Investing Decisions - 1
INVESTING DECISIONS
TEMPORARY INVESTMENTS
 Use of idle cash
 Low risk investments
 Quickly and easily converted to cash
 Highly liquid securities
LONG-TERM INVESTMENTS
 Long-term income source (interest,
dividends, price appreciation)
 Develop beneficial intercompany
relationships to improve profitability of
investing company.
 Gain ownership interest.
ACCOUNTING ISSUES
 Classification issues
– Management’s intended holding period for
the security
 Valuation and investment income
measurement
– Cost vs. fair value
– Treatment of holding gains & losses
 Disclosure issues
Investing Decisions - 5
ACCOUNTING METHODS FOR
VARIOUS INVESTMENTS
Classification
Investment in
Debt Securities
Investment in
Equity Securities
Control-greater than 50%
ownership of voting stock
Not applicable
Consolidation
Significant influence - 20% to
50% ownership of voting stock
Not applicable
Equity method
Debt securities classified as held
to maturity, and equity securities
for which fair value is not readily
determinable
Amortized cost method
Cost method
Debt and equity securities
classified as trading securities
Fair value method, with unrealized holding gain or loss
included in net income
Debt and equity securities
classified as available for sale
Fair value method, with unrealized holding gain or loss
included as a component of comprehensive income
Investing Decisions - 6
OPERATIONAL ASSETS
 Common characteristics
– Actively used in primary operations
– Long-term = benefits future periods
– Generally not held for resale
 Categories
– Tangible assets = have physical substance
– Intangible assets – lack physical substance
Investing Decisions - 7
OPERATIONAL ASSETS
Classes
 Property, plant & equipment
– Buildings
– Machinery, furniture & fixtures
– Land & land improvements
 Natural resource rights
 Intangibles
– Patents, copyrights, trademarks, trade
names
– Franchise rights
– Goodwill
Investing Decisions - 8
OPERATIONAL ASSETS
Acquisition Cost
 Cost of gaining right to use asset, bring it
to the location and condition necessary
for its intended use
 Cost = FMV of consideration given or
FMV of asset received, whichever
can be more reliably determined
Investing Decisions - 9
LONG-TERM LEASES
 Capital vs. Operating Leases
 Criteria - must be accounted for as a capital
lease if ANY ONE of the following exist:
– Transfer of ownership
– Bargain purchase option
– Term is greater than or equal to 75% of
economic life of asset
– PV of minimum lease payments is greater
than
or equal to 90% of FMV of asset
Investing Decisions - 10
DEPRECIATION CONCEPTS
 Depreciation - expiration or consumption of
the economic service potential of plant assets
AN ECONOMIC FACT
 Depreciation accounting - the systematic and
rational allocation of the cost of the tangible
plant assets, less salvage, to expense over the
estimated useful life of the asset
AN ACCOUNTING PROCEDURE
 Depreciation accounting is a “cost allocation”
process and is not directly related to the
“market value” of the asset
Investing Decisions - 11
CAUSES OF DEPRECIATION
 Physical deterioration
– Wear and tear from use
– Exposure to elements
– Passage of time
 Obsolescence
– Technological
– Market
Investing Decisions - 12
DEPRECIATION CONCEPTS
Related Areas
 Depletion accounting - periodic
allocation of the cost of natural
resources
 Amortization accounting - periodic
allocation of intangible assets
Investing Decisions - 13
DETERMINING DEPRECIATION
Determinants of computed “Depreciation
Expense”
 Asset cost
 Estimated residual value
 Estimated useful (economic) life
 Specific method of depreciation
Investing Decisions - 14
DEPRECIATION METHODS
 Straight-Line
 Activity methods
– Units of service
– Units of production
 Accelerated methods
– Sum-of-the-years’-digits
– Declining balance
 Tax depreciation methods
PLANT ASSET IMPAIRMENT
n Impairment is the loss of a significant portion
of the utility of an asset through casualty,
obsolescence or lack of demand for the
company’s asset.
n When plant assets suffer a permanent
impairment in value, a loss should be
recorded.
IMPAIRMENT OF LONG-LIVED
ASSETS
Reporting Requirements
Reviewed when circumstances indicate the
carrying value may not be recoverable
Recognition of impairment loss
– Required if sum of expected future net cash flows
is less than carrying value of the asset
Measurement of impairment loss
The amount by which the carrying value of
the asset exceeds the fair value of the asset
IMPAIRMENT OF LONG-LIVED
ASSETS
Reporting Requirements - Continued
Presentation of impairment losses
Shown as a component of income from
continuing operations before taxes
Restoration of impairment losses
Reduced carrying value is basis for future
accounting and restoration is prohibited
IMPAIRMENT OF LONG-LIVED
ASSETS
Disclosure Requirements
Description of impaired assets
Circumstances leading to impairment
Amount of impairment loss
How fair value was determined
Investing Decisions - 19
BUSINESS COMBINATIONS
Motivations
 Growth
– New markets
– Increase in market share
– New products





