CHAPTER 8:

INVESTING
ACTIVITIES
GROUP 7
Investments in Long-Lived Operating Assets
Investments in Long-Lived Operating Assets

Tangible Asset
Buildings
Equipment
Inventory
Investments in Long-Lived Operating Assets

Intangible Asset
Patents
Trademarks
Copyrights
Goodwill
 Are the
Acquisition Costs
Assets or Expenses?
Acquisition Costs

Total amount spent to buy

something, including all
expenses necessary to
make the purchase and get
it ready for use.
Acquisition Costs

BREAKDOWN:
Purchase Price
Additional Expenses
Shipping Fees
Taxes
Installation
Legal Fees
 Are the
Acquisition Costs
Assets or Expenses?
 Acquisition Costs

ASSET If the acquisition costs are

for something that will
provide long-term benefits
(like property, equipment,
or intangible assets), they
are typically recorded as
assets.
 Acquisition Costs

EXPENSES If the acquisition costs are for

items that are consumed or
used up quickly (like supplies
or inventory), they may be
treated as expenses. These
costs are recorded on the
income statement in the
period they are incurred.
 Issues related to the financial reporting of
expenditures incurred in activities relating to real
assets (tangible and intangible). We consider:

property, plant, and equipment.

research and development costs.
software development costs.
subsequent expenditures to enhance or maintain
property, plant, and equipment.
 Issues related to the financial reporting of
expenditures incurred in activities relating to real
assets (tangible and intangible). We consider:

costs of self-construction
Cost Involved:
Labor
Materials
Other Expenses
costs of acquiring intangible asset
Beakdown:
Purchase Price
Legal Fees
Registration Cost
 Issues related to the financial reporting of
expenditures incurred in activities relating to real
assets (tangible and intangible). We consider:

costs of acquiring natural resources

Breakdown:
Purchase Price
Exploration Cost
Development Cost
Extraction Cost
Environmental and Regulatory Cost
Transportation Cost
 Accounting for the Acquisition of Property, Plant,
and Equipment:
General Rule

PP&E is recognized as an asset when future benefits

are expected and recorded at the fair value of
resources sacrificed (cash, debt, or equity),
including preparation costs like shipping and setup.
Cash payments are reported as investing cash
outflows, while debt or equity acquisitions are
disclosed as non-cash investing and financing
activities.
 Accounting for Research and Development Costs

U.S. GAAP requires immediate expensing of internal

R&D costs due to uncertain future benefits, while
externally acquired R&D (e.g., patents) can be
capitalized as they have reliable costs and indicate
future benefits. This significantly impacts high R&D
industries like biotechnology, as major R&D assets
remain off the balance sheet.
 Accounting for Software Development Costs

Under U.S. GAAP, internal software development

costs are expensed until "technological feasibility" is
achieved, defined as completing a program design
or working model. After this, development costs are
capitalized and amortized. Determining feasibility
requires significant managerial judgment.
 Subsequent Expenditures for Enhancement or
Improvements

Expenditures that extend an asset's service life or

enhance its potential are capitalized, while routine
repairs and maintenance are expensed. For example,
replacing truck tires is expensed, but adding a
refrigeration unit to the truck is capitalized as it
improves its service quality.
 Costs of Self-Construction

A company might choose to self-construct plant

and equipment because it wants to save costs or
because no external supplier is available.
 Costs of Acquiring Natural Resources

Oil fields, timber tracts, and mineral deposits are

examples of natural resources. Three types of costs
incurred in connection with natural resources are as
follows:

Acquisition costs
Exploration costs
Development costs
 Acquisition Costs

Acquisition costs include expenses for obtaining

natural resources and restoring the site afterward. If
the land is salvageable, the cost is split between the
land account and the natural resources account,
with the latter reported under property, plant, and
equipment.
 Exploration Costs

Exploration costs are incurred to discover the

existence and exact location of a natural resource.
For example, a petroleum manufacturer acquires an
oil field (acquisition cost) and then drills to discover
oil.
 Development Costs

Once the natural resource has been acquired and

exploration has determined the location of deposits,
the natural resource must be developed.
 Costs of Acquiring Intangible Assets

Under U.S. GAAP and IFRS, costs of internally

developing intangible assets are expensed as
incurred due to uncertainty in determining future
benefits, prioritizing reliability over asset recognition.
 What Choices Are Managers Making to Allocate
Acquisition Costs to the Periods Benefited?

