slide 12-1. slide 12-2 chapter 12 investments financial accounting, ifrs edition weygandt kimmel...

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Chapter 12

InvestmentsInvestments

Financial Accounting, IFRS EditionWeygandt Kimmel Kieso

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1. Discuss why corporations invest in debt and share securities.

2. Explain the accounting for debt investments.

3. Explain the accounting for share investments.

4. Describe the use of consolidated financial statements.

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

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

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

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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



Debt Debt



Share Share



Share Share


Valuing and Valuing and

Reporting Reporting


Valuing and Valuing and

Reporting Reporting


Categories of Categories of securitiessecurities

Statement of Statement of financial positionfinancial position

Realized and Realized and unrealized gain unrealized gain or lossor loss

Classified Classified statement of statement of financial positionfinancial position

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

InvestmentsInvestmentsInvestmentsInvestments

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

Why Corporations InvestWhy Corporations InvestWhy Corporations InvestWhy Corporations Invest

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

1. Corporation may have excess cash.

2. To generate earnings from investment income.

3. For strategic reasons.Illustration 12-1

Temporary investments

and the operating cycle

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Pension funds and banks regularly invest in debt and share 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 share securities.SO 1 Discuss why corporations invest in debt and share securities.

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Accounting for Debt InstrumentsAccounting for Debt InstrumentsAccounting for Debt InstrumentsAccounting for Debt Instruments

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.

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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.

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Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2011, 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

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Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2011, 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

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


SO 2SO 2

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

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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 debt investments 4,000

Jan. 1

Recording Sale of Bonds

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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.

Question



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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.

Question



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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 Share InvestmentsAccounting for Share InvestmentsAccounting for Share InvestmentsAccounting for Share Investments

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

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

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Companies record

the investment at cost, and

recognize revenue only when cash dividends are

received.


Holdings of Less than 20% (Cost Method)


Cost includes all expenditures necessary to acquire these investments,

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

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July 1


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

Illustration: On July 1, 2011, Sanchez Corporation acquires 1,000 ordinary shares (10% ownership) of Beal Corporation. Sanchez pays $40 per share plus brokerage fees of $500. The entry for the purchase is:

Share investments 40,500

Cash 40,500

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Dec. 31



Illustration: During the time Sanchez owns the shares, 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

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Feb. 10



Illustration: Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal shares on February 10, 2012. Because the shares cost $40,500, Sanchez incurred a loss of $1,000. The entry to record the sale is:

Cash 39,500

Loss on sale of share 1,000


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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.



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

a. Dividend Revenue.

b. Investment Income.

c. Revenue from Investment.

d. Share Investments.

Question

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


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Illustration: Illustration: Milar Corporation acquires 30% of the ordinary

shares of Beck Company for $120,000 on January 1, 2011. For

2011, 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



Revenue from investments 30,000


($40,000 x 30%)

($100,000 x 30%)


Jan. 1

Dec. 31

Dec. 31

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

Debit Credit

Share 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 ordinary

shares of Beck Company for $120,000 on January 1, 2011. For

2011, Beck reports net income of $100,000 and paid dividends of

$40,000. Prepare the entries for these transactions.

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

Holdings of More Than 50%


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Consolidated statements indicate the magnitude and scope

of operations of the companies under common control.

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

Holdings of More Than 50%


Illustration 12-5

Examples of consolidated companies and their subsidiaries

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Answer on notes

page

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Valuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing and Reporting Investments

Categories of Securities

Companies classify debt and share investments into

three categories:

Fair value through profit or loss (FVPL) securities

Available-for-sale (AFS) securities

Held-to-maturity securities

These guidelines apply to all debt securities and all share investments in which the holdings are less than 20%.

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

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Fair Value Through Profit or Loss (FVPL)

Companies hold securities with the intention of selling

them in a short period (< month).

Frequent buying and selling.

Companies report securities at fair value, and report

changes from cost as part of net income.

Changes are reported as unrealized gains or losses.


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Illustration: Investment of Pace classified as fair value through profit or loss securities on December 31, 2011.

Fair Value Through Profit or Loss (FVPL)Fair Value Through Profit or Loss (FVPL)Fair Value Through Profit or Loss (FVPL)Fair Value Through Profit or Loss (FVPL)

The adjusting entry for Pace Corporation is:


Dec. 31 Market adjustment—FVPL 7,000

Unrealized gain—income 7,000

Illustration 12-7

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Answer on notes page

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Available-for-Sale (AFS) Securities

Held with the intent of selling these investments sometime in the future.

Classified as current assets or as non-current assets, depending on the intent of management.

Report securities at fair value

Report changes from cost as a component of the equity


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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. Share securities.

d. Fair value through profit or loss

Question



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Problem: How would the entries for fair value through

profit or loss securities 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 equity rather

than charged to income.

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


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Illustration: Assume that Ingrao Corporation has two securities that it classifies as available-for-sale.

The adjusting entry for Ingrao Corporation is:


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

Market adjustment—AFS 9,537

Illustration 12-8


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An unrealized loss on available-for-sale securities is:

a. reported under other revenue and expenses in the income statement.

b. closed-out at the end of the accounting period.

c. reported as a separate component of equity.

d. deducted from the cost of the investment.

