acct 100 chapter 12 investments 2 objectives of the chapter 1.to learn the accounting for...

ACCT 100

Chapter 12

Investments

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Objectives of The Chapter

1. To learn the accounting for investments in stock (with ownership less than 20%) and bonds.

2. To learn the accounting for investments in stock with significant influence on investee’s operating and dividend policy (i.e., ownership is between 20% ~ 50%).

3. To learn the accounting for consolidated financial statements (i.e., ownership is more than 50%).

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Types of Investments

Equity Investments: invest in corporate Stock (i.e., common stock, preferred stock, and stock options).

Debt Investments: invest in U.S. treasury bills, municipal securities, corporate bonds, commercial papers.

Investment in equity or debt securities provides an opportunity to park cash in a financial instrument with an earning power

Reasons of Investments

1) Invest excess cash for short period of time (i.e., invest in highly liquid securities such as treasury bills).

2) Invest cash in securities to generate earnings (i.e., banks invest in debt securities; mutual funds invest in equity securities).

3) Invest in equity securities of a supplier or a customer to gain influence.

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Acquisition of Bonds

Initial Recording: at cost.

Interest revenue and realized gains (or losses) from sales of investments are reported in the income statement.

Example: CGS Corp. Acquires 80 Creative Corp. 6%, 5-year, $1,000 bonds on 12/1/20x7 for the face value plus the brokerage fees of $1,000. Interests are paid semiannually. The related entries for this transaction are:

Short-Term Investments & Receivables 6

Acquisition of Bonds (contd.)

12/1/x7 Investment in bonds 81,000

Cash 81,000

Purchase of 80 Creative bonds

12/31/07 Interest Receivable 400Interest Revenue

400 Record the one-month accrued interest $80,000x 6% x 1/12

Short-Term Investments & Receivables 7

Acquisition of Bonds (contd.)

6/1/x8 CGS collects the 6-month interest:

Cash 2,400

Interest Receivable 400

Interest Revenue 2,000

Sale of Bonds

CGS sells the investment in Creative bonds on 6/1/20x8 after receiving the interest due for net proceeds of $90,000 (i.e., sales price minus the brokerage fees). The entry to record this transaction is:

Cash 90,000

Investment in bonds 81,000

Gain on sale of investment in bonds 9,000

L-T Investments and International Operations 8

Acquisition of Stock (Holdings of Less than 20%) Valuation:

(1) Initial Recording: at cost.

(2) Dividends and realized gains (or losses) from sales of investments are reported in the income statement.


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Acquisition of Stock (Holdings of Less than 20%) – An Example On11/18/08, EDS acquires 2,000 shares

(5% ownership) of Freddy Corp. common stock for $30 per share plus brokerage fees of $1,000.

Freddy pays cash dividend $1 per share on 12/2/08. At year end, the market value of Ford stock is $65,000.

On 12/27/08, EDS sells Freddy stock for $35 per shares and pays brokerage fees of $1,000.

Acquisition of Stock- An Example (contd.)11/18/08 Investments in stock 61,000

Cash 61,000

12/2/08 Cash 2,000

Dividend revenue 2,000

12/27/08 Cash 69,000*

Investment in stock 61,000

Gain on sale of inv. In stock 8,000

*$35x 2,000-$1,000


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Investments in stock (holdings less than 20%) and bonds can be classified into the following three categories:

Categories of Securities and End of Period Reporting for Investments

1. Trading securities: held for sale in the near future (debt or equity securities).

2. Available-for-sale securities: held for sale sometime in the future (debt or equity securities.

3. Held-to-maturity securities: debt securities that the investor has the intent and ability to hold to maturity.

Reporting of Investments in Securities

Reporting of Trading Securities (TS):

(1) At purchase: Cost.

(2) End of Period: Market value. the unrealized gains/ losses reported in

the income statement.


Reporting of Investments (contd.) Reporting of available-for-sale securities

(ASS):


(2) End of period: Market value. The unrealized gains/ losses reported in

the balance sheet statement as a separate component of stockholders’ equity.


Reporting of Investments (contd.)

Reporting of Held-to-maturity securities (HTM):


(2) End of Period: Amortized cost.


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Example A: Assume that Camp Corp. acquired the following securities on 1/1/x9

Shares $ per shareA. Company’s common stock 100 $50

B. Company’s common stock 300 $80

C. Company’s preferred stock 200 $120

D. Company’s 10% bonds with a face value of $15,000 at par.

Interests are paid on 6/30 and 12/31.

These securities are reported as trading securities by Camp Corp.


Example A (contd.)

