Long-Term Investments & the Time Value of Money

Copyright ©2012 Pearson Education Inc. Publishing as Prentice Hall.

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Long-Term Investments & the Time Value of MoneyChapter 8


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Key Terms


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Investments on the Balance SheetCurrent Assets:

Cash $X

Short-term investments X

Accounts receivable X

Inventories X

Prepaid expenses X

Total current assets $X

Long-term investments X

Property, plant and equipment X

Intangible assets X

Other assets X


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Analyze and report investments in held-to-maturity debt securities


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Bonds

Investor (Bondholder)

Investment in bonds

Interest revenue

Issuing Corporation

Bonds payable

Interest expense


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Held-to-Maturity Investments

•Recorded at amortized cost•Interest received semi-annually•Issued in $1,000 denominations•Price is quoted as percent of par

▫Fluctuate with market interest rates If market rate > face rate, sell at discount If market rate < face rate, sell at premium


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Accounting for held-to-maturity investments•Initially recorded at cost•Interest revenue recorded at semiannual

interest payment date•Premium or discount is amortized

▫Carrying value is adjusted towards face value

•Face value received at maturity


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Accounting for Held-to-Maturity Investments

JOURNAL

Date Accounts and explanation Debit Credit

Apr 1

Long-Term Investment in Bonds 9,520

Cash ($10,000 x 0.952) 9,520

To purchase bond investments.

Oct 1

Cash ($10,000 x 6% x 1/2) 300

Interest Revenue 300

To receive semi-annual interest.

Oct 1

Long-Term Investment in Bonds 60

Interest Revenue ([($10,000 – $9,520)/48]x6)

60

To amortize bond investment.


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Amortization of Held-to-Maturity Investment

Increases Long-Term

Investment account as it

reaches maturity

Increases Long-Term

Investment account as it

reaches maturity

Records interest revenue earned from carrying

amount increase

Records interest revenue earned from carrying

amount increase


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Analyze and report investments in available-for-sale securities


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Available-for-Sale Investments

•May be debt securities not held to maturity or equity securities

•Initially record at cost•Adjusted to current fair value at balance

sheet date


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Accounting Methods for Long-Term Investments

Percentage Ownership by the

Investor

GAAP Accounting

MethodLess than 20% Fair market value

20 – 50% Equity

Greater than 50% Consolidation


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Accounting for Available-for-Sale Investments

JOURNAL

Date Accounts and explanation Debit Credit

Oct 23

Long-Term Investment (1,000 × $44) 44,000

Cash 44,000

Purchased investment

Nov 14

Cash (1,000 ×$0.2) 200

Dividend Revenue 200

Received dividends


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The Fair Value Adjustment

JOURNAL

Date

Accounts and explanation Debit Credit

Allowance to Adjust Investment to Market

Unrealized Gain on Investment

Adjusted investment to marketJOURNAL

Date


Unrealized Loss on Investment


Adjusted investment to market

If market value is greater than carrying value

If market value is greater than carrying value

If market value is less than

carrying value

If market value is less than

carrying value


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Carrying Amount of Investment

Original cost of investment

Original cost of investment

Debit balance in Allowance to Adjust Investments to

Market

Debit balance in Allowance to Adjust Investments to

Market

OR

Credit balance in Allowance to Adjust Investments to

Market

Credit balance in Allowance to Adjust Investments to

Market

If fair value >

cost

If fair value >

cost

If fair value <

cost

If fair value <

cost


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Unrealized Gains and Losses

Fair value declines

Fair value declines DEBIT

Unrealized loss on investments

Unrealized loss on investments

Fair value increasesFair value increases

CREDIT Unrealized gain on investments

Unrealized gain on investments

Reported as element of other

comprehensive income


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Selling an Available-for-Sale Investment

JOURNAL

Date


Unrealized Gain on Investments


To eliminate unrealized gain on available-for-sale investments sold

Cash

Loss on Sale of Investment

Long-Term Investment

Sold investment

If cash > cost, “Gain” would be

credited

If cash > cost, “Gain” would be

credited


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Exercise 8-13A

JOURNAL

Date


(a) Long-Term Investment 14,350

Cash (410 x $35) 14,350

Purchased investment

(b) Cash 738

Dividend Revenue (410 X $1.80) 738

Received dividends

(c) Allowance to Adjust Investment to Market

2,870

Unrealized Gain on Investment 2,870

Adjusted investment to market


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Exercise 8-13A

JOURNAL

Date


(d) Unrealized Gain on Investment 2,870


2,870

Eliminate unrealized gain on investment sold

(d) Cash ($27 x 410) 11,070

Loss on Sale of Investment 3,280

Long-Term Investment 14,350

Sold investment


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Analyze and report investments in affiliated companies using the equity method


