Report
Gross Unrealized
Estimated
2008 (in millions)
Cost
Gains
Losses Fair Value
Trading securities
Equity Securities
$74
$ ($30)
$ 44
Other securities
7
(2)
5
$81
$ ($32)
$ 49
Available-for-sale securities:
Equity securities
$329
$193
($7)
$515
Other securities
12
(5)
7
$341
$193
($12)
$522
Held-to-maturity securities:
Bank and corporate debt
$74
$
$
$74
©Cambridge Business Publishing, 2010
4
Coca-Cola’s Investments
 Marketable securities
 Includes trading, available-for-sale, and cost
method investments
 Equity method investments
 Investments for which Coca-Cola intends to
exert significant influence over operations
 Coca-Cola’s equity method investments
 35% interest in Coca-Cola Enterprises Inc.
 23% interest in Coca-Cola Hellenic
 32% interest in Coca-Cola FEMSA
 30% interest in Coca-Cola Amatil
©Cambridge Business Publishing, 2010
5
Coca-Cola’s Investments
 Joint ventures
 Investments for which Coca-Cola and at least
one other company share ownership interest
and jointly control a separate entity
 Controlling interest
 Investments for which Coca-Cola has a
controlling interest in another company for
strategic reasons
 2007-2008 acquisitions by Coca-Cola
 18 German bottling and distribution operations
 Energy Brands Inc.
©Cambridge Business Publishing, 2010
Types of Investments for Reporting
Purposes
Trading
Controlling
Interest
Statutory
Mergers
Hedges
©Cambridge Business Publishing, 2010
Held-toMaturity
Availablefor-Sale
Equity
method
6
7
Fair Value Option
 SFAS 159 allows companies to elect ‘fair
value option’ for eligible intercorporate
investments
 Investments reported at fair value
 Value changes reported as part of income
 Excludes controlling equity investments
The discussion on marketable
investments and equity method
investments in this chapter assumes
the company did NOT elect the fair
value option for these investments.
©Cambridge Business Publishing, 2010
8
Investments Under SFAS 115
 Must have readily determinable market
value
 Must have no significant influence over the
investee
 Three categories
Trading
Investments
©Cambridge Business Publishing, 2010
Available-for-Sale
Investments
Held-to-Maturity
Securities
9
Trading Investments
 Debt or equity securities
 Reported as current assets at fair value
 Income statement reporting
Income Statement
Other Income/losses:
Unrealized gains/losses on trading investments…………$ xx
Realized gains/losses on trading investments……………..xx
Investment income…………………………………………… xx
©Cambridge Business Publishing, 2010
10
Accounting for Trading Investments
Securities owned by Zinc, Inc. are:
Exhibit 1.2
Date
Security Acquired
A
10/15/10
B
10/15/10
C
10/15/10
Cost
$100,000
500,000
200,000
$800,000
December 31, 2010
Value
$125,000
485,000
N/A
Selling
Date Sold Price
1/15/11
$120,000
1/15/11
496,000
12/5/10
214,000
To record purchase of investments costing $800,000:
2010
Oct. 15 Investment in trading securities
Cash
©Cambridge Business Publishing, 2010
800,000
800,000
11
Accounting for Trading Investments
To record the sale of trading security C for $214,000:
2010
Dec. 5
Cash
214,000
Investment in trading securities
200,000
Realized gain on sale of trading securities
14,000
To record the unrealized value change for securities A and B:
Security
A
B
Cost
$100,000
500,000
Year-end Value
Unrealized Gain(loss)
$125,000
485,000
$25,000 Gain
$15,000 Loss
2010
Dec. 31 Investment in trading securities
Unrealized gain on trading securities
©Cambridge Business Publishing, 2010
Net unrealized
gain = $10,000
10,000
10,000
12
Accounting for Trading Investments
To record the sale of trading securities A and B:
Security
Cost
A
B
$100,000
500,000
Exhibit 1.2
Realized
Year-end Value Date Sold Selling Price Gain (Loss)
$125,000
485,000
$610,000
1/15/11
1/15/11
$120,000
496,000
$616,000
($5,000)
$11,000
Net realized
gain = $6,000
2011
Jan. 15 Cash
Investment in trading securities
Realized gain on sale of trading securities
©Cambridge Business Publishing, 2010
616,000
610,000
6,000
13
Available-for-Sale Investments
 Debt or equity securities
 Balance sheet
 Reported as current or noncurrent assets at fair
value
 Unrealized gains/losses reported in accumulated
other comprehensive income
 Income statement reporting
 Realized gains/losses on available-for-sale
investments
 Investment income
 Other comprehensive income
 Unrealized gains/losses on available-for-sale
investments
©Cambridge Business Publishing, 2010
Journal Entries for Available-for-Sale
