13 – Financial
Reporting of
Investments
(revisited)
CORPORATE
FINANCIAL
REPORTING
·1
Long-Lived Assets
INVESTMENT IN THE STOCK OF
ANOTHER COMPANY
Reporting investments is a continuum based on
some measure of influence over the investee:
We can own:
1 share
50%
100% of
shares
passive
investor
market
value
active investor
equity
consolidated
method
financial statements
Financial Reporting of
Investments
2
THE EQUITY METHOD
The “theory”.
Investments
3
THE EQUITY METHOD
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
before acquiring B’s assets/liabilities:
Assume the following values for B’s assets/liabilities
cash
$ 200,000
acct. rec.
300,000
inventory
500,000
PPE
900,000
accum. deprec (300,000)
patent
1,000
trademark
3,000
$1,604,000
Book Value Market Value
cash
$ 1,000
$ 1,000
acct. rec.
8,000
8,000
inventory
12,000
15,000
PPE
110,000
90,000
accum. deprec (30,000)
patent
1,000
0
trademark
2,000
$102,000
$116,000
liabilities
com. stock
APIC
ret. earnings
liabilities
com. stock
APIC
ret. earnings
100,000
300,000
350,000
854,000
$1,604,000
Investments
10,000
30,000
35,000
27,000
$102,000
$ 10,000
4
THE EQUITY METHOD
What would appear in Co. A’s financial
statements?
Then Co. A’s accountant would ask “Why
did we pay so much?”
Investments
5
THE EQUITY METHOD
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
com. stock
APIC
ret. earnings
100,000
300,000
350,000
854,000
$1,604,000
Investments
6
THE EQUITY METHOD
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
com. stock
APIC
ret. earnings
25% of B’s OE
trademark
patent
PPE
inventory
goodwill
23,000
500
( 250)
2,500
750
1,500
28,000
100,000
300,000
350,000
854,000
$1,604,000
Investments
7
THE EQUITY METHOD
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.
Investments
8
TWO COMMON WAYS
TO OBTAIN CONTROL
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).
Investments
9
EQUITY INVESTMENTS
ACCOUNTING METHOD TO USE:
ACTIVE INVESTMENT
Equity method
control (in US)
Consolidate
50%
|
Investments
100% of stock
|
10
BUY B’S ASSETS/LIABILITIES
1. If Co. A buys Co. B’s assets and liabilities, this is
what happens:
Owners of A
Co. A
Owners of B
Co. B
assets/liabilities
Investments
11
BUY B’S ASSETS/LIABILITIES
1. Afterwards, this is what we have:
Owners of A
Owners of B
Co. A
lots of
assets
Co. B
lots of
liabilities
Investments
12
BUYING CO. B’s STOCK – A
Consolidation Example
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
before acquiring B’s stock:
Assume the following values for B’s assets/liabilities
cash
$ 200,000
acct. rec.
300,000
inventory
500,000
PPE
900,000
accum. deprec (300,000)
patent
2,000
trademark
3,000
$1,605,000
Book Value Market Value
cash
$ 1,000
$ 1,000
acct. rec.
8,000
8,000
inventory
12,000
15,000
PPE
110,000
90,000
accum. deprec (30,000)
patent
1,000
0
trademark
2,000
$102,000
$116,000
liabilities
com. stock
APIC
ret. earnings
liabilities
com. stock
APIC
ret. earnings
100,000
300,000
350,000
855,000
$1,605,000
10,000
30,000
35,000
27,000
$102,000
Consolidated Financial Statements
$ 10,000
13
BUYING CO. B’s STOCK – A
Consolidation Example
This is what happened:
Owners of A
Owners of B
$135,000
90% Co.
Co. A
B stock
Co. B
What will Co. A’s journal entry look like?
Consolidated Financial Statements
14
BUYING CO. B’s STOCK – A
Consolidation Example
This is “after”:
Owners of A
Owners of B
10% owners
Co. A 90% owner
Co. B
Consolidated Financial Statements
15
BUYING CO. B’s STOCK – A
Consolidation Example
A’s balance sheet after the transaction:
cash
$ 65,000
acct. rec.
300,000
inventory
500,000
Invest. in B stock 135,000
PPE
900,000
accum. deprec (300,000)
patent
2,000
trademark
3,000
$1,605,000
liabilities
com. stock
APIC
ret. earnings
Consolidated Financial Statements
100,000
300,000
350,000
855,000
$1,605,000
16
BUYING CO. B’s STOCK – A
Consolidation Example
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
com. stock
APIC
ret. earnings
10,000
30,000
35,000
27,000
$102,000
Consolidated Financial Statements
17
BUYING CO. B’s STOCK – A
Consolidation Example
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.
Consolidated Financial Statements
18
BUYING CO. B’s STOCK – A
Consolidation Example
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.