Cost allocation includes the processes of depreciation (for

tangible fixed assets), amortization (for limited-life intangible
assets), and depletion (for natural resources). When allocating
acquisition costs to the periods benefited, managers must:
(1) choose an allocation method,
(2) estimate useful life, and
(3) estimate salvage value
 Useful Life for Long-Lived Tangible and
Limited-Life Intangible Assets

Physical wear and tear and technological obsolescence

affect the projection of the total useful life and salvage
value. Managers have an opportunity to convey
information to the firm’s stakeholders about their
expectations of the future usefulness of long-lived assets.
However, the estimation process also provides an
opportunity to introduce bias into reported earnings.
 Cost Allocation
(Depreciation/Amortization/Depletion) Method

Firms may allocate the acquisition costs over the useful

life of the asset using any systematic and rational
method. The allocation of cost is charged to
depreciation expense (for tangible fixed assets),
amortization expense (for intangibles), or depletion
expense (for natural resources) and is reported on the
income statement.
When Will the Long-Lived Assets Be Replaced?

To forecast future financial statements, you need to estimate how much the
company will spend on acquiring new assets to replace old ones and
expand its capacity. This requires understanding the industry and the
company's strategy. However, you can make two calculations to better
understand when the company might need to replace its current long-term
assets:
The average age of assets can be found by dividing accumulated
depreciation by the annual depreciation expense. This tells you how many
years the company has been using its depreciable assets.
What Is the Relation between the
Book Values and Market Values of
Long-Lived Assets

The book value and market value of long-lived

assets are two distinct measures of an asset's
worth, and their relationship often depends on
various factors such as asset condition,
economic environment, and accounting
practices.
 Impairment of Long-Lived Assets Subject to
Depreciation and Amortization

refers to a situation where the carrying amount of an

asset exceeds its recoverable amount, requiring the
company to write down the asset’s value to reflect its
diminished economic utility. Impairment ensures
financial statements accurately represent the asset's
value.
 Differences in U.S. GAAP and IFRS
Impairment of Long-Lived Assets

The impairment of long-lived assets is

addressed under both U.S. GAAP and IFRS, but
there are key differences in how impairment is
tested, recognized, and measured.
 Impairment of Intangible Assets Not
Subject to Amortization

For intangibles not requiring amortization (that is,

intangible assets with an indefinite life), firms must
test for asset impairment annually—or more
frequently if events and circumstances indicate
that the asset may be impaired.
Impairment of Goodwill

The U.S. GAAP and IFRS goodwill

impairment tests are similar.
U.S. GAAP (FASB Codification Topic 350)
defines a reporting unit
IFRS (IAS 36) defines a cash generating unit
 IFRS Treatment of Upward Asset
Revaluations

IFRS gives firms the option to revalue upward

both intangible and tangible long lived assets.

Many firms choose not to exercise the upward

revaluation option .
 Investment in Securities
Firms also may invest in the securities of other firms.

The degree of influence and control one firm has over another
entity, which may be:
• minority, passive
• minority, active
• majority, active
 Minority, Passive Investments

Less than 20% ownership .

To account for minority, passive
investments:
Initially record investments at
acquisition cost
Interest & Dividend received/receivable
each year are recorded as revenue
 Minority, Passive Investments

the accounting at the end of each period and at time of sale

depends on the type
of security and the firm’s ability and intent to hold it, as
follows:
Debt securities held-to-maturity
Trading security
Available-for-sale securities
 Minority, Passive Investment

‘‘Other than Temporarily Impaired’’ Securities

The securities must be written down to fair value
with the unrealized loss.
Managers must test whether securities that have
experienced unrealized losses are ‘‘other than
temporarily impaired.’’
 Minority, Active Investments

U.S. GAAP and IFRS require firms to

account for minority, active
investments, generally those for which
ownership is between 20% and 50%,
using the equity method.
 Majority, Active Investments

When one investor firm owns more than 50% of

the voting stock of another company, the investor
firm generally has control.

