Aa3e Hamlen PPT Ch01 040815

Advanced Accounting
3rd Edition
Susan S. Hamlen
University at Buffalo, The State University of New York
Ronald J. Huefner
University at Buffalo, The State University of New York
James A. Largay III
Lehigh University
Cambridge Business Publishers

Chapter 1
Intercorporate Investments:
An Overview
Cambridge Business Publishers, 2016

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

Investments on the Balance Sheet
Coca-Cola Company reported the following investments

at December 31, 2013 and 2012 (in millions):

Coca-Colas Investments
Marketable securities
Includes trading, available-for-sale, and held-to-maturity
investments
Equity method investments
Investments for which Coca-Cola exerts significant influence
over operations
Coca-Colas equity method investments
23% interest in Coca-Cola Hellenic
28% interest in Coca-Cola FEMSA
29% interest in Coca-Cola Amatil

Coca-Colas 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)

Types of Investments for
Reporting Purposes
Trading
Controlling Available-
interest for-sale
Derivatives Held-to-
(hedges) maturity
Equity
method

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.

Learning Objective 1
Describe the reporting for

trading, available-for-sale,
and held-to-maturity
intercorporate investments.

Examples of Marketable Debt
and Equity Investments
Debt Securities Equity Securities
Commercial
Common stock
paper
Corporate
Preferred stock
bonds
Redeemable Put and Call

preferred stock options

Investments Under ASC Topic 320
Readily determinable market values

No significant influence over the investee
Three categories:
Trading Available-for-sale Held-to-maturity

investments investments investments

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

Accounting for Trading Investments
Securities owned:
Total cost of trading investments = $800,000
To record purchase of trading investments costing $800,000

2015
Oct. 15 Investment in trading securities 800,000
Cash 800,000

continued
To record the sale of trading security C for $214,000

2015
Dec. 5 Cash 214,000
Investment in trading securities 200,000
Gain on sale of trading securities (income) 14,000
To record the unrealized value change for securities A and B

Security Cost Year-End Value Unrealized Gain (Loss)
A $100,000 $125,000 $25,000 gain
B 500,000 485,000 $15,000 loss
2015
Dec. 31 Investment in trading securities 25,000
Unrealized gain on trading securities (income) 25,000
Dec. 31 Unrealized loss on trading securities (income) 15,000
continued
To record the sale of trading securities A and B

Security Cost Year-End Value Date Sold Selling Price Realized Gain (Loss)
A $100,000 $125,000 1/15/16 $120,000 $(5,000)
B 500,000 485,000 1/15/16 496,000 $11,000.
Security A
2016
Jan 15 Cash 120,000
Loss on sale of trading securities (income) 5,000
Security B
2016
Jan 15 Cash 496,000
Gain on sale of trading securities (income) 11,000
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.

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
Journal Entries for
AFS investments:
Total cost of trading investments = $800,000
To record purchase of investments costing $800,000

2015
Oct. 15 Investment in AFS securities 800,000
Cash 800,000

Journal Entries for
continued
To record the sale of AFS security C for $214,000

2015
Dec. 5 Cash 214,000
Investment in AFS securities 200,000
Gain on sale of AFS securities (income) 14,000
To record the unrealized value change for securities A and B

Security Cost Year-End Value Unrealized Gain (Loss)
A $100,000 $125,000 $25,000 gain
B 500,000 485,000 $15,000 loss
2015
Dec. 31 Investment in AFS securities 25,000
Unrealized gain on trading securities (OCI) 25,000
Dec. 31 Unrealized loss on AFS securities (OCI) 15,000
Journal Entries for
continued
2015 Year-End Date Selling Realized

Security Cost Value Sold Price Gain (Loss)
A $100,000 $125,000 1/15/16 $120,000 $2,000.
B 500,000 485,000 1/15/16 496,000 $(4,000)
To record the sale of AFS security A

2016
Jan 15 Cash 120,000
Reclassification of gain on AFS securities 25,000
Gain on sale (income) 20,000
To record the sale of AFS security B

2016
Jan 15 Cash 496,000
Loss on sale (income) 4,000
Reclassification of loss on AFS securities 15,000
Impairment Testing for AFS Securities
Required because impairment losses go through

income but normal declines are reported in OCI
Is the securitys 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 $15,000 decline in value of AFS security B at December 31, 2015

2015
Dec. 31 Impairment loss on security B (income) 15,000

Impairment Testing of AFS Securities
continued
After recognition of impairment, Security Bs 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

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
Reclassification of gain on AFS securities (OCI) 40,000

Impairment loss on AFS securities (income) 70,000

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 $ xx

Journal Entries for HTM Investments
Example
A company purchased a $1 million face value, 5% corporate bond

on January 1, 2015 for $965,349, yielding 6%. Interest is paid
annually on December 31. Maturity is December 31, 2018.
To record the purchase of HTM securities

2015
Jan. 1 Investment in HTM securities 965,349
Cash 965,349
To record the receipt of interest income for 2015

2015
Dec. 31 Cash $1,000,000 x 5% 50,000
Investment in HTM securities $57,921 $50,000 7,921
Interest income $965,349 x 6%
57,921

Example
continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%.

