1
Susan S.
Hamlen
Ronald J.
Huefner
James A.
Largay
Chapter 1:
Intercorporate Investments:
An Overview
Motivations for Intercorporate
Investments
 As a temporary investment of excess cash
or part of a long-term risk-adjusted portfolio
 Expectations of dividends and gains
 As a strategic investment
 Develop relationships with suppliers and
customers
 Gain access to new product or geographic
markets
 To facilitate activity along its supply chain
©Cambridge Business Publishing, 2013
2
3
Investments on the Balance Sheet
Coca-Cola Company reported the following investments at
December 31, 2010 and 2009 (in millions):
2010
2009
Investments
Trading securities
$
209
$
61
Available-for-sale securities
485
398
Held-to-maturity securities
111
199
6,954
6,217
631
538
Equity method investments
Other investments, principally bottling companies
©Cambridge Business Publishing, 2013
4
Coca-Cola’s Investments
 Marketable securities
 Includes trading, available-for-sale, and heldto-maturity investments
 Equity method investments
 Investments for which Coca-Cola exerts
significant influence over operations
 Coca-Cola’s equity method investments
 23% interest in Coca-Cola Hellenic
 32% interest in Coca-Cola FEMSA
 30% interest in Coca-Cola Amatil
©Cambridge Business Publishing, 2013
5
Coca-Cola’s Investments
continued
 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
 2010 acquisition: Coca-Cola Enterprises (CCE)
©Cambridge Business Publishing, 2013
Types of Investments for Reporting
Purposes
Trading
Controlling
interest
Availablefor-sale
Derivatives
(hedges)
Held-tomaturity
Equity
method
©Cambridge Business Publishing, 2013
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7
Fair Value Option
 ASC Topic 825 allows companies to elect
the fair value option for eligible
intercorporate investments
 Investments reported at fair value
 Value changes reported as part of income
 Option available only for noncontrolling
investments
This chapter assumes the company
did NOT elect the fair value option.
©Cambridge Business Publishing, 2013
8
Learning Objective 1
Describe the reporting for trading,
available-for-sale, and held-to-maturity
investments in other companies.
©Cambridge Business Publishing, 2013
Examples of Marketable Debt and
Equity Investments
Debt
securities
Equity
securities
Commercial
paper
Common stock
Corporate
bonds
Preferred stock
Redeemable
preferred stock
Put and call
options
©Cambridge Business Publishing, 2013
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10
Investments Under ASC Topic 320
 Readily determinable market values
 No significant influence over the investee
 Three categories:
Trading
investments
©Cambridge Business Publishing, 2013
Available-for-sale
investments
Held-to-maturity
investments
11
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, 2013
12
Accounting for Trading Investments
Securities owned:
Exhibit 1.1
Date
Security Acquired
A
10/15/12
B
10/15/12
C
10/15/12
Cost
$100,000
500,000
200,000
$800,000
December 31, 2012
Value
$125,000
485,000
N/A
Selling
Date Sold Price
1/15/13
$120,000
1/15/13
496,000
12/5/12
214,000
To record purchase of trading investments costing $800,000:
2012
Oct. 15 Investment in trading securities
Cash
©Cambridge Business Publishing, 2013
800,000
800,000
Accounting for Trading Investments
13
continued
To record the sale of trading security C for $214,000:
2012
Dec. 5
Cash
214,000
Investment in trading securities
200,000
Realized gain on sale of trading 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
2012
Dec. 31 Investment in trading securities
25,000
Unrealized gain on trading securities (income)
2012
Unrealized loss on trading securities
Dec. 31 (income)
15,000
Investment in trading securities
©Cambridge Business Publishing, 2013
25,000
15,000
14
Accounting for Trading Investments
continued
To record the sale of trading securities A and B:
Security
Cost
A
B
$100,000
500,000
Realized
Year-end Value Date Sold Selling Price Gain (Loss)
$125,000
485,000
1/15/13
1/15/13
$120,000
496,000
2013
Jan. 15 Cash
Realized loss on sale of trading securities
(income)
Investment in trading securities
2013
Jan. 15 Cash
Investment in trading securities
Realized gain on sale of trading securities
(income)
©Cambridge Business Publishing, 2013
Exhibit 1.1
($5,000)
$11,000
120,000
5,000
125,000
496,000
485,000
11,000
15
Accounting for Trading Investments
continued
 Gains and losses are reported in income as
the value of the securities changes
 No impairment testing is necessary since
all changes in value flow through income
 No difference in accounting between a
“normal” decline in value and a decline
characterized as “impairment.”
