Type
Solution Manual
Book Title
Financial Accounting Fundamentals 5th Edition
ISBN 13
978-0078025754

978-0078025754 Appendix C Lecture Note

March 26, 2020
APPENDIX C
INVESTMENTS AND
INTERNATIONAL OPERATIONS
Related Assignment Materials
Student Learning Objectives
Questions
Quick
Studies*
Exercises*
Problems*
Beyond the
Numbers
Conceptual objectives:
C1. Distinguish between debt and
equity securities and between
long-term investments and
short-term investments.
1, 2, 5
C-1, C-2
C-1, C-11
C-5, C-6
C2. Describe how to report equity
securities with controlling
influence.
17, 18
C-12, C-13
C-13
C-5
C-6
C3. Explain foreign exchange rates
between currencies and record
transactions listed in a foreign
currency.
12, 13, 14,
15
C-16, C-17
C-15, C-16
C-6
C-1, C-7,
C-8
Analytical objectives:
A1. Compute and analyze the
components of return on total
assets.
C-14, C-15
C-14
C-1, C-2,
C-9
Procedural objectives:
P1. Account for trading securities.
C-3, C-4,
C-5, C-16,
C-18
C-2, C-3,
C-6, C-8
C-1
C-6
P2. Account for held-to-maturity
securities.
5, 9
C-6
C-4, C-6,
C-11
C-3, C-6
P3. Account for available-for-sale
securities.
3, 4, 6, 7, 8,
15
C-7, C-8,
C-9, C-10
C-5, C-6,
C-7, C-8,
C-9, C-10,
C-11, C-17
C-2, C-3,
C-4, C-5
C-3, C-6
P4. Account for securities with
significant influence.
4, 10, 11
C-11
C-11, C-12
C-4, C-5
C-4, C-6
*See additional information on next page that pertains to these quick studies, exercises and problems.
Additional Information on Related Assignment Material
Corresponding problems in set B (in text), also relate to learning objectives identified in grid on
previous page. The Serial Problem for Success Systems continues in this chapter. Problem C-1A, C-3A
can be completed with Sage 50 or QuickBooks
Connect reproduces assignments online, in static or algorithmic mode, which allows instructors to
monitor, promote, and assess student learning. It can be used for practice, homework, or exams.
Synopsis of Chapter Revisions
BANGS: NEW opener with new entrepreneurial assignment
New 3-step process for fair value adjustment
New learning note for investee vs investor securities
New Google example for learning comprehensive income
Updated return analysis using Gap
Chapter Outline
Notes
I. Basics of Investments
A. Motivation for Investmentsthree reasons:
1. Companies transfer excess cash to investments to produce
higher income.
2. Some entities, such as mutual funds and pension funds, are set
up to produce income from investments.
3. Strategic reasons. Examples: investments in competitors,
suppliers or customers.
B. Short-Term Investments
1. Cash equivalents are investments that are both readily
converted to known amounts of cash and mature within three
months.
2. Short-term investments (temporary investments or marketable
securities) -current assets that must meet these 2 requirements:
a. Intended to be converted into cash within one year or the
current operating cycle, whichever is longer.
b. Readily convertible to cash.
C. Long-Term Investments
1. Are not readily convertible to cash and not intended to be
converted to cash in short-term.
2. Can also include funds earmarked for special purpose funds or
investments in land or other assets not used in business
operations.
D. Investments in securities can include both debt and equity
securities.
1. Debt securities reflect a creditor relationship.
2. Equity securities reflect an owner relationship.
E. Classification and Reporting of Investmentsaccounting for
investments in securities depends on three factors:
1. Security typeeither debt or equity.
2. Holding intentioneither short term or long term.
3. Percentage of ownership.
E. Classifications of investments and reporting approach:
1. Trading securities (always short-term)reported at fair value.
2. Held-to-maturity (debt securities)reported at amortized cost
3. Available-for-sale (debt and non-influential equity
securities)reported at fair value.
4. Significant influence (equity securities)reported under
equity method.
5. Controlling influence (equity securities)reported in
consolidated statements.
Chapter Outline
Notes
F. Accounting Basics for Investments
1. Debt Securities
a. Acquisition is recorded at cost (including any fees).
b. Interest revenue recorded when earned.
c. When the cost is greater than maturity value, the
difference is amortized over remaining life of security.
2. Equity Securities.
a. Acquisition is recorded at cost (including any fees).
b. Dividends received are recorded as dividend revenue and
reported on income statement.
c. At sale, proceeds are compared to cost and any gain or
loss is recorded.
II. Reporting of Noninfluential Investmentsmost must be reported at
fair value. Exact reporting depends on classification. The accounting
for each classification is as follows:
A. Trading (debt and equity less than 20% of voting stock)
intended to be actively managed and traded for profit.
1. Entire portfolio is reported at fair value.
2. Fair value adjustment from cost results in unrealized gain (or
loss) which is reported on the income statement.
3. Upon sales of individual securities, the difference between
their cost and net proceeds is recognized as gain or loss.
Subsequent fair value adjustments will exclude the sold
securities.
B. Held-to-Maturity Securities (HTM)Debt securities a company
intends and is able to hold until maturity.
1. Classify as long-term investment when maturity date extends
beyond one year or the operating cycle, whichever is longer.
2. Record interest revenue when earned.
3. Amortize the difference between cost and maturity value over
the remaining life of the security. (Discussed in advance
course.)
4. Adjustments to fair value are not required.
Chapter Outline
Notes
C. Available-for-Sale Securities (AFS)debt and equity (less than
20% of voting stock) securities that are not intended to be held to
maturity. Intent is to sell them in future.
1. Long vs. short-term classification depends on when they are
intended to be sold.
2. Entire portfolio is reported at fair value.
3. Unrealized gains or losses are not reported on income
statement. It is reported in equity section of the balance sheet
and is part of comprehensive income. (discussed later)
III. Reporting of Influential Investments
A. Equity Securities with Significant Influence.Implies investor
can exert significant influence over the investee.
