12 ch3. 12 - investments powerpoints

Investments

Chapter 12

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1. Demonstrate how to identify and account for investments classified for reporting purposes as held-to-maturity, trading and available-for-sale.

2. Explain what constitutes significant influence by the investor over the operating and financial policies of the investee.

3. Demonstrate how to identify and account for investments accounted for under the equity method.

4. Explain the adjustments made in the equity method when the fair value of the net assets underlying the investment exceeds their book value.

5. Explain how electing the fair value option affects accounting for investments.6. Analyze the impact of investments on the financial statements.

Learning Objectives – Investments

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Investments

Types of Securities•Debt - Bonds & Notes•Equity - Common & Preferred Stock

Accounting for Investments

Degree of Influence

Ownership Level

Accounting Method

No significant influence

< 20% Cost or Market* – HTM,TS, AFS

Significant influence

20-50% Equity Method

Control > 50% Consolidation

Investment strategies•Liquidity cushion•Cyclical cash needs•Earn income

•Exercise influence•Control

Determine Purpose

Purchase Securities

Classify Investments

Recognize Earnings & Cash Flows

Sell Securities

Monitor Changes in Value

Disclose in F/S*Cost – For non-marketable equity securities*Market – For publicly traded securities

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Class: Initially recorded:

Balance Sheet:

Income Statement:

Statement of Cash Flows:

Realized G/L:

HTM Cost Amortized cost

Interest earned +/- realized G/L

Buy/sell = Investing Activities; Interest = OA

Selling price minus amortized cost

AFS Cost Fair value; unrealized G/L = AOCI

Interest & dividends earned +/- realized G/L

Buy/sell = Investing Activities; Interest & dividends = OA

Selling price minus (amortized) cost

TS Cost Fair value Interest & dividends earned +/- realized G/L +/- unrealized G/L

Buy/sell = Operating Activities; Interest & dividends = OA

Selling price minus fair value at most recent Balance Sheet date

Marketable Securities

Investments

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Equity Method

Investments

• Applies when investor company exercises significant influence (20%-50% ownership).

• Investment is initially recorded at cost and then adjusted as follows:

Beginning investmentShare of investee’s net income (loss)*Dividend received from investeeEnding investment

+/-+/-=

* Adjusted for additional depreciation or amortization due to excess of fair value of investment over the underlying book value at acquisition.

• Changes in market value of publicly-traded shares are NOT recognized, unless permanently impaired. Do not record unrealized gains/losses.

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InvestmentsFair Value Option – companies are allowed to use the “fair value option” for HTM, AFS and equity method investments.

Marketable Securities• When an HTM and AFS security is purchased, the company makes an irrevocable

decision about whether to elect the fair value option.• The company can elect the fair value option for some securities and not for identical

others. The company must explain the partial election in the notes.• The Fair Value Option requires that the selected HTM & AFS securities be classified

as trading securities and disclosed as trading securities on the financial statements.• Unrealized gains and losses are included in income.Equity-Method Investments

• The company makes an irrevocable decision about whether to elect the fair value option.

• The company can elect the fair value option for some investments and not for others.

• The company carries the investment at fair value in the Balance Sheet and includes unrealized gains and losses in income.

• Investments are NOT reclassified as trading securities, but are shown on their own line in the Balance Sheet or are combined with equity method investments with the amount at fair value shown parenthetically.

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Investments - EntriesHTM Securities – Discount BondsOn January 1, 2009, Matrix, Inc. purchased as an investment $1,000,000, of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%. Let’s look at calculation of the present value of the bond issue.

