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Chapter

16-1
Chapter 16
Investments

Chapter
16-2 Accounting Principles, Ninth Edition
Study Objectives

1. Discuss why corporations invest in debt and stock


securities.
2. Explain the accounting for debt investments.
3. Explain the accounting for stock investments.
4. Describe the use of consolidated financial statements.
5. Indicate how debt and stock investments are reported in
financial statements.
6. Distinguish between short-term and long-term
investments.

Chapter
16-3
Long-Term Liabilities

Why Accounting for Accounting for Valuing and


Corporations Debt Stock Reporting
Invest Investments Investments Investments

Cash Recording Holdings of less Categories of


management acquisition of than 20% securities
Investment bonds Holdings Balance sheet
income Recording bond between 20% presentation
Strategic interest and 50% Realized and
reasons Recording sale Holdings of more unrealized gain
of bonds than 50% or loss
Classified
balance sheet

Chapter
16-4
Why Corporations Invest

Corporations generally invest in debt or stock


securities for one of three reasons.
1. Corporation may have excess cash.
2. To generate earnings from investment income.
3. For strategic reasons. Illustration 16-1

Temporary
investments
and the
operating cycle

Chapter
16-5 SO 1 Discuss why corporations invest in debt and stock securities.
Why Corporations Invest

Question
Pension funds and banks regularly invest in debt and
stock securities to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.

Chapter
16-6 SO 1 Discuss why corporations invest in debt and stock securities.
Accounting for Debt Instruments

Recording Acquisition of Bonds


Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus
brokerage fees (commissions), if any.

Recording Bond Interest


Calculate and record interest revenue based upon the
carrying value of the bond times the interest rate
times the portion of the year the bond is outstanding.

Chapter
16-7 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Sale of Bonds
Credit the investment account for the cost of the
bonds and record as a gain or loss any difference
between the net proceeds from the sale (sales price
less brokerage fees) and the cost of the bonds.

Chapter
16-8 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Exercise: Issel Corporation had the following transactions
pertaining to debt investments.
Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for
$60,000 cash plus brokerage fees of $900.
Interest is payable semiannually on July 1 and
January 1.
July 1 Received semiannual interest on Hollis Co. bonds.
July 1 Sold 30 Hollis Co. bonds for $34,000 less $500
brokerage fees.
Instructions: (a) Journalize the transactions. (b) Prepare
the adjusting entry for the accrual of interest at December
31.
Chapter
16-9 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Exercise: Jan. 1 Purchased 60, 8%, $1,000 Hollis Co.


bonds for $60,000 cash plus brokerage fees of $900.
Interest is payable semiannually on July 1 and January 1.

Jan 1 Debt investment 60,900 *


Cash 60,900

* ($60,000 + $900 = $60,900)


Chapter
16-10 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Exercise: July 1 Received semiannual interest on


Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000
less $500 brokerage fees.

July 1 Cash 2,400 *


Interest revenue 2,400

Cash 33,500 **
Debt investments 30,450 ***
Gain on sale 3,050

* ($60,000 x 8% x ½ = $2,400) *** ($60,900 x ½ = $30,450)


** ($34,000 - $500 = $33,500)
Chapter
16-11 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Exercise: (b) Prepare the adjusting entry for the


accrual of interest at December 31.

Dec 31 Interest receivable 1,200 *


Interest revenue 1,200

* ($30,000 x 8% x ½ = $1,200)

Chapter
16-12 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Question
An event related to an investment in debt securities
that does not require a journal entry is:
a. acquisition of the debt investment.
b. receipt of interest revenue from the debt
investment.
c. a change in the name of the firm issuing the
debt securities.
d. sale of the debt investment.

Chapter
16-13 SO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments

Question
When bonds are sold, the gain or loss on sale is the
difference between the:
a. sales price and the cost of the bonds.
b. net proceeds and the cost of the bonds.
c. sales price and the market value of the bonds.
d. net proceeds and the market value of the
bonds.

