1

Motivations for Intercorporate

Investments
 As a temporary investment of excess cash
 As part of a long-term risk-adjusted
portfolio
 Expectations of dividends and gains
 As a strategic investment
 To develop relationships with suppliers and
customers
 To gain access to new product or geographic
markets
 To facilitate activity along a supply chain
©Cambridge Business Publishing, 2010
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Investments on the Balance Sheet

Coca-Cola Company reported the following investments at
December 31, 2007 and 2008 (in millions):
Assets 2008 2007
Current Assets
Cash and cash equivalents $4,701 $4,093
Marketable securities 278 215
Trade accounts receivable, less allowances of $51 and
$56, respectively 3,090 3,317
Inventories 2,187 2,220
Prepaid expenses and other assets 1,920 2,260
Total Current Assets $12,176 $12,105
Investments
Equity method investments:
Coca-Cola Hellenic Bottling Company, S.A. $1,487 $1,549
Coca-Cola FEMSA, S.A.B. de C.V. 877 996
Coca-Cola Amatil Limited 638 806
Coca-Cola Enterprises, Inc. - 1,637
Other, principally bottling companies and joint ventures 2,314 2,301
Other investments,,principally bottling companies 463 488
Total Investments $5,779 $7,777
©Cambridge Business Publishing, 2010
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Note Disclosure of Investments

Coca-Cola Company reported the following in Footnote 10 of
its 2008 annual report:
The Coca-Cola Company, Footnote 10, 2008 Annual Report
Gross Unrealized Estimated
2008 (in millions) Cost Gains Losses Fair Value
Trading securities
Equity Securities $74 $ - ($30) $ 44
Other securities 7 - (2) 5
$81 $ - ($32) $ 49
Available-for-sale securities:
Equity securities $329 $193 ($7) $515
Other securities 12 - (5) 7
$341 $193 ($12) $522
Held-to-maturity securities:
Bank and corporate debt $74 $ - $ - $74

©Cambridge Business Publishing, 2010

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Coca-Cola’s Investments

 Marketable securities
 Includes trading, available-for-sale, and cost
method investments
 Equity method investments
 Investments for which Coca-Cola intends to
exert significant influence over operations
 Coca-Cola’s equity method investments
 35% interest in Coca-Cola Enterprises Inc.
 23% interest in Coca-Cola Hellenic
 32% interest in Coca-Cola FEMSA
 30% interest in Coca-Cola Amatil
©Cambridge Business Publishing, 2010
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Coca-Cola’s Investments
 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 for
strategic reasons
 2007-2008 acquisitions by Coca-Cola
 18 German bottling and distribution operations
 Energy Brands Inc.

©Cambridge Business Publishing, 2010

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Types of Investments for Reporting

Purposes

©Cambridge Business Publishing, 2010

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Fair Value Option

 SFAS 159 allows companies to elect ‘fair
value option’ for eligible intercorporate
investments
 Investments reported at fair value
 Value changes reported as part of income
 Excludes controlling equity investments
The discussion on marketable
investments and equity method
investments in this chapter assumes
the company did NOT elect the fair
value option for these investments.
©Cambridge Business Publishing, 2010
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Investments Under SFAS 115

 Must have readily determinable market

value
 Must have no significant influence over the
investee
 Three categories
Trading
Investments Available-for-Sale
Investments Held-to-Maturity
Securities

©Cambridge Business Publishing, 2010

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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

©Cambridge Business Publishing, 2010

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Accounting for Trading Investments

Securities owned by Zinc, Inc. are:
Exhibit 1.2

Date December 31, 2010 Selling

Security Acquired Cost Value Date Sold Price
A 10/15/10 $100,000 $125,000 1/15/11 $120,000
B 10/15/10 500,000 485,000 1/15/11 496,000
C 10/15/10 200,000 N/A 12/5/10 214,000
$800,000

To record purchase of investments costing $800,000:

2010
Oct. 15 Investment in trading securities 800,000
Cash 800,000

©Cambridge Business Publishing, 2010

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Accounting for Trading Investments

To record the sale of trading security C for $214,000:
2010
Dec. 5 Cash 214,000
Investment in trading securities 200,000
Realized gain on sale of trading securities 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 Net unrealized
B 500,000 485,000 $15,000 Loss gain = $10,000

