The document discusses different types of investments corporations can make in other entities and the appropriate accounting methods. It covers passive investments in debt and equity securities, investments that allow significant influence over another company using the equity method, and controlling investments that require consolidation. The level of ownership and intent of the investment determines the proper accounting classification and reporting.

1. Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved.
Reporting and
Interpreting
Investments
in Other
Corporations
Chapter 12

2. 12-2
Understanding the Business
A company may invest in the
securities of another company to:
Earn a return
on idle funds.
(Passive
investments)
Control the
other
company.
Influence the
other
company’s
policies and
activities.

3. 12-3
Types of Investments
Investments in debt
securities are always
considered passive
investments.
Passive investments are made to earn a
high rate of return on funds that may be
needed for future purposes.

4. 12-4
Types of Investments
Equity security
investments are
presumed passive
if the investing
company owns
less than 20% of
the outstanding
voting shares.
Investor is not
interested in controlling
or influencing other
company.
Passive investments are made to earn a
high rate of return on funds that may be
needed for future purposes.

5. 12-5
Investments made with the intent of exerting
significant influence over another corporation.
The ability of the
investing company to
have an important
impact on the
operating and
financial policies of
another company.
Significant
Influence
20% - 50%
outstanding shares
Types of Investments

6. 12-6
Investments made with the intent to exert
control over another corporation.
>50%
outstanding shares
Control
The investing
company has the
ability to determine
the operating and
financial policies of
another corporation.
Types of Investments

7. 12-7
Types of Investments and Accounting
Methods
Measuring and
Investment Category Reporting Method
Debt Passive, Held-to-maturity Amortized cost
Debt Passive, Not-held-to-maturity Market value
Stock Passive Market value
Stock Significant influence Equity
Stock Control Consolidated statement
The accounting method depends
on the type of security and the level
of ownership (influence).

8. 12-8
Learning Objectives
Analyze and report bond investments
held to maturity.

9. 12-9
Debt Held To Maturity: Amortized Cost
Method
Record at cost on
acquisition date.
Amortize discount
or premium
Record interest
received
Record principal
received at maturity

10. 12-10
Debt Held To Maturity: Amortized Cost
Method
On July 1, 2008, Dow Jones paid the par value
of $100,000 for 8 percent bonds that mature on
June 30, 2013. The 8 percent interest is paid on each
June 30 and December 31. Management plans
to hold the bonds until maturity.
The journal entry to record the
investment is . . .

11. 12-11
Debt Held To Maturity: Amortized Cost
Method
Date Description Debit Credit
Jul. 1 Held-to-maturity Investments 100,000
Cash 100,000
GENERAL JOURNAL
The journal entry to record the receipt of
interest on December 31 of the first year is . . .

12. 12-12
Debt Held To Maturity: Amortized Cost
Method
Date Description Debit Credit
Dec. 31 Cash 4,000
Interest Revenue 4,000
GENERAL JOURNAL
The journal entry to record the receipt of
the principal payment at maturity is . . .
$100,000 × 8% × 6/12

13. 12-13
Debt Held To Maturity: Amortized Cost
Method
Date Description Debit Credit
June 30 Cash 100,000
Held-to-maturity Investments 100,000
GENERAL JOURNAL

14. 12-14
Learning Objectives
Analyze and report passive investments in
securities using the market value approach.

15. 12-15
Passive Investments: The Market
Value Method
Date of
acquisition
Investment is
initially
recorded at
cost.
Future
measurement date
Unrealized
holding gains and
losses are
recognized.
Investment
carrying amount is
adjusted to current
market value.

16. 12-16
Classifying Passive Investments
Effect of Unrealized Holding Gains and
Losses On . . .
Type of
Investment Definition
Investment
Account Equity Net Income
Trading
Securities
Actively traded
for potential
profit.
Allowance
Account
N/A
Reported on
the Income
Statement
Securities
Available for
Sale
Not actively
traded, held for
investment
returns.
Allowance
Account
Reported
as part of
equity
N/A
NOTE: Realized gains and losses go on the Income Statement.

