chapter 16-1 chapter 16 investments accounting principles, ninth edition

Chapter 16-1

Chapter 16

Investments

Accounting Principles, Ninth Edition

Chapter 16-2

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.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Chapter 16-3

Why Why

Corporations Corporations

InvestInvest

Why Why

Corporations Corporations

InvestInvest

Cash Cash managementmanagement

Investment Investment incomeincome

Strategic Strategic reasonsreasons

Accounting for Accounting for

Debt Debt

InvestmentsInvestments


Debt Debt



Stock Stock



Stock Stock


Valuing and Valuing and

Reporting Reporting


Valuing and Valuing and

Reporting Reporting


Categories of Categories of securitiessecurities

Balance sheet Balance sheet presentationpresentation

Realized and Realized and unrealized gain unrealized gain or lossor loss

Classified Classified balance sheetbalance sheet

Holdings of less Holdings of less than 20%than 20%

Holdings Holdings between 20% between 20% and 50%and 50%

Holdings of more Holdings of more than 50%than 50%

Recording Recording acquisition of acquisition of bondsbonds

Recording bond Recording bond interestinterest

Recording sale Recording sale of bondsof bonds

Long-Term LiabilitiesLong-Term LiabilitiesLong-Term LiabilitiesLong-Term Liabilities

Chapter 16-4

Corporations generally invest in debt or stock securities for one of three reasons.

Why Corporations InvestWhy Corporations InvestWhy Corporations InvestWhy Corporations Invest

SO 1 Discuss why corporations invest in debt and stock SO 1 Discuss why corporations invest in debt and stock securities.securities.

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

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.

QuestionQuestion

Why Corporations InvestWhy Corporations InvestWhy Corporations InvestWhy Corporations Invest

SO 1 Discuss why corporations invest in debt and stock SO 1 Discuss why corporations invest in debt and stock securities.securities.

Chapter 16-6

Accounting for Debt InvestmentsAccounting for Debt InvestmentsAccounting for Debt InvestmentsAccounting for Debt Investments

SO 2 Explain the accounting for debt investments.SO 2 Explain the accounting for debt investments.

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



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

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2010, for $54,000, including brokerage fees of $1,000. The entry to record the investment is:

Debt investments 54,000

Cash 54,000



Jan. 1

Chapter 16-9

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2010, for $54,000, including brokerage fees of $1,000. The bonds pay interest semiannually on July 1 and January 1. The entry for the receipt of interest on July 1 is:



Cash 2,000

Interest revenue 2,000

* ($50,000 x 8% x ½ = $2,000)

*July 1

Chapter 16-10

Illustration: If Kuhl Corporation’s fiscal year ends on December 31, prepare the entry to accrue interest since July 1.



Interest receivable 2,000

Interest revenue 2,000

Kuhl reports receipt of the interest on January 1 as follows.

Cash 2,000

Interest receivable 2,000

Dec. 31

Jan. 1

Chapter 16-11

Illustration: Assume that Kuhl corporation receives net proceeds of $58,000 on the sale of the Doan Inc. bonds on January 1, 2011, after receiving the interest due. Prepare the entry to record the sale of the bonds.



Cash 58,000

Debt investments 54,000

Gain on sale of investments 4,000

Jan. 1

Chapter 16-12

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.

QuestionQuestion



Chapter 16-13

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.

QuestionQuestion



Chapter 16-14

0 --------------20% ------------ 50% -------------- 100%0 --------------20% ------------ 50% -------------- 100%No

significant influence

usually exists

Significant influence

usually exists

Control usually exists

Investment valued using

Cost Method

Investment valued using

Equity Method

Investment valued on parent’s books using

Cost Method or Equity Method (investment

eliminated in Consolidation)

Ownership PercentagesOwnership Percentages

Accounting for Stock InvestmentsAccounting for Stock InvestmentsAccounting for Stock InvestmentsAccounting for Stock Investments

SO 3 Explain the accounting for stock investments.SO 3 Explain the accounting for stock investments.

The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation.

Chapter 16-15

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).