1/1/x9 Initial recordingInvestment in stock -Trading 68,000*

Cash 68,000* Cost = 100 x 50 + 300 x 80 + 200 x 120 + 15,000 = 68,000

6/30/x9Cash 750

Interest Revenue 750

12/31/x9Cash 750

Interest Revenue 750

Assuming Kent received $1,000 of dividends in 20x9:Cash 1,000

Dividends Revenue 1,000

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Example A (contd.) At the end of 20x9, the market value for these

securities is $71,000. The following entry is needed to adjust the value of investment in trading securities:12/31/x9 Fair Value Adjustment – Trading Sec. 3,000

Unrealized Gain* on Investment -Income3,000

To record unrealized gain on trading securities

*reported in the income statement of 20x9


Balance Sheet Presentation

Balance Sheet 12/31/x9

AssetsInvestments - Trading Securities (at market value) $71,000

Liabilities....

Stockholders’ Equity

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Example B: Assume that Camp Corp. acquired the following securities on 1/1/x9

Shares $ per shareA. Company’s common stock 100 $50

B. Company’s common stock 300 $80

C. Company’s preferred stock 200 $120

D. Company’s 10% bonds with a face value of $15,000 at par.

Interests are paid on 6/30 and 12/31.

These securities are reported as available-for-sale securities by Camp Corp.


Example B (contd.)

1/1/x9 Initial recordingInvestment in stock –Available-for-Sale 68,000

Cash 68,000

6/30/x9Cash 750

Interest Revenue750

12/31/x9Cash 750

Interest Revenue750

Assuming Kent received $1,000 of dividends in 20x9:Cash 1,000

Dividends Revenue1,000

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Example B (contd.) At the end of 20x9, the market value for these

securities is $71,000. The following entry is needed to adjust the value of available-for-sale securities market:12/31/x9 Fair Value Adjustment – Avail.-for-Sale 3,000

Unrealized Gain* on Investment –Equity

3,000To record unrealized gain on avail.-for-sale securities

*reported in the balance sheet of 20x9


Balance Sheet Presentation

Balance Sheet 12/31/x9

AssetsInvestments - Available-for-Sale $71,000

Liabilities....

Stockholders’ EquityUnrealized gain on

investments 3,000


Income Statement (skip)for the period ended 12/31/x9

Revenues $XXXExpenses (including income tax) (XXX)Net Income $XXX

Other Comprehensive Income:Unrealized Gain on Investment 3,000Less income tax (40%) (1,200) $1,800Comprehensive Income ........….. $XXX

Presentation of Realized and Unrealized Gain and Loss• The revenue and gains/losses related to the

investments are presented in the income statement as follows (source: Financial Accounting by Weygandt, Kimmel and Kieso)

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Other Revenue and Gains Other Expenses and Losses

Interest Revenue

Dividend Revenue

Gain on Sale of Investments Loss on Sale of Investments

Unrealized Gain – Income Unrealized Loss - Income

Presentation – contd.

The unrealized gain/loss – equity (from the valuation of available-for-sale securities) is presented in the stockholders’ equity section of the balance sheet, NOT the income statement.

See Illustration 13-12 of WKK textbook for an example of balance sheet presentation on investments and the unrealized gain/loss on available-for-sale securities.



Investments in Debt Securities Held to Maturity The GAAP for Investment in Debt securities

held to maturity (FASB 115):(a) Initial recording at cost.

(i.e., the present value of the investment in debt security).

(b) End of period reporting at amortized cost.(c) Unrealized holding gains (or losses): not

recognized.(d) Interests and realized gains (Losses)

from sale (if any) are included in income.


Example C : Held-to-Maturity

Assume that Emey Corp. purchases $100,000 of GNC 9% bonds on 7/1/20x1 at 99. Interests on the bond are paid on 7/1 and 12/31. Emey Corp intends to hold the bonds till their maturity date on 7/1/20x6.

7/1/x1 (Initial recording at cost) = 99,000(Face amount - Discount) = 100,000 - 1000

Investments in Bonds 100,000 Cash 99,000

Discount on Investment in Bonds 1,000


Example E (contd.)

The discount ($1,000) will be amortized to increase the interest revenue using the effective interest method, unless the use of straight-line method does not result in a material difference on the amount of interest revenue recognized each year.


Example E (contd.)

The followings are subsequent entries for this investment (assuming the amortization method is straight-line method):

12/31/x1Cash 4,500

Interest Revenue4,500

To recognize interest revenue for 6 months.

Discount on Investment in Bonds 100Interest Revenue

100To amortize discount on bond investment for 6 months.


Example E (contd.)

7/1/x2Cash 4,500

Int. Revenue 4,500To receive semiannual interest.

Discount on Investment in Bonds 100Interest Revenue 100

To amortize discount for six months.

