Intermediate accounting 13th kieso warfield chapter 17

Illustration Single Security: To apply the fair value method to these debt securities, assume that at year-end the fair value of the bonds is $105,000 and that the carrying amount of the

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C H A P T E R 17

INVESTMENTS

Intermediate Accounting

13th Edition Kieso, Weygandt, and Warfield

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1 Identify the three categories of debt securities and describe the

accounting and reporting treatment for each category.

2 Understand the procedures for discount and premium amortization on bond

investments.

3 Identify the categories of equity securities and describe the accounting and

reporting treatment for each category.

4 Explain the equity method of accounting and compare it to the fair value

method for equity securities.

5 Describe the accounting for the fair value option.

6 Discuss the accounting for impairments of debt and equity investments.

7 Explain why companies report reclassification adjustments.

Describe the accounting for transfer of investment securities between

Learning Objectives

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Investments in

Debt Securities

Investments in Equity Securities

Fair value controversy Summary

Investments

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Different motivations for investing:

To earn a high rate of return.

To secure certain operating or financing arrangements with another company.

Investment Accounting Approaches

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Companies account for investments based on

Investment Accounting Approaches

Illustration 17-1

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Debt securities (creditor relationship):

Investments in Debt Securities

U.S government securities

Municipal securities Corporate bonds

Convertible debtCommercial paper

Type

Held-to-maturityTrading

Available-for-sale

Accounting Category

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Investments in Debt Securities

Accounting for Debt Securities by Category

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Held-to-Maturity Securities

if it has both

effective-interest method unless the straight-line method yields

a similar result.

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Illustration: KC Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2009, at a discount, paying $92,278 The bonds mature January 1,

2014 and yield 10%; interest is payable each July 1 and

January 1 KC records the investment as follows:

January 1, 2009

Held-to-Maturity Securities 92,278

Cash 92,278

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Illustration: KC Company records the receipt of the first semiannual interest payment on July 1, 2009, as follows:

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Illustration: KC is on a calendar-year basis, it accrues

interest and amortizes the discount at December 31, 2009,

as follows:

December 31, 2009

Interest Receivable 4,000Held-to-Maturity Securities 645

Interest Revenue

4,645

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Reporting of Held-to-Maturity Securities

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Illustration: Assume that KC Company sells its investment

in Evermaster bonds on November 1, 2013, at 99.75 plus

accrued interest KC records this discount amortization as follows:

November 1, 2013

Held-to-Maturity Securities 635

Interest Revenue

635

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Gain on Sale of Securities

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Companies report available-for-sale securities at

part of comprehensive income (equity).

Any discount or premium is amortized.

Available-for-Sale Securities

Available-for-Sale Securities Securities Debt

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Illustration (Single Security): Graff Corporation purchases

$100,000, 10 percent, five-year bonds on January 1, 2009, with interest payable on July 1 and January 1 The bonds sell for $108,111, which results in a bond premium of $8,111 and

an effective interest rate of 8 percent Graff records the purchase of the bonds on January 1, 2009, as follows

Available-for-Sale Securities 108,111

Cash 108,111

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Illustration (Single Security): The entry to record interest revenue on July 1, 2009, is as follows.

Available-for-Sale Securities 676

Interest Revenue 4,324

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Illustration (Single Security): At December 31, 2009, Graff makes the following entry to recognize interest revenue.

Interest Receivable 5,000

Available-for-Sale Securities 703

Interest Revenue 4,297

Graff reports revenue for 2009 of $8,621 ($4,324 + $4,297).

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Illustration (Single Security): To apply the fair value

method to these debt securities, assume that at year-end the fair value of the bonds is $105,000 and that the

carrying amount of the investments is $106,732 Graff

makes the following entry

Unrealized Holding Gain or Loss—Equity 1,732

Securities Fair Value Adjustment (AFS) 1,732

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Illustration (Portfolio of Securities): Webb Corporation has two debt securities classified as available-for-sale The following illustration identifies the amortized cost, fair

value, and the amount of the unrealized gain or loss

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Illustration (Portfolio of Securities): Webb makes an

adjusting entry to a valuation allowance on December 31,

2010 to record the decrease in value and to record the loss

as follows

Webb reports the unrealized holding loss of $9,537 as other

comprehensive income and a reduction of stockholders’ equity.