2010
Dec. 31 Investment in trading securities 10,000
Unrealized gain on trading
securities 10,000

©Cambridge Business Publishing, 2010

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Accounting for Trading Investments

To record the sale of trading securities A and B: Exhibit 1.2

Realized
Security Cost Year-end Value Date Sold Selling Price Gain (Loss)
A $100,000 $125,000 1/15/11 $120,000 ($5,000)
B 500,000 485,000 1/15/11 496,000 $11,000
$610,000 $616,000
Net realized
gain = $6,000

2011
Jan. 15 Cash 616,000
Investment in trading securities 610,000
Realized gain on sale of trading securities 6,000

©Cambridge Business Publishing, 2010

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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

©Cambridge Business Publishing, 2010

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Journal Entries for Available-for-Sale

Investments
Securities owned by Zinc, Inc. are: Exhibit 1.2

Date Selling
Security Acquired Cost December 31, 2010 Value Date Sold Price
A 10/15/10 $100,000 $125,000 1/15/11 $120,000
B 10/15/10 500,000 485,000 1/15/11 496,000
C 10/15/10 200,000 N/A 12/5/10 214,000
$800,000

To record the purchase of investments costing $800,000:

2010
Oct. 15 Investment in AFS securities 800,000
Cash 800,000

©Cambridge Business Publishing, 2010

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Journal Entries for Available-for-Sale

Investments continued

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

2010
Dec. 5 Cash 214,000
Investment in AFS securities 200,000
Realized 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 Net unrealized
B 500,000 485,000 $15,000 Loss gain = $10,000

2010
Dec. 31 Investment in AFS securities 10,000
Unrealized gains on AFS securities
(OCI) 10,000

©Cambridge Business Publishing, 2010

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Journal Entries for Available-for-Sale

Investments continued

Realized
Security Cost Year-end Value Date Sold Selling Price Gain (Loss)
A $100,000 $125,000 1/15/11 $120,000 ($5,000)
B 500,000 485,000 1/15/11 496,000 $11,000
$610,000 $616,000
Net unrealized
To record the sale of AFS securities A and B: gain = $6,000
2011
Jan. 15 Cash 616,000
Investment in AFS securities 610,000
Realized gains on sale of AFS securities 6,000

To reclassify unrealized gains of AFS securities from AOCI

to income:
Jan. 15 Unrealized gains on AFS securities 10,000
Realized gains on sale of AFS securities 10,000

©Cambridge Business Publishing, 2010

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Held-to-Maturity Investments
 Debt securities only
 Reported as noncurrent assets at amortized
cost
 Discount or premium amortized over time
 Moved to current assets during year of
maturity
 No gains or losses unless sold prior to
maturity
 Early sale requires extreme circumstances
Income Statement
Other Income/losses:
Interest income…………………………………………………… $xx
©Cambridge Business Publishing, 2010
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Journal Entries for HTM Investments

A company invested in a $1 million, 5% face value corporate bond
on January 1, 2010 for $965,349, yielding 6%. Interest is paid
annually on December 31. Maturity is December 31, 2013.
To record the purchase of HTM securities:
2010
Jan. 1 Investment in HTM securities 965,349
Cash 965,349

To record the receipt of interest income for 2010:

2010 $1,000,000 × 5%
Dec. 31 Cash 50,000
Investment in HTM securities 7,921
Interest income 57,921

$50,000 – $57,921 $965,349 × 6%

©Cambridge Business Publishing, 2010
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Journal Entries for HTM Investments

$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2010: $965,349 + $7,921 = $973,270

To record the receipt of interest income for 2011: $1,000,000

× 5%
2011
Dec. 31 Cash 50,000
Investment in HTM securities 8,396
Interest income 58,396
$50,000 – $58,396 $973,270 × 6%

Carrying value at December 31, 2011: $973,270 + $8,396 = $981,666

To record the receipt of interest income for 2012: $1,000,000
× 5%
2012
Dec. 31 Cash 50,000
Investment in HTM securities 8,900
Interest income 58,900
$50,000 – $58,900 $981,666 × 6%
©Cambridge Business Publishing, 2010
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Journal Entries for HTM Investments