Consolidated Financial Statements
19
BUYING CO. B’s STOCK – A
Consolidation Example
What we have:
Owners of A
F/S
Co. A
90%
F/S
“Old” Owners of B
10%
Co. B
Consolidated Financial Statements
20
BUYING CO. B’s STOCK – A
Consolidation Example
What FASB also wants:
Owners of A
F/S
Co. A
consolidated
F/S
F/S
Co. B
Consolidated Financial Statements
21
BUYING CO. B’s STOCK – A
Consolidation Example
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).
Consolidated Financial Statements
22
BUYING CO. B’s STOCK – A
Consolidation Example
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
Consolidated Financial Statements
23
BUYING CO. B’s STOCK – A
Consolidation Example
A’s balance sheet after the transaction:
cash
$ 65,000
acct. rec.
300,000
inventory
500,000
Invest. in B stock 135,000
PPE
900,000
accum. deprec (300,000)
patent
2,000
trademark
3,000
$1,605,000
liabilities
com. stock
APIC
ret. earnings
100,000
300,000
350,000
855,000
$1,605,000
cash
1,000
acct. rec.
8,000
inventory
PPE
patent
trademark
goodwill
liabilities
15,000
90,000
0
2,000
41,000
(10,000)
24
BUYING CO. B’s STOCK – A
Consolidation Example
So, Co. A’s consolidated balance
sheet “substitutes” the assets and
liabilities Co. A controls when it
bought Co. B’s stock.
Consolidated Financial Statements
25
BUYING CO. B’s STOCK – A
Consolidated Balance Sheet
A’s consolidated Balance Sheet:
cash
$ 66,000
acct. rec.
308,000
inventory
515,000
Invest. in B stock
PPE
990,000
accum. deprec.
(300,000)
patent
2,000
trademark
5,000
goodwill
41,000
$1,627,000
liabilities
com. stock
APIC
ret. earnings
Consolidated Financial Statements
110,000
300,000
350,000
855,000
$1,615,000
26
BUYING CO. B’s STOCK – A
Consolidated Balance Sheet
A’s consolidated Balance Sheet:
cash
$ 66,000
acct. rec.
308,000
inventory
515,000
Invest. in B stock
PPE
990,000
accum. deprec.
(300,000)
patent
2,000
trademark
5,000
goodwill
41,000
$1,627,000
liabilities
com. stock
APIC
ret. earnings
110,000
300,000
350,000
855,000
$1,615,000
WHAT??
Consolidated Financial Statements
27
BUYING CO. B’s STOCK – A
Consolidated Balance Sheet
A’s consolidated Balance Sheet:
cash
$ 66,000
acct. rec.
308,000
inventory
515,000
Invest. in B stock
PPE
990,000
accum. deprec.
(300,000)
patent
2,000
trademark
5,000
goodwill
41,000
$1,627,000
liabilities
N.C.I. *
com. stock
APIC
ret. earnings
110,000
12,000
300,000
350,000
855,000
$1,627,000
WHEW!
* NONCONTROLLING INTEREST IN NET ASSETS OF SUBSIDIARY
Consolidated Financial Statements
28
BUYING CO. B’s STOCK – A
Consolidated Income Statement
One year later, these were the income
statements for A and B:
Sales revenue
COGS
Deprec. exp.
Pat. amort. exp.
Other exp.
Net income
A
$200,000
( 80,000)
( 45,000)
(
400)
( 14,600)
$ 60,000
B
$70,000
( 36,000)
( 5,500)
(
200)
( 7,800)
$20,500
and B paid $10,000 in cash dividends.
What entries would A’s accountant make (assuming A
uses the equity method)?
Consolidated Financial Statements
29
BUYING CO. B’s STOCK – A
Consolidated Income Statement
A’s income statement that it would issue to the
public (IF it issued a non-consolidated
income statement):
Sales revenue
COGS
Deprec. exp.
Pat. amort. exp.
Other expenses
Equity income
Net income
$200,000
( 80,000)
( 45,000)
(
400)
( 14,600)
15,030
$ 75,030
Consolidated Financial Statements
30
BUYING CO. B’s STOCK – A
Consolidated Income Statement
What would appear in A’s
consolidated Income Statement:
Sales revenue
COGS
Deprec. exp.
Pat. amort. exp.
Other exp.
Equity income
Consol. net income
Net income to N.C.I
Net income to Co. A
$270,000
(119,000)
( 51,500)
(
400)
( 22,400)
-$ 76,700
( 1,670)
$ 75,030
Consolidated Financial Statements
31
BUYING CO. B’s STOCK – An Example
Co. A’s accountant also must
prepare a consolidated owners’
equity statement and a consolidated cash flow statement.
Consolidated Financial Statements
32
QUESTIONS
?
Consolidated Financial Statements
33