©Cambridge Business Publishing, 2013
16
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, 2013
Journal Entries for Available-for-Sale
Investments
AFS investments:
Security
Date
Acquired
A
B
C
10/15/12
10/15/12
10/15/12
Cost
$100,000
500,000
200,000
$800,000
Exhibit 1.1
December 31, 2012 Value Date Sold
$125,000
485,000
N/A
1/15/13
1/15/13
12/5/12
Selling
Price
$120,000
496,000
214,000
To record the purchase of investments costing $800,000:
2012
Oct. 15 Investment in AFS securities
Cash
©Cambridge Business Publishing, 2013
800,000
800,000
17
Journal Entries for Available-for-Sale
Investments continued
To record the sale of AFS security C for $214,000:
2012
Dec. 5 Cash
Investment in AFS securities
Realized gain on sale of AFS
securities (income)
214,000
200,000
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
2012
Dec. 31 Investment in AFS securities
Unrealized gain on AFS securities (OCI)
25,000
2012
Dec. 31 Unrealized loss on AFS securities (OCI)
Investment in AFS securities
15,000
©Cambridge Business Publishing, 2013
25,000
15,000
18
Journal Entries for Available-for-Sale
Investments continued
Security
Cost
2013 Year-end
Value
A
B
$100,000
500,000
$125,000
485,000
Realized
Date Sold Selling Price Gain (Loss)
1/15/13
1/15/13
$120,000
496,000
$20,000
$(4,000)
To record the sale of AFS security A:
2013
Jan. 15 Cash
Other comprehensive income
Investment in AFS securities
Realized gain on sale (income)
120,000
25,000
125,000
20,000
To record the sale of AFS security B:
2013
Jan. 15 Cash
Realized loss on sale (income)
Investment in AFS securities
Other comprehensive income
©Cambridge Business Publishing, 2013
496,000
4,000
485,000
15,000
19
Impairment Testing for AFS
Securities
 Required because impairment losses go through
income but “normal” declines are reported in
OCI
 Is the security’s fair value below its cost?
 If so, is the decline other than temporary?
 Common indicator: security will be sold before value
can be recovered
To record the $15,000 decline in value of AFS security B at
December 31, 2012 as impairment:
2012
Dec. 31 Loss on security B (income)
Investment in AFS securities
©Cambridge Business Publishing, 2013
15,000
15,000
20
21
Impairment Testing of AFS Securities
continued
 After recognition of impairment, Security
B’s “cost” is $485,000.
 Subsequent value increases are not reported
 Example of loss recognition when
unrealized gains/losses previously
reported:
 AFS security, book value $200,000, original
cost $160,000, fair value $90,000
©Cambridge Business Publishing, 2013
22
Impairment Testing of AFS Securities
continued
 Fair value ($90,000) < cost ($160,000)
 If the decline in value is other than
temporary:
Record the decline in value of the AFS security
from cost to fair value as impairment loss, in
income, reclassify the unrealized gain out of AOCI,
and write the investment down from book value to
fair value:
Unrealized loss on AFS securities (OCI)
Impairment loss on AFS securities (income)
Investment in AFS securities
©Cambridge Business Publishing, 2013
40,000
70,000
110,000
23
Held-to-Maturity Investments
 Debt securities only
 Reported at amortized cost
 Discount or premium amortized over time
 No gains or losses unless sold prior to
maturity
 Early sale requires extreme circumstances
Income Statement
Other income/losses:
Interest income……………………………………………………
©Cambridge Business Publishing, 2013
$xx
24
Journal Entries for HTM Investments
A company invested in a $1 million face value, 5% corporate bond
on January 1, 2012 for $965,349, yielding 6%. Interest is paid
annually on December 31. Maturity is December 31, 2015.