Chapter
16-14 SO 2 Explain the accounting for debt investments.
Accounting for Stock Investments
Ownership Percentages

0 --------------20% ------------ 50% -------------- 100%


No significant Significant Control
influence influence usually exists
usually exists usually exists

Investment Investment Investment valued on


valued using valued using parent’s books using Cost
Cost Equity Method or Equity Method
Method Method (investment eliminated in
Consolidation)

The accounting depends on the extent of the investor’s influence


over the operating and financial affairs of the issuing corporation.
Chapter
16-15 SO 3 Explain the accounting for stock investments.
Holdings of Less than 20%

Companies use the cost method. Under the cost


method, companies record the investment at cost,
and recognize revenue only when cash dividends are
received.

Cost includes all expenditures necessary to acquire


these investments, such as the price paid plus any
brokerage fees (commissions).

Chapter
16-16 SO 3 Explain the accounting for stock investments.
Holdings of Less than 20%

Exercise: Dossett Company had the following transactions


pertaining to stock investments.
Feb. 1 Purchased 800 shares of Hippo common stock (2%)
for $8,000 cash, plus brokerage fees of $200.
July 1 Received cash dividends of $1 per share on Hippo
common stock.
Sept. 1 Sold 300 shares of Hippo common stock for
$4,400, less brokerage fees of $100.
Instructions:
Journalize the transactions.

Chapter
16-17 SO 3 Explain the accounting for stock investments.
Holdings of Less than 20%

Exercise: Feb. 1 Purchased 800 shares of Hippo


common stock (2%) for $8,000 cash, plus brokerage
fees of $200. July 1 Received cash dividends of $1
per share on Hippo common stock.
Feb. 1 Stock investments 8,200 *
Cash 8,200

July 1 Cash 800 **


Dividend revenue 800

* ($8,000 + $200 = $8,200)


** (800 x $1 = $800)
Chapter
16-18 SO 3 Explain the accounting for stock investments.
Holdings of Less than 20%

Exercise: Sept. 1 Sold 300 shares of Hippo common


stock for $4,400, less brokerage fees of $100.

Sept. 1 Stock investments 4,300 *


Cash 3,075 **
Gain on sale 1,225

* ($4,400 - $100 = $4,300)


** ($8,200 x 3/8 = $3,075)
Chapter
16-19 SO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%

Equity Method
Record the investment at cost and subsequently
adjust the amount each period for
 the investor’s proportionate share of the
earnings (losses) and
 dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying


amount of the investment, the investor ordinarily should
discontinue applying the equity method.
Chapter
16-20 SO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%

Question
Under the equity method, the investor records
dividends received by crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Stock Investments.

Chapter
16-21 SO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%

Exercise: (Equity Method) On January 1, 2010,


Pennington Corporation purchased 30% of the common
shares of Edwards Company for $180,000. During the
year, Edwards earned net income of $80,000 and paid
dividends of $20,000.

Instructions:
Prepare the entries for Pennington to record the
purchase and any additional entries related to this
investment in Edwards Company in 2008.

Chapter
16-22 SO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%

Exercise: Pennington purchased 30% of the common


shares of Edwards for $180,000. Edwards earned net
income of $80,000 and paid dividends of $20,000.

Stock investments 180,000


Cash 180,000

Stock investments 24,000


Investment revenue ($80,000 x 30%) 24,000

Cash 6,000
Stock investments ($20,000 x 30%) 6,000
Chapter
16-23 SO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%

Exercise: Pennington purchased 30% of the common


shares of Edwards for $180,000. Edwards earned net
income of $80,000 and paid dividends of $20,000.

After Pennington posts the transactions for the year, its


investment and revenue accounts will show the following.

Stock Investments Investment Revenue


Debit Credit Debit Credit
180,000 24,000
24,000 6,000
198,000
Chapter
16-24 SO 3 Explain the accounting for stock investments.
Holdings of More Than 50%

Controlling Interest - When one corporation acquires a


voting interest of more than 50 percent in another
corporation
 Investor is referred to as the parent.
 Investee is referred to as the subsidiary.
 Investment in the subsidiary is reported on the
parent’s books as a long-term investment.
 Parent generally prepares consolidated financial
statements.

Chapter
16-25 SO 4 Describe the use of consolidated financial statements.
Chapter
16-26
Valuing and Reporting Investments

Categories of Securities
Companies classify debt and stock investments
into three categories:
 Trading securities

 Available-for-sale securities

 Held-to-maturity securities

These guidelines apply to all debt securities and all stock


investments in which the holdings are less than 20%.

