12-1

Copyright 2004 The McGraw-Hill Companies, Inc. Permission required for reproduction or display.

PowerPoint Presentation Materials

For

Financial Accounting:

A New Perspective

by

Paul Solomon

2

CHAPTER 12

How Investing Activities Affect Financial Statements

12-3

PERFORMANCE OBJECTIVES 1

PO43: Determine which costs should be capitalized, expensed at acquisition

PO44: Describe, calculate depreciation under Straight line Double-declining balance Sum-of-the-years’ digits

12-4

PERFORMANCE OBJECTIVES 2

PO45: Describe how depletion calculated with units-of-productionPresent financial statement effects

PO46: Describe how amortization calculated with straight-linePresent financial statement effects

12-5

PERFORMANCE OBJECTIVES 3

PO47: Determine valuation for current, noncurrent debt, equity securitiesRecord investmentsPresent financial statements effects

PO48: Distinguish between cost/fair value & equity method to account for minority investments in equity securities

12-6

INSIGHTS

Why is useful life critical?

Real world complications of accounting for investment securities

12-7

WHY ENGAGE IN INVESTING ACTIVITIES?

Noncurrent assets on balance sheet

Without noncurrent assets, entities unable to generate revenues

12-8

INVESTING ACTIVITY TRANSACTIONS

Transaction

C1

E

Acquired equipment

Paid lease security deposit

C2

H

Paid for equipment

Investment in savings

L

R

Bought equipment with note

Sold some equipment

12-9

EFFECTS OF INVESTING ACTIVITIES: Balance Sheet

Transaction

C1

L

Store equipment account

Security deposit receivable

12-10

EFFECTS OF INVESTING ACTIVITIES: Income Statement

Transaction

R Loss on sale of store equipment

12-11

EFFECTS OF INVESTING ACTIVITIES: Cash Flow Effects

Transaction E

C2

L

R

Paid lease security deposit

Paid for equipment

Bought equipment with note

Sold some equipment

12-12

CMUBalance Sheet

12/31

Investments:

Security deposit receivable $2,000

Property, Plant, Equipment

Store Equipment 19,000

12-13

CMUIncome Statement

for Year Ended 12/31RevenuesSales

Service

Interest

ExpensesCost of goods sold

Other

Loss on sale equipment

Net income

$86,600

600

300

$30,000

27,150

350

$87,500

57,500

$30,000

12-14

CMUStatement of Cash Flows

for Year Ended 12/31

Cash flows from investing

Proceeds, sale equipment

Payment security deposit

Acquisition equipment

$1,350

<2,000>

<17,000> <17,650>

Supplemental: noncash investing, financing

Exchanged 2-year promissory note for computer equipment

12-15

ACCOUNTING FOR PROPERTY, PLANT, EQUIPMENT

Noncurrent

Tangible

Use in operation of business

ExamplesDepreciable property, plant, equipmentNatural resourcesNon-depreciable property (land)

12-16

COST MEASUREMENT

General ruleAll costs to bring asset to condition,

location for its intended use

Historical cost =

Purchase price-cash discounts

+ shipping, storage, taxes, insurance, legal fees, installation

12-17

DEPRECIATION: Transaction Analysis

Account Assets = Liabilities + Equity

Depreciation expense

Accumulated depreciation

<2,000>

<2,000>

12-18

DEPRECIATION:Journal Entry

Account Debit Credit

Depreciation expense

Accumulated depreciation

2,000

2,000

12-19

DEPRECIATION EXPENSE:Straight-line

Historical cost – salvage

Life $10,000 - $0

5

= $2,000

12-20

INSIGHT:Useful Life

Why is estimated useful life critical to accurate income measurement?

Estimate, not actual amount

Changes in useful life affect pretax income

Subject to manipulation of unethical management

12-21

ACCELERATED DEPRECIATION METHODS

Matching conceptAssets expected to generate most

revenues in earliest years

Greatest depreciation taken in earliest years

ExamplesDouble-declining balanceSum-of-the-years’ digits

12-22

DEPRECIATION EXPENSE:Double-declining Balance

2 * 1/life(historical cost – accumulated depreciation)

Assume salvage = $400 Expense Balance

Y 1

Y 2

Y 3

2*1/5(10,000 – 0) =

2*1/5(10,000 – 4,000) =

2*1/5(10,000 – 6,400) =

$4,000

2,400

1,440

$6,000

3,600

2,160

Y 4

Y 5

2/1/5(10,000 – 7,440) =

10,000 – 8736 – 400 =

864

894

778

400

12-23

DEPRECIATION EXPENSE:Sum-of-the-years’ Digits

Last unused year *

Sum of years(Historical cost – Salvage)

Y1

Y2

Y3

5/15 * (10,000 – 400) =

4/15 * (10,000 – 400) =

3/15 * (10,000 – 400) =

$3,200

2,560

1,920

Y4

Y5

2/15 * (10,000 – 400) =

1/15 * (10,000 – 400) =

1,280

640

12-24

GAINS & LOSSES 1:Transaction Analysis

Account Assets = Liabilities + Equity

Cash

Accumulated depr.

Store equipment

Gain on sale

800

9,600

<10,000>

400

Store equipment sold for $800

12-25

GAINS & LOSSES 1:Journal Entry

Account Debit Credit

Cash

Accumulated depr.

Store equipment

Gain on sale

800

9,600

10,000

400

12-26

GAINS & LOSSES 2:Transaction Analysis

Account Assets = Liabilities + Equity

Cash

Accumulated depr.

Store equipment

400

9,600

<10,000>

Store equipment sold for $400

12-27

GAINS & LOSSES 2:Journal Entry

Account Debit Credit

Cash

Accumulated depr.