To record the purchase of HTM securities:
2012
Jan. 1
Investment in HTM securities
Cash
965,349
965,349
To record the receipt of interest income for 2012:
2012
Dec. 31 Cash
Investment in HTM securities
Interest income
$57,921 – $50,000
©Cambridge Business Publishing, 2013
$1,000,000 × 5%
50,000
7,921
57,921
$965,349 × 6%
25
Journal Entries for HTM Investments
continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2012: $965,349 + $7,921 = $973,270
To record the receipt of interest income for 2013:
2013
Dec. 31 Cash
Investment in HTM securities
Interest income
$1,000,000
× 5%
50,000
8,396
58,396
$58,396 – $50,000
$973,270 × 6%
Carrying value at December 31, 2013: $973,270 + $8,396 = $981,666
To record the receipt of interest income for 2014:
2014
Dec. 31 Cash
Investment in HTM securities
Interest income
$58,900 – $50,000
©Cambridge Business Publishing, 2013
$1,000,000
× 5%
50,000
8,900
58,900
$981,666 × 6%
Journal Entries for HTM Investments
26
continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2014: $981,666 + $8,900 =
$990,566
To record the receipt of interest income for 2015:
$1,000,000 × 5%
2015
Dec. 31 Cash
Investment in HTM securities
Interest income
50,000
9,434
59,434
$59,434 – $50,000
$990,566 × 6%
Carrying value at December 31, 2015: $990,566 + $9,434 = $1,000,000
To record receipt of face value of bonds at maturity:
2015
Dec. 31
Cash
Investment in HTM securities
©Cambridge Business Publishing, 2013
1,000,000
1,000,000
Impairment Testing for
HTM Investments
 Required because normally HTM investments are
carried at amortized cost
 Two criteria, same as for AFS securities
 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, 2013
27
28
Recording an Impairment Loss
Example:
An investor owns an HTM security with a current amortized cost
of $981,666. At the end of 2013, the investor determines 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 $500,000.
To record the impairment:
2013
Dec. 31
Impairment loss on HTM securities
(income)
Investment in HTM securities
©Cambridge Business Publishing, 2013
481,666
481,666
29
Learning Objective 2
Explain the reporting for equity method
intercorporate investments.
©Cambridge Business Publishing, 2013
30
Investments with Significant Influence
 Two accounting options exist
 Elect to use the ASC Topic 825 fair value
option, or
 Apply the equity method (ASC Topic 323)
 Investor must exert significant influence
over operating and financing decisions of
the investee
©Cambridge Business Publishing, 2013
31
When is Significant Influence Present?
 Representation on the investee’s board
 Involvement in investee operating and
financial policies
 Significant transactions between investor
and investee
 Guideline: 20% to 50% ownership
 BUT significant influence can exist with less
than 20% ownership
©Cambridge Business Publishing, 2013
32
Accounting Using the Equity Method
Investment performance reflects the investee’s
performance
Equity method investment
Cost of investment
Increases
Investor's share of
Investor's share of
investee's income and investee's losses and
OCI gains
OCI losses
Decreases
Dividends declared by
investee
Ending balance
Investment changes in proportion to
the investee’s retained earnings and
AOCI accounts
©Cambridge Business Publishing, 2013
33
Equity Method Example
Investment cost = $2,000,000 for 30% of the investee’s stock.
During the first year, the investee reports net income of $800,000,
declares and pays dividends of $300,000, and has $50,000 in
unrealized losses on AFS securities.
To record the purchase of equity investment:
Equity method investment
Cash
2,000,000
2,000,000
To record dividends declared and paid:
Cash
Equity method investment
90,000
90,000
To accrue earnings of investee:
Equity method investment
Equity in income of investee
©Cambridge Business Publishing, 2013
240,000
240,000
34
Equity method example continued
Investment cost = $2,000,000 for 30% of the investee’s stock.
During the first year, the investee reports net income of $800,000,
declares and pays dividends of $300,000, and has $50,000 in
unrealized losses on AFS securities.
