12-1

Reporting and Interpreting

Investments in Other Corporations

Appendix E

McGraw-Hill/Irwin © 2009 The McGraw-Hill Companies, Inc.

Understanding the Business

A company may invest in the securities

of another company to:

Earn a return Influence the Control the

on idle funds. other company’s other
(Passive policies and company.
investments) activities.
(Control)
(Significant
Influnce)

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 12-2

Passive Investments in Debt and Equity

Securities
Passive investments are made to earn a high rate of
return on funds that may be needed for future purposes.

Two types: investments in debt and equity.

Investments in debt securities are always

considered passive investments.

Equity security investments

are presumed passive if the The investor is not
investing company owns less interested in controlling
than 20% of the outstanding or influencing the other
voting shares. company.

12-3

Investments in Stock for Significant Influence

Investments made with the intent of exerting

significant influence over another corporation.

The ability of the

investing company to Significant
have an important Influence
impact on the 20% - 50%
operating and outstanding shares
financial policies of
another company.

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 12-3

Investments in Stock for Control

Investments made with the intent to exert

control over another corporation.

The investing
Control
company has the
ability to determine
>50%
the operating and
outstanding shares
financial policies of
another corporation.

12-5

Types of Investments and Accounting

Methods

The accounting method depends

on the type of security and the level
of ownership (influence).

Measuring and
Investment Category Reporting Method
Stock Passive Market value
Stock Significant influence Equity
Stock Control Consolidated statement

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 12-4

Passive Stock Investments: The Market

Value Method
Dividend is
Date of regarded as Future
acquisition investment measurement date
income (revenue).

Investment carrying
Investment is
amount is adjusted to
initially
current market value.
recorded at
cost. Unrealized holding
gains and losses are
recorded.

12-7

Passive Stock Investments: The Market

Value Method
 Why use market value for passive stock investments?
 Relevance
 Measurability

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 12-5

Classifying Passive Stock Investments

Effect of Unrealized Holding Gains and

Losses On . . .
Type of Investment
Investment Definition Account Equity Net Income
Actively traded Reported on
Trading Investment
for potential N/A the Income
Securities Account
profit. Statement
Not actively
Available for Reported
traded, held for Investment
Sale as part of N/A
investment Account
Securities equity
returns.

NOTE: Realized gains and losses go on the Income Statement.

12-9

Available for Sale (AFS) Securities – acquisition

On January 5, 2017, Washington Post acquires 10,000 of the
100,000 outstanding shares of INews on the open market at a
cost of $60 per share. Washington Post has no influence over
INews, and does not plan to sell the shares in the near future.

Should the acquired shares be classified as Trading

Securities or Available for Sale Securities?
Washington Post 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 Available for Sale Securities.

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 12-6

Available for Sale (AFS) Securities - acquisition

The journal entry to record
the investment is . . .

GENERAL JOURNAL
Date Description Debit Credit
Jan. 5 Investment in AFS (+A) 600,000
Cash (-A) 600,000

The investment may be a current asset or a noncurrent asset,

depending on management’s intended holding period.

12-11

Available for Sale (AFS) Securities– dividend earned

On July 2, Washington Post receives a

$10,000 dividend from INews. Prepare the
journal entry to record the dividend.

GENERAL JOURNAL
Date Description Debit Credit
July 2 Cash (+A) 10,000
Investment Income (+R, +SE) 10,000

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 12-7

Available for Sale (AFS) Securities– year-end valuation

 If market price increases:
 Dr: Investment - AFS
 Cr: Unrealized gains - AFS
 If market price decreases:
 Dr: Unrealized losses - AFS
 Cr: Investment - AFS
 Unrealized gain/loss is under SE on B/S
 Current period’s market price compared to latest
adjustment price.

12-13

Available for Sale (AFS) Securities – year-end valuation

By December 31, Washington Post’s fiscal year-end, the
market value of INews’ shares has dropped from $60
to $58 per share.
How much has Washington Post’s portfolio
value changed?

Market value ($58 per share × 10,000 shares) $ 580,000

Cost ($60 per share × 10,000 shares) 600,000
Unrealized holding loss on AFS portfolio $ (20,000)

The journal entry to recognize the change in

market value is . . .
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Available for Sale (AFS) Securities – year-end valuation

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Net Unrealized Gains
and Losses - AFS (-SE) 20,000
Investment - AFS (-A) 20,000

The unrealized holding loss is reported in the stockholders’ equity section

of Washington Post’s balance
sheet as Other Comprehensive Income.

