motivations for intercorporate investments

©Cambridge Business Publishing, 2010©Cambridge Business Publishing, 2010

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

1


Investments on the Balance SheetCoca-Cola Company reported the following investments at December 31, 2007 and 2008 (in millions):

2

Assets 2008 2007Current Assets

Cash and cash equivalents $4,701 $4,093Marketable securities 278 215Trade accounts receivable, less allowances of $51 and $56, respectively 3,090 3,317Inventories 2,187 2,220Prepaid expenses and other assets 1,920 2,260

Total Current Assets $12,176 $12,105

InvestmentsEquity method investments:Coca-Cola Hellenic Bottling Company, S.A. $1,487 $1,549Coca-Cola FEMSA, S.A.B. de C.V. 877 996Coca-Cola Amatil Limited 638 806Coca-Cola Enterprises, Inc. - 1,637Other, principally bottling companies and joint ventures 2,314 2,301Other investments,,principally bottling companies 463 488

Total Investments $5,779 $7,777


Note Disclosure of InvestmentsCoca-Cola Company reported the following in Footnote 10 of its 2008 annual report:

3

The Coca-Cola Company, Footnote 10, 2008 Annual Report Gross Unrealized Estimated

2008 (in millions) Cost Gains Losses Fair ValueTrading securitiesEquity Securities $74 $ - ($30) $ 44Other securities 7 - (2) 5

$81 $ - ($32) $ 49Available-for-sale securities:Equity securities $329 $193 ($7) $515 Other securities 12 - (5) 7

$341 $193 ($12) $522Held-to-maturity securities:Bank and corporate debt $74 $ - $ - $74


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

4


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.

5


Types of Investments for Reporting Purposes

6


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

7

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.


Investments Under SFAS 115

Must have readily determinable market value

Must have no significant influence over the investee

Three categories

8

Held-to-Maturity Securities

Trading Investments Available-for-Sale

Investments


Trading Investments

Debt or equity securities Reported as current assets at fair value Income statement reporting

9

Income StatementOther Income/losses: Unrealized gains/losses on trading investments…………$ xx Realized gains/losses on trading investments……………..xx Investment income…………………………………………… xx


Accounting for Trading InvestmentsSecurities owned by Zinc, Inc. are:

10

SecurityDate

Acquired CostDecember 31, 2010

Value Date SoldSelling

PriceA 10/15/10 $100,000 $125,000 1/15/11 $120,000B 10/15/10 500,000 485,000 1/15/11 496,000C 10/15/10 200,000 N/A 12/5/10 214,000

$800,000

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

To record purchase of investments costing $800,000:

Exhibit 1.2


Accounting for Trading Investments

2010 Dec. 5 Cash 214,000 Investment in trading securities 200,000 Realized gain on sale of trading securities 14,000

2010 Dec. 31 Investment in trading securities 10,000

Unrealized gain on trading securities 10,000

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

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 GainB 500,000 485,000 $15,000 Loss

Net unrealized gain = $10,000

11


Accounting for Trading Investments

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

To record the sale of trading securities A and B:

Net realized gain = $6,000

12

Security Cost Year-end Value Date Sold Selling PriceRealized

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

Exhibit 1.2


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

13


Journal Entries for Available-for-Sale Investments

14

SecurityDate

Acquired Cost December 31, 2010 Value Date SoldSelling

PriceA 10/15/10 $100,000 $125,000 1/15/11 $120,000B 10/15/10 500,000 485,000 1/15/11 496,000C 10/15/10 200,000 N/A 12/5/10 214,000

$800,000

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

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

Securities owned by Zinc, Inc. are: Exhibit 1.2


Journal Entries for Available-for-Sale Investments continued

15

2010 Dec. 5 Cash 214,000 Investment in AFS securities 200,000

Realized gain on sale of AFS securities (income) 14,000

2010 Dec. 31 Investment in AFS securities 10,000

Unrealized gains on AFS securities (OCI) 10,000

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

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 GainB 500,000 485,000 $15,000 Loss

Net unrealized gain = $10,000


Journal Entries for Available-for-Sale Investments continued

16

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

To record the sale of AFS securities A and B: Net unrealized gain = $6,000

Security Cost Year-end Value Date Sold Selling PriceRealized

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

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

To reclassify unrealized gains of AFS securities from AOCI to income:


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

17

Income StatementOther Income/losses: Interest income…………………………………………………… $xx


Journal Entries for HTM InvestmentsA 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.