The majority investor in this case is the parent, and

the majority-owned company is the subsidiary.
 Purpose of Consolidated Statements

A consolidation of the financial statements of the parent and

each of its subsidiaries presents the results of operations,
financial position, and changes in cash flows of an affiliated
group of companies under the control of a parent, essentially
as if the group of companies were a single entity.
 Corporate Acquisitions

A Corporate acquisitions occur when one

corporation acquires a majority ownership
interest in another corporation.
 Statutory Mergers

Statutory mergers that result when one entity

acquires all of the assets and liabilities of another
entity and places the acquired assets and
liabilities on its books.
 Acquisition

Acquisitions of between 51% and 100% of the

common stock of an acquired entity, where the
acquired entity continues to operate as a separate
legal entity with separate financial records.
 Consolidated Financial Statements
to the Date of Acquisition

Refers to a financial statements generated by a parent

business that include the financial information of its
subsidiary as of the exact date when the acquisition
happened. These statements are intended to reflect the
financial situation and performance of the entire
corporate group—parent and subsidiary—while
treating them as a single economic unit.
 Noncontrolling Interests

Arises if an investing firm acquires less than 100% of

another firm.
Also termed as minority interest.
Disclosure
-Income Statement: Is deducted from the net income
of the parent.
-Balance Sheet: A component of shareholders’ equity
of the parent.
 Corporate Acquisitions and
Income Taxes

The acquired company does not restate its assets & liabilities for tax
purposes.

The tax basis of assets & liabilities of the acquired company before
acquisition carries over after the acquisition called nontaxable
reorganization.
Consolidation of Unconsolidated
Subsidiaries and Affiliates

Companies do not consolidate the financial statements of joint

ventures or minority-owned affiliates.
Under U.S.GAAP firms use the equity method to account for
joint ventures.
IFRS permits use of proportionate consolidation for joint
ventures.
 Special-Purpose or Variable- Interest Entity
(VIE)

Can be a corporation, partnership, trust or any other legal

structures for business purpose.
May be passive or active.
The sponsoring firm would not consolidate a VIE under the
percentage of ownership criterion.
Also called a bankruptcy remote entity.
 Consolidating VIE
Firm must consolidate if it is the primary beneficiary of the VIE.

FIN 46R- Firm is primary beneficiary if it has

The direct or indirect ability to make decisions about the entity's activities.

The obligation to absorb the entity's expected losses if they occur.

The right to receive the entity's expected residual returns if they occur.
 Income Tax Consequences of Investment in Securities

For income tax purposes, investments fall into two categories

Investments in debt securities, preferred stock, and in less than 80% of the common stock.

Interest or dividends, gains or losses- taxable income.

Investments in 80% or more of the common stock.

Consolidated tax returns are prepared.

Foreign Currency Translation

Types of Foreign Entities

A foreign entity operates as a self-contained & integrated unit (Al
current method)
The operations of a foreign entity are a direct & integral extension of
the parent company's operations (Monetary/Non-monetary methods)
Exception to these guidelines - U.S.GAAP
If the foreign entity operates in a highly inflationary country (FASI
Statement No.52).
Translation Methodology-Foreign Currency is the Functional
Currency

Revenues & expenses are translated at average exchange rate.

Income
Income includes realized translation gains & losses on sale of
Statement foreign unit

Assets & liabilities are translated at end-of- period exchange rate.

.
Balance Sheet Unrealized translation adjustment is included in other
comprehensive income
Translation Methodology-Foreign Currency
is the Functional Currency

Translation adjustment" is a component of other

comprehensive income & includes:

Effect of exchange rate changes on the parent's equity

investment in subsidiaries.

Change in fair value of a derivative (Firms hedge their

foreign operations).
Translation Methodology-U.S. Dollar is the Functional Currency

Firms must use the Monetary or Non-monetary translation method.

Monetary items include cash, marketable securities, receivables,

accounts payable, short-term & long-term debt.

Nonmonetary items include inventories, fixed assets, common stock,

revenues and expenses.
 Translation Methodology-U.S. Dollar is the
Functional

Revenues & Expenses are Statement translated at average exchange rate

Income .
.
Cost of goods sold & depreciation are translated using historical exchange
Statement rate.

Balance Monetary assets & liabilities are translated at end-of-period

exchange rate. Non-monetary assets & equities using historical
Sheet exchange rate.
 Foreign Currency Translation and Income Taxes

Branch of US parent
Use all-current or monetary/non-monetary translation
method as appr
Subsidiary of US parent
Dividends received are translated at exchange rate on date
of remittance.
Analyst Adjustments

Analyst should consider how changes in exchange rates

affect changes in sales levels, sales mix, and net income.

To swing the balance of factors towards use of foreign

currency, management may.
-Decentralize decision making to foreign unit.
-Minimize remittances or dividends.
Thank You!!