Holdings of Less than 20%Holdings of Less than 20%Holdings of Less than 20%Holdings of Less than 20%


Chapter 16-16

July 1



Illustration: On July 1, 2010, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 pershare plus brokerage fees of $500. The entry for the purchase is:

Stock investments 40,500

Cash 40,500

Chapter 16-17

Dec. 31



Illustration: During the time Sanchez owns the stock, it makes entries for any cash dividends received. If Sanchez receives a $2 per share dividend on December 31, the entry is:

Cash 2,000

Dividend revenue 2,000

Chapter 16-18

Feb. 10



Illustration: Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal stock on February 10, 2011. Because the stock cost $40,500, Sanchez incurred a loss of $1,000. The entry to record the sale is:

Cash 39,500

Loss on sale of stock 1,000


Chapter 16-19

Holdings Between 20% and 50%Holdings Between 20% and 50%Holdings Between 20% and 50%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

Under the equity method, the investor records dividends received by crediting:

a. Dividend Revenue.

b. Investment Income.

c. Revenue from Investment.

d. Stock Investments.

QuestionQuestion



Chapter 16-21

Exercise: 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

Illustration: Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2010. For 2010, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.


Cash

120,000

Cash 12,000

Stock investments

12,000


Revenue from investments

30,000


($40,000 x 30%)

($100,000 x 30%)


Jan. 1

Dec. 31

Dec. 31

Chapter 16-23

After Milar posts the transactions for the year, its investment and revenue accounts will show the following.

Debit Credit

Stock Investments

120,000120,000 30,00030,000

Debit Credit

Revenue from Investments



30,00030,000 12,00012,000

138,000138,000

Illustration: Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2010. For 2010, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.

Chapter 16-24

Holdings of More Than 50%Holdings of More Than 50%Holdings of More Than 50%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.

SO 4 Describe the use of consolidated financial SO 4 Describe the use of consolidated financial statements.statements.

Chapter 16-25

Chapter 16-26

Valuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing 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%.

SO 5 Indicate how debt and stock SO 5 Indicate how debt and stock investments are reported in investments are reported in financial statements.financial statements.

Chapter 16-27


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 16-28


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. SO 5 Indicate how debt and stock SO 5 Indicate how debt and stock

investments are reported in investments are reported in financial statements.financial statements.

Chapter 16-29

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

QuestionQuestion



Chapter 16-30

Illustration: Investment of Pace classified as trading securities on December 31, 2010.

Trading SecuritiesTrading SecuritiesTrading SecuritiesTrading Securities

The adjusting entry for Pace Corporation is:


Dec. 31 Market adjustment—trading 7,000

Unrealized gain—income 7,000

Illustration 16-7

Chapter 16-31

Problem: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.

Available-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale Securities


Chapter 16-32

Illustration: Assume that Ingrao Corporation has two securities that it classifies as available-for-sale. Illustration 16-8 provides information on their valuation.

The adjusting entry for Ingrao Corporation is:


Dec. 31 Unrealized gain or loss—equity 9,537

Market adjustment—available-for-sale 9,537

Illustration 16-8


Chapter 16-33

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.

QuestionQuestion



Chapter 16-34

Chapter 16-35

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.

Short-Term InvestmentsShort-Term Investments

Balance Sheet PresentationBalance Sheet PresentationBalance Sheet PresentationBalance Sheet Presentation

SO 6 Distinguish between short-term and long-term investments.

Investments that do not meet both criteria are classified as long-term investments.

Chapter 16-36

Nonoperating items related to investments

Presentation of Realized and Presentation of Realized and Unrealized Gain or LossUnrealized Gain or Loss



Illustration 16-10

Chapter 16-37

Realized and Unrealized Gain or LossRealized 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 16-38



Classified Balance Sheet (partial)Classified Balance Sheet (partial)

Illustration 16-12

Chapter 16-39

“Copyright © 2009 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.”

CopyrightCopyrightCopyrightCopyright

chapter 16-1 chapter 16 investments accounting principles, ninth edition

Documents