Chapter 17 - Investments and international operations
In Chapters 14 and 15, you learned about shares from the perspective of the issuing company. In Chapter 16 we examined non-current liabilities and how companies account for debentures and other obligations. Now we expand these topics but change the perspective. Companies frequently purchase shares and debentures as investments. In addition, we learn about parent and subsidiary relationships and foreign currency transactions. The learning objectives for this chapter are to: 1. 2. 3. 4. 5. Account for investments in shares by the cost method. Use the equity method for investments. Understand consolidated financial statements. Account for long-term investments in debentures. Account for transactions stated in a foreign currency.
Shares are traded in markets. Prices are quoted in dollars and cents (in the US in dollars and oneeighth fractions of a dollar; occasionally you will see quotes in 1/16 and even 1/32 of a dollar). The owner of shares is the investor. The company that issues the shares is the investee. See Exhibit 17-1 for a detailed discussion of share price and trade information. You may also like to look in the print media or on the Internet at, say, tradingroom.com.au or the ComSec site. Share investments, cash deposits and loans to other companies are assets to the investor. Short-term investments are 1) liquid (readily convertible to cash) and 2) expected to be converted to cash within one year and are called marketable securities and classified as current assets. Long-term investments are 1) expected to be held for longer than one year or 2) not readily marketable.
Objective 1 - Account for investments in shares by the cost method.
When a company owns less than 20% of another company, unless there is evidence to the contrary, the investor is said to have neither control nor significant influence over the investee and the investor uses the cost method to account for the investment. The investment is reported in the statement of financial position at the lower of cost or net fair (market) value. When acquired, these investments are recorded cost (price per share number of shares acquired plus brokerage commission) and debited to a Short-Term Investment account as follows: Short-Term Investments Cash As dividends are received, the transaction is: Cash Dividend Revenue XX XX XX XX
Share dividends do not trigger an entry. Rather, the portfolio is updated to reflect the additional shares.
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On the statement of financial position date, all short-term investments are reported at cost (not their current market value unless the share price has fallen). If the current market value is lower than original cost the adjustment is: Loss on Short-term Investments Short-term Investment XX XX
While reductions in individual investments are reported as a loss on the statement of financial performance, gains are not recorded as revenue, unless the shares are sold. When an investment is sold, a gain or loss on sale will result when the proceeds are greater than (a gain) or less than (a loss) the carrying value of the investment. These gains and losses are realised and therefore reported on the statement of financial performance. Consistent with the treatment of short-term investments in AASB 1033 (Presentation and Disclosure of Financial Instruments) AASB 1010 Recoverable Amount of Non-Current Assets requires long-term investments to be written down if the carrying amount is greater than the amount expected to be recovered through the disposal of the asset. The only difference for long-term investments is they may not need to be written down if the decline is reasonably expected to be only temporary. In Chapter 10 AASB 1041 examined the revaluation of non-current assets. Long-term investments could be revalued upwards, if all assets in the class were revalued, but the increase in value is not recognised on the statement of financial performance.
Objective 2 - Use the equity method for investments.
The equity method is used when an investor holds between 20% and 50% of an investee’s voting shares because the investor is thought to exert significant influence on the investee’s business decisions. The investment is recorded at cost. Debit Investment in XYZ Limited and credit Cash. The investor records her or his proportionate ownership of the investee’s net profit and dividends. If the investor owns 40% of the voting shares, the investor will record 40% of the net profit as revenue and will receive 40% of the dividends. The share of profit is recorded with a debit to the Investment account and a credit to Share of Profit - Investment (revenue). The receipt of cash dividends reduces the investment. Therefore, the dividend is recorded with a debit to Cash and a credit to the Investment account. Share of Profit - Investment is reported on the statement of financial performance. Therefore investee’s profits increase the investment (asset) and increase revenue while dividends increase one asset (cash) and decrease another (investment). When the equity method is used and an investment is sold, the gain (or loss) on sale is the difference between the proceeds and the balance in the investment account. (Conceptually the equity method may seem a little odd. Think of the investee company as a bank account. When the bank account earns interest (the investee makes a profit) you record the increase in the amount of money in the bank and the interest revenue. When you take money out of the bank (the investee pays a dividend) you reduce the value of the bank account and increase your cash.)
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Objective 3 - Understand consolidated financial statements.