1/1/09Investment in HTM securities 1,000,000

Discount on bond investment 114,699 Cash 885,301

53,118 Discount on bonds investment 3,118 6/30/09Cash 50,000

Investment revenue

53,305 Discount on bonds investment 3,305 12/31/09Cash 50,000

Investment revenue

N I/Y PV PMT FV

20 6.00 50,000 1,000,000

(885,301)

Face Value: 1,000,000$

Cash Received

Investment Revenue

5.00% 6.00%

1-Jan-09 114,699$ 885,301$

30-Jun-09 50,000$ 53,118$ 3,118$ 111,581 888,419

31-Dec-09 50,000 53,305 3,305 108,276 891,724

30-Jun-10 50,000 53,503 3,503 104,773 895,227

31-Dec-10 50,000 53,714 3,714 101,059 898,941

30-Jun-11 50,000 53,936 3,936 97,122 902,878

Carrying Amount of Bonds

Year

Effective Interest Method

Discount Amortized

Unamortized Discount

8,276

Discount on bonds Investment 108,276 12/31/09

Cash 900,000

Gain on sale of investmentsInvestment in HTM securities 1,000,000

Entry to record bond purchase. Discount on bonds investment is a valuation account. Initial carrying value is $885,301.

Interest Received, amortization of discount, & recognition of revenue after six months.

Amortization Schedule – Effective Interest Method

Interest Received, amortization of discount, & recognition of revenue after six months.

Bond Valuation

On December 31, 2009, the bonds are sold for $900,000. Hypothetical Transaction!

• Cash received = Coupon x Face Value• Investment revenue = Carrying Value x

Effective Interest Rate

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Investments - EntriesHTM Securities – Premium BondsOn January 1, 2009, PUC Corp purchased as an investment $100,000, of 13%, 3-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%. Let’s look at calculation of the present value of the bond issue.

1/1/09 Investment in HTM securities 102,459 Cash 102,459

6,148 352 6/30/09

Cash 6,500

Investment revenueInvestment in HTM securities (Premium)

N I/Y PV PMT FV

6 6.00 6,500 100,000

(102,459)

Face Value: 100,000$

Cash Received

Investment Revenue

6.50% 6.00%

1-Jan-09 2,459$ 102,459$

30-Jun-09 6,500$ 6,148$ 352$ 2,106 102,106

31-Dec-09 6,500 6,126 374 1,733 101,733

30-Jun-10 6,500 6,104 396 1,337 101,337

31-Dec-10 6,500 6,080 420 917 100,917

30-Jun-11 6,500 6,055 445 472 100,472

31-Dec-11 6,500 6,028 472 (0) 100,000

Carrying Amount of Bonds

Year

Effective Interest Method

Premium Amortized

Unamortized Premium

Entry to record bond purchase. Could have debited Premium on bonds investment which would be a valuation account.

Interest Received, amortization of premium, & recognition of revenue after six months.

Amortization Schedule – Effective Interest Method

Interest Received, amortization of premium, & recognition of revenue after six months.

Bond Valuation

• Cash received = Coupon x Face Value• Investment revenue = Carrying Value x

Effective Interest Rate

6,126 374 12/31/09

Cash 6,500

Investment revenueInvestment in HTM securities (Premium)

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1/1/09Investment in HTM securities 100,000

Cash 102,459 Premium on bond investments 2,459

or

P12-1: Fuzzy Monkey Technologies, Inc. purchased as a long-term investment $80 million of 8% bonds, dated January 1, on January 1, 2009. Management has the positive intent and ability to hold the bonds until maturity. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $66 million. Interest is received semiannually on June 30 and December 31.

Investments - EntriesHTM Securities - Bonds

1/1/09Investment in HTM securities 80,000,000

Discount on bond investment 14,000,000 Cash 66,000,000

6/30/09Cash 3,200,000

100,000 Investment revenue 3,300,000

Discount on bond investment

12/31/09Cash 3,200,000



Investment in HTM securities 80,000,000 Less: discount on bond investments 13,790,000 66,210,000

Construction Forms CorporationBalance Sheet (Partial)

31-Dec-09

Investing Activities 66,000,000$ OutflowFinancing Activities -$ None

SOCF Section Amount Inflow/OutflowOperating Activities 6,400,000$ Inflow

Impact on Statement Of Cash Flows

Disclosure on Balance Sheet

Interest on December 31.

Interest on June 30.

Investment on January 1.

The amount of interest revenue is based on the effective interest rate (yield) at the time of acquisition. Any premium or discount is amortized over the remaining life of the bond.

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P12-2: Fuzzy Monkey Technologies, Inc. purchased as a short-term investment $80 million of 8% bonds, dated January 1, on January 1, 2009. Management intends to include the investment in a short-term, active trading portfolio. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $66 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2009, was $70 million.