Investments
Securities owned by Zinc, Inc. are:
Security
Date
Acquired
A
B
C
10/15/10
10/15/10
10/15/10
Cost
$100,000
500,000
200,000
$800,000
Exhibit 1.2
December 31, 2010 Value Date Sold
$125,000
485,000
N/A
1/15/11
1/15/11
12/5/10
Selling
Price
$120,000
496,000
214,000
To record the purchase of investments costing $800,000:
2010
Oct. 15 Investment in AFS securities
Cash
©Cambridge Business Publishing, 2010
800,000
800,000
14
Journal Entries for Available-for-Sale
Investments
continued
To record the sale of AFS security C for $214,000:
2010
Dec. 5 Cash
214,000
Investment in AFS securities
200,000
Realized gain on sale of AFS
securities (income)
14,000
To record the unrealized value change for securities A and B:
Security
A
B
Cost
$100,000
500,000
Year-end Value
Unrealized Gain(loss)
$125,000
485,000
$25,000 Gain
$15,000 Loss
2010
Dec. 31 Investment in AFS securities
Unrealized gains on AFS securities
(OCI)
©Cambridge Business Publishing, 2010
Net unrealized
gain = $10,000
10,000
10,000
15
Journal Entries for Available-for-Sale
Investments
continued
Security
Cost
A
B
$100,000
500,000
Realized
Year-end Value Date Sold Selling Price Gain (Loss)
$125,000
485,000
$610,000
1/15/11
1/15/11
$120,000
496,000
$616,000
To record the sale of AFS securities A and B:
($5,000)
$11,000
Net unrealized
gain = $6,000
2011
Jan. 15 Cash
616,000
Investment in AFS securities
610,000
Realized gains on sale of AFS securities
6,000
To reclassify unrealized gains of AFS securities from AOCI
to income:
Jan. 15 Unrealized gains on AFS securities
10,000
Realized gains on sale of AFS securities
©Cambridge Business Publishing, 2010
10,000
16
17
Held-to-Maturity Investments
 Debt securities only
 Reported as noncurrent assets at amortized
cost
 Discount or premium amortized over time
 Moved to current assets during year of
maturity
 No gains or losses unless sold prior to
maturity
 Early sale requires extreme circumstances
Income Statement
Other Income/losses:
Interest income……………………………………………………
©Cambridge Business Publishing, 2010
$xx
18
Journal Entries for HTM Investments
A company invested in a $1 million, 5% face value corporate bond
on January 1, 2010 for $965,349, yielding 6%. Interest is paid
annually on December 31. Maturity is December 31, 2013.
To record the purchase of HTM securities:
2010
Jan. 1
Investment in HTM securities
Cash
965,349
965,349
To record the receipt of interest income for 2010:
2010
Dec. 31 Cash
Investment in HTM securities
Interest income
$50,000 – $57,921
©Cambridge Business Publishing, 2010
$1,000,000 × 5%
50,000
7,921
57,921
$965,349 × 6%
19
Journal Entries for HTM Investments
$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2010: $965,349 + $7,921 = $973,270
$1,000,000
× 5%
To record the receipt of interest income for 2011:
2011
Dec. 31 Cash
Investment in HTM securities
Interest income
50,000
8,396
58,396
$50,000 – $58,396
$973,270 × 6%
Carrying value at December 31, 2011: $973,270 + $8,396 = $981,666
To record the receipt of interest income for 2012:
2012
Dec. 31 Cash
Investment in HTM securities
Interest income
$50,000 – $58,900
©Cambridge Business Publishing, 2010
$1,000,000
× 5%
50,000
8,900
58,900
$981,666 × 6%
20
Journal Entries for HTM Investments
$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2012: $981,666 + $8,900 = $990,566
To record the receipt of interest income for 2013:
$1,000,000 × 5%
2013
Dec. 31 Cash
Investment in HTM securities
Interest income
50,000
9,434
59,434
$50,000 – $59,434
$990,566 × 6%
Carrying value at December 31, 2013: $990,566 + $9,434 = $1,000,000
To record receipt of face value of bonds at maturity:
2013
Dec. 31
Cash
Investment in HTM securities
©Cambridge Business Publishing, 2010
1,000,000
1,000,000
21
Impairment Test for HTM Investments
 HTM investments must be evaluated for
impairment
 Two criteria
 Fair value declines below amortized cost, and
 Decline is judged to be ‘other than temporary’
 If judged to be impaired
 Write down the security to fair value
 Report the decline as an impairment loss on
the income statement
 Ignore subsequent increases in fair value
©Cambridge Business Publishing, 2010
22
Recording an Impairment Loss
Example:
An investor owns an HTM security with a current amortized cost of
$981,666. During 2011, the investor has determined that it is
probable that all amounts due according to the contractual terms
of a debt security will not be collected. The current market value is
$200,000.