An investor who owns more than 50% of an investee’s voting shares has a controlling (majority) interest. The investor is called the parent company, and the investee is called the subsidiary. See Exhibits 17-3 and 17-4 in your text. Parent-subsidiary relationships are very common. The two applicable accounting standards are AASB 1024 Consolidated Accounts and IAS 27 Consolidated Financial Statements and Accounting for Investments in Subsidiaries. Consolidation accounting combines the financial statements of two or more companies that are controlled by the same owners. All the assets, liabilities, revenues, and expenses (and cash flows) of the subsidiary are added to the parent’s accounts. All (100%) are added even if the parent owns only 50% of the subsidiary. A separate set of books for the consolidated entity does not exist. The consolidation is accomplished by the use of a work sheet. Goodwill is recorded during the consolidation process if the parent buys the subsidiary for a price above the fair (market) value of its net assets (assets minus liabilities). A minority interest (Outside Equity Interest) will appear on the consolidated statement of financial position when the parent company owns more than 50% but less than 100% of the subsidiary’s shares. Outside equity interest is recorded as part of shareholders’ equity (not a liability as in the US) on the consolidated statement of financial position. Consolidated profit is equal to the net profit of the parent plus the parent’s proportionate interest in the subsidiary’s net profit. When consolidating financial statements, the individual amounts (cash, payables, investments, etc.) from the subsidiaries must be added to those amounts of the parent. Each entity has a set of books; however, the consolidated entity does not keep a separate set of books. Instead, the combining process is accomplished with a work sheet. An important consideration is the elimination of activity occurring between the two entities. If not eliminated, the effect would be double counting the activity. Examples of such activity are loans and sales between the parent and the subsidiary.
Objective 4 - Account for long-term investment in debentures.
Investors purchase debentures issued by companies. Most investors would be superannuation funds or insurance companies. Short-term investments in debentures are rare. More commonly, companies purchase debentures as long-term investments, known as held-to-maturity securities. When acquired, these held-to-maturity debentures are recorded at cost. Thereafter they are reported on the statement of financial position at their amortised cost. This means the balance in the Investment account reflects both the initial cost of the debenture plus or minus the amortised portion of the discount or premium on the debenture. No Discount or Premium account is used. If the debentures were initially purchased at a discount, the balance in the Investment account increases as the debentures approach maturity. If the debentures were initially purchased at a premium, the balance in the Investment account decreases as the debentures approach maturity. The amortisation of the debenture discount would appear as follows: Investment in Debentures (Long-term) XX Interest Revenue (equal to the cash received)
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The amortisation of a debenture premium would be recorded as follows: Interest Revenue Long-Term Investment in Debentures X X
(The interest when received or receivable would have been debited to cash or interest receivable and credited to interest revenue.) Study Tip: From the buyer’s perspective, a discount means additional interest revenue while a premium means less interest revenue. This effect is exactly the opposite from the perspective of the issuer. Carefully review the Decision Guidelines in your text. It presents an excellent summary of the rules governing share and debenture investments.
Objective 5 - Account for transactions stated in a foreign currency.
International accounting deals with business activities that cross national boundaries. Each country uses its own national currency; therefore, a step has been added to the transaction - one currency must be converted into another. The price of one nation’s currency stated in terms of another country’s currency is called the foreign currency exchange rate. The conversion of one currency into another currency is called translation. Exchange rates are determined by international supply and demand. A strong currency is rising relative to other nations’ currencies and a weak currency is falling relative to other currencies. When Company A in Country A purchases goods from Company B in Country B, the transaction price may be stated in the currency of either country or a third currency (often US$). Suppose the transaction is stated in Country A’s currency. The transaction requires two steps: 1. The transaction price must be translated for recording in the accounting records of Company B. 2. When payment is made, Company B may experience a foreign-currency translation gain or loss. This gain or loss results when there is a change in the exchange rate between the date of the purchase on account and the date of the subsequent payment of cash. Note that there will be no foreign-currency gain or loss for Company A because the transaction price was stated in the currency of Country A. The net amount of Foreign Currency Exchange Gains and Losses are combined for each accounting period and reported on the statement of financial performance. Hedging is a means of protecting the company from foreign currency transaction losses by purchasing a futures contract, the right to receive a certain amount of foreign currency on a particular date. Companies with foreign subsidiaries must consolidate the subsidiary financial statements into their own for external reporting. This can cause two problems: 1. GAAP may be different in the foreign country. (See Exhibit 17-6.)