$1 million, 5% face value corporate bond for $965,349, yielding 6%.
Carrying value at December 31, 2012: $981,666 + $8,900 = $990,566
To record the receipt of interest income for 2013:
$1,000,000 × 5%
2013
Dec. 31 Cash 50,000
Investment in HTM securities 9,434
Interest income 59,434
$50,000 – $59,434 $990,566 × 6%

Carrying value at December 31, 2013: $990,566 + $9,434 = $1,000,000

To record receipt of face value of bonds at maturity:

2013
Dec. 31 Cash 1,000,000
Investment in HTM securities 1,000,000
©Cambridge Business Publishing, 2010
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Impairment Test for HTM Investments

 HTM investments must be evaluated for
impairment
 Two criteria
 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
©Cambridge Business Publishing, 2010
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Recording an Impairment Loss

Example:
An investor owns an HTM security with a current amortized cost of
$981,666. During 2011, the investor has determined 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:

2011
Dec. 31 Impairment loss on HTM securities 781,666
Investment in HTM securities 781,666

©Cambridge Business Publishing, 2010

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Investments with Significant Influence

 Two accounting options exist

 Elect to use the SFAS 159 fair value option, or
 Apply the equity method
 Investor must exert significant influence
over operating and financing decisions of
the investee

©Cambridge Business Publishing, 2010

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When is Significant Influence Present?

 Assumed to be present if the investment
allows the investor to exercise significant
influence over the financial and operating
decisions of the investee
 Generally 20 to 50% ownership required
 Less than 20% ownership exceptions
 Representation on the investee’s board
 Involvement in investee operating and financial
policies
 Significant transactions between investor and
investee
©Cambridge Business Publishing, 2010
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Accounting Under the Equity Method

Investment performance should parallel the

investee’s performance
Investment in Stock

Cost of investment

Increases Decreases
Investor's share of Investor's share of
investee's income investee's loss

Dividends received
from investee
Ending cost basis

Changes in proportion to the

investee’s retained earnings account
©Cambridge Business Publishing, 2010
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Equity Method Example

Coca-Cola acquires 300,000 voting shares of Rocky Mountain
Bottlers for $12 million cash to obtain a 30% ownership with
significant influence over the investee. Rocky Mountain reports
net income of $2 million and declares a cash dividend of $0.50
per share on November 1, and pays the dividend on December 2.

To record the purchase of equity investment:

2011
Jan. 2 Investment in Rocky Mountain Bot. 12,000,000
Cash 12,000,000
To record dividends declared:
2011
Nov. 1 Dividends receivable 150,000
Investment in Rocky Mountain Bottlers 150,000

$0.50 × 300,000
©Cambridge Business Publishing, 2010
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Equity Method Example continued

Coca-Cola acquires 300,000 voting shares of Rocky Mountain

Bottlers for $12 million cash to obtain a 30% ownership with
significant influence over the investee. Rocky Mountain reports
net income of $2 million and declares a cash dividend of $0.50
per share on November 1, and pays the dividend on December 2.

To record dividends received:

2011
Dec. 2 Cash 150,000
Dividends receivable 150,000

To accrue earnings of the investee:

2011
Dec. 31 Investment in Rocky Mountain Bottlers 600,000
Equity in income of Rocky Mountain Bottlers 600,000

30% × $2,000,000
©Cambridge Business Publishing, 2010
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Equity Method Example continued

Coca-Cola acquires 300,000 voting shares of Rocky

Mountain Bottlers for $12 million cash to obtain a 30%
ownership with significant influence over the investee. Rocky
Mountain reports net income of $2 million and declares a
cash dividend of $0.50 per share on November 1, and pays
the dividend on December 2.
Investment in Rocky Equity in income
Mountain Bottlers of Rocky Mountain
12,000,000 600,000
150,000
600,000
12,450,000 600,000

Balance Sheet as
long-term asset Income
Statement
©Cambridge Business Publishing, 2010
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Equity in Net Income

 Adjustments to reported net income may
be required
 If investment cost differs from investee’s book
value
 Adjustment required: Must amortize investment cost
in excess of book value acquired
 If investor and investee transact business with
each other
 Adjustment required: Remove gross margin that is
not yet earned