To record investee’s OCI:
Other comprehensive income
Equity method investment
15,000
15,000
Change in investee’s equity = $800,000 - $300,000 $50,000 = $450,000
Change in equity method investment = $240,000 $90,000 - $15,000 = $135,000, or 30% of the change in
the investee’s equity
©Cambridge Business Publishing, 2013
35
Equity Method Example continued
Investment cost = $2,000,000 for 30% of the investee’s
stock. During the first year, the investee reports net income
of $800,000, declares and pays dividends of $300,000, and
has $50,000 in unrealized losses on AFS securities.
Equity method investment
2,000,000
240,00090,000
15,000
2,135,000
Equity in income
of investee
240,000
240,000
Balance Sheet as
long-term asset
©Cambridge Business Publishing, 2013
Income
Statement
36
Equity in Net Income
 Adjustments to reported net income may be
required
 If investment cost differs from investee’s book
value
 Adjustment required: Amortize investment cost in
excess of book value acquired
 If investor and investee transact business with
each other
 Adjustment required: Remove intercompany profit
that is not yet earned
©Cambridge Business Publishing, 2013
37
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 or impairment
of other indefinite life intangibles
©Cambridge Business Publishing, 2013
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, 2013
38
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
39
Example: Revaluations
On January 1, 2013, Rocky Mountain reports total assets of $80
million and total liabilities of $50 million, for a net book value of
$30 million. Coca-Cola paid $12 million for 30% of Rocky
Mountain’s shares. 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, 2013 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, 2013
$12,000,000
$9,000,000
300,000
1,500,000
10,800,000
$1,200,000
Example: Unconfirmed Inventory
Profits
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, 2013
40
Recognition of Adjusted Equity in
Net Income for 2013
Coca-Cola's share of Rocky Mountain's reported
2013 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
2013
Dec. 31 Investment in Rocky Mountain Bottlers
253,500
Equity in income of Rocky Mountain Bottlers
253,500
©Cambridge Business Publishing, 2013
41
Impairment Testing:
Equity Method Investments
 Impairment testing required for equity
method investments (ASC Topic 323)
 Criteria
 Fair value of the investment declines below its
carrying value, and
 The decline is other than temporary
 Accounting requirements
 Investment is written down and a loss is
recognized on the investor’s income statement
 Subsequent increases are ignored
©Cambridge Business Publishing, 2013
42
43
Joint Ventures
 An entity formed by a 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
U.S. companies use the equity
method for joint ventures.
©Cambridge Business Publishing, 2013
44
Learning Objective 3
Describe the reporting for controlling
interests in other companies.
©Cambridge Business Publishing, 2013
45
Controlling Investments
 The investor has control over the
operating and financial decisions of the
investee
 Three forms
 Statutory merger, statutory consolidation, or
asset acquisition
 Stock acquisition
 Variable interest entity
 Assets, liabilities, revenues, and expenses
are combined with those of the investor for
financial statement reporting
©Cambridge Business Publishing, 2013
46
Statutory Mergers, Statutory
Consolidations, and Asset Acquisitions
 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, 2013
Statutory consolidation
Occurs when a new entity is
formed to acquire both the
investor and the investee
47
Statutory Merger Example
Coca-Cola acquires all of Rocky Mountain’s assets and liabilities
in a statutory merger by paying $40 million in cash on Jan. 2,
2013. Fair values in millions are: Current assets, $20; plant and
equipment, $61; current liabilities, $15; and long-term liabilities,
$35. Coca-Cola identified and valued Rocky Mountain’s
previously unreported intangibles asset, technology, at $5 million.
Price paid
Fair value of identifiable net assets acquired:
Current assets
Plant and equipment
Technology
Current liabilities
Long-term debt
Goodwill
©Cambridge Business Publishing, 2013
$40,000,000
$20,000,000
61,000,000
5,000,000
(15,000,000)
(35,000,000)
36,000,000
$4,000,000
48
Statutory Merger Example
continued
To record the acquisition of Rocky Mountain Bottlers:
Current assets
Plant and equipment
Technology
Goodwill
Current liabilities
Long-term debt
Cash
©Cambridge Business Publishing, 2013
20,000,000
61,000,000
5,000,000
4,000,000
15,000,000
35,000,000
40,000,000
49
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, 2013
The separate
financial records
are consolidated
at the end of
each reporting
period.
