CORPORATE FINANCIAL REPORTING

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CORPORATE FINANCIAL REPORTING

13 – Financial Reporting of Investments (revisited)

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 50% 100% of

shares passive

investor active investor market equity consolidated value method financial

statements

THE EQUITY METHOD

The “theory”.

3Investments

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 Assume the following values for B’s assets/liabilities before acquiring B’s assets/liabilities:

Book Value Market Valuecash $ 200,000 cash $ 1,000 $ 1,000acct. rec. 300,000 acct. rec. 8,000 8,000inventory 500,000 inventory 12,000 15,000PPE 900,000 PPE 110,000 90,000accum. deprec (300,000) accum. deprec (30,000)patent 1,000 patent 1,000 0trademark 3,000 trademark - 2,000

$1,604,000 $102,000 $116,000

liabilities 100,000 liabilities 10,000 $ 10,000com. stock 300,000 com. stock 30,000APIC 350,000 APIC 35,000ret. earnings 854,000 ret. earnings 27,000

$1,604,000 $102,000

4Investments

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?”

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THE EQUITY METHOD

A’s balance sheet after acquiring B’s stock:

cash $ 172,000acct. rec. 300,000inventory 500,000PPE 900,000accum. deprec (300,000)Invest. in Co. B 28,000patent 1,000 trademark 3,000trade secret -

$1,604,000

liabilities 100,000com. stock 300,000APIC 350,000ret. earnings 854,000

$1,604,000

6Investments

THE EQUITY METHOD

A’s balance sheet after acquiring B’s stock:

cash $ 172,000acct. rec. 300,000inventory 500,000 25% of B’s OE 23,000 PPE 900,000 trademark 500accum. deprec (300,000) patent ( 250)Invest. in Co. B 28,000 PPE 2,500patent 1,000 inventory 750trademark 3,000 goodwill 1,500 trade secret - 28,000

$1,604,000

liabilities 100,000com. stock 300,000APIC 350,000ret. earnings 854,000

$1,604,000

7Investments

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.

8Investments

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). 9Investments

EQUITY INVESTMENTS

ACCOUNTING METHOD TO USE: ACTIVE INVESTMENT Equity method

control (in US) Consolidate

50% 100% of stock

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10Investments

BUY B’S ASSETS/LIABILITIES

1. If Co. A buys Co. B’s assets and liabilities, this is what happens:

Owners of A Owners of B

Co. A Co. B

assets/liabilities

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BUY B’S ASSETS/LIABILITIES

1. Afterwards, this is what we have:


Co. A Co. B

lots of lots of assets liabilities

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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 Assume the following values for B’s assets/liabilities before acquiring B’s stock:

Book Value Market Valuecash $ 200,000 cash $ 1,000 $ 1,000acct. rec. 300,000 acct. rec. 8,000 8,000inventory 500,000 inventory 12,000 15,000PPE 900,000 PPE 110,000 90,000accum. deprec (300,000) accum. deprec (30,000)patent 2,000 patent 1,000 0trademark 3,000 trademark - 2,000

$1,605,000 $102,000 $116,000

liabilities 100,000 liabilities 10,000 $ 10,000com. stock 300,000 com. stock 30,000APIC 350,000 APIC 35,000ret. earnings 855,000 ret. earnings 27,000

$1,605,000 $102,000

13Consolidated Financial Statements


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?14Consolidated Financial Statements


This is “after”:


10% owners Co. A 90% owner

Co. B



A’s balance sheet after the transaction:cash $ 65,000 liabilities 100,000acct. rec. 300,000inventory 500,000 com. stock 300,000Invest. in B stock 135,000 APIC 350,000PPE 900,000 ret. earnings 855,000accum. deprec (300,000) $1,605,000patent 2,000trademark 3,000

$1,605,000



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 10,000 com. stock 30,000APIC 35,000ret. earnings 27,000

$102,000



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.18Consolidated Financial Statements


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.



What we have:

Owners of A

F/S Co. A “Old” Owners of B

90% 10%

F/S Co. B



What FASB also wants:

Owners of A

F/S Co. A consolidated F/S

F/S Co. B



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).



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



A’s balance sheet after the transaction:cash $ 65,000 liabilities 100,000acct. rec. 300,000 com. stock 300,000inventory 500,000 APIC 350,000Invest. in B stock 135,000 ret. earnings 855,000PPE 900,000 $1,605,000accum. deprec (300,000) cash 1,000

patent 2,000 acct. rec. 8,000

trademark 3,000 inventory 15,000PPE 90,000 $1,605,000 patent 0trademark 2,000goodwill 41,000liabilities (10,000)

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So, Co. A’s consolidated balance sheet “substitutes” the assets and liabilities Co. A controls when it bought Co. B’s stock.


BUYING CO. B’s STOCK – A Consolidated Balance Sheet

A’s consolidated Balance Sheet:cash $ 66,000 liabilities 110,000acct. rec. 308,000inventory 515,000Invest. in B stock - com. stock 300,000PPE 990,000 APIC 350,000accum. deprec. (300,000) ret. earnings 855,000patent 2,000 $1,615,000trademark 5,000goodwill 41,000

$1,627,000



A’s consolidated Balance Sheet:cash $ 66,000 liabilities 110,000acct. rec. 308,000inventory 515,000Invest. in B stock - com. stock 300,000PPE 990,000 APIC 350,000accum. deprec. (300,000) ret. earnings 855,000patent 2,000 $1,615,000trademark 5,000 WHAT??goodwill 41,000

$1,627,000



A’s consolidated Balance Sheet:cash $ 66,000 liabilities 110,000acct. rec. 308,000inventory 515,000 N.C.I. * 12,000Invest. in B stock - com. stock 300,000PPE 990,000 APIC 350,000accum. deprec. (300,000) ret. earnings 855,000patent 2,000 $1,627,000trademark 5,000 WHEW!goodwill 41,000

$1,627,000 * NONCONTROLLING INTEREST IN NET ASSETS OF

SUBSIDIARY28Consolidated Financial Statements

BUYING CO. B’s STOCK – A Consolidated Income Statement

One year later, these were the income statements for A and B:

A B Sales revenue $200,000 $70,000COGS ( 80,000) ( 36,000)Deprec. exp. ( 45,000) ( 5,500)Pat. amort. exp. ( 400) ( 200)Other exp. ( 14,600) ( 7,800)Net income $ 60,000 $20,500

and B paid $10,000 in cash dividends.

What entries would A’s accountant make (assuming A uses the equity method)?



A’s income statement that it would issue to thepublic (IF it issued a non-consolidated income statement):

Sales revenue $200,000COGS ( 80,000) Deprec. exp. ( 45,000)Pat. amort. exp. ( 400)Other expenses ( 14,600)Equity income 15,030Net income $ 75,030



What would appear in A’s consolidated Income Statement:

Sales revenue $270,000COGS (119,000) Deprec. exp. ( 51,500)Pat. amort. exp. ( 400) Other exp. ( 22,400)Equity income --Consol. net income $ 76,700Net income to N.C.I ( 1,670)Net income to Co. A $ 75,030


BUYING CO. B’s STOCK – An Example

Co. A’s accountant also must prepare a consolidated owners’ equity statement and a consol-idated cash flow statement.


QUESTIONS

?


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CORPORATE FINANCIAL REPORTING