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While the problem of different currencies has disappeared in much of Europe with the introduction of the euro, the differences in GAAP still remain but should disappear with the adoption of International Accounting Standards. The problem of different GAAP arises not only in consolidating foreign subsidiaries, but also when Australian companies ‘list’ on foreign stock exchanges where they are required to adjust their financial statements to conform with that country’s GAAP and accounting standards. International accounting standards should allow more efficient capital markets. The Australian Accounting Reporting Council has announced its intention to adopt International Accounting Standard Board international standards in Australia. 2. The foreign subsidiary’s financial statements need to be translated (converted) into Australian dollars.
All the self-testing materials in this chapter focus on information and procedures that your instructor is likely to test in quizzes and examinations.
_____ 1. _____ 2. _____ 3. _____ 4. _____ 5. _____ 6. _____ 7. _____ 8. _____ 9.
Match each numbered term with its lettered definition. _____ 10. _____ 11. _____ 12. _____ 13. _____ 14. _____ 15. _____ 16. _____ 17. _____ 18. marketable securities consolidated statements parent company AASB 1033, 1010 foreign currency exchange rate subsidiary company IASB weak currency cost method
minority interest goodwill controlling interest held-to-maturity investments equity method strong currency short-term investments hedging long-term investment
A. B. C. D.
E. F. G. H. I. J. K. L. M.
excess of the cost of acquiring another company over the sum of the fair value of the net assets the body responsible for international accounting standards shares and debentures held for the short term, able to be sold at any time combine the statement of financial positions, statement of financial performances, and other financial statements of the parent with those of the majority-owned subsidiaries into an overall set as if the separate entities were one currency whose exchange rate is rising relative to other nations’ currencies investee company in which a parent owns more than 50% of the voting shares investor company that owns more than 50% of the voting shares of a subsidiary company accounting standards requiring decreases in the value of investments to be recognised in the period when the decrease occurs method used to account for investments in which the investor can significantly influence the decisions of the investee debentures and notes that investors intend to hold to maturity ownership of more than 50% of an investee company’s voting shares an investment that is readily convertible to cash and that the investor intends to convert to cash within one year or to use to pay a current liability separate asset category reported on the statement of financial position between current assets and plant assets
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N. O. P. Q. R.
strategy to avoid foreign currency transaction losses subsidiary company’s equity that is held by shareholders other than the parent company the price of one country’s currency stated in terms of another country’s monetary unit currency whose exchange rate is decreasing relative to other nations’ currencies used to account for investments of less than 20% of the shares of another company
II. Multiple Choice
Circle the best answer.
1. A share is listed in the Financial Review as having a High of $45.25, a Low of $43.10, a Close of $43.50 and a Net Change of +$1.25. What was the previous day’s closing price? A. $46.50 B. $41.75 C. $44.75 D. $42.25
2. Assets listed as Marketable Securities on the statement of financial position are: A. B. C. D. only liquid listed on a stock exchange only intended to be converted to cash within one year usually liquid and intended to be converted to cash within one year
3. Marketable securities are usually reported on the statement of financial position at: A. current cost B. historical cost C. lower of cost or market D. fair value
4. Inter-company payables and receivables are eliminated in the consolidated entries so that: A. assets will not be overstated B. liabilities will not be understated C. shareholders’ equity will not be understated D. net profit will not be overstated
5. Unrealised gains on investments are not reported as revenue on the statement of financial performance because this would breach the accounting principle of: A. relevance B. conservatism C. reliability D. comparability
6. The minority interest account is usually classified as a (n): A. revenue B. expense C. shareholders’ equity D. liability
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7. The rate at which one unit of a currency can be converted into another currency is called the foreign currency: A. market rate B. interest rate C. exchange rate D. conversion rate
8. A strong currency has an exchange rate that is: A. B. C. D. inelastic with respect to other nations’ currencies inelastic with respect to its balance of trade increasing relative to other nations’ currencies decreasing relative to other nations’ currencies
9. The equity method of accounting for share investments reports dividends as an increase in cash and: A. a decrease in the investment B. an increase in revenue C. a decrease in shareholders’ equity D. an increase in expenses
10. Debentures purchased at a premium or discount are accounted for using the: A. consolidation method B. amortised cost method C. equity method D. cost method
