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CORPORATE FINANCIAL REPORTING
11 – Financial Reporting of Investments
Long-Lived Assets
Financial Reporting of Investments
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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 100% of
shares
Financial Reporting of Investments
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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 active investor
Financial Reporting of Investments
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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 active investor
market equity consolidated value method financial statements
Financial Reporting of Investments
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INVESTMENT IN THE STOCK OF
ANOTHER COMPANY
Marketable security orTrading security
or
1 share Security available for sale
The difference is where the
passive “unrealized” gains or losses
investor will appear
market value
Financial Reporting of Investments
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Reporting Trading Securities vs.
Securities Available for Sale
International rules differ slightly, but in general:
Trading Securities are meant to be held for short periods of time and are part of a company’s “operating activity.”
Securities Available for Sale are not part of a company’s “operating activity” rather they are investments made as a short or long term investment to generate financing (not operating) profits.
Held to maturity securities - later
Financial Reporting of Investments
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Reporting Trading Securities vs.
Securities Available for Sale
A brief aside - a visit to the “hidden” income statement - Other Comprehensive Income
and a bizarre new account.
Financial Reporting of Investments
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Reporting Trading Securities vs.
Securities Available for Sale
On April 2nd, our company buys shares of X Company common stock for $10,000 (includes broker charges); our company prepares quarterly financial statements.
On June 30th, the stock has a fair value of $9,000.
On Sept. 30th, the stock has a fair value of $12,000.
On Dec. 21st, we sell the stock for $12,200 (net).
Scenario A: IF TRADING SECURITY (unrealized gains and losses on the income statement)
Financial Reporting of Investments
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Reporting Trading Securities vs.
Securities Available for Sale
On April 2nd, our company buys shares of X Company common stock for $10,000 (includes broker charges); our company prepares quarterly financial statements.
On June 30th, the stock has a fair value of $9,000.
On Sept. 30th, the stock has a fair value of $12,000.
On Dec. 21st, we sell the stock for $12,200 (net).
Scenario B: IF AVAILABLE-FOR-SALE (unrealized gains and losses in Other Comprehensive Income)
Financial Reporting of Investments
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Reporting Trading Securities vs.
Securities Available for Sale
IF YOU HAD A CHOICE, WHICH WOULD YOU CHOOSE AS A CEO OF A COMPANY?
WHY?
Financial Reporting of Investments
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INVESTMENT IN THE STOCK OF
ANOTHER COMPANY
50% 100% of
shares
active investor
equity consolidated method financial
statements
Financial Reporting of Investments
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The Equity Method - General Idea
Owners Owners of Co. A of Co. B
Co. A Co. B
Financial Reporting of Investments
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The Equity Method - General Idea
Owners Owners of Co. A of Co. B
$ shares of B
Co. A Co. B
Financial Reporting of Investments
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The Equity Method - General Idea
some former Owners Owners Owners
of Co. A of Co. B of Co. B
$
Co. A Co. B
Financial Reporting of Investments
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The Equity Method - General Idea
Brief example:(1) In January 2008, A pays $100,000 for 30% of B’sstock (which gives A “significant influence” over B).
In December 2008: (2) B reports $20,000 of net income and (3) pays $10,000 of cash dividends.
What will appear in A’s financial statements when those three things occur?
Financial Reporting of Investments
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The Equity Method - General Idea
In practice it is a little morecomplicated (of course).
I know you can’t wait to find out more.
Financial Reporting of Investments
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The Equity Method - Practice
On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash. The following relate to Sonn:
Balance sheet Fair values
ASSETS
Cash $ 10 $ 10
Inventory * 40 50
Other current assets 100 100
P P &E. ** 200 240
TOTAL $ 350
LIAB & O. E.
Liabilities $ 220 220
Common stock 50
Retained Earnings 80
TOTAL $ 350
Financial Reporting of Investments
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The Equity Method - Practice
Popp’s accountant immediately asks:
“Why did we pay so much?”
Financial Reporting of Investments
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The Equity Method - Practice
On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash. The following relate to Sonn:
Balance sheet Fair values
ASSETS
Cash $ 10 $ 10
Inventory * 40 50
Other current assets 100 100
P P &E. ** 200 240
TOTAL $ 350
LIAB & O. E.
