 Hello and welcome to this session in which we would look at introduction to investments. First, we need to learn why do companies invest in other companies? So why do companies buy stocks, buy equity in other companies? Why is this topic important? Well, two reasons. One, it's covered in your advanced accounting course. So if you are an accounting student, you need to know this topic. Also, it's covered on your CPA exam. So whether you are an accounting student or a CPA candidate, what I suggest you do is to take a look at my website, farhatlectures.com. Most likely if you're studying for your CPA exam, you do have a CPA course already. That's fine. I don't intend to replace your CPA review course. My lectures, my material about this topic is to be a useful addition. How so? I can explain the material differently. I can give you an alternative explanation. I can give you alternative resources to help you understand your CPA review course, which in turn will help you understand your CPA topics, which in turn will help you pass the exam. Your risk to try me is one month of subscription. If it works, you keep it. That's a subscription. If not, you cancel. Your potential gain is passing the exam. Now, I do have resources for other accounting courses, as well as CPA sections, as well as the CMA. So I strongly suggest you take a look at my website. If you haven't connected with me on LinkedIn, please do so and take a look at my LinkedIn recommendation, like this recording, share it with other, connect with me on Instagram, Facebook, Twitter, and LinkedIn. So the first thing we want to know is why do companies invest in other companies? Well, let's think about it. Why do we invest? Why do you invest? Well, you invest when you have idle cash, extra cash, and you want to earn a return, a better return because cash don't give you the lowest return. Cash is safe. If you have your cash in the bank, you should not be compensated for any risk because you're technically not taking any risk. But if you want to invest, the assumption is you would earn a higher return, but also you can lose your principal. But the point is to earn a better return. That's one reason. Companies also invest for other reasons. What are those other reasons is to gain voting privilege, to elect board members, to elect members of the board, to elect the officers of the company. That's why companies do invest in other companies some of the time, is to have sayings, to have some sort of an influence. Why? Because they want to help the company direct their operation in a strategic way, strategic planning or strategic direction. They want to influence that company. Maybe because it's in their best interest to do so. Maybe that company is their suppliers. Maybe it's a potential competitor. For whatever reason, we want to be on board with them to see what's going on. Also, if we are on board, if we are part of the company, we can advocate cooperation between the two companies in terms of R&D, distribution, knowledge sharing, advertising, strategic planning, so on and so forth. Basically, you have an ally. When you have an ally, you have more resources. I always think about my business. For example, I operate by myself. I really don't have a partner. Well, sometimes I really hope I do have a partner. Why? Because it's another brain working with you. Think about two companies. You have many brains working together. The more you can have people working together, supposedly the better off you are. Also, it comes with disadvantages, but the point is you have more resources, more human resources. That's the least. Let alone, you might have more financial resources or physical resources. How to report the investments? Because this is what we care about as accountant. As accountant, we want to know, okay, we made an investment in another company. How do we report for this investment? At the beginning, it's easy. All investments are recorded at cost. What does that mean? It means how much we pay for them? We record them at that cost. What about subsequent changes? What happened after we buy the investment? The investment might go up in value, go down in value, might pay us dividend. The investment could go bad. What do we have to do? Gaps, as we have four methods that we have to deal with. We have the fair value. We could report it at cost method. We could report the investment using the equity method, or we could use the consolidation method. How do we determine which method are we going to be using? Well, it depends mainly on the degree of control. What does that mean, degree of control? It means how much do we control of the other company? Simply put, let me do this. Let's assume this is 100%. And here's how it works. If you own, okay, and I want you to kind of, you know, keep that, keep those percentages in mind, but don't, you know, don't take them to heart. But this is just an overview of what it looks like. If you own up to 20%, up to 20% of the stocks of the other company, up to 20%, okay, you can use the fair value or the cost method. And we're going to see, we're going to talk a little bit about those. If you own between 20 to 50, you have more than 20, but less than 50, you would use the equity method. If you own more than 50%, 50% plus, 50% plus, you would use the consolidation. So those are the three, when do we use the method? Now we're going to look at each method separately. So it's very important when you are giving the exercise, whether on the exam day, the homework or the CPA exam is, look at these percentages. And those are a good starting point. How should I report my investment? I'm going to talk about each one of these investment categories separately, investment categories separately. But let me tell you, I'm going to tell you right now, the whole course is about consolidation. So the course that I am starting today, it's going to be all about consolidation. We're going to devote a lot of time, not a lot of time, maybe one or two lectures about the equity method, the fair value and the cost method, you should be familiar with those from your intermediate accounting. But consolidation is what we focus on in this, not in this session, in this course, in this whole course. So let's talk real quick about the fair value. Fair value is one of the four options, usually when you own less than 20%, okay? Not, you know, in the real world this percentage could differ, but let's say less than 20%. And here we assume you have no influence. The reason I say this, because in the real world sometime you might own 6% and you might have influence. But from our perspective, from the CPA exam perspective, from a academic perspective, we say less than 20%, you have no influence. And that's not really true in the real world. So what happened when you invest and you own less than 20%, you're looking for dividend, you're looking for income, and you're looking for capital appreciation. So you bought some stocks and another company, you're looking for them to pay you dividend from their profit, and you're looking