III. Completion Complete each of the following statements.
1. The price at which shares change hands is determined by the __________________________. 2. Unrealised losses on investments ___________________________________. are reported on the
3. Investments in shares are initially recorded at ____________________________. 4. The ______________________ method is used to account for investments when the investor can significantly influence the actions of the investee. 5. A(n) ______________________ is ownership of at least 50% of the voting shares of a company. 6. Goodwill is an ____________________________ asset. 7. A change in the currency exchange rates between the date of purchase and the date of payment will result in a (n) __________________________________ or ______________. 8. Cash used to purchase debentures is reported on the statement of cash flows as a (n) __________________ activity. 9. When a parent owns less than 100% of a subsidiary, the other owners are called the ________________ _________________.
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10. A strategy to avoid foreign exchange losses is called ______________________________ .
IV. Daily Exercises
1. Parent Limited owns 100% of Subsidiary Company. Parent’s Investment in Subsidiary account shows a balance of $1,530,000, while Subsidiary’s Ordinary Shares account has a balance of $150,000 and Subsidiary’s Retained Profits account has a balance of $950,000. In the space below, make the journal entry to eliminate the appropriate accounts.
2. On October 20 of the current year, Miller Company purchases 1,000 shares of Webster Company for $18.37 a share, plus a broker’s commission of $55. On December 15, Miller receives a cash dividend of $0.50 a share. Assuming Miller’s investment is not significant, what is the balance in Miller’s Investment account immediately after receipt of the cash dividend?
3. Review the information in Daily Exercise #2 and assume the Webster shares are trading at $10.75 on June 30, the end of Miller’s fiscal year. Prepare the necessary adjusting entry.
4. Review the same facts in Daily Exercise #2 (but not the information in Daily Exercise 3) and assume the shares are classified as a long-term investment and trading at $20.75. Prepare the necessary adjusting entry on June 30, assuming all the assets in the class were revalued.
5. When a company purchases shares as an investment, what determines whether the investment is accounted for using the cost, equity or consolidation methods?
6. On April 1 of the current year, Long Company purchased a $100,000, 8%, ten-year debenture at 98.00. Interest is payable on October 1 and April 1 each year. Long’s intent is to hold the debenture to maturity. Prepare the entry to record the purchase of the debenture.
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7. Review the information in Daily Exercise #6 and prepare the necessary adjusting entry on June 1, the end of Long’s financial year.
1. Polly Company purchased 185,000 shares of Cracker Company on July 1, 2004, for $850,000. Cracker Company has 1,850,000 shares issued. Cracker earned profit of $240,000 and paid dividends of $80,000 during the 2004/05 financial year. Cracker Company shares were trading at $7.50 on June 30, 2005. a. What method should be used to account for the investment in Cracker and why?
b. How much revenue will be recorded by Polly in 2004/05 from the investment in Cracker?
c. What is the balance in Polly’s Investment account at June 30, 2005?
2. King Company purchased 40% of Prince Company on January 1, 2005, for $6,750,000. Prince Company earned profit of $1,800,000 and paid dividends of $500,000 during 2005. a. What method should be used to account for the investment in Prince Company and why?
b. How much revenue will be recorded by King Co. in 2005 from the investment in Prince Company?
c. What is the balance in the Investment account at the end of 2005?
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3. Golden Company invested in Gate Company on January 1, 2006, by purchasing 70% of the total shares of Gate Company for $787,500. Gate Company had ordinary shares of $400,000 and retained profits of $725,000. a. What amount of Minority Interest will appear on a consolidated statement of financial position prepared on January 1, 2006?
b. If Golden Company owes Gate Company $85,000 on a bill payable, prepare the two elimination entries in general journal form (beyond the textbook but may be covered in lectures). Date Account Debit Credit
4. Hunter Company purchased 100% of the ordinary shares of Prey Company for $3,945,000. Prey Company showed Ordinary Share Capital of $840,000 and Retained Profits of $1,530,000. Calculate the amount of goodwill resulting from the purchase.
