Chapter 12 (Reporting and Analyzing Financial Investments) Flashcards
(28 cards)
Short-term investment of excess cash
Excess cash for investment either during slow times or for liquidity needs
Alliances for strategic purposes
Acquiring an interest in another company for strategic purposes, such as R&D, supply or distribution markets, or to their production and marketing expertise.
Market penetration or expansion
Acquisition of controlling interests in other companies can achieve vertical or horizontal integration in existing markets or can be avenues to penetrate new and growing markets.
Financial investments
Investments in government securities and in the securities of other companies
Passive influence
An investor but can’t exert influence over the investee organization
Significant influence
An investor can exert significant influence over, but not control, the activities of an investee company.
Controlling influence
When a company has control over another, it has the ability to elect a majority of the board of directors and, as a result, the ability to determine its strategic direction and hiring of executive management.
Fair value
The amount an independent buyer would be willing to pay for an asset in an orderly transaction
Fair value hierarchy
Level 1: Values based on quoted prices in active markets.
Level 2: Values based on observable inputs other than Level 1 (e.g., quote prices for similar assets/liabilities or interest rates or yield curves)
Level 3: Values based on inputs observable only to the reporting entity (e.g. management estimates or assumptions).
Fair value option
Provides companies with the option of using fair value to measure the value of most financial assets and liabilities, including accounts and notes receivable, accounts and notes payable, and bonds payable.
Two types of marketable securities that require the investment to be reported on the balance sheet at current fair value
Trading (T) securities and Available-for-sale (AFS) securities
Trading (T) securities
Investments in securities that management intends to actively buy and sell for trading profits as market prices fluctuate.
Available-for-sale (AFS) securities
These are investments in securities that management intends to hold for capital gains and dividend revenue; although it may sell them if the price is right or if the organization needs cash.
How are holding gains/losses recorded for trading securities?
They are recognized in income in the period in which they occur
How are holding gains/losses recorded for AFS securities?
The gain/loss is recorded as an increase in accumulated other comprehensive income (AOCI)
How is the amount determined for the gain/loss when selling AFS securities?
By comparing the amount received when the shares are sold to the amount paid for the shares when originally purchased.
What’s the principal difference between trading securities and AFS securities?
Reporting on the income statement for trading securities
How can you manage earnings with securities?
If management wants to report higher net income, investments that have increased in value could be classified as trading securities while investments that have declined in value could be classified as available-for-sale securities.
Cost method
Investments for which fair value cannot be determined must be accounted for using the cost method
Held-to-maturity (HTML)
Debt securities that management intends to hold to maturity are also reported using the cost method
Intercorporate investments are usually made for strategic reasons, including:
Prelude to acquisition, strategic alliance, and pursuit of research and development
Equity method
Investments with significant influence must be accounted for using the equity method. The method of accounting for investments reports the investment on the balance sheet at an amount equal to the proportion of the investee’s equity and investor: Hence the name Equity method.
Summary of the equity method
Investments are initially recorded after purchase cost. Dividends received or treated as a recovery of the investment and, thus, produce investment balance.The investor reports income equal to its proportionate share of the reported income of the investee; the investment account is increased by that income were decreased by its share of any loss. The Investment is not reported at fair value as is the case with most passive investments.
Are the assets and liabilities to which the investment relates reported when using the equity method?
Under a clean method accounting, only the net equity owned is reported on the balance sheet not the assets and liabilities to which the investment relates. Only the net equity and earnings is reported in the income statement not the investee’s sales and expenses.Both the balance sheets and income statements bar, therefore, markedly affected.
