Professional Documents
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CH
CH
CH
Corporation purchase investment in debts or stock securities generally for one of three
reasons:
First :
A corporation may have excess cash that it doesn’t not need for the immediate
purchase of operating assets.
These companies may invest the excess funds to earn a greater return than they would
gest bu just holding the fund in the bank.
Third reason companies may invest for strategic reasons. a company may purchase a
non controlling interest in another company in a relates industry in which it wishes to
establish a presence , a company may also choose to purchase a controlling interest in
another company this might be done to enter a new industry without incurring the risk
associated with starting point. The purchase of a company that in your industry is
called a vertical acquisition, in a horizontal acquisition you purchase a company that
does the same activity as your company.
Note: at acquisition , the cost principle is applied , cost include all expenditures
necessary to acquire these investments.
Example :
kuhl corporation acquires 50 doan inc, 8%, 10 year, $1,000 bonds on January
1,2005, for %54,000 , including brokerage fees of $1,000.
Solution
Interest = 50,000 × 8% × ½ = 2,000
Example :
Assume that on july 1, 2005 , sanchez corporation acquires 1,000 shares (10%
ownership ) of beal corporation common stock. Sanchez pays $40 per share plus
brokerage fees of $500.
Solution
The entry for the purchase is :
July 1 Stock investments 40,500
Cash 40,500
During the time the stock is held, entries are required for any cash dividends received
by sanchez corporation on December 31.
Journal entry
Dec. Cash ( 1,000 × $2) 2,000
31 Dividend revenue 2,000
Note that dividend revenue is reported under ‘’ other revenues and gain in the
income statement since dividends don’t accrue, adjusting entries are not made to
accrue dividends.
Example:
sanchez corporation receives net proceeds of $39,500 on the sale of its beal stock on
February 10,2006. Because the stock cost $40,500 , a loss of $1,000 has been
incurred.
Example
Milar corporation acquires 30% of the common stock of Beck company for $120,000
on January 1, 2005
For 2005, Beck reports net income of $100,000. It declares and pays a $40,000 cash
dividend,
Case (3)
Holding more than 50% :
A company owns more than 50% of the common stock of an other company is known
as a parent company.
The entity whose stock owned by the parent company is called the subsidiary
company. The company is perceived to have a controlling interest in the subsidiary
due to its stock ownership.
When one company owns more than 50% of the common stock of another company,
consolidated financial statements are usually prepared.
Fair value is the amount for which a security could be sold in a normal market and
offers the best approach at investment valuation since it represents the expected cash
realizable value of the securities. For purposes of valuation and reporting at a
financial statement date, debt and stock investments are classified into the following:
Trading securities.
Available for sale securities.
Held to maturity securities.
1) trading securities
Are held with the intention of selling them in a short period less than a month,
and are reported at fair value, and change from cost are reported as part of net
income. The changes from cost are reported as unrealized gains or losses since
the securities have not been sold.
The unrealized gains or losses is fair value – total cost of trading securities)
Example
Pace corporation on decemer 31,2005 has the cost and fair value for investments
classified as trading securities.
The changes are reported as unrealized gains or losses since the securities have not
been sold . the unrealized gains or losses is (fair value – total cost of the securities )
Example
Pace corporation on decemer 31,2005 has the cost and fair value for investments
classified as available for sale securities.
Available for sale securities, December 31,2005
Investments Cost Fair value Unrealized gain
(loss)
Yorkvile company 93,537 103,600 10,063
bonds 200,000 180,400 (19,600)
Kodak company
stock
Total 293,537 284,000 (9,537)
Entry