5. Prepare journal entries for the following share investment: 10/6 Purchased 1,000 ordinary shares (in the large international company of Micro-Tech) at $35.25 per share, plus a broker’s commission of $205. 2/10 Received a $1.50 per share cash dividend. 15/11 Sold 400 shares at $40.25 per share, less a commission of $80. 31/12 Micro-Tech Company shares closed at $39.12. (Is this relevant?) Date Account Debit Credit
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6. Prepare journal entries for the following foreign currency transactions: 5/1 20/1 10/2 20/3 Date Purchased 5,000 cases of dry cider from a British wholesaler for 4.55 pounds sterling per case. Today’s exchange rate is $2.30 = 1 pound sterling. Purchased 2,000 cases of red wine from a cooperative in Coustouge, France. The price was 64 francs per case. Today’s exchange rate is $1.00 = 6.10 French francs. Paid the British wholesaler. Today’s exchange rate is $2.10 = 1 pound sterling. Paid for the French wine. Today’s exchange rate is $1.00 = 5.90 French francs. Account and Explanation Debit Credit
VI. Beyond the Numbers
Review the information in Exercise 5 and change the 2/10 entry to the following: 2/10 Received a 15% share dividend. The shares were trading at $38 per share. Prepare journal entries for 2/10, 15/11. Date Account Debit Credit
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VII. Demonstration Problems
Demonstration Problem #1 This is beyond the information provided in the textbook but may be selected by your lecturer to illustrate the consolidation process.
Parent Company paid $375,000 for 90% of the Ordinary Shares of Subsidiary Company. Subsidiary owes Parent $60,000 on an intercompany bill payable. Complete the following work sheet: Parent Company Assets: Cash Bill receivable from Subsidiary Investment in Subsidiary Goodwill Plant & equipment, net Other assets Total Liabilities and Shareholders’ equity: Accounts payable Notes payable Ordinary shares Retained profits Minority interest Total 58,000 60,000 375,000 218,000 37,000 748,000 Subsidiary Company 26,000 328,000 92,000 446,000 Eliminations Debit Credit Consolidated Amounts
38,000 170,000 500,000 40,000 748,000
41,000 125,000 110,000 170,000 446,000
Demonstration Problem #2 At 30/6/05, Knox Company had the following long-term investments in its portfolio: Cost Shares 2,500 shares Bibtech, Inc. 6,000 shares FFA Industries 3,800 shares Globex 1,400 shares Textronics Debentures $100,000, 9% NatSci, Inc., due 1/10/2009 Market Value
$25.20 $10.37 $48.00 $63.50
$28 $18.50 $37.75 $66.92
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Requirement 1 In the space below, present the long-term investments as they would appear on Knox Company’s 30/6/05 statement of financial position. None of the share investments are influential. The debentures pay interest semiannually on 1/4 and 1/10.
Requirement 2 Record the following 2005/06 events related to Knox Company’s long-term investments. Bibtech, Inc. - these shares paid quarterly dividends of $.15/share on 10/8/05 and 10/11/05. The shares were sold on 7/2/06 for $32/share less a broker’s commission of $185. FFA Industries - these shares pay no cash dividends; however, a 10% share dividend was received on 8/10/05. The investment remained in the portfolio at the end of the year, at which time its market value was $24.25 per share. Globex - these shares continued to decline in value throughout July and management decided to sell them on 8/8/05 for $3l/share, less a commission of $205. Textronics- these shares remained in the portfolio throughout the year. On 15/3/06 the share split three for two. At year-end, the shares were trading for $55/share. NatSci, Inc. - Cheques for interest were received 1/10/05 and 1/4/06. The debentures remained in the portfolio at year end. On 1/5/2006 Knox Company purchased $250,000, ten-year, 6% debentures from Wood, Inc., for 97. The debentures pay half yearly interest on 1/5 and 1/11. Date Account Debit Credit
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Requirement 3 Record the necessary adjusting entries. Date Account Debit Credit
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Requirement 4 Present the long-term investments as they would appear on Knox Company’s 30/6/2006 statement of financial position, taking into consideration the events described in Requirement 2 above.