12-15

Available for Sale (AFS) Securities– year-end valuation

Now let’s assume that the INew’s securities were held through the
year 2018. At the end of 2018, the stock had a $61 per share
market value.

GENERAL JOURNAL Page 86

Date Description Debit Credit
Dec. 31 Investment - AFS 30,000
Net unrealized gains
and Losses - AFS 30,000

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 12-9

Available for Sale (AFS) Securities– year-end valuation

Investment - AFS
1/5/2017 600,000
20,000 AJE
12/31/17 580,000
AJE 30,000
12/31/18 610,000

Net Unrealized Losses/Gains (SE)

Beginning of 2017 $ -
2017 Unrealized loss 20,000
12/31/17 Balance $ 20,000
$ 30,000 2018 Unrealized gain
$ 10,000 12/31/18 Balance

12-17

Available for Sale (AFS) Securities– sale of stock

In 2019 Washington Post sold all of its AFS investment in INews for
$62.5 per share.

Date Description Debit Credit

Jan. 31 Cash 625,000
31 Net unrealized gains and losses - AFS 10,000
Investment in AFS 610,000
Gain on sale of investments 25,000

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 12-10

Trading Securities (TS) – sale of stock

In 2019 Washington Post sold all of its TS investment in INews for

$62.5 per share.

Date Description Debit Credit

Jan. 31 Cash 625,000
Investment in TS 610,000
Gain on sale of investment 15,000

12-19

Comparing TS and AFS

Year-end
Valuation
Type of Receipt of (unrealized Sale (realized
Investment Purchase Dividend gain/loss) gain/loss)
current - the
Trading investment
at cost I/S latest
Securities income
adjustment
Available-for- current -
investment
Sale at cost B/S acquisition
income
Securities cost

NOTE: Realized gains and losses go on the Income Statement.

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 12-11

Investments For Significant Influence:

Equity Method

Used when an investor can exert

significant influence over an investee.
Measuring and
Investment Category Reporting Method
Stock Passive Market value
Stock Significant influence Equity
Stock Control Consolidated statement

It is presumed that the investment

was made as a long-term investment.
20% - 50% outstanding shares

12-21

Investments For Significant Influence:

Equity Method

Unrealized
Date of holding gains and Future
acquisition losses are not measurement date
recorded.

Investment is Investment carrying

initially amount is adjusted for
recorded at dividends received, and
cost. a percentage share of
the investee’s income.

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 12-12

Investments For Significant Influence:

Equity Method

When Purchase
Dr. Investment in associated companies (A)
Cr. Cash (A)
When investee reports income
Dr. Investment in associated companies (A)
Cr. Equity in earnings of associated co. (R,SE)
When investee reports loss
Dr. Equity in loss of associated companies (R,SE)
Cr. Investment in associated companies (A)
When receive dividend
Dr. Cash (A)
Cr. Investment in associated companies (A)
12-23

Investments For Significant Influence: Equity

Method

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 12-13

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.

GENERAL JOURNAL
Date Description Debit Credit
Jan. 2 Investments in Affiliated Co. (+A) 2,000,000
Cash (-A) 2,000,000

12-25

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.

GENERAL JOURNAL
Date Description Debit Credit
Dec. 31 Investment in Affiliated Co. (+A) 480,000
Equity in Investee
Earnings (+R, +SE) 480,000
TeleCom credits Equity in Investee Earnings (an income
statement account) for its share of Sports.com’s earnings.
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Investments For Significant Influence:

Equity Method
On March 31 of the next year, Sports.com pays
$200,000 in dividends, $60,000 (30%) of which goes to
TeleCom. Record TeleCom’s receipt of the dividend.

GENERAL JOURNAL
Date Description Debit Credit
Mar. 31 Cash (+A) 60,000
Investments in
Affiliated Co. (-A) 60,000

Dividends are not revenue under the equity method. They

are treated as a reduction of the investment account.
12-27

Investments For Significant Influence: Equity

Method
Investments in Affiliates(A)
Beginning balance $ -
Purchase $ 2,000,000
Share of affiliate's Share of affiliate's
net earnings 480,000 $ 60,000 dividends
Ending Balance $ 2,420,000

If sold, any
No adjustment to fair gain or loss is
value at the end of reported in the
the accounting period. income statement as
other income.

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Investments For Control - Consolidated

Statement

Used when an investor can

control over an investee.