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Sale of Available-for-Sale Securities

If company sells bonds before maturity date:

Must make entry to remove the,

 Cost in Available-for-Sale Securities and

 Securities Fair Value Adjustment accounts

Any realized gain or loss on sale is reported in the

“Other expenses and losses” section of the income statement.

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Illustration (Sale of Available-for-Sale Securities): Webb Corporation sold the Watson bonds (from Illustration 17-7)

on July 1, 2011, for $90,000, at which time it had an

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Illustration (Sale of Available-for-Sale Securities):

Webb reports this realized loss in the “Other expenses and losses” section of the income statement Assuming no other purchases and sales of bonds in 2011, Webb on December 31,

2011, prepares the information:

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Illustration (Sale of Available-for-Sale Securities):

Webb records the following at December 31, 2011

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Financial Statement Presentation

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Trading Securities

Companies report trading securities at

part of net income.

Any discount or premium is amortized.

Debt Securities

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Illustration: On December 31, 2010, Western Publishing Corporation determined its trading securities portfolio to

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Illustration: At December 31, Western Publishing makes

an adjusting entry:

Securities Fair Value Adjustment (Trading) 3,750

Unrealized Holding Gain or Loss—Income3,750

Trading Securities Securities Debt

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BE17-4: (Trading Securities) Hendricks Corporation

purchased trading investment bonds for $50,000 at par At December 31, Hendricks received annual interest of

$2,000, and the fair value of the bonds was $47,400

Instructions:

(a) Prepare the journal entry for the purchase of the

investment

(b) Prepare the journal entry for the interest received

(c) Prepare the journal entry for the fair value

adjustment

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BE17-4: Prepare the journal entries for (a) the purchase of the investment, (b) the interest received, and (c) the fair value adjustment.

(a) Trading securities 50,000

Interest revenue 2,000

(c) Unrealized Holding Loss - Income 2,600

Securities Fair Value Adj.- Trading 2,600

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Represent ownership of capital stock

Cost includes:

 price of the security, plus

 broker’s commissions and fees related to purchase

an interest in the common stock of another corporation

(investee) generally determines the accounting

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Significant influence usually exists

Control usually exists

Investment valued using

Fair Value Method

Investment valued using

Equity Method

Investment valued on parent’s books using Cost

Method or Equity Method

(investment eliminated in

Consolidation)

Ownership Percentages

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Accounting and Reporting for Equity Securities by Category

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Holdings of Less Than 20%

Accounting Subsequent to Acquisition

Market Price Available

Value and report the

investment using the

fair value method

Market Price Unavailable

Value and report the investment using the

cost method *

* Securities are reported at cost Dividends are recognized when received and gains or losses only recognized on sale of securities.

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Upon acquisition, companies record available-for-sale

securities at cost

Illustration: On November 3, 2010 Republic Corporation

purchased common stock of three companies, each investment representing less than a 20 percent interest

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On December 6, 2010, Republic receives a cash dividend of

$4,200 from Campbell Soup Co

Dividend revenue 4,200

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Illustration: Republic’s available-for-sale equity security

portfolio on December 31, 2010:

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Illustration: On December 31, 2010, Republic records the net unrealized gains and losses related to changes in the fair value of available-for-Sale equity securities in an Unrealized Holding Gain or Loss—Equity account

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Illustration: On January 23, 2011, Republic sold all of its

Northwest Industries, Inc common stock receiving net

proceeds of $287,220

Available-for-Sale Securities

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Illustration: On February 10, 2011, Republic purchased

20,000 shares of Continental Trucking at a price of $12.75 per share plus brokerage commissions of $1,850 (total cost,

$256,850)

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P17-6: McElroy Company has the following portfolio of

securities at September 30, 2010, its last reporting date

On Oct 10, 2010, the Horton shares were sold at a price of

$54 per share In addition, 3,000 shares of Patriot common stock were acquired at $54.50 per share on Nov 2, 2010 The Dec 31, 2010, fair values were: Monty $106,000, Patriot

$132,000, and the Oakwood common $193,000

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P17-6: 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

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P17-6: Prepare the journal entries to record the sale, purchase,

and adjusting entries related to the trading securities in the last quarter of 2010.

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P17-6:

P17-6: Portfolio at December 31, 2010

Unrealized holding loss - Income 36,500

December 31, 2010:

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P17-6: How would the entries change if the securities

The entries would be the same except that the

Unrealized Holding Gain or Loss—Equity account is used instead of Unrealized Holding Gain