Investments - EntriesTrading Securities - Bonds

1/1/09Investment in Trading securities 80,000,000


6/30/09Cash 3,200,000



12/31/09Cash 3,200,000




31-Dec-09Investment in Trading securities 80,000,000 Add: Fair value adjustment 3,795,000 Less: discount on bond investments 13,795,000 70,000,000








12/31/09 Fair value adjustment - TS 3,795,000 3,795,000 Net unrealized holding gains and losses - ISRevaluation on December 31.

Because these are trading securities, the unrealized holding gain of $3.79 would be recognized in Fuzzy Monkey’s 2009 income statement.

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P12-3: Fuzzy Monkey Technologies, Inc. purchased as a long-term investment $80 million of 8% bonds, dated January 1, on January 1, 2009. Management intends to have the investment available for sale when circumstances warrant. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $66 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2009, was $70 million.

Investments - EntriesAvailable-For-Sale Securities - Bonds

1/1/09Investment in AFS securities 80,000,000


6/30/09Cash 3,200,000



12/31/09Cash 3,200,000



Add: Fair value adjustment 3,795,000 Less: discount on bond investments 13,795,000 70,000,000


31-Dec-09Investment in AFS securities 80,000,000








12/31/09 Fair value adjustment - AFS 3,795,000 3,795,000 Net unrealized holding gains and losses - OCI

Revaluation on December 31.

Because these are available-for-sale securities, the unrealized holding gain of $3.79 would be recognized in Fuzzy Monkey’s 2009 other comprehensive income, and serve to increase the accumulated other comprehensive income shown in shareholders’ equity.

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$70,000,000 - $66,205,000 = $3,795,000

P12-4: Fuzzy Monkey Technologies, Inc. purchased as a long-term investment $80 million of 8% bonds, dated January 1, on January 1, 2009. Management intends to have the investment available for sale when circumstances warrant. When the company purchased the bonds, management elected to account for them under the fair value option. For bonds of similar risk and maturity the market yield was 10%. The price paid for the bonds was $66 million. Interest is received semiannually on June 30 and December 31. Due to changing market conditions, the fair value of the bonds at December 31, 2009, was $70 million.

Investments - EntriesFair Value Option - Bonds

Because Fuzzy Monkey elected the fair value option, these investments will be reclassified from AFS to trading securities and accounted for under that approach.

For investments in trading securities, changes in market values, and thus market returns, provide an indication of management’s success in deciding when to acquire the investment, when to sell it, whether to invest in fixed-rate or variable-rate securities, and whether to invest in long-term or short-term securities.

See Problem 12-2 for entries!

Because these are trading securities, the unrealized holding gain of $3.79 would be recognized in Fuzzy Monkey’s 2009 income statement.

The answers would not differ if the investment qualified for treatment as a held-to-maturity investment, because Fuzzy Monkey’s choice of the fair value option still requires reclassification of the investment as trading securities.

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Cash 211,070 Investment revenue 6,500

200,000 Premium on bond investments 4,570

Date Account Titles/Explanations Debit Credit

6/30/09Cash 13,000

Premiums on bond investments 363 Investment revenue 12,637

4/3/09

Investment in HTM securities

12/31/09Cash 13,000

Premiums on bond investments 748 Investment revenue 12,252

Date Account Titles/Explanations Debit Credit

4/3/09Investment in HTM securities 204,570 Investment revenue 6,500

Cash 211,070

6/30/09Cash 13,000

Investment in HTM securities 363 Investment revenue 12,637

12/31/09Cash 13,000

Investment in HTM securities 748 Investment revenue 12,252

Investments – Bonds Acquired Between Interest Dates

Using Premium Valuation Account

On April 3, 2009, PUC Corp. purchased bonds with a 13% coupon that had been issued on December 31, 2008. The bonds have a face value of $200,000. The cost of the bonds was $204,570. The bonds mature on December 31, 2011 (33 months after the purchase date or 5.5 payment periods). Interest is paid semi-annually.