SOLUTIONS I. Matching
1. 2. 3. 4. O A K J 5. 6. 7. 8. I E L N 9. M 10. C 11. D 12. G 13. 14. 15. 16. H P F B 17. Q 18. R
II. Multiple Choice
1. D The High is the day’s highest price, the Low is the lowest price of the day. The Close is the last price at which the shares traded. Net Change is the increase (+) or decrease (-) in the Close compared to the previous day. The previous day’s Close is $42.25 or $43.50 - $1.25. Note that besides the determinable liquidity of the investment, the intent of management determines an investment’s classification as a marketable security. AASB 1033 requires where investments are not reported at the lower of cost or net fair value management must explain why they believe the carrying amount will be recovered. Failure to eliminate intercompany payables and receivables would result in the overstatement of both assets and liabilities of the consolidated entity. Accordingly, of the items listed, only A is correct. Conservatism; because the investment has not been sold the gain is not realised. It is only a potential gain - tomorrow the share price may fall and the potential gain will disappear. But with low brokerage there is the temptation to sell the shares - realise the gain and then buy them back. Would this be ethical? The Minority Interest account represents the ownership interest of parties outside of the parent-subsidiary relationship. In actual practice it is to report them as part of the owners’ equity section on the statement of financial position.
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7. 8. 9.
C C A
The exchange rate is used to convert one currency into another. Strong currencies are those that increase relative to other currencies. The entry is to Dr Cash and Cr Investment. Initially it may be recorded as a Cr to Dividend Revenue but this is closed to Investment. The amortised cost method recognises the lower interest revenue if the debentures are purchased at a premium (we paid more for the debentures than we will receive on maturity so some of the interest revenue received is compensation for the higher price paid) and vice versa for a discount.
1. market (The market allows buyers and sellers with opposing interests to arrive at a price acceptable to both.) 2. statement of financial performance 3. cost 4. equity 5. controlling interest 6. intangible 7. foreign-currency exchange gain, loss 8. investing 9. minority interest 10. hedging
IV. Daily Exercises
1. Ordinary Shares Retained Profits Goodwill Investments in Subsidiary 150,000 950,000 430,000 1,530,000
Goodwill is the difference between the Investment in Subsidiary account balance and the combined balance of the Subsidiary’s Shareholders’ equity. 2. $18,425 (1,000 $1837 = $18,370 + $55) The dividends would be credited to a Dividend Revenue account.
3. Loss on Short-term Investment Short-term Investment $18,425 - ($10.75 1,000) = $7,675 7,675 7,675
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AASB 1033 Presentation and Disclosure of Financial Instruments implies short-term investments should be reported at the lower of cost or the net fair (market) value. The shares are currently worth $10,750 but listed in the account at $18,430. The difference, $7,675, is an unrealised loss on short term investment and reported as an expense in the statement of financial performance. (The same does not apply to unrealised gains - they are not reported as revenue and the increase in value is not reported on the statement of financial position. In the USA unrealised gains would be reported as both revenue and at an increased value on the statement of financial position.)
4. This is a long-term investment. AASB 1041 Revaluation of Non-current Assets applies and revaluations upwards are credited directly to a reserve (shareholders’ equity). (Downwards revaluations would be credited to an expense.)
Long-term Investment (Webster) Asset Revaluation Reserve ($20.75 1,000) - $18,425 = $2,325
5. The correct answer is control, significant influence or no significant influence but in the absence of evidence to the contrary this is assumed to be above 50%, 20-50% or less than 20%.
6. Long-term Investment Cash 98,000 98,000
The discount is not recorded on the books of the purchaser, only on the books of the selling company.
7. Interest Receivable Interest Revenue ($100,000 8% 3/12) Long-term Investment Interest Revenue ($2,000 10 years 3/12 straight-line amortisation) 2,000 2,000
1. a. Hold 10% so cost method b. 10% of $80,000 = $8,000 dividend revenue c. $850,000 balance in the Investment account (no account is taken of the increase in price from $5.00 to $7.50 unless the investment is classified as long-term and all the assets in the class have been revalued)
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2. a. Equity method because the hold is between 20% and 50% b. 0.40 × $1,800,000 = $720,000 c. $6,750,000 + $720,000 - (0.40 × $500,000) = $7,2700,000
3. a. 0.30 × ($400,000 + $725,000) = $337,500 b. (1) Bill Payable (to Gate) Bill Receivable from Golden (2) Ordinary shares (Gate) Retained profits (Gate) Investment in Gate Minority Interest 85,000 85,000 400,000 725,000 787,500 337,500
(Note: Refer to Demonstration Problem 1 if this has been selected by your lecturer but has not been covered in class.)