Reduction in costs
Diversification
Tax implications
Management incentives
Ego
BUSINESS COMBINATIONS
Economic Substance
 Horizontal combinations
 Vertical combinations (integration)
 Conglomerates
Investing Decisions - 21
BUSINESS COMBINATIONS
Legal Forms
 Merger
 Statutory Consolidation
 Acquisition
Investing Decisions - 22
BUSINESS COMBINATIONS
Method of Accounting
 Pooling
 Purchase
 Acquisition
The FASB has eliminated pooling and purchase as methods
of accounting for business combinations, but this
requirement is NOT retroactive!
Investing Decisions - 23
Accounting for Combinations
June 30, 2001
Purchase
OR
Pooling
Selection based on
specific criteria
for Pooling
Calendar 2009
Purchase
only
(Not retroactive)
All new combinations
must use Purchase
(no adjustment of
older results)
Acquisition
only
(Not retroactive)
All new combinations
must use Acquisition
(no adjustment of
older results)
Investing Decisions - 24
Pooling
Purchase
Acquisition
Horizontal
Vertical
Conglomerate
Merger
Statutory
Consolidation
Stock
Acquisition
PURCHASE ACCOUNTING
Accounting Considerations
 Combination = one entity BUYING another
 Normal GAAP for acquisition of an asset
Valuation of acquired net assets:
- Fair value of consideration given
AND
- Fair value of net assets acquired
 Recognition of COST/FAIR VALUE differential
 Recognition of Earnings and Retained earnings of
acquired entity: from DATE OF ACQUISITION
 Direct expenses of combination = Cost of Investment
Investing Decisions - 26
PURCHASE ACCOUNTING
Key Computations
Cost of investment:
(FMV of consideration given – cash, debt,
stock – or some combination of all three)
versus
Book value of net assets (assets – liab.) acquired
= Total differential to be accounted for in the
combination
Investing Decisions - 27
ALLOCATION OF DIFFERENTIAL
Purchase Accounting
 Determine “differential” on acquisition of net assets
acquired (see previous slide)
 Allocate “cost” to identifiable NET assets acquired
- Based on FMV of individual assets and liabilities
- Includes identified intangibles
- May involve writeups or writedowns
 Account for differential
– If positive (cost > FMV of identifiable net assets) =
“Goodwill”
– If negative (cost < FMV of identifiable net assets) =
differential is allocated to a reduction of selected
assets (other than highly liquid assets) with any
remainder treated as an extraordinary gain
Investing Decisions - 28
CRITERIA FOR POOLING
APB No. 16
 Attributes of combining companies
- Autonomous
- Independent of one another
 Manner of achieving combination
- Single transaction
- Common stock for Common stock
- Exchange for “substantially all” common
(90%)
 Absence of planned transactions
- Planned spin-off of assets
- Contingent agreements
Investing Decisions - 29
POOLING OF INTERESTS
Accounting Considerations

Combination of ownership interests
- NOT AN ACQUISITION

NO TRANSACTION by the corporate entities
- No new basis of accountability
- Total combined net assets unchanged

NO CHANGE in total combined stockholders’ equity
– Reallocation of individual accounts may be required

Retained earnings accounts combined

Earnings - combined for entire year of pooling

Direct combination expenses = period expenses
Investing Decisions - 30
POOLING OF INTEREST
Key Computations
Total par value of new shares issued
Versus
Total par value of old shares exchanged
= Possible rearrangement of stockholders’
equity on combined balance sheet
Investing Decisions - 31
POOLING OF INTERESTS
Assets
+
Assets
=
Assets
Par
RE
Liab.
+
Liab.
=
Liabilities
Par
OCC
Par
OCC
RE
Par
+
OCC
RE
=
Stockholders’
Equity
RE
Par
OCC
RE