Liabilities $ 220 220
Common stock 50
Retained Earnings 80
TOTAL $ 350
Financial Reporting of Investments
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The Equity Method - Practice
Here’s the complicating part:
the inventory will be sold 2007
and 1/6th of the PPE’s services will be used up in 2007.
Financial Reporting of Investments
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The Equity Method - Practice
Sonn’s Income Statement for 2008
Sales $1,540
COGS expense ( 840)
Deprec. expense ( 300)
Other expenses ( 100)
Net income $ 300
Sonn’s COGS and depreciation are based on Sonn’s cost of inventory and PP&E.
Financial Reporting of Investments
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The Equity Method - Practice
What will appear in Popp’s financial statements when:
1. Popp paid the $262 on January 2, 3008? 2. Sonn sends Popp its income statement at
Dec. 31, 2008?
3. Popp’s accountant remembers what a previous slide said about Sonn’s inventory and PP&E?
Financial Reporting of Investments
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The Equity Method - Practice
Popp’s Income Statement for 2008
Sales $ 4,000
COGS expense ( 1,300)
Deprec. expense ( 800)
Other expenses ( 700)
Income before equity income 1,200
Equity in earnings of affiliate
Net income $
Financial Reporting of Investments
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The Equity Method - Practice
Popp’s Income Statement for 2008
Sales $ 4,000
COGS expense ( 1,300)
Deprec. expense ( 800)
Other expenses ( 700)
Income before equity income 1,200
Equity in earnings of affiliate 255
Net income $ 1,455
Financial Reporting of Investments
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The Equity Method - Practice
Popp’s Balance Sheet December 31, 2007
Investment in Sonn $ 517 (262 + 270 - 15)
Financial Reporting of Investments
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INVESTMENT IN THE STOCK OF
ANOTHER COMPANY
50% 100% of
shares
consolidated financial
statements
Financial Reporting of Investments
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Consolidated Financial Statements-Theory
Theory behind consolidated financial statements;If one company controls another company, then they are “economically” one company and should “consolidate.”
Co. A F/S As separate legal entities A and B must prepare their
own financial statements.
Co. B F/S .
Financial Reporting of Investments
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Consolidated Financial Statements-Theory
Theory behind consolidated financial statements;If one company controls another company, then they are “economically” one company and should “consolidate.”
Co. A F/S As separate legal entities A and B must prepare their
F/S own financial statements.And A must also prepare Co. B F/S a set of financial statementsCONSOLIDATED - as if A
and B were one company.
Financial Reporting of Investments
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Consolidated Financial Statements - Illustration
On January 2, 2008, Popp Corporation acquired 90% of the shares of stock of Sonn Corporation by paying $262 cash to the shareholders of Sonn Corporation.
Financial Reporting of Investments
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Consolidated Financial Statements - Illustration
(some former) Owners Owners Owners of Popp of Sonn of Co. B
10%
Popp $
90% Sonn
Financial Reporting of Investments
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Consolidated Financial Statements - Illustration
(some former) Owners Owners Owners of Popp of Sonn of Co. B
10%
Popp $
90% Sonn a little complicated by
the noncontrolling (10%)
interest
Financial Reporting of Investments
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Consolidated Financial Statements - Illustration
Now we have two things going on: Popp uses the equity method to report “investment in Sonn” in its financial statements and Popp prepares consolidated financial statements.
We’ve already discussed Popp’s use of the equity method - Popp does the same thing now.
Financial Reporting of Investments
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Consolidated Financial Statements - Illustration
And also prepares the additional set of financial statements -as if Popp and Sonn are one company.
Consolidated Financial Statements - Illustration
P’s balance sheet after the transaction:cash $ 282 liabilities $ 350inventory 70 com. stock 260other current assets 110 ret. earnings 252PPE 400 $ 862Invest. in Sonn 262
$ 862 cash 10
inventory 49 acct. rec. 100
PPE 236liabilities 220 goodwill 100
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Financial Reporting of Investments
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INVESTMENTS IN THE STOCKOF ANOTHER COMPANY
How do you think managers try to “manage” earnings prior to acquiring other companies?
Before the acquisition, they manage earnings upward if they are giving
shares to acquire another company, but not if giving cash.
Financial Reporting of Investments
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INVESTMENTS IN THE STOCK OF ANOTHER COMPANY
QUESTIONS?
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