4. $3,945,000 - (840,000 + $1,530,000) = $1,575,000
Investment - Micro-Tech 35,455 Cash (1,000 shares × $35.25 plus $205) Actual cost/share is 35,455 / 1000 = $35.455 Cash Dividend Revenue 1,500
15/11 Cash 16,020 Investment - Micro-Tech 14,182 Gain on Sale of Investment 1,838 The gain is the difference between the proceeds and our cost. Our cost is 400 shares × $35.455/share (see 10/6). 12/31 Perhaps (see below) Investment - Micro-Tech Asset Revaluation Reserve 2,199 2,199
Our cost basis was $35.455/share and we have 600 shares for a total of $21,273. The current market value is 600 × $39.12 = $23,472, Therefore, $2,199 is needed to adjust the Investment to fair value. Since the $2,199 represents an increase in value, it represents an unrealised gain on the investment and may be accounted for as all assets in the class were revalued. Note it is not a profit and if management decides not to revalue it will have no effect on the statement of financial performance.
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Should the likely commission be subtracted from the $23,472 to arrive at the fair value? $200 brokerage commission in $23,472 is probably immaterial but $200 in the gain of $2,199 is almost 10%!
Inventory 52,325.00 Accounts Payable 52,325.00 (5,000 cases × 4.55 pounds sterling × 2.30) Inventory Accounts Payable (2,000 cases × 64 francs / 6.10) 20,983.61 20,983.61
Accounts Payable 52,325.00 Foreign Currency Exchange Gain 4,550.00 Cash 47,775.00 (5,000 cases × 4.55 pounds sterling × $2.10) Accounts Payable Foreign Currency Exchange Loss Cash (2,000 cases × 64 francs / 5.90) 20,983.61 711.31 21,694.92
Because the dollar strengthened relative to the British pound (on 5/1 it took $2.30 to purchase 1 pound sterling - a month later the same pound would cost only $2.10) a foreign currency transaction gain was realised when we paid the account. Conversely, the dollar weakened relative to the French franc, so we realised a foreign currency transaction loss. Foreign currency transaction gains and losses are reported on the statement of financial performance as ‘Other Revenues and Expenses’.
VI. Beyond the Numbers
10/6 Investment - Micro-Tech Cash (1,000 shares × $35.25 plus $205) 35,455 35,455
No entry - however we need to note the receipt of the additional 150 shares. We now own 1,150 shares which cost us $35,455, or $30.83 (rounded) per share.
Study Tip: the current trading value of the shares is irrelevant from our perspective. It is relevant only to Micro-Tech. They used it to record the charge against Retained Profits when the dividend was declared. 15/11 Cash Investment - Micro-Tech Gain on Sale of Investment 16,020 12,332 3,688
Our cost per share was $30.83 (rounded) - see 2/10 details. We sold 400 shares at $40.25/share, less the $80 commission. The gain is the difference between our proceeds (400 shares × $40.25 less $80) and the cost basis of those shares, $30.83 × 400.
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VII. Demonstration Problems
Demonstration Problem #1 Solved and Explained Parent Company Assets: Cash Bill receivable from Subsidiary Investment in Subsidiary Goodwill Plant & equipment, net Other assets Total Liabilities and Shareholders’ equity: Accounts payable Notes payable Ordinary shares Retained profits Minority interest Total 58,000 60,000 375,000 218,000 37,000 748,000 Subsidiary Company 26,000 328,000 92,000 446,000 (b) 123,00 0 (a) (b) 60,000 375,00 0 123,000 546,000 129,000 882,000 Eliminations Debit Credit Consolidated Amounts 84,000
38,000 170,000 500,000 40,000
41,000 125,000 (a) 110,000 (b) 170,000 (b)
60,000 110,00 0 170,00 0 463,00 0 28,000 463,00 0
79,000 235,000 500,000 40,000 28,000 882,000
Entry (a) eliminated Parent’s $60,000 intercompany note receivable against the note payable owed by the Subsidiary. Note that the consolidated total represents the amount owed to outside creditors ($170,000 owed by Parent + $125,000 owed by Subsidiary less $60,000 intercompany debt = $235,000). Entry (b) eliminates Parent’s $375,000 investment balance against the $280,000 in Subsidiary’s equity. Parent acquired a 90% interest, so the minority interest is $28,000 (10% × $280,000). Goodwill is the difference between the investment ($375,000) and 90% of the Subsidiary’s Ordinary Shares and Retained Profits, or $123,000 ($375,000 - 90% × $280,000).