PurchaseN I/Y PV PMT FV

5.5 6.00 13,000 200,000

(204,570)

June 30, entry

December 31, entry

($204,570 *.12*1/4)+$6,500=$12,637

($204,570 - $363) *.12*1/2=$12,252

No Valuation AccountPurchase

June 30, entry

December 31, entry13

IR: $200,000 X 13% X 1/4

BE12-2: S& L Financial buys and sells securities expecting to earn profits on short-term differences in price. On December 27, 2009, S& L purchased Coca-Cola common shares for $875,000 and sold the shares on January 3, 2010, for $880,000. At December 31, the shares had a fair value of $873,000. What pretax amounts did S& L include in its 2009 and 2010 earnings as a result of this investment?

Investments - EntriesTrading Securities - Stocks

12/27/09 Investment in Trading securities 875,000 Cash 875,000

5,000 875,000 1/3/10

Cash 880,000

Gain on sale of investmentsInvestment in Trading securities

12/31/09 Net unrealized gains or losses - IS 2,000 Fair value adjustment - TS 2,000

Unlike for securities available-for-sale, unrealized holding gains and losses for trading securities are included in earnings. S&L reports its $2,000 holding loss in 2009 earnings. When the fair value rises by $7,000 in 2010, that amount is reported in 2010 earnings ($5000 as a realized gain, and $2000 as the reversal of the unrealized loss that was recognized in 2009).

Assuming no other trading securities, the 2010 adjusting entry to remove the fair value adjustment associated with the sold securities would be:

12/31/10 Fair value adjustment - TS 2,000 Net unrealized holding gains and losses - IS 2,000

Investment on December 27.


Sale on January 3.


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Investments - EntriesAvailable-For-Sale Securities - Stocks

12/27/09 Investment in AFS securities 875,000 Cash 875,000

5,000 875,000 1/3/10

Cash 880,000

Gain on sale of investmentsInvestment in AFS securities

12/31/09 Net unrealized gains or losses - OCI 2,000 Fair value adjustment - AFS 2,000


12/31/10 Fair value adjustment - AFS 2,000 Net unrealized holding gains and losses - OCI 2,000



Sale on January 3.


BE12-3: S& L Financial buys and sells securities which it classifies as available-for-sale. On December 27, 2009, S& L purchased Coca-Cola common shares for $875,000 and sold the shares on January 3, 2010, for $880,000. At December 31, the shares had a fair value of $873,000. What pretax amounts did S& L include in its 2009 and 2010 earnings as a result of this investment?

Unlike for trading securities, unrealized holding gains and losses for securities available-for-sale are not included in earnings. S&L reports its $2,000 holding loss in 2009 as Other comprehensive income in the statement of comprehensive income. When the fair value rises to $880,000 in 2010, the amount is reported in 2010 earnings is the $5,000 gain realized by the sale of the securities.

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Investments - EntriesFair Value Option - Stocks

BE12-6: S& L Financial buys and sells securities that it typically classifies as available-for-sale. On December 27, 2009, S& L purchased Coca-Cola common shares for $875,000 and sold the shares on January 3, 2010, for $880,000. At December 31, the shares had a fair value of $873,000. When it purchased the Coca-Cola shares, S& L Financial decided to elect the fair value option for this investment. What pretax amounts did S& L include in its 2009 and 2010 earnings as a result of this investment?

12/27/09 Investment in Trading securities 875,000 Cash 875,000

5,000 875,000 1/3/10

Cash 880,000

Gain on sale of investmentsInvestment in Trading securities

12/31/09 Net unrealized gains or losses - IS 2,000 Fair value adjustment - TS 2,000


12/31/10 Fair value adjustment - TS 2,000 Net unrealized holding gains and losses - IS 2,000



Sale on January 3.


Because S&L elected the fair value option, it would classify this investment as a trading security and account for it in that fashion. Therefore, S&L reports its $2,000 holding loss in 2009 earnings. When the fair value rises by $7,000 in 2010, that amount is reported in 2010 earnings ($5000 as a realized gain, and $2000 as the reversal of the unrealized loss that was recognized in 2009).