17. 12-17
Securities Available for Sale (SAS)
IFNews and Dow Jones both produce film. Dow
Jones wants to acquire an ownership interest in
IFNews.
On January 5, Dow Jones acquires 10,000 of the
100,000 outstanding shares of IFNews on the
open market at a cost of $60 per share. Dow
Jones has no influence over IFNews, and does not
plan to sell the shares in the near future.

18. 12-18
Should the acquired shares be classified as Trading
Securities or Securities Available for Sale?
The journal entry to record the
investment is . . .
Securities Available for Sale (SAS)
Dow Jones does not plan to actively trade the
shares. Instead, they will be held to earn a return
on invested funds that may be needed for future
operations. The shares should be classified as
Securities Available for Sale.

19. 12-19
Date Description Debit Credit
Jan. 5 Investment in SAS 600,000
Cash 600,000
GENERAL JOURNAL
The investment may be a current asset or a noncurrent asset,
depending on management’s intended holding period.
Securities Available for Sale (SAS)

20. 12-20
Date Description Debit Credit
July 2
GENERAL JOURNAL
Securities Available for Sale (SAS)
On July 2, Dow Jones receives a $10,000
dividend from IFNews. Prepare the
journal entry to record the dividend.

21. 12-21
On July 2, Dow Jones receives a $10,000
dividend from IFNews. Prepare the
journal entry to record the dividend.
Date Description Debit Credit
July 2 Cash 10,000
Investment Income 10,000
GENERAL JOURNAL
Securities Available for Sale (SAS)

22. 12-22
By December 31, Dow Jones’ fiscal year-end, the
market value of IFNews’ shares has dropped from
$60 to $58 per share.
How much has Dow Jones’ portfolio value
changed?
The journal entry to recognize the
change in market value is . . .
Securities Available for Sale (SAS)
Market value ($58 per share × 10,000 shares) 580,000
$
Cost ($60 per share × 10,000 shares) 600,000
Unrealized holding loss on SAS portfolio (20,000)
$

23. 12-23
The unrealized holding loss would be reported in the
stockholders’ equity section of Dow Jones’ balance sheet.
Date Description Debit Credit
Dec. 31 Net Unrealized Gains
and Losses - SAS 20,000
Allowance to Value at Market 20,000
GENERAL JOURNAL
Securities Available for Sale (SAS)
Balance need in valuation allowance (20,000)
$
Unadjusted balance in valuation allowance* 0
Amount for adjusting entry (20,000)
$
* Assumes there were no passive investments
at the end of the of the prior year.

24. 12-24
Comparing Trading and Securities Available
for Sale
Trading Securities
Effects Securities Available for Sale
Realized Gains Sales Price > Cost Sales Price > Cost
Realized Losses Sales Price < Cost Sales Price < Cost
Unrealized Gains Adjusted at
and Losses Year-end
Trading Securities
Effects Securities Available for Sale
Unrealized Gains
and Losses
Income Statement
Balance Sheet
N/A
N/A
Adjusted at
Year-end

25. 12-25
Learning Objectives
Analyze and report investments involving
significant influence using the equity method.

26. 12-26
Investments For Significant Influence:
Equity Method
Used when an investor can exert
significant influence over an investee.
It is presumed that the investment
was made as a long-term investment.
Measuring and
Investment Category Reporting Method
Stock Passive Market value
Stock Significant influence Equity
Stock Control Consolidated statement

27. 12-27
Date of
acquisition
Investment is
initially
recorded at
cost.
Future
measurement date
Unrealized
holding gains and
losses are not
recognized.
Investment carrying
amount is adjusted for
dividends received, and
a percentage share of
the investee’s income.
Investments For Significant Influence:
Equity Method

28. 12-28
Adjusting Effect on
Item Investment Account
Reduce investment
for dividends received.
Investee Increase investment
Net Income by our proportionate
share.
Investee Decrease investment
Net Loss by our proportionate
share.
Dividends
Investments For Significant Influence:
Equity Method