Question



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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 Investments

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

Investments that do not meet both criteria are classified as

long-term investments.

Statement of Financial Position Presentation


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Nonoperating items related to investments

Presentation of Realized and Unrealized Gain or Loss

Statement of Financial Position PresentationStatement of Financial Position PresentationStatement of Financial Position PresentationStatement of Financial Position Presentation


Illustration 12-10

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Realized and Unrealized Gain or Loss


Unrealized gain or loss on available-for-sale securities is

reported as a separate component of equity.Illustration 12-11


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

Classified Statement of Financial Position

(partial)

Illustration 12-12

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

Classified Statement of Financial Position

(partial)

Illustration 12-12

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Identify where each of the following items would be

reported in the financial statements.

SO 6 Distinguish between short-term and long-term investments.Answers on notes page

Use the following possible categories:Intangible assets EquityProperty, plant, and equipment Non-current liabilitiesInvestments Current liabilitiesCurrent assets Other income and expenses


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Both IFRS and GAAP use the same criteria to determine

whether the equity method of accounting should be used—that

is, significant influence with a general guide of over 20%

ownership. GAAP uses the term equity investment whereas

IFRS uses the term associate investment to describe

investments under the equity method.

Under IFRS, both the investor and an associate company

should follow the same accounting policies. As a result, in

order to prepare financial information, adjustments are made to

the associate’s policies to conform to the investor’s books.

GAAP does not have that requirement.

Understanding U.S. GAAPUnderstanding U.S. GAAPUnderstanding U.S. GAAPUnderstanding U.S. GAAP

Key DifferencesKey Differences Investments

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The basis for consolidation under IFRS is control. Under GAAP,

a bipolar approach is used, which is a risk-and reward model

(often referred to as a variable-entity approach) and a voting

interest approach. However, under both systems, for

consolidation to occur, the investor company must generally

own 50% of another company.

IFRS specifies the following four types of financial assets:

1. Financial assets at fair value through profit or loss.

2. Held-to-maturity investments.

3. Loans and receivables.

4. Available-for-sale financial assets.

The loans and receivables category does not exist under GAAP.



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The category of financial asset at fair value through profit or

loss is similar to the trading securities discussed in GAAP. As

noted in the chapter, this category also includes investments

that the company has decided to report at fair value. GAAP also

gives the company the option to report investments at fair value.

Unrealized gains and losses related to available-for-sale

securities are reported in other comprehensive income under

GAAP and IFRS. These gains and losses that accumulate are

then reported in the equity section. Under IFRS, they are

frequently reported in a line item labeled “Reserves” whereas

under GAAP, they are reported in accumulated other

comprehensive income.



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Looking to the FutureLooking to the Future


As indicated earlier, both the FASB and IASB have indicated that

they believe that all financial instruments should be reported at fair

value and that changes in fair value should be reported as part of

net income. It seems likely, as more companies choose the fair

value option for financial instruments, that we will eventually arrive

at fair value measurement for all financial instruments.

Investments

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Consolidated Statement of Financial Position

Preparing Consolidated Financial StatementsPreparing Consolidated Financial StatementsPreparing Consolidated Financial StatementsPreparing Consolidated Financial Statements

Companies prepare consolidated statements of

financial position from the individual statements of their

affiliated companies.

Transactions between the affiliated companies are

eliminated.

Appendix

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Illustration: Assume that on January 1, 2011, Powers Construction Company pays $150,000 in cash for 100% of Serto Brick Company’s ordinary shares. Powers Company records the investment at cost, as required by the cost principle.

The combined totals do not represent a consolidated statement of financial position, because there has been a double counting of assets and equity in the amount of $150,000.


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Illustration 12A-1

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Use of a Worksheet—Cost Equal to Book Value


Illustration 12A-2

SO 7

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Use of a Worksheet—Cost Above Book Value


SO 7 Describe the content of a worksheet for a consolidated statement of financial position.

Illustration: Assume the same data used above, except that Powers Company pays $165,000 in cash for 100% of Serto’s ordinary shares. The excess of cost over book value is $15,000 ($165,000 - $150,000).

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Illustration 12A-3

SO 7

Use of a Worksheet—Cost Above Book Value

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SO 8 Explain the form and content of consolidated financial statements.

Illustration: The prior worksheet shows an excess of cost over book value of $15,000. In the consolidated statement of financial position, Powers first allocates this amount to specific assets, such as inventory and plant equipment, if their fair market values on the acquisition date exceed their book values. Any remainder is considered to be goodwill. For Serto Company, assume that the fair market value of property and equipment is $155,000.Thus, Powers allocates $10,000 of the excess of cost over book value to property and equipment, and the remainder, $5,000, to goodwill.

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Illustration 12A-4Consolidated Statement of Financial Position

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Consolidated Income Statement


Statement shows the results of operations of affiliated

companies as though they are one economic unit.

All intercompany revenue and expense transactions

must be eliminated.

A worksheet facilitates the preparation of consolidated

income statements in the same manner as it does for

the statement of financial position.

Appendix


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