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Acquisition of Stock (Holding of 20% to 50%) GAAP requires the use of equity method by

an investor who is able to exercise significant influence over the operating and financial policies of an investee.

In the absence to the contrary, an investment of 20% to 50% in the outstanding common stock of the investee leads to the presumption of significant influence.

The investee companies are referred to as affiliates.


Equity Method

In some cases, the investors hold more than 20% of the outstanding common stock of an investee and do not have significant influence. The equity method should not be used to account for the investment in those cases.


Equity Method

A survey of 600 companies conducted by Accounting Trends & Techniques indicated 252 (42%) of the corporations surveyed used the equity method to account for their investments.


The Accounting Procedures of the Equity Method The investment is recorded at cost of

the shares acquired. The investment is subsequently

adjusted each period for the changes in the equity of the investee.


The Accounting Procedures of the Equity Method For example, the investment account

will be increased (decreased) by the investors’ proportionate shares of investees’ earnings (losses) and decreased by the dividends received.*

* This is due to investee’s net income will increase investee’s equity while dividends will decrease investee’s equity.


The Accounting Procedures of the Equity Method (contd.)Therefore, the investor’s investment account = Acquisition Cost + Investor’s Share of Investee’s Income - Dividends Received


Equity Method: An Example

On 1/1/x9, Clibron Company purchases 4,200 shares of common stock of the Sam Corporation which has 16,800 shares of common stock outstanding on 1/1/x9. Thus, Cliborn has 25% of the ownership and significant influence is presumed to exist. The acquisition cost for the 4,200 shares is $125,000 (including $2,000 brokerage fees).

Also, Sam Corp. paid $20,000 dividends on 8/28/x9, and reported net income of 81,000 for 20x9. These events are recorded on Cliborn Company’s book as follows:


Equity Method Example (contd.)

1. To record the investment on 1/1/x9:


Cash125,000

2. To record the receipt of dividends on 3/28/x9:

Cash (20,000 x 25%) 5,000



Equity Method Example (contd.)

3. To record Cliborn Company’s 25% share in the year’s net income:

12/31/x9Investment in stock ($81,000 x 25%) 20,250

Investment Revenue20,250


Presentation on the B/S and I/S:

Balance Sheet12/31/x9

AssetsInvestment in Sam’s stock, at equity 140,250

Income Statementfor the year ended 12/31/x9

Other Revenue:Investment Revenue20,250


Gain or Loss on Sales of an Equity-Method Investment (Skip p22, p23) Gain or loss on sales of an equity-

method investment is measured as the difference between the sale proceeds and the carrying amount of the investment.


Sale of Equity Investment: An Example (skip) On 1/3/10, Clibor Sells 20% of its holding of Sam

Corp. for net proceeds of $30,000.

Cash 30,000

Investment in stock 28,050*

Gain on Sale of Investment 1,950

* 140,250 x 20% = 28,050


Joint Venture

A joint venture is a separate entity or business project owned by a small group of investors.

A Joint venturer usually accounts for its investments using the equity method even if their shares are less than 20%.

This is because a joint venturer usually has significant influence on the investee company.


Accounting for Consolidated Subsidiaries When a parent company purchased more

than 50% of the outstanding common stock of subsidiary corporations, consolidated financial statements (F/S) should be prepared.

The consolidated F/S will combine the F/S of the parent company with those of majority-owned subsidiaries as if the parent and its subsidiaries were a single entity.


Income of A Consolidated Entity

The income of a consolidated entity is the net income of the parent plus the parent’s share (proportion) of the subsidiary’s net income.


Accounting for Consolidated Subsidiaries (contd.) A work sheet is used to facilitate the

combining of the financial statements of the parent company and the subsidiaries.

A. Parent corporation owns all of subsidiary’s stock.

B. Parent company owns less than 100% of subsidiary’s stock.


A. Parent Corporation Owns All of Subsidiary’s Stock

Some accounts are eliminated: a. the parent company’s investment in

subsidiary account and the subsidiary’s equity accounts because these two accounts represent the same thing – subsidiary’s equity which is also represented by assets and liabilities of the subsidiary in the combined financial statements).

Parent Corporation Owns All of Subsidiary’s Stock (contd.)b. The reciprocal of note receivable/payable

accounts of the parent and subsidiary.

• For an example of the consolidated balance sheet, see illustration 13-A2 on p616 of the textbook



B. Parent Company Owns Less Than 100% of Subsidiary’s Stock

A minority interest account (on the credit side as a liability) is used to account for the subsidiary’s equity which is held by stockholders other than the parent company.

acct 100 chapter 12 investments 2 objectives of the chapter 1.to learn the accounting for...

Documents

debt investments

sales of investments

freddy stock

corporate stock

common stock

preferred stock

stock options

cash dividend