29. 12-29
On January 2, TeleCom, Inc. acquires a 30%
interest in Sports.com at a cost of
$2,000,000. Prepare the journal entry to
record TeleCom’s investment.
Date Description Debit Credit
Jan. 2
GENERAL JOURNAL
Investments For Significant Influence:
Equity Method

30. 12-30
Date Description Debit Credit
Jan. 2 Investments in Associated Co. 2,000,000
Cash 2,000,000
GENERAL JOURNAL
Investments For Significant Influence:
Equity Method
On January 2, TeleCom, Inc. acquires a 30%
interest in Sports.com at a cost of
$2,000,000. Prepare the journal entry to
record TeleCom’s investment.

31. 12-31
On March 31, Sports.com pays $200,000 in
dividends, $60,000 (30%) of which goes to
TeleCom. Record TeleCom’s receipt of the
dividend.
Date Description Debit Credit
Mar. 31
GENERAL JOURNAL
Investments For Significant Influence:
Equity Method

32. 12-32
Date Description Debit Credit
Mar. 31 Cash 60,000
Investments in Associated Co. 60,000
GENERAL JOURNAL
Dividends are not revenue under the equity method. They
are treated as a reduction of the investment account.
Investments For Significant Influence:
Equity Method
On March 31, Sports.com pays $200,000 in
dividends, $60,000 (30%) of which goes to
TeleCom. Record TeleCom’s receipt of the
dividend.

33. 12-33
Sports.com net income for the year is
$1,600,000. TeleCom’s 30% share is
$480,000. Record TeleCom’s share of
Sports.com’s income.
Date Description Debit Credit
Dec. 31
GENERAL JOURNAL
Investments For Significant Influence:
Equity Method

34. 12-34
Date Description Debit Credit
Dec. 31 Investment in Associated Co. 480,000
Equity in Investee Earnings 480,000
GENERAL JOURNAL
TeleCom credits Equity in Investee Earnings (an income
statement account) for its share of Sports.com’s earnings.
Investments For Significant Influence:
Equity Method
Sports.com net income for the year is
$1,600,000. TeleCom’s 30% share is
$480,000. Record TeleCom’s share of
Sports.com’s income.

35. 12-35
Focus on Cash Flows
Investing activities:
 Purchase of investment (cash outflow)
 Sale of investment (cash inflow)
Operating activities:
 Gain on sale of investment (subtract from net income)
 Loss on sale of investment (add to net income)
 Equity in earnings of investee (subtract from net income)
 Dividends from investee (add to net income)
 Unrealized holding gains trading securities (subtract from
net income)
 Unrealized holding losses trading securities (add to net
income)

36. 12-36
Learning Objectives
Analyze and report investments
in controlling interests.

37. 12-37
Controlling Interests: Mergers and
Acquisitions
Off and running
with less than 20% .
. .
Clearing the 20%
hurdle to gain
influence . . .
Vaulting over
the 50% mark
to gain control!

38. 12-38
Horizontal
integration
Vertical
integration
Controlling Interests: Mergers and
Acquisitions
Synergy

39. 12-39
What Are Consolidated Statements?
 The acquiring company is the
parent.
 The company acquired is the
subsidiary.
 Consolidated statements
combine two or more
companies into a single set
of statements.
Any transactions
between the
parent and
subsidiary must
be eliminated
when preparing
consolidated
financial
statements.

40. 12-40
Occurs when one
company buys
another company.
The amount by which the
purchase price exceeds the fair
market value of net assets acquired.
Only purchased
goodwill is an
intangible asset.
Goodwill
Accounting for Goodwill

41. 12-41
Not amortized.
Subject to assessment
for impairment of
value and may be
written down.
Goodwill
Accounting for Goodwill

42. 12-42
Recording a Merger
Dow Jones paid $100,000,000 in cash to purchase
all the stock of IFNews. Dow Jones merged
IFNews’ operations into its own operations, and
IFNews ceased to exist as a separate entity. The
following information is taken from IFNews’ balance
sheet at the date of acquisition:
Plant and equipment, net 30,000,000
$
Other assets 60,000,000
Total assets 90,000,000
Current liabilities 10,000,000
Net assets 80,000,000
$
Should Dow Jones record goodwill?