Carrying value at December 31, 2015: $965,349 + $7,921 = $973,270
2016
$1,000,000 x 5%
Dec. 31 Cash 50,000
Interest income $973,270 x 6% 58,396

2017
Dec. 31 Cash $1,000,000 x 5% 50,000
Interest income $981,666 x 6%
58,900
Example
continued
$1 million, 5% face value corporate bond for $965,349, yielding 6%.

2018
$1,000,000 x 5%
Dec. 31 Cash 50,000
Interest income $990,566 x 6% 59,434
Carrying value at December 31, 2018; $990,566 + $9,434 = $1,000,000

To record the receipt of face value bonds at maturity
2018
Dec. 31 Cash 1,000,000
Investment in HTM securities 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
Recording an Impairment Loss
Example
An investor owns an HTM security with a current amortized cost

of $981,666. At the end of 2016, 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 $200,000.
To record the impairment

2016
Dec. 31 Impairment loss on HTM securities (income) 781,666
Investment in HTM securities 781,666

Proposed Reporting Changes
for Financial Instruments
Classification and measurement

Deliberations substantially completed, with a final standard
expected later in 2015
Key provisions
Marketable equity investments generally measured at fair value
through earnings (AFS classification eliminated)
No significant changes expected to classification and measurement
guidance for investments in loans and debt securities
For financial assets and liabilities measured at amortized cost, public
business entities required to present fair value information (either
parenthetically on face of balance sheet or in notes to the financial
statements)
Proposed Reporting Changes
for Financial Instruments
continued
Impairment
Deliberations continue on this issue
FASB has proposed a current expected credit loss (CECL)
model for financial assets measured at amortized cost
Requires recognition of an allowance for the full amount of
contractual cash flows not expected to be collected
FASB continues to refine the CECL approach

Explain the reporting for

equity method
intercorporate investments.

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

When is Significant Influence Present?
Representation on the investees 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

Accounting Using the Equity Method
Investment performance reflects the investees

performance.
Equity Method Investment
Increases Cost of investment
Investor's share of investee's Investor's share of investee's

income and OCI gains losses and OCI losses
Decreases
Dividends declared
by investee
Ending balance
Investment changes in proportion to the investees

retained earnings and AOCI accounts.
Equity Method
Example
Suppose Coca-Cola acquires 30% of Rocky Mountain Bottlers stock
(300,000 shares) for $12 million. During the first year, the investee
reports net income of $2 million and declares and pays dividends of
$0.50/share.
To record the purchase of equity investment
Investment in Rocky Mountain Bottlers 12,000,000
Cash 12,000,000
To record dividends declared; $0.50 x 300,000
Dividends receivable 150,000
Investment in Rocky Mountain Bottlers 150,000
To record dividends paid
Cash 150,000
Dividends receivable 150,000
To accrue earnings of investee; 30% x $2,000,000 = $600,000
Equity in net income of Rocky Mountain Bottlers 600,000
Equity Method
Example
continued
Suppose Rocky Mountain Bottlers (the investee) reported $200,000

in unrealized gains on AFS securities, its only OCI item.
To record share of investees OCI (unrealized gains on AFS securities);

30% x $200,000 = $60,000
Unrealized gains on AFS investments (OCI) 60,000
Change in investees equity = $2,000,000 $500,000 + $200,000

= $1,700,000
Change in equity method investment = $600,000 $150,000 +
$60,000 = $510,000, or 30% of the change in the investees equity.
Equity Method
Example
continued
Coca-Cola (investor) acquired 30% of Rocky Mountain Bottlers

(investee) stock (300,000 shares) for $12 million. During the first
year, Rocky Mountain reported net income of $2 million, declared
and paid dividends of $0.50/share, and reported $200,000 in
unrealized gains on AFS securities.
Investment in Equity in Net Income of
Rocky Mountain Bottlers Rocky Mountain Bottlers
12,000,000 600,000
600,000 150,000
60,000
12,510,000 600,000
Balance Sheet as Income Statement

long-term asset
Equity in Net Income
Adjustments to reported net income may be required

If investment cost differs from investees 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

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.