Store equipment

400

9,600

10,000

12-28

GAINS & LOSSES 3:Transaction Analysis

Account Assets = Liabilities + Equity

Cash

Accumulated depr.

Loss on sale

Store equipment

800

9,600

<10,000>

200

Store equipment sold for $200

12-29

GAINS & LOSSES 3:Journal Entry

Account Debit Credit

Cash

Accumulated depr.

Loss on sale

Store equipment

200

9,600

200

10,000

12-30

NATURAL RESOURCES

ExamplesTimberMineral depositsOil fields

Cost matched to revenue by depletion

12-31

DEPLETIONTotal depletion cost

= Acquisition + Exploration & development costs

Units of production (straight line)

Cost per unit = Total cost/Discovered units

Depletion expense= Cost per unit * Units sold

12-32

PROPERTY NOT SUBJECT TO DEPRECIATION

LandUnlimited lifeNo depreciation, depletion

12-33

INTANGIBLE ASSETS

Value derived from rights that possession conveys to ownersExamplesCopyrightsPatentsTrademarksFranchisesLeases

12-34

INTANGIBLE ASSETS:Amortization Transaction Analysis

Straight-line method over legal life

Goodwill not subject to amortization

Account Assets = Liabilities + Equity

Patent amortization exp.

Patent <2,000>

<2,000>

12-35

INTANGIBLE ASSETS:Amortization Journal Entry

Account Debit Credit

Patent amortization exp.

Patent

2,000

2,000

12-36

INTANGIBLE ASSETS:After Acquisition

When book value exceeds fair value Asset is impaired Value must be written down to fair value

Book value: goodwill

Fair value: goodwill

Impairment

$330,000

295,000

$35,000

12-37

IMPAIRED ASSET:Transactional Analysis

Account Assets = Liabilities + Equity

Loss on goodwill impairment

Goodwill <35,000>

<35,000>

12-38

IMPAIRED ASSET:Journal Entry

Account Debit Credit

Loss on goodwill impairment

Goodwill35,000

35,000

12-39

DEBT & EQUITY SECURITIES

Debt securitiesTreasury billNoteBond

Equity securitiesCommon stockPreferred stock

12-40

SECURITIES:Distinguishing Characteristics

3 categoriesCash equivalentsMarketable securities Investments

3 characteristicsNatureMaturityManagement’s intention

12-41

INVESTMENTS: 3 Distinguishing Characteristics 1

Nature of securityLiquidity

Expected maturity date Investments: greater than 1 year

12-42

INVESTMENTS: 3 Distinguishing Characteristics 2

(cont.)Management’s intention to holdTrading securities:

Actively traded for profitAvailable for sale:

Intention to sell; Not actively traded

Held-to-maturity: Intent & ability to hold

12-43

ACQUISITION DEBT SECURITY:Transactional Analysis

Account Assets = Liabilities + Equity

Investment in bonds

Cash 101,000

<101,000>

12-44

ACQUISITION DEBT SECURITY:Journal Entry

Account Debit Credit

Investment in bonds

Cash

101,000

101,000

12-45

INTEREST REVENUE FROM DEBT SECURITY:

Transactional Analysis

Account Assets = Liabilities + Equity

Interest receivable

Interest revenue

2,500

2,500

Cash

Interest revenue

2,500

2,500

12-46

INTEREST REVENUE FROM DEBT SECURITY:

Journal Entry

Account Debit Credit

Interest receivable

Interest revenue

2,500

2,500Cash

Interest receivable

2,500

2,500

12-47

ADJUSTMENT TO FAIR VALUE FOR HOLDING GAIN:Transactional Analysis

Account Assets = Liabilities + Equity

Investment in bonds

Unrealized holding gain

200

200

12-48

ADJUSTMENT TO FAIR VALUE FOR HOLDING GAIN:

Journal Entry

Account Debit Credit

Investment in bonds

Unrealized holding gain

200

200

12-49

ADJUSTMENT TO FAIR VALUE FOR HOLDING LOSS:Transactional Analysis

Account Assets = Liabilities + Equity

Unrealized holding loss

Investment in bonds <300>

<300>

12-50

ADJUSTMENT TO FAIR VALUE FOR HOLDING LOSS:

Journal Entry

Account Debit Credit

Unrealized holding loss

Investment in bonds

300

300

12-51

SALE OF DEBT SECURITY:Transactional Analysis

Account Assets = Liabilities + Equity

Cash

Investment in bonds

Realized gain on sale

101,900

<101,000>

900

12-52

SALE OF DEBT SECURITY:Journal Entry

Account Debit Credit

Cash

Investment in bonds

Realized gain on sale

101,900

101,000

900

12-53

STOCK OWNERSHIP:Levels of Ownership

Ownership Influence Type

<20%

20% < x < 50%

> 50%

Insignificant

Significant

Control

Minority (passive)

Minority (active)

Majority

12-54

ACCOUNTING FOR EQUITY SECURITIES: Minority Passive

Cost/fair value methodDividends increase revenueNo recognition of investee

incomeYear-end adjustments

Unrealized gains, losses recognized on trading, available-for-sale securities

Realized gain, loss on sale

12-55

ACCOUNTING FOR EQUITY SECURITIES: Minority Active

Equity methodDividends reduce investmentShare of investee net income/loss

increases investmentRealized gain, loss on sale

12-56

COMPARING COST & EQUITY METHODS: Equity Investments

Cost/fair value Equity

Minority, passive

Unrelated businesses

Minority, activity

Significant influence

Standard revenue recognition

Dividends as revenue

Proportionate share investee income, loss

Dividends as decrease in investment

12-57

INSIGHT:Real World Complications

4 valuation methods for security investments Held-to-maturity: amortized cost Trading, available for sale (debt & equity)

Cost fair value

Minority active stock investments: equity method Majority active stock investments: consolidation