To record the impairment:
2011
Dec. 31
Impairment loss on HTM securities
Investment in HTM securities
©Cambridge Business Publishing, 2010
781,666
781,666
23
Investments with Significant Influence
 Two accounting options exist
 Elect to use the SFAS 159 fair value option, or
 Apply the equity method
 Investor must exert significant influence
over operating and financing decisions of
the investee
©Cambridge Business Publishing, 2010
24
When is Significant Influence Present?
 Assumed to be present if the investment
allows the investor to exercise significant
influence over the financial and operating
decisions of the investee
 Generally 20 to 50% ownership required
 Less than 20% ownership exceptions
 Representation on the investee’s board
 Involvement in investee operating and financial
policies
 Significant transactions between investor and
investee
©Cambridge Business Publishing, 2010
25
Accounting Under the Equity Method
Investment performance should parallel the
investee’s performance
Investment in Stock
Cost of investment
Increases
Investor's share of
investee's income
Investor's share of
investee's loss
Decreases
Dividends received
from investee
Ending cost basis
©Cambridge Business Publishing, 2010
Changes in proportion to the
investee’s retained earnings account
26
Equity Method Example
Coca-Cola acquires 300,000 voting shares of Rocky Mountain
Bottlers for $12 million cash to obtain a 30% ownership with
significant influence over the investee. Rocky Mountain reports
net income of $2 million and declares a cash dividend of $0.50
per share on November 1, and pays the dividend on December 2.
To record the purchase of equity investment:
2011
Jan. 2 Investment in Rocky Mountain Bot.
Cash
12,000,000
12,000,000
To record dividends declared:
2011
Nov. 1
Dividends receivable
150,000
Investment in Rocky Mountain Bottlers
$0.50 × 300,000
©Cambridge Business Publishing, 2010
150,000
27
Equity Method Example
continued
Coca-Cola acquires 300,000 voting shares of Rocky Mountain
Bottlers for $12 million cash to obtain a 30% ownership with
significant influence over the investee. Rocky Mountain reports
net income of $2 million and declares a cash dividend of $0.50
per share on November 1, and pays the dividend on December 2.
To record dividends received:
2011
Dec. 2
Cash
Dividends receivable
150,000
150,000
To accrue earnings of the investee:
2011
Dec. 31
Investment in Rocky Mountain Bottlers
600,000
Equity in income of Rocky Mountain Bottlers
600,000
30% × $2,000,000
©Cambridge Business Publishing, 2010
28
Equity Method Example
continued
Coca-Cola acquires 300,000 voting shares of Rocky
Mountain Bottlers for $12 million cash to obtain a 30%
ownership with significant influence over the investee. Rocky
Mountain reports net income of $2 million and declares a
cash dividend of $0.50 per share on November 1, and pays
the dividend on December 2.
Investment in Rocky
Mountain Bottlers
12,000,000
150,000
600,000
12,450,000
Balance Sheet as
long-term asset
©Cambridge Business Publishing, 2010
Equity in income
of Rocky Mountain
600,000
600,000
Income
Statement
29
Equity in Net Income
 Adjustments to reported net income may be
required
 If investment cost differs from investee’s book
value
 Adjustment required: Must amortize investment cost
in excess of book value acquired
 If investor and investee transact business with
each other
 Adjustment required: Remove gross margin that is
not yet earned
©Cambridge Business Publishing, 2010
30
Adjustments to Equity in Net Income
Adjustments should be made for
 Depreciation and amortization on
revaluations of
 Tangible assets, and
 Limited life intangible assets
Exceptions
No adjustments for goodwill impairment (SFAS 142)
and other indefinite life intangibles (EITF Issue 08-06)
©Cambridge Business Publishing, 2010
31
Additional Investment Cost Valuation
Rocky Mountain reports total assets of $80 million and total
liabilities of $50 million, for a net book value of $30 million. The
original cost paid by Coca-Cola was $12 million. Analysis
indicates that Rocky Mountain has unreported technology valued
at $5 million and its plant and equipment is undervalued by $1
million. Plant and equipment has a remaining life of 10 years as of
January 2, 2011 and uses straight-line depreciation. The
previously unreported technology is a limited life intangible asset
with a 5-year life.