Inventory Sales
Between Investee and Investor
Downstream Sales
Investor sells inventory to investee
Upstream Sales
Investee sells inventory to investor
Both companies record sales Both companies report

as if selling to outside Results in gross margin as part
customers. of income.
If inventory not sold to Investor must remove

unrelated outside party at when calculating equity
year-end, gross margin is not in net income
yet earned. of investee.
Revaluations
Example
Suppose on January 1, 2016, Rocky Mountain Bottlers 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 Mountains 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, 2016 and uses straight-line
depreciation. The previously unreported technology is a limited life
intangible asset with a 5-year life.
Price paid $12,000,000
Share of Rocky Mountains net assets acquired:
Book value (30% x $30,000,000) $9,000,000
Revaluation of plant & equipment (30% x $1,000,000) 300,000
Unreported technology (30% x $5,000,000) 1,500,000 10,800,000
Additional investment cost (goodwill) $ 1,200,000
Unconfirmed Inventory Profits
Example
Suppose Rocky Mountain Bottlers 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
Recognition of Adjusted Equity in Net
Income for 2016
Coca-Colas share of Rocky Mountains reported

2016 income (30% x $2,000,000) $600,000.
Adjustments for revaluation write-offs:
$300,000 / 10
Plant and equipment (30,000)
Previously unreported technology (300,000) $1,500,000 / 5
Adjustments for unconfirmed inventory profits:
Upstream sales (10,500) 30% x $35,000
Downstream sales (6,000) 30% x $20,000

Equity in net income of Rocky Mountain $253,500.
2016
Dec. 31 Investment in Rocky Mountain Bottlers 253,500
Equity in net income of Rocky Mountain Bottlers 253,500

Impaired Technology
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
investors income statement
Subsequent increases are ignored

Joint Ventures
An entity formed by a group of individuals or firms

that contributes resources and jointly shares in
managing and controlling the venture
Often established for a short-term, single business
transaction or activity
Enables expertise, special technology, capital, access to
markets to be combined
U.S. companies use the equity method

for joint ventures.

Describe the reporting

for controlling interests
in other companies.

Controlling Investments
The investor has control over the operating and financial

decisions of the investee
Three forms
Merger, 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

Mergers, Consolidations,
and Asset Acquisitions
Investor directly acquires the assets and liabilities of

the investee
Assets and liabilities recorded directly on investors
balance sheet at fair value
Merger Consolidation
Occurs when the investor acquires Occurs when a new entity is
the investee and becomes the formed to acquire both the
remaining legal entity. investor and the investee.
Asset Acquisition
Occurs when an investor acquires
a subset of the investees assets.
Merger
Example
Coca-Cola acquires all of Rocky Mountain Bottlers assets and

liabilities in a merger by paying $40 million in cash on Jan. 2, 2016.
Fair values are: Current assets, $20 million; plant and equipment,
$61 million; current liabilities, $15 million; and long-term liabilities,
$35 million. Coca-Cola identified and valued Rocky Mountains
previously unreported intangibles asset, technology, at $5 million.
Price paid $40,000,000
Fair value of identifiable net assets acquired:
Current assets $20,000,000.
Plant and equipment 61,000,000.
Technology 5,000,000.
Current liabilities (15,000,000)
Long-term debt (35,000,000) 36,000,000
Goodwill $ 4,000,000

Merger
Example
continued
To record the acquisition of Rocky Mountain Bottlers
Current assets 20,000,000

Plant and equipment 61,000,000
Technology 5,000,000
Goodwill 4,000,000
Current liabilities 15,000,000
Long-term debt 35,000,000
Cash 40,000,000

Stock Acquisitions
Occurs when an investor obtains control over another

company by investing in its voting stock
Investee remains a separate legal entity
The separate
financial records
are consolidated
at the end of
PARENT each reporting
The investor SUBSIDIARY period.
The acquired company
(investee)
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 40,000,000

Cash 40,000,000
This is the entry Coca-Cola makes on its own books,

but its annual report shows Coca-Cola and
Rocky Mountains combined accounts as if Coca-Cola
recorded the acquisition as a merger.

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
Issue of Control with VIEs
Consequences of control
Must have the power to direct the VIEs activities
Must absorb the majority of the VIEs risks and rewards
Reporting is the same as for stock investments
Voting rights are not an indicator

of controlling a VIE.