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Valuing and Reporting Investments

Trading Securities
Companies hold trading securities with the
intention of selling them in a short period.
Trading means frequent buying and selling.
Companies report trading securities at fair
value, and report changes from cost as part of
net income.

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Valuing and Reporting Investments

Available-for-Sale Securities
Companies hold available-for-sale securities
with the intent of selling these investments
sometime in the future.
These securities can be classified as current
assets or as long-term assets, depending on the
intent of management.
Companies report securities at fair value, and
report changes from cost as a component of the
stockholders’ equity section.
Chapter SO 5 Indicate how debt and stock investments
16-29
are reported in financial statements.
Valuing and Reporting Investments

Question
Marketable securities bought and held primarily for
sale in the near term are classified as:
a. available-for-sale securities.
b. held-to-maturity securities.
c. stock securities.
d. trading securities

Chapter SO 5 Indicate how debt and stock investments


16-30
are reported in financial statements.
Trading Securities

Problem: Loxley Company has the following portfolio of


securities at September 30, 2010, its last reporting date.

Trading Securities Cost Fair Value


Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000

On Oct. 10, 2010, the Fogelberg shares were sold at a price


of $54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2,
2008. The Dec. 31, 2010, fair values were: Petra $96,000, Los
Tigres $132,000, and the Weisberg common $193,000.

Chapter SO 5 Indicate how debt and stock investments


16-31
are reported in financial statements.
Trading Securities
Problem: Prepare the journal entries to record the sale,
purchase, and adjusting entries related to the trading
securities in the last quarter of 2010.
Portfolio at September 30, 2010
Trading Securities Cost Fair Value
Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000
$ 538,000 $ 519,000

Market Adjustment – Trading (account balance) ($19,000)

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Trading Securities
Problem: On Oct. 10, the Fogelberg shares were sold at a
$54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2.
October 10, 2010 (Fogelberg):
Cash (5,000 x $54) 270,000
Trading securities 225,000
Gain on sale 45,000

November 2, 2010 (Los Tigres):


Trading securities (3,000 x $59.50) 178,500
Cash 178,500

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Trading Securities
Problem: Portfolio at December 31, 2010
Unrealized
Trading Securities Cost Fair Value Gain (Loss)
Petra, Inc. preferred $ 133,000 $ 96,000 $ (37,000)
Tim Weisberg Corp. common 180,000 193,000 13,000
Los Tigres common 178,500 132,000 (46,500)
$ 491,500 $ 421,000 (70,500)
Prior market adjustment balance (19,000)
Market fair value adjustment $ (51,500)

December 31, 2010:


Unrealized loss - Income 51,500
Market adjustment - Trading 51,500
Chapter SO 5 Indicate how debt and stock investments
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are reported in financial statements.
Available-for-Sale Securities

Problem: How would the entries change if the securities


were classified as available-for-sale?

The entries would be the same except that the


Unrealized Gain or Loss—Equity account is used
instead of Unrealized Gain or Loss—Income.
The unrealized loss would be deducted from the
stockholders’ equity section rather than charged to
the income statement.

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Available-for-Sale Securities

Question
An unrealized loss on available-for-sale securities is:
a. reported under Other Expenses and Losses in
the income statement.
b. closed-out at the end of the accounting period.
c. reported as a separate component of
stockholders' equity.
d. deducted from the cost of the investment.

Chapter SO 5 Indicate how debt and stock investments


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are reported in financial statements.
Chapter
16-37
Balance Sheet Presentation

Short-Term Investments
Also called marketable securities, are securities
held by a company that are
(1) readily marketable and
(2) intended to be converted into cash within the
next year or operating cycle, whichever is
longer.

Investments that do not meet both criteria are


classified as long-term investments.

Chapter
16-38 SO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation

Presentation of Realized and Unrealized Gain


or Loss

Nonoperating items related to investments


Illustration 16-10

Chapter
16-39 SO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation

Realized and Unrealized Gain or Loss


Unrealized gain or loss on available-for-sale
securities are reported as a separate component of
stockholders’ equity. Illustration 16-11

Chapter
16-40 SO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation
Classified Balance Sheet (partial)
Illustration 16-12

Chapter
16-41 SO 6 Distinguish between short-term and long-term investments.
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Chapter
16-42