Measuring and
Investment Category Reporting Method
Stock Passive Market value
Stock Significant influence Equity
Stock Control Consolidated statement
50% outstanding shares

12-29

What Are Consolidated Statements?

• The acquiring company is the Any transactions

parent. The company acquired between the
is the subsidiary. parent and
• Parent and subsidiaries are subsidiary must
separate legal entities be eliminated
• Consolidated statements when preparing
combine two or more consolidated
companies into a single set of financial
statements. statements.

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Recording a Merger

Goodwill
Occurs when one Only purchased
company buys goodwill is an
another company. intangible asset.

The amount by which the

purchase price exceeds the fair
market value of net assets acquired.

12-31

Recording a Merger
Washington Post paid $100,000,000 in cash to
purchase all the stock of INews. Washington Post
merged INews’ operations into its own operations,
and INews ceased to exist as a separate entity.
The following information is taken from INews’
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 Washington Post record goodwill?

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 12-17

Recording a Merger
Washington Post determined that INews’ 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 INews is . . .
12-33

Recording a Merger

GENERAL JOURNAL
Date Description Debit Credit
Plant and Equipment (+A) 35,000,000
Other Assets (+A) 60,000,000
Goodwill (+A) 15,000,000
Cash (-A) 100,000,000
Current Liabilities (+L) 10,000,000

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 12-18

Postmerger Balance Sheet

(dollars in millions) Washington Post
Assets
Cash and other current assets($935-$100) 835
Plant and equipment (net) ($1218+$35) 1,253
Other assets ($3229+$60) 3,289
Goodwill ($100-$85) 15
Total assets 5,392

Liabilities and Stockholders' Equity

Current liabilities ($803+$10) 813
Noncurrent liabilities 1,407
Stockholders' equity 3,172
Total liabilities and stockholders' equity 5,392

12-35

Postmerger Income Statement

(dollars in millions) Washington Post

Revenues ($3989+$120) 4,109
Expenses ($3665+$106+$1) 3,772
Net Income 337

$1 million additional
depreciation on the $5
million additional fair value
of assets acquired.

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 12-19

Comparison

Accounting for investments in securities depends on the degree of influence

and control the investor has over the investee:
Trading Securities
(Market Method)
Not significant
(<20% of Available-for-Sale Securities
outstanding shares) (Market Method)
Degree of Significant Investments in Affiliates
Influence (20% and <50% of (Equity Method)
outstanding shares)
Control Consolidated F/S
(50% of
outstanding shares)

12-37

Key Ratio Analysis

Return on Net Income

=
Assets Average Total Assets

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.

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 12-20

Key Ratio Analysis

For the year 2018, Washington Post had $324,469 of
net income. End-of-year assets were $5,381,372
and beginning-of-year assets were $4,584,773.
Return on Net Income
=
Assets Average Total Assets

Return on $324,469
= = 6.5%
Assets ($4,584,773 + $5,381,372) ÷ 2

2018 Return on Assets Comparisons

Washington Post News Corp Gannett
6.50% 5.70% 6.60%

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End of Chapter 12

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Summary

1. Reading: Appendix E
2. Understand the concept of passive investment, significant
influence and control
3. Two types of passive investment
4. Understand: market value method and the related transactions
under market value method; equity method and the related
transactions under equity method；Basic idea about
Consolidated Statement
5. Chapter 12 due next class
6. Quiz 5 (chap. 11, Appendix E): the 14th week
7. Presentation: 9 min+1 min Q&A.
上午课堂：12（14周）+15 （15周） ；下午课堂：8 （14周） +10 （15周）
8. 大作业提交时间：4PM, Nov. 14.
9. 考试时间：考试周，形式 待定
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 On March 1, 2018, Young Company purchased the following stock as

long-term investments in available-for-sale securities:
1. Old Corporation common stock (par $5), 2,000 shares at $5 per
share (10% of outstanding shares)
2. ABC Corporation common stock (par $10), 3,000 shares at $25 per
share (15% of outstanding shares)
3. XYZ Corporation common stock (par $10), 3,000 shares at $20 per
share (10% of outstanding shares)
The market prices per share at December 31, end of the accounting
period, were as follows:
Stock Dec. 31. 2018 Dec. 31. 2019
Old common $6 $7
ABC common $24 $25
XYZ common $21 $17
Give the required journal entries at the following dates: Match 1, 2018,
December 31, 2018 and December 31, 2019; Jan. 4th, sold all Old
Corporation’s stock at $8 per share. How about if all are TS?
12-42