Demonstration Problem #2 Solved and Explained Requirement 1
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Long-Term Investments (at market value)
The cost of the combined long-term investments (both equity and debt) is $496,675, while the 30/6/03 market value of the portfolio is $518,075. Recall that long-term investments can be reported on the statement of financial position at fair value (AASB 1041). Prior to the preparation of the statement of financial position, an adjusting entry would have been recorded, as follows: Investment Asset Revaluation Reserve 21,400 21,400
The effect of this adjustment is to increase the investments to their market value. Most companies would report the Investments at market value, then report the cost in a footnote. The unrealised gain would be added into the shareholders’ equity section as an Asset Revaluation Reserve. Knox would also have adjusted for the accrued interest on the NatSci debenture; however, the amount ($2,250) is not included with the Long-Term Investments, but reported separately as Interest Receivable in the current asset section.
Requirement 2 Bibtech, Inc. 10/8/05 Cash Dividend Revenue Cash Dividend Revenue Cash Long-Term Investment Gain on Sale of Investment 375 375 375 375 79,815 70,000 9,815
The gain is the difference between the proceeds (2,500 shares × $32/share less the $185 commission) and the cost (2,500 shares × $28.00).
FFA Industries 8/10/05 30/6/06 no entry - memo only reflecting 6,600 shares now in the portfolio (only the FFA revaluation) Long-term Investment - FFA Asset Revaluation Reserve ($24.25 6,600) - ($18.50 6,000) 49,050 49,050
Globex 8/8/05 Cash Loss on Sale of Investment Long-Term Investment 117,595 25,855 143,450
Investments and international operations 21
The loss is the difference between the written down or carrying value at the end of the last financial year (3,800 × $37.75) and the proceeds (3,800 × $31 less the $205 commission).
Textronics 15/3/06 30/6/06 no entry - memo only reflecting 2,100 shares now in the portfolio (only the Textronics revaluation) Investment 21,812 Asset Revaluation Reserve 21,812 ($55 2,100) - ($66.92 1,400) Although the share price has decreased the number of shares the company holds (without any further purchase) has increased.
NatSci 1/10/05 Cash Interest Receivable* Interest Revenue 4,500 2,250 2,250
(*Remember the interest receivable referred to at the end of Requirement 1 solution above.) 1/4/06 Cash Interest Revenue 4,500 4,500
Wood, Inc. 11/1/06 Long-Term Investment Cash 242,500 242,500
As the purchaser of the debentures, we do not record the $7,500 discount in a contra account.
Requirement 3 (Adjusting entries) This adjustment has been recorded above in two separate entries. 30/606 Investments Asset Revaluation Reserve 70,862 70,862
As of 30/6/05 and 30/6/06 the market value of FFA and Textronics were: Market 30/6/05 $111,000 $93,688 Market 30/6/06 $160,050 $115,500
FFA Industries Textronics
6,000 $18.50 1,400 $66.92
6,600 $24.25 2,100 $55.00
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These totals reflect a difference of $70,862. Because the shares are being revalued each year (the standard requires regular revaluation) the increase is only the difference between market values this year and last. 30/6/06 Interest Receivable 2,250 Interest Revenue 2,250 To adjust accrued interest ($100,000 × 0.09 × 3/12) on NatSci debentures Interest Receivable 2,500 Long-Term Investment 125 Interest Revenue 2,625 To adjust for accrued interest ($250,000 × 0.06 × 2/12) and amortise the discount ($7,500/10 years × 2/12).
Recall that long-term investments in debentures must be reported on the statement of financial position at their fully amortised cost. When debentures are purchased at a discount, the amortised cost will increase over the life of the debentures. At maturity, the amortised cost will equal the debenture’s face value.
Requirement 4 Long-Term Investments (at market) $618, 175
The balance in the Long-Term Investments account consists of the following: Shares (from Requirement 3 solution above) Debentures NatSci Wood, Inc. ($242,500 + $125) Total $275,550 100,000 242,625 $618,175
Interest Receivable will be listed among the current assets, Interest Revenue under ‘Other Revenues’ on the statement of financial performance, and the Asset Revaluation Reserve with shareholders’ equity on the statement of financial position.
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