investing decisions

Investing Decisions - 1

INVESTING DECISIONS

TEMPORARY INVESTMENTS

Use of idle cash

Low risk investments

Quickly and easily converted to cash

Highly liquid securities

LONG-TERM INVESTMENTS

Long-term income source (interest, dividends, price appreciation)

Develop beneficial intercompany relationships to improve profitability of investing company.

Gain ownership interest.

ACCOUNTING ISSUES

Classification issues– Management’s intended holding period

for the security

Valuation and investment income measurement– Cost vs. fair value– Treatment of holding gains & losses

Disclosure issues


ACCOUNTING METHODS FORVARIOUS INVESTMENTS

Classification Investment inDebt Securities

Investment inEquity Securities

Control-greater than 50%ownership of voting stock

Not applicable Consolidation

Significant influence - 20% to50% ownership of voting stock

Not applicable Equity method

Debt securities classified as heldto maturity, and equity securitiesfor which fair value is not readilydeterminable

Amortized cost method Cost method

Debt and equity securitiesclassified as trading securities

Fair value method, with unrealized holding gain or lossincluded in net income

Debt and equity securitiesclassified as available for sale

Fair value method, with unrealized holding gain or lossincluded as a component of comprehensive income


OPERATIONAL ASSETS

Common characteristics– Actively used in primary operations– Long-term = benefits future periods– Generally not held for resale

Categories– Tangible assets = have physical substance– Intangible assets – lack physical substance


OPERATIONAL ASSETSClasses

Property, plant & equipment– Buildings– Machinery, furniture & fixtures– Land & land improvements

Natural resource rights Intangibles

– Patents, copyrights, trademarks, trade names

– Franchise rights– Goodwill


OPERATIONAL ASSETSAcquisition Cost

Cost of gaining right to use asset, bring it to the location and condition necessary for its intended use

Cost = FMV of consideration given or FMV of asset received, whichever can be more reliably determined


LONG-TERM LEASES Capital vs. Operating Leases

Criteria - must be accounted for as a capital lease if ANY ONE of the following exist:– Transfer of ownership– Bargain purchase option– Term is greater than or equal to 75% of economic life of asset– PV of minimum lease payments is greater

than or equal to 90% of FMV of asset


DEPRECIATION CONCEPTS Depreciation - expiration or consumption of the

economic service potential of plant assetsAN ECONOMIC FACT

Depreciation accounting - the systematic and rational allocation of the cost of the tangible plant assets, less salvage, to expense over the estimated useful life of the asset

AN ACCOUNTING PROCEDURE

Depreciation accounting is a “cost allocation” process and is not directly related to the “market value” of the asset


CAUSES OF DEPRECIATION

Physical deterioration– Wear and tear from use– Exposure to elements– Passage of time

Obsolescence– Technological– Market


DEPRECIATION CONCEPTSRelated Areas

Depletion accounting - periodic allocation of the cost of natural resources

Amortization accounting - periodic allocation of intangible assets


DETERMINING DEPRECIATION

Determinants of computed “Depreciation Expense”

Asset cost

Estimated residual value

Estimated useful (economic) life

Specific method of depreciation


DEPRECIATION METHODS Straight-Line Activity methods

– Units of service– Units of production

Accelerated methods– Sum-of-the-years’-digits– Declining balance

Tax depreciation methods

PLANT ASSET IMPAIRMENT

Impairment is the loss of a significant portion of the utility of an asset through casualty, obsolescence or lack of demand for the company’s asset.

When plant assets suffer a permanent impairment in value, a loss should be recorded.

IMPAIRMENT OF LONG-LIVED ASSETS

Reporting Requirements Reviewed when circumstancescircumstances indicate the

carrying value may not be recoverable Recognition of impairment loss

– Required if sum of expected future net cash flows is less than carrying value of the asset

Measurement of impairment lossThe amount by which the carrying value of the asset exceeds the fair value of the asset


Reporting Requirements - Continued

Presentation of impairment lossesShown as a component of income fromcontinuing operations before taxes

Restoration of impairment lossesReduced carrying value is basis for futureaccounting and restoration is prohibited


Disclosure Requirements

Description of impaired assets

Circumstances leading to impairment

Amount of impairment loss

How fair value was determined


BUSINESS COMBINATIONSMotivations

Growth– New markets– Increase in market share– New products

Reduction in costs Diversification Tax implications Management incentives Ego

BUSINESS COMBINATIONSEconomic Substance

Horizontal combinations

Vertical combinations (integration)

Conglomerates


BUSINESS COMBINATIONSLegal Forms

Merger

Statutory Consolidation

Acquisition


BUSINESS COMBINATIONSMethod of Accounting

Pooling

Purchase

Acquisition

The FASB has eliminated pooling and purchase as methods of accounting for business combinations, but this requirement is NOT retroactive!


Accounting for CombinationsJune 30, 2001 Calendar 2009

PurchaseOR

Pooling

Purchaseonly

(Not retroactive)

Acquisitiononly

(Not retroactive)

Selection based onspecific criteria

for Pooling

All new combinationsmust use Purchase(no adjustment of

older results)

All new combinationsmust use Acquisition

(no adjustment ofolder results)


Purchase

Acquisition

Horizontal

Vertical

Conglomerate

Merger StatutoryConsolidation

StockAcquisition

Pooling

PURCHASE ACCOUNTINGAccounting Considerations

Combination = one entity BUYING another Normal GAAP for acquisition of an asset Valuation of acquired net assets: - Fair value of consideration given AND - Fair value of net assets acquired

Recognition of COST/FAIR VALUE differential

Recognition of Earnings and Retained earnings of acquired entity: from DATE OF ACQUISITION

Direct expenses of combination = Cost of Investment


PURCHASE ACCOUNTINGKey Computations

Cost of investment: (FMV of consideration given – cash, debt, stock – or some combination of all three)

versus

Book value of net assets (assets – liab.) acquired

= Total differential to be accounted for in the combination


ALLOCATION OF DIFFERENTIALPurchase Accounting

Determine “differential” on acquisition of net assets acquired (see previous slide)

Allocate “cost” to identifiable NET assets acquired - Based on FMV of individual assets and liabilities - Includes identified intangibles - May involve writeups or writedowns

Account for differential– If positive (cost > FMV of identifiable net assets) =

“Goodwill” – If negative (cost < FMV of identifiable net assets) =

differential is allocated to a reduction of selected assets (other than highly liquid assets) with any remainder treated as an extraordinary gain


CRITERIA FOR POOLINGAPB No. 16

Attributes of combining companies - Autonomous - Independent of one another Manner of achieving combination - Single transaction - Common stock for Common stock - Exchange for “substantially all” common (90%) Absence of planned transactions - Planned spin-off of assets - Contingent agreements


POOLING OF INTERESTS Accounting Considerations

Combination of ownership interests- NOT AN ACQUISITION

NO TRANSACTION by the corporate entities - No new basis of accountability

- Total combined net assets unchanged

NO CHANGE in total combined stockholders’ equity– Reallocation of individual accounts may be required

Retained earnings accounts combined

Earnings - combined for entire year of pooling

Direct combination expenses = period expenses


POOLING OF INTERESTKey Computations

Total par value of new shares issued

Versus

Total par value of old shares exchanged

= Possible rearrangement of stockholders’ equity on combined balance sheet


POOLING OF INTERESTS

=+Assets Assets Assets

+ = Liabilities Liab. Liab.

Par Par OCC OCCRE RE

+ = Stockholders’ Equity

OCC

Par

OCC

Par

RE

RE

RE

Par

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