18

2010 Jan. 1 Investment in HTM securities 965,349 Cash 965,349

2010 Dec. 31 Cash 50,000 Investment in HTM securities 7,921 Interest income 57,921

To record the purchase of HTM securities:

To record the receipt of interest income for 2010: $1,000,000 × 5%

$965,349 × 6%$50,000 – $57,921


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

19



$973,270 × 6%



$981,666 × 6%

$50,000 – $58,396

$50,000 – $58,900

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


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

20

2013 Dec. 31 Cash 1,000,000 Investment in HTM securities 1,000,000

To record receipt of face value of bonds at maturity: Carrying value at December 31, 2013: $990,566 + $9,434 = $1,000,000



$990,566 × 6%$50,000 – $59,434

Carrying value at December 31, 2012: $981,666 + $8,900 = $990,566


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

21


Recording an Impairment LossExample: 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.

22

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

To record the impairment:


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

23


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

24


Accounting Under the Equity Method

Investment performance should parallel the investee’s performance

25

Investment in Stock

Cost of investment

Investor's share of investee's income

Investor's share of investee's loss

Dividends received

from investeeEnding cost basis

Increases Decreases

Changes in proportion to the investee’s retained earnings account


Equity Method ExampleCoca-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.

26

2011 Jan. 2 Investment in Rocky Mountain Bot. 12,000,000 Cash 12,000,000

2011 Nov. 1 Dividends receivable 150,000 Investment in Rocky Mountain Bottlers 150,000

To record the purchase of equity investment:

To record dividends declared:

$0.50 × 300,000


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

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.

27

To record dividends received:

To accrue earnings of the investee:

30% × $2,000,000

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


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.

28

Investment in Rocky Mountain Bottlers

12,000,000 150,000

600,000 12,450,000

Equity in income of Rocky Mountain

600,000

600,000

Income Statement

Balance Sheet as long-term asset


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

29


Adjustments to Equity in Net IncomeAdjustments should be made for Depreciation and amortization on

revaluations of Tangible assets, and Limited life intangible assets

30

ExceptionsNo adjustments for goodwill impairment (SFAS 142)

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


Additional Investment Cost ValuationRocky 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.

31

Price paid $12,000,000Share 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


Inventory Sales Between Investee and Investor

Downstream SalesInvestor sells

inventory to investee

32

Upstream SalesInvestee sells

inventory to investor

Both companies Both companies record sales as if record sales as if selling to outside selling to outside

customerscustomers

Both report gross Both report gross margin as part of margin as part of

incomeincomeResults in

If inventory not sold to If inventory not sold to unrelated outside party at unrelated outside party at year-end, gross margin is year-end, gross margin is

not yet earnednot yet earned

Investor must remove Investor must remove when calculating equity in when calculating equity in

net income of investeenet income of investee


Adjustments for Unconfirmed Inventory Profits Example

33

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


Recognition of Adjusted Equity Income Coca-Cola's share of Rocky Mountain's reported 2011 income (30% x $2,000,000) $600,000Adjustments for revaluation write-offs:

Plant and equipment (30,000)Previously unreported technology (300,000)

Adjustments for unconfirmed inventory profits: Upstream sales (10,500)Downstream sales (6,000)

Equity in net income of Rocky Mountain $253,500

34

30% × $35,000

30% × $20,000

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

$300,000÷ 10

$1,500,000÷ 5


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

35

Suppose Rocky Mountain reported $200,000 in unrealized gains on AFS securities.

30% × $200,000 = $60,000

2011 Dec. 31 Investment in Rocky Mountain Bottlers 60,000

Unrealized gains on equity method investments (OCI) 60,000


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

36


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

37

U.S. companies use the equity method for joint ventures.


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

38


Statutory Mergers, Statutory Consolidations, and Asset AcquisitionsAn investor directly acquires the assets

and liabilities of the investeeAssets and liabilities recorded directly on

investor’s balance sheet at fair value

39

Statutory MergerOccurs when the investor acquires

the investee and becomes the remaining legal entity

Statutory ConsolidationOccurs when a new entity is formed to acquire both the investor and the investee

Asset AcquisitionOccurs when an investor acquires a subset of the

investee’s assets


Stock Acquisitions Occurs when an investor obtains control

over another company by investing in its voting stock Investee remains a separate legal entity

40

The separate financial records are consolidated

at the end of each reporting

period.


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.

41

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.

motivations for intercorporate investments

Documents