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Accounting for Equity Method Investments

•Method used when investors owns between 20 – 50% of investee’s voting stock▫Investor has significant influence over

investee operations•Investment initially recorded at cost•Investor records its share of investee net

income and dividends


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Recording Investee Income and Dividends

JOURNAL

Date



Equity-Method Investment Revenue

To record investment revenue

Cash


To receive cash on equity-method investment


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Summary of the Equity Method

Equity-Method Investment

Original cost

Share of income Share of dividends

Share of losses

Balance


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Exercise 8-15AJOURNAL

Date


Long-Term Investment 1,800,000

Cash 1,800,000

To purchase the equity-method investment.

Long-Term Investment ($660,000×40%)

264,000

Equity-Method Investment revenue

264,000

To record investment revenue.

Cash ($460,000×40%)

184,000

Long-Term Investment 184,000

To receive cash on equity-method.


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1,800,000

264,000 184,000

1,880,000

Exercise 8-15A


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Analyze and report controlling interests in other corporations using consolidated financial statements


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Consolidated Subsidiaries

•Investor controls investee▫Owns more than 50% of investee’s voting

stock▫Investor can elect majority of board

members•Investor is called the parent company•Investee is called the subsidiary


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Many investors (the stockholders)

Many investors (the stockholders)

own

own

The parent corporationThe parent corporation

who ownswho owns

The subsidiaryThe subsidiary


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Consolidation Accounting

•Method of combining financial statements of all companies controlled by same stockholders

•Result is a single set of statements as if parent and its subsidiaries are one company

•Gives better perspective on total operations than individual statements

•Worksheet is used to combine parent and sub accounts▫Intercompany accounts are eliminated


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Goodwill Noncontrolling interest

• Arises when parent pays more to acquire a subsidiary than the fair value of its net assets

• Recorded as an intangible asset

• Arises when parent company owns less than 100% of subsidiary stock

• Recorded as a separate account in the stockholders’ equity section

Goodwill and Noncontrolling Interest


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Summary of Accounting for Investments

Type of Long-Term InvestmentAccounting

Method

Investor owns less than 20% of investee stock

Available-for-sale

Investor owns between 20 – 50% of investee stock

Equity

Investor owns more than 50% of investee stock

Consolidation

Investor owns a long-term investment in bonds

Amortized cost


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Foreign Currencies & Exchange Rates•International business often results in

companies receiving or paying in a foreign currency

•Measure of one nation’s currency against another:▫Foreign-currency exchange rate

•Conversion of an item in one currency to another:▫Translation


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Factors Affecting Exchange Rates


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Foreign Currency Translation Adjustments•Foreign subsidiaries financial statements

are translated into US dollars▫Assets and liabilities at current exchange

rates▫Stockholders’ equity at historical exchange

rates•Difference cause out-of-balance condition•Translation adjustment needed to balance


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Report investing activities on the statement of cash flows


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Investment Transactions on the Cash Flow Statement

Purchases of available-for-sale investments Outflow

Sale of available-for-sale investments Inflow

Purchase of equity-method investments Outflow

Sale of equity-method investments Inflow


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Explain the impact of the time value of money on certain types of investments


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Time Value of Money

Present value Future value

Roll forward (accumulate)

Present value x (1 + interest rate) = Future value

Time = 0 1 year


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Future Value

•Value a current investment will be worth at a specified date in the future

•Due to interest revenue•Three inputs needed

▫Amount of initial payment▫Length of time▫Interest rate


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Present Value

•What amount in the future is worth today•Often called discounting•To simplify calculations

▫Present value tables▫Excel software

•Single amount or annuity


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Present Value of Investments in Bonds•Market price of bonds equals

▫Present value of principal received at maturity Single amount

▫Present value of interest payments Annuity


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Business

Long-Term Investments & the Time Value of Money