43. 12-43
Recording a Merger
Dow Jones determined that IFNews’ plant and
equipment had a fair value of $35,000,000. The
book value at the acquisition date was
$30,000,000. The balance sheet amounts for
other assets and current liabilities are fair values.
Now let’s determine goodwill.
Purchase price for IFNews 100,000,000
$
Fair value of net assets acquired 85,000,000
Purchased goodwill 15,000,000
$
The journal entry to record the
acquisition of IFNews is . . .

44. 12-44
Recording a Merger
Date Description Debit Credit
Plant and Equipment 35,000,000
Other Assets 60,000,000
Goodwill 15,000,000
Current Liabilities 10,000,000
Cash 100,000,000
GENERAL JOURNAL

45. 12-45
Learning Objectives
Analyze and interpret the
return on assets ratio.

46. 12-46
Key Ratio Analysis
Measures how much the firm earned for each dollar of
investment. In general, a higher return indicates
management is doing a better job selecting investments.
For the year 2003, Dow Jones had $170,599 of
net income. Interest expense was negligible. End-of-year
assets were $1,304,154 and beginning-of-year assets
were $1,207,659. (All numbers in thousands.)
Return on
Assets
Net Income + Interest Expense (net of tax)
Average Total Assets
=

47. 12-47
Key Ratio Analysis
Dow Jones New York Times Knight-Ridder
13.60% 8.10% 7.20%
2003 Return on Assets Comparisons
Return on
Assets
=
$170,599
$1,304,154 + 1,207,659) ÷ 2
= 13.6%
Return on
Assets
Net Income + Interest Expense (net of tax)
Average Total Assets
=

48. 12-48
Preparing Consolidated Statements
Chapter Supplement A

49. 12-49
Consolidated Financial Statements
When one company acquires another
company and both companies continue
their separate legal existence, consolidated
financial statements must be prepared.
Let’s revisit the Dow Jones acquisition
of IFNews, assuming both companies
continued their separate legal existence, and
prepare consolidated financial statements.

50. 12-50
Consolidated Financial Statements
Goodwill = ?
Dow Jones uses $100 million of its $123 million in
current assets to purchase all the stock of IFNews
for $100 million. IFNews’ net assets (assets less
liabilities) are $80 million at the date of purchase,
but have a fair market value of $85 million.
Goodwill = $100 million – $85 million = $15 million
Fair Value Adjustment = ?
Fair Value Adjustment = $85 million - $80 million
Fair Value Adjustment = $ 5 million

51. 12-51
Consolidated Balance Sheet
Eliminations &
Dow Jones IFN Adjustments Consolidated
ASSETS
Current assets 23
$ 23
$
Investment in IFN 100 (100)
$ -
Plant and property (net) 689 30
$ 5 724
Other assets 492 60 552
Goodwill 15 15
Total assets 1,304
$ 90
$ 1,314
$
LIABILITIES & EQUITY
Current liabilities 613
$ 10
$ 623
$
Noncurrent liabilities 561 561
Stockholders' equity 130 80 (80) 130
Total liabilities & equity 1,304
$ 90
$ 1,314
$
Eliminate the Investment against the Equity of IFN,
establish goodwill, and record the assets at fair value.

52. 12-52
Consolidated Income Statement
Dow Jones IFN Adjustments Consolidated
Revenues 2,158
$ 120
$ 2,278
$
Expenses (2,150) (106) (1) (2,257)
Income 8
$ 14
$ (1) 21
$
$1 million additional
depreciation on the $5
million additional fair value
of assets acquired.

53. 12-53
End of Chapter 12