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• Security transferred at fair value.• Unrealized gain or loss at date of transfer increases or decreases stockholders’ equity.• Unrealized gain or loss at date of transfer is recognized in income.

Transfers between Trading and Available-for-Sale

Transfer from Held-to-Maturity to Available-for-Sale• Security transferred at fair value. • Separate component of stockholders’ equity (OCI) is increased or decreased by

the unrealized gain or loss at date of transfer . • NO impact of transfer on net income.

• Security transferred at fair value. • Unrealized gain or loss at date of transfer carried as a separate component of

stockholders’ equity (OCI) is amortized over the remaining life of the security.• NO impact of transfer on net income.

Transfer from Available-for-Sale to Held-to-Maturity

Investments – Transfer Between CategoriesMarketable Securities

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Other Than Temporary Impairments - OTTI• Impairments of debt and equity securities are :

‒ losses in value that are determined to be other than temporary, ‒ based on a fair value test, and ‒ are charged to income.

• Must record a realized loss on the Income Statement by writing down the investment.

• After OTTI impairment is recorded, the normal treatment of unrealized gains or losses is resumed, that is, changes in fair value are reported in OCI for AFS investments and not recognized for HTM investments.

PUC Corporation has municipal bonds classified as available-for-sale at December 31, 2008. These bonds have a par value of $1,000,000, an amortized cost of $1,000,000, and a fair value of $940,000. The unrealized loss of $60,000 that was recognized as other comprehensive income and as a separate component of stockholders' equity was determined to be other than temporary on March 31. That is, the company believes that impairment accounting is now appropriate for these bonds.

The new carrying value is $960,000.

At December 31, 2009, the fair value of the bonds is $960,000. Prepare the journal entry to record this information.

60,00060,000

60,00060,000

Loss on impairment ($1,000,000 - $940,000)Investment in AFS securities

03/31/09 Fair value adjustment - AFS

Net unrealized holding gains or losses - OCIWrite down

20,00020,000

12/31/09 Fair value adjustment - AFSNet unrealized holding gains or losses - OCI

$960,000 - $940,00018

Investments - EntriesEquity Method

E12-12: As a long-term investment, Painters’ Equipment Company purchased 20% of AMC Supplies, Inc.’ s 400,000 shares for $480,000 at the beginning of the fiscal year of both companies. On the purchase date, the fair value and book value of AMC’s net assets were equal. During the year, AMC earned net income of $250,000 and distributed cash dividends of 25 cents per share. At year-end, the fair value of the shares is $505,000.

Investment in AFS securities 480,000 Cash 480,000

Cash 20,000 Investment revenue 20,000

Fair value adjustment - AFS 25,000 Net unrealized holding gains and losses - OCI 25,000

Investment

Dividend

Revaluation

* No entry is made for the net income.

Available-For-Sale Securities - Stocks

Equity MethodInvestment in AMC shares 480,000

Cash 480,000

Cash 20,000 Investment in AMC shares 20,000

Investment in AMC shares 50,000 Investment revenue 50,000

Investment

Dividend

Net Income

* No adjusting entry is made to revalue the stock under the equity method.

Dividends are a return of capital – dividends lower the investment balance.

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Investments - EntriesEquity MethodE12-16: Fizer Pharmaceutical paid $68 million on January 2, 2009, for 4 million shares of Carne Cosmetics common stock. The investment represents a 25% interest in the net assets of Carne and gave Fizer the ability to exercise significant influence over Carne’s operations. Fizer received dividends of $ 1per share on December 21, 2009, and Carne reported net income of $40 million for the year ended December 31, 2009. The fair value of Carne’s common stock at December 31, 2009, was $18.50 per share.

•The book value of Carne’s net assets was $192 million.•The fair value of Carne’s depreciable assets exceeded their book value by $ 32 million. These assets had an average remaining useful life of eight years.•The remainder of the excess of the cost of the investment over the book value of net assets purchased was attributable to goodwill.