for capital appreciation, the stock price to go up. So any changes in the fair market value will be reported in income as an, an income as an adjustment at the end of the year. And dividend is reported in income. So anything, any profit you make from this investment, it goes into income. First, it used to go into stockholders' equity and to available for sale, but for stocks, it goes directly now into income and you changes. So it made it easier for us. Everything is reported in income. Okay? And again, you should be very familiar with this one from your intermediate accounting course. Now, if you are not, here's what I suggest you do. You go to Farhat Lectures to my intermediate accounting and learn about the fair value because this is supposed to be a review. The cost method is used when the fair value is not readily available. Here also we are assuming you have no influence and no control. So you own less than 20%. But what happened, you purchase an investment in a company that they have no fair value. It's not a publicly traded company. Okay? If it's publicly traded, it's easy. The stock is well known. The price of the stock is well published, well known. But if you invest in a company that it's private, they may not have a fair value. So what do you have to do? You would report it at cost. It means you would keep it at cost until something else happened, which we'll talk about this. If you receive any dividend from this company, you would report the dividend as income. Obviously, if they gave you a dividend, it's a dividend income. However, although it's called the cost method, you can gap allows you to do two fair value assessment. So in other words, although it's reported at cost, although there's no publicly traded prices for that company, but you have to assess for impairment. What is impairment? Impairment is when that investment go down in value and you don't think it's going to go up. So you purchase an investment for a million dollars. That's great. Let's assume you invested in a small pharmaceutical company for a million dollars, just for the sake of illustration. And that company has only one they're in only one line of business. Let's assume, just to even make it more interesting, they started this company to find the vaccine for COVID. That's the whole purpose of the company and you invested in it. There's no public information or no public stock for this company. Let's assume the request was rejected by the FDA. So they submitted their research, they submitted their vaccine and the FDA said, no, it doesn't meet our standard. Well, guess what? At the same time, Pfizer, Moderna and all the other companies, they already have a product on the market. So it's too late for them to come up with a new product. What happened is, this company is now it's impaired because the value of it is gone because they exist for the vaccine, they failed, therefore they are impaired. If that happens, if impairment is likely, that's it, the value goes down, then you have to report a loss. Okay, so you do adjust them downward, if anything. Also, let's assume a similar company to yours or identical company was sold recently in an orderly transaction, in an arm length transaction, and it's exactly like your company. It's identical, identical to your company. It's misspelled. Under those circumstances, if that's the case, you can use the basis for market adjustment. We go back to the same company. It's a million dollar. Another company for us, you know, has similar size, similar purpose, was sold for 1.2 million dollar. Well, you'd say my company is comparable to that company. It was sold for 1.2. It means my investment should be worth 1.2. Therefore, you adjust your investment for an increase of 200,000. So under those two circumstances, you can adjust your investment, although you are using the cost method. But again, those are special circumstances, but you need to be aware of it in the real world, as well as for the exam. Consolidation, here's where you have control. Control means you own more than 50% of the company. When you own more than 50%, you direct the whole operation, because you can select the people to run the company. You can select yourself to run the company. So you direct everything. Okay, now what you have to do, once you own more than 50% of the company, you own it. You only have one set of financial statement between the parent and the subsidiary. And we're going to talk about parent and subsidiaries much, much longer in this course. Now, the control, it doesn't have to be 50%, and we'll talk about this later on when we talk about special purpose entity or variable interest entity, is the control can be done through some contractual obligations, special contractual arrangement. So rather than owning 50%, you might own only three or four or five percent, but you finance the company through that. Well, you don't own the company by stocks, but you own the company by debt. Guess what? Or you don't own the company directly. You own it through subsidiaries. That's still your company. So that would amount to consolidation. And we're going to talk about this topic later on, which called the special purpose entity. And the reason is because Enron, what happened with Enron is Enron owned many other companies, and they did not consolidate because they did not own more than 50%. Although they did not own more than 50%, they really direct those companies. They were in control of them. Therefore, we have no rules about this. Again, consolidation, this is our course. We're going to have a complete course about consolidation from A to Z. So we'll talk about all these topics later. But the point, all you have to know for now, consolidation is when you own more than 50%, you have controlled, you control the whole company. The equity method is the fourth method. This is when you only remember between 20 and 50. You're more than fair value, but less than control. Here you assume to have significant influence. You assume you have a saying in the company. And what I suggest we do about the equity method is to devote one or two full lectures because we want to examine the equity method in depth. And we will not be given the equity method any justice if we dump the equity method in this recording. So what I'm going to do, and the next recording, it will be all about the equity method from A to Z, from purchasing the equity method, to disposing of it, to subject for impairment, to changing the equity method from the equity method to control from the fair value to equity. So we'll talk about the equity method. At the end of this recording, I'm going to remind you again, whether you are an accounting students or CPA candidate, especially if you're a CPA candidate, take a look at my resources. I don't replace your CPA review course. Are you willing to risk $30 to try whether you're, whether my resources will help you pass the exam, which is you pass the exam once, it's a permanent success, and you're good to go for your life. Good luck, study hard, and of course, stay safe.