Price paid
Share of Rocky Mountain's net assets acquired:
Book value (30% x $30,000,000)
Revaluation of plant and equipment
(30% x $1,000,000)
Unreported technology (30% x $5,000,000)
Additional investment cost (goodwill)
©Cambridge Business Publishing, 2010
$12,000,000
$9,000,000
300,000
1,500,000
10,800,000
$1,200,000
Inventory Sales Between Investee and
Investor
Downstream Sales
Investor sells
inventory to investee
Both companies
record sales as if
selling to outside
customers
Results in
If inventory not sold to
unrelated outside party at
year-end, gross margin is
not yet earned
©Cambridge Business Publishing, 2010
Upstream Sales
Investee sells
inventory to investor
Both report gross
margin as part of
income
Investor must remove
when calculating equity in
net income of investee
32
Adjustments for Unconfirmed Inventory
Profits Example
Suppose Rocky Mountain sells canned beverages to Coca-Cola
upstream for $800,000 at a 20% markup on cost. Coca-Cola
holds $210,000 of this inventory at year-end. Coca-Cola sells
finished products to Rocky Mountain downstream for $500,000 at
a 25% markup on cost. Rocky Mountain holds $100,000 of this
inventory at year-end. How much is unconfirmed profit?
Unconfirmed gross profit on $210,000 upstream sales:
$210,000 –[ $210,000 ÷ 1.20] = $35,000
Unconfirmed gross profit on $100,000 downstream sales:
$100,000 – [$100,000 ÷ 1.25] = $20,000
©Cambridge Business Publishing, 2010
33
34
Recognition of Adjusted Equity Income
Coca-Cola's share of Rocky Mountain's reported
2011 income (30% x $2,000,000)
Adjustments for revaluation write-offs:
Plant and equipment
Previously unreported technology
Adjustments for unconfirmed inventory profits:
Upstream sales
Downstream sales
Equity in net income of Rocky Mountain
30% ×
$35,000
$600,000
$300,000
÷ 10
(30,000)
(300,000)
$1,500,000
÷5
(10,500)
(6,000)
$253,500
30% ×
$20,000
2011
Dec. 31 Investment in Rocky Mountain Bottlers
253,500
Equity in income of Rocky Mountain Bottlers
253,500
©Cambridge Business Publishing, 2010
Other Comprehensive Income and the
Equity Method
 Investor must adjust its investment and other
comprehensive income for its share of the
investee’s yearly OCI
 Such as investor’s recognition of unrealized
gain on AFS securities
Suppose Rocky Mountain reported $200,000 in unrealized gains
on AFS securities.
2011
Dec. 31 Investment in Rocky Mountain Bottlers
Unrealized gains on equity method
investments (OCI)
60,000
30% × $200,000 = $60,000
©Cambridge Business Publishing, 2010
60,000
35
36
Impairment Testing
 Impairment testing required under APBO
18 for equity method investments
 Criteria
 If fair value of the investment declines below its
carrying value, and
 The decline is judged to be other than
temporary
 Accounting requirements
 Investment is written down and a loss is
recognized on the investor’s income statement
 Subsequent increases ignored
©Cambridge Business Publishing, 2010
37
Joint Venture
 An entity formed by a small group of individuals
or firms that contribute resources and jointly
share in managing and controlling the venture
 Often established for a short-term, single business
transaction or activity
 Enables expertise, special technology, capital,
market access to be combined
 Corporate joint venture
 Exists when the venture is organized as a
corporation
U.S. companies use the equity
method for joint ventures.
©Cambridge Business Publishing, 2010
38
Controlling Investments
 Give the investor control over the operating
and financial decisions of the investee
 Three forms
 Statutory merger, statutory consolidation, or
asset acquisition
 Stock acquisition
 Variable interest entity
 General rule: assets, liabilities, revenues,
and expenses are combined with those of
the investor for financial statement
reporting
©Cambridge Business Publishing, 2010
Statutory Mergers, Statutory
Consolidations, and Asset Acquisitions
 An investor directly acquires the assets
and liabilities of the investee
 Assets and liabilities recorded directly on
investor’s balance sheet at fair value
Statutory Merger
Occurs when the investor acquires
the investee and becomes the
remaining legal entity
Asset Acquisition
Occurs when an investor
acquires a subset of the
investee’s assets
©Cambridge Business Publishing, 2010
Statutory Consolidation
Occurs when a new entity is
formed to acquire both the
investor and the investee
39
40
Stock Acquisitions
 Occurs when an investor obtains control
over another company by investing in its
voting stock
 Investee remains a separate legal entity
Parent
the investor
Subsidiary
the acquired
company
©Cambridge Business Publishing, 2010
The separate
financial records
are consolidated
at the end of
each reporting
period.
41
Stock Acquisition Example
Assume Coca-Cola acquires and holds all of the voting stock
of Rocky Mountain Bottlers, paying the former stockholders of
Rocky Mountain $40 million cash.
Investment in Rocky Mountain Bottlers
Cash
This is the entry Coke makes on its
own books, but its annual report
shows Coke and Rocky Mountain’s
combined accounts as if Coke
recorded the acquisition as a
statutory merger.
©Cambridge Business Publishing, 2010
40,000,000
40,000,000