1/2/09 Investment in Carne Cosmetics shares 68,000,000 Cash 68,000,000 Investment

Dividend

Net Income

12/21/09 Cash 4,000,000 Investment in Carne Cosmetics shares 4,000,000

12/31/09 Investment in Carne Cosmetics shares 10,000,000 Investment revenue 10,000,000

Depreciation adjustment 12/31/09 Investment revenue 1,000,000 Investment in Carne Cosmetics shares 1,000,000

* No adjusting entry is made to revalue the stock under the equity method.

$192,000,000 X 25% = $48,000,000 $224,000,000 X 25% = $56,000,000

Book Value:

Fair Value:

$68,000,000 Cost:$12,000,000 Goodwill

$8,000,000 Undervaluation of assets

Depreciation adjustment: $8,000,000 8 years = $1,000,000 20

E12-21: As a long-term investment at the beginning of the fiscal year, Florists International purchased 30% of Nursery Supplies, Inc.’ s 8 million shares for $56 million. The fair value and book value of the shares were the same at that time. The company realizes that this investment typically would be accounted for under the equity method, but instead chooses the fair value option. During the year, Nursery Supplies earned net income of $40 million and distributed cash dividends of $1.25 per share. At the end of the year, the fair value of the shares is $52 million.

Investments - EntriesEquity Method – Fair Value Option

Required 1:

Electing the fair value option for significant-influence investments requires use of the same basic accounting approach that is used for trading securities. However, the investments will still be classified as significant-influence investments and shown either on the same line of the balance sheet as equity-method investments (but with the amount at fair value indicated parenthetically) or on a separate line of the balance sheet.

Required 2:

Investment in Nursery Supplies shares 56,000,000 Cash 56,000,000

Cash 3,000,000 Investment revenue 3,000,000

Net unrealized holding gains and losses - IS 4,000,000 Fair value adjustment - TS 4,000,000

Investment

Dividend

Revaluation

* No entry is made for the net income.

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Equity Method

Investments – Transfer Between Methods

• Any difference between the carrying value and fair value is recorded in a valuation account and is recognized as an unrealized holding gain or loss.

• After the transfer the security is treated as a Trading Security or Available-For-Sale security, depending on management intent.

Transfers from the Equity Method to Another Method:

• The original cost, unrealized holding gains or losses, and valuation account are closed.• A retroactive change is recorded to recognize the investor’s share of the investee’s

earnings since the original investment.

Transfers from Another Method to the Equity Method :

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Financial Statement Impact

Marketable Securities

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Purchase - HTM & AFS Investments

= +CA Inv. = CL LTL + CC RE Rev. COGS GP SGA EBIT Other NI CFO CFI CFF

Purchase - Trading Investments = +

CA Inv. = CL LTL + CC RE Rev. COGS GP SGA EBIT Other NI CFO CFI CFF

Revenue Recognition - Interest or Dividends= +

CA Inv. = CL LTL + CC RE Rev. COGS GP SGA EBIT IR NI CFO CFI CFF

Investment RevenueMarket Value Adjustments (Increase in Value) - Trading Securities


Unrealized Gain (Loss)Market Value Adjustments (Increase in Value) - AFS Securities

= +CA Inv. = CL LTL + CC OCI Rev. COGS GP SGA EBIT Other NI CFO CFI CFF

Sale (Gain) - HTM & AFS Investments = +


Realized Gain (Loss)Sale (Gain) - Trading Investments


Realized Gain (Loss)

Balance Sheet Income Statement SOCFAssets Liabilities Equity

NC NC NC NC NC NC NC NC NC NC NC NC NC

Assets Liabilities Equity

NC NC NC NC NC NC NC NC NC NC NC NC NC NC


NC NC NC NC NC NC NC NC NC NC NC NC




NC NC NC NC NC NC NC NC NC NC NC NC NC NC


NC NC NC NC NC NC NC NC NC NC


NC NC NC NC NC NC NC NC NC NC NC

Investments - Financial Statement Impact

Equity Method

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Equity Method Investment


Revenue Recognition - Share of Net Income= +


Investment RevenueDividend Receipt


Balance Sheet Income Statement SOCFAssets Liabilities Equity






12 ch3. 12 - investments powerpoints

Documents

market value

equity method investments

equitymethod investments

underlying book value

trading securities

traded securities

impact of investments

selected htm afs securities