Discuss International Financial

Reporting Standards (IFRS)
for intercorporate investments.

IFRS for Marketable Debt and Equity
Investments
Currently accounted for the same as U.S. GAAP (IAS 39)

IFRS 9 (effective 2018):
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 (i.e., no intent to sell): amortized cost

IFRS for Marketable Debt and Equity
Investments
continued
Impairment losses
IAS 39 focuses on observance of specific loss events
related to a decline in value, such as
Decline in credit rating, or
Investee misses scheduled debt payments
IFRS 9 introduces the expected credit losses (ECL) model
Focuses on more timely recognition of losses
Entities must account for ECL from when financial instruments are
first recognized
Amount of ECL recognized is updated at each reporting date to
reflect changes in credit risk of financial instruments

IFRS for Significant Influence Investments
Investee is defined as an associate

Principles-oriented view to significant influence
Representation on the investees board
Participation in policy-making process
Material transactions between the investor and the investee
Interchange of managerial personnel
Provision of essential technical information

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 investments future
expected cash flows
Possible differences in impairment loss recognition

between IFRS and U.S. GAAP.

IFRS and Joint Ventures
IFRS 11
Two kinds of joint arrangements:
Joint operations (rights to entitys assets and liabilities)
Joint ventures (rights to entitys returns and disposal value)
Joint ventures are most common
Reported using the equity method

IFRS and Controlling Investments
IFRS 10: When should an entity be consolidated?

Control occurs when investor has all of the following:
Power to direct the activities that significantly affect the
investees returns
Exposure to variable returns from investee
Ability to use power to affect the amount of investors
returns

IFRS and Controlling Investments
continued
IFRS 10 applies to all control relationships

Investments in stock of a company
Control achieved through contractual relationships
Variable interest entities
Should an entity controlled through a financial

relationship be consolidated?
Possible differences between IFRS and U.S. GAAP.

For additional practice materials,
please visit
www.cambridgepub.com/
student-materials/21
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Advanced Accounting

Cambridge Business Publishers

Cambridge Business Publishers, 2016

As a temporary investment of excess cash or part of a

Cambridge Business Publishers, 2016

Coca-Cola Company reported the following investments

Cambridge Business Publishers, 2016

Cambridge Business Publishers, 2016

Cambridge Business Publishers, 2016

Cambridge Business Publishers, 2016

ASC Topic 825 allows companies to elect the fair value

This chapter assumes the company

Cambridge Business Publishers, 2016

Describe the reporting for

Cambridge Business Publishers, 2016

Debt Securities Equity Securities

Redeemable Put and Call

Cambridge Business Publishers, 2016

Readily determinable market values

Trading Available-for-sale Held-to-maturity

Cambridge Business Publishers, 2016

Debt or equity securities

Cambridge Business Publishers, 2016

Total cost of trading investments = $800,000

To record purchase of trading investments costing $800,000

Cambridge Business Publishers, 2016

To record the sale of trading security C for $214,000

To record the unrealized value change for securities A and B

To record the sale of trading securities A and B

Gains and losses are reported in income as the value of

Cambridge Business Publishers, 2016

Debt or equity securities

Total cost of trading investments = $800,000

To record purchase of investments costing $800,000

Cambridge Business Publishers, 2016

To record the sale of AFS security C for $214,000

To record the unrealized value change for securities A and B

2015 Year-End Date Selling Realized

To record the sale of AFS security A

To record the sale of AFS security B

Required because impairment losses go through

To record $15,000 decline in value of AFS security B at December 31, 2015

Cambridge Business Publishers, 2016

After recognition of impairment, Security Bs cost is

Cambridge Business Publishers, 2016

Fair value ($90,000) < cost ($160,000)

Reclassification of gain on AFS securities (OCI) 40,000

Cambridge Business Publishers, 2016

Debt securities only

Cambridge Business Publishers, 2016

A company purchased a $1 million face value, 5% corporate bond

To record the purchase of HTM securities

To record the receipt of interest income for 2015

Cambridge Business Publishers, 2016

$1 million, 5% face value corporate bond for $965,349, yielding 6%.

Carrying value at December 31, 2016: $973,270 + $8,396 = $981,666

$1 million, 5% face value corporate bond for $965,349, yielding 6%.

Carrying value at December 31, 2018; $990,566 + $9,434 = $1,000,000

Required because normally HTM investments are

An investor owns an HTM security with a current amortized cost

To record the impairment

Cambridge Business Publishers, 2016

Classification and measurement