50
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 Coca-Cola makes
on its own books, but its annual
report shows Coca-Cola and Rocky
Mountain’s combined accounts as if
Coca-Cola recorded the acquisition
as a statutory merger.
©Cambridge Business Publishing, 2013
40,000,000
40,000,000
51
Variable Interest Entities (VIEs)
 Investee is a separate legal entity
controlled by another company
 Control occurs through legal relationships
rather than stock ownership
Entity is considered to be a VIE if:
• The entity must obtain guarantees from other
parties in order to obtain financing, or
• The equity holders do not have the usual
rights and responsibilities of equity ownership,
such as voting and residual return rights
©Cambridge Business Publishing, 2013
52
Issue of Control with VIEs
 Consequences of control
 Must have the power to direct the VIE’s
activities
 Must absorb the majority of the VIE’s risks and
rewards
 Reporting is the same as for stock
investments
Voting rights are not an
indicator of controlling a VIE
©Cambridge Business Publishing, 2013
53
Learning Objective 4
Discuss International Financial Reporting
Standards (IFRS) for intercorporate
investments.
©Cambridge Business Publishing, 2013
IFRS for Marketable Debt and
Equity Investments
 Currently accounted for the same as U.S.
GAAP (IAS 39)
 IFRS 9 (effective 2015):
 Default: FV-NI
 Option for equity investments not held for
trading: FV-OCI, never reclassified to income
 Option for debt securities held for principal and
interest payments: amortized cost
©Cambridge Business Publishing, 2013
54
IFRS for Marketable Debt and
Equity Investments
continued
 Impairment losses
 Focus on observance of ‘loss events’ related to
the decline in value
 Such as decline in credit rating, or
 Investee misses scheduled debt payments
 New standards for impairment testing under
consideration
©Cambridge Business Publishing, 2013
55
IFRS for Significant Influence
Investments
 Investee is defined as an associate
 Principles-oriented view to significant
influence
 Representation on the investee’s board
 Participation in policy-making process
 Material transactions between the investor and
the investee
 Interchange of managerial personnel
 Provision of essential technical information
©Cambridge Business Publishing, 2013
56
IFRS for Significant Influence
Investments
continued
 Equity method required
 Similar to U.S. GAAP procedures
 Impairment testing
 Compare the investment carrying value with
the higher of its market value or value-in-use
 Value-in-use is the present value of the
investment’s future expected cash flows
Possible differences in impairment
loss recognition between IFRS and
U.S. GAAP
©Cambridge Business Publishing, 2013
57
58
IFRS and Joint Ventures
 IFRS 11, effective 2013
 Two kinds of joint arrangements:
 Joint operations (rights to entity’s assets and
liabilities)
 Joint ventures (rights to entity’s returns and
disposal value)
 Joint ventures are most common
 Reported using the equity method
©Cambridge Business Publishing, 2013
59
IFRS and Joint Ventures
continued
 Until 2013, joint ventures may be reported
using proportionate consolidation
 Investor includes proportionate share of JV’s
assets and liabilities on its balance sheet
 Affects investor’s leverage
 No effect on investor’s equity or income
©Cambridge Business Publishing, 2013
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IFRS and Controlling Investments
 IFRS 10: When should an entity be
consolidated: all of the following
 Power to direct the activities that significantly
affect the investee’s returns
 Exposure to variable returns from investee
 Ability to use power to affect the amount of
investor’s returns
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IFRS and Controlling Investments
continued
 IFRS 10 applies to all control relationships
 Investments in stock of a company
 Control achieved through financial
relationships
 Variable interest entities
Should an entity controlled through a
financial relationship be consolidated?
Possible differences between IFRS and
U.S. GAAP
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End of Chapter 1
©Cambridge Business Publishing, 2013