©Cambridge Business Publishing, 2010

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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 (SFAS 142)
and other indefinite life intangibles (EITF Issue 08-06)

©Cambridge Business Publishing, 2010

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Additional Investment Cost Valuation

Rocky Mountain reports total assets of $80 million and total
liabilities of $50 million, for a net book value of $30 million. The
original cost paid by Coca-Cola was $12 million. 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, 2011 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 Mountain's net assets acquired:
Book value (30% x $30,000,000) $9,000,000
Revaluation of plant and 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
©Cambridge Business Publishing, 2010
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Inventory Sales Between Investee and

Investor
Downstream Sales Upstream Sales
Investor sells Investee sells
inventory to investee inventory to investor
Both companies Both report gross
record sales as if
Results in margin as part of
selling to outside income
customers

If inventory not sold to Investor must remove

unrelated outside party at when calculating equity in
year-end, gross margin is net income of investee
not yet earned
©Cambridge Business Publishing, 2010
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Adjustments for Unconfirmed Inventory

Profits Example
Suppose Rocky Mountain 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

©Cambridge Business Publishing, 2010

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Recognition of Adjusted Equity Income

Coca-Cola's share of Rocky Mountain's $300,000
reported ÷ 10
2011 income (30% x $2,000,000) $600,000
Adjustments for revaluation write-offs:
Plant and equipment (30,000)
Previously unreported technology (300,000) $1,500,000
Adjustments for unconfirmed inventory profits: ÷5
Upstream sales (10,500)
Downstream sales (6,000)
Equity in net income of Rocky Mountain $253,500
30% × 30% ×
$35,000 $20,000

2011
Dec. 31 Investment in Rocky Mountain Bottlers 253,500
Equity in income of Rocky Mountain Bottlers 253,500

©Cambridge Business Publishing, 2010

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Other Comprehensive Income and the

Equity Method
 Investor must adjust its investment and other
comprehensive income for its share of the
investee’s yearly OCI
 Such as investor’s recognition of unrealized
gain on AFS securities
Suppose Rocky Mountain reported $200,000 in unrealized gains
on AFS securities.
2011
Dec. 31 Investment in Rocky Mountain Bottlers 60,000
Unrealized gains on equity method
investments (OCI) 60,000
30% × $200,000 = $60,000
©Cambridge Business Publishing, 2010
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Impairment Testing
 Impairment testing required under APBO
18 for equity method investments
 Criteria
 If fair value of the investment declines below its
carrying value, and
 The decline is judged to be other than
temporary
 Accounting requirements
 Investment is written down and a loss is
recognized on the investor’s income statement
 Subsequent increases ignored
©Cambridge Business Publishing, 2010
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Joint Venture
 An entity formed by a small group of individuals
or firms that contribute resources and jointly
share in managing and controlling the venture
 Often established for a short-term, single business
transaction or activity
 Enables expertise, special technology, capital,
market access to be combined
 Corporate joint venture
 Exists when the venture is organized as a
corporation
U.S. companies use the equity
method for joint ventures.
©Cambridge Business Publishing, 2010
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Controlling Investments

 Give the investor control over the operating

and financial decisions of the investee
 Three forms
 Statutory merger, statutory consolidation, or
asset acquisition
 Stock acquisition
 Variable interest entity
 General rule: assets, liabilities, revenues,
and expenses are combined with those of
the investor for financial statement reporting
©Cambridge Business Publishing, 2010
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Statutory Mergers, Statutory

Consolidations, and Asset Acquisitions
 An investor directly acquires the assets
and liabilities of the investee
 Assets and liabilities recorded directly on
investor’s balance sheet at fair value
Statutory Merger
Occurs when the investor acquires Statutory Consolidation
the investee and becomes the Occurs when a new entity is
remaining legal entity formed to acquire both the
investor and the investee
Asset Acquisition
Occurs when an investor
acquires a subset of the
investee’s assets
©Cambridge Business Publishing, 2010
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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
each reporting
period.

©Cambridge Business Publishing, 2010

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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 Coke makes on its

own books, but its annual report
shows Coke and Rocky Mountain’s
combined accounts as if Coke
recorded the acquisition as a
statutory merger.

©Cambridge Business Publishing, 2010