1. An investor who owns more than 20% (but not more than
50%) is presumed to have a significant influence over the
investee.
2. Equity method is used. Under this method the investor
a. records its share of the investee’s earnings as increase to
its investment and on its income statement.
b. reduces investment by share of losses and also reports
them on the income statement.
c. does not record cash dividends received as income (share
of investee’s income already reported) but instead that
dividend is viewed as a conversion of one asset to another
asset. (Cash increased and investment account decreased).
d. records and reports gain or loss when investment is sold.
Gain or loss is computed by comparing proceeds from sale
to book value of the investment on the date of sale.
B. Equity Securities with Controlling InfluenceInvestor is able to
exert a controlling influence over the investee (generally owns
more than 50% of a company's voting stock).
1. The equity method with consolidation (subject for advanced
course) is used.
2. The controlling investor is called the parent company and the
investee company is called the subsidiary.
3. Investor also reports consolidated financial statements
(subject for advanced course) to the public when owning such
securities.
C. Summary of Accounting for Investments in Securities
See Exhibit C.8 (text p. 634).
Chapter Outline
Notes
D. Comprehensive Incomeis defined as all changes in equity for a
period except those due to owner investments and dividends.
1. Includes: Unrealized gains and losses on AFS securities,
foreign currency adjustments and certain pension adjustments.
2. Can be reported in financial statements in one of two ways
(new FASB guidelines):
a. on a separate statement of comprehensive income that
immediately follows the income statement
b. On the lower section of the income statement (as a single
statement of income and comprehensive income).
IV. Global ViewCompares U.S. GAAP to IFRS
A. Accounting for Noninfluential Securitiesboth systems are
broadly similar. Differences in terminology exist.
B. Accounting for Influential Securitiesboth systems are broadly
similar. Differences in terminology exist.
V. Decision AnalysisComponents of Return on Total Assets
A. Assesses financial performance and can be separated into two
components:
1. Profit margin (net income divided by net sales) reflects the
percentage of net income in each dollar of net sales.
2. Total asset turnover (net sales divided by average total assets)
reflects a company's ability to produce net sales from total
assets
B. Calculated as:
Net Income
Average total assets
Net Income
Net Sales xNet Sales
Average total assets
=
VI. Investments in International OperationsAppendix C-A
A. Exchange Rates Between Currencies
1. Price of one currency stated in terms of another currency is
called a foreign exchange rate.
2. These rates fluctuate due to changing economic and political
conditions (include the supply and demand for currencies and
expectations about future events).
B. Sales and Purchases Listed in a Foreign Currency
1. Companies making sales (or purchases) for which they receive
(or pay) foreign currency must translate the transaction
amounts into domestic currency. The transaction is recorded
using exchange rates on the date of the event.
2. Prior to statements, and/or at point of collection/payment,
adjustments to receivables/payables resulting from change in
exchange rates must be recorded. These adjustments result in
Foreign Exchange Gains/Losses.
Alternate Demonstration Problem
Appendix C
2015
Jan
1
Investor Corporation purchased 8,000 shares (20%) of Investee
Company’s outstanding stock at a cost of $150,000.
May
31
Investee Company declared and paid a cash dividend of $1.50 per
share.
Dec
31
Investee Company announced that its net income for the year was
$100,000.
2016
Oct
1
Investee Company declared and paid a cash dividend of $1.00 per
share.
Dec
31
Investee Company announced that its net income for the year was
$80,000.
2017
Jan
1
Investor Corporation sold all of its shares of Investee Company
for $178,000 cash.
Required:
1. Prepare journal entries on Investor Corporation’s books using the
equity method, which assumes that Investor has significant influence
over Investee Company.
2. Prepare journal entries on Investor Corporation’s books using the cost
method, which assumes that even though Investor owns 20% of
Investee’s stock, Investor does not have significant influence over
Investee (for example, another corporation owns 70% of Investee
Company’s stock).
Solution: Alternate Demonstration Problem
Appendix C
Part 1
2015
Jan
1
Long-Term Investment--Investee Stock ..
150,000
Cash ......................................................
150,000
May
31
Cash ............................................................
12,000
Long-Term Investment--Investee Stock
12,000
Dec
31
Long-Term Investment--Investee Stock ..
20,000
Earnings from Long-Term Investment --Investee Stock
20,000
2016
Oct
1
Cash ............................................................
8,000
Long-Term Investment--Investee Stock
8,000
Dec
31
Long-Term Investment--Investee Stock ..
16,000
Earnings from Long-Term Investment --Investee Company
16,000
2017
Jan
1
Cash ............................................................
178,000
Long-Term Investment--Investee Stock
166,000
Gain on Sale of Investments ..............
12,000
Solution: Alternate Demonstration Problem
Appendix C
Part 2
2015
Jan
1
Long-Term Investment--Investee Stock ..
150,000
Cash ......................................................
150,000
May
31
Cash ............................................................
12,000
Dividends Earned ................................
12,000
Dec
31
No entry
2016
Oct
1
Cash ............................................................
8,000
Dividends Earned ................................
8,000
Dec
31
No entry
2017
Jan
1
Cash .............................................................
178,000
Long-term InvestmentInvestee Stock
150,000
Gain on Sale of Investments ...............
28,000
Note that the total income statement effect is the same under both
methods:
Part 1:
$20,000
earnings in 2013
16,000
earnings in 2014
12,000
gain on sale in 2015
$48,000
Part 2:
$12,000
dividends in 2013
8,000
dividends in 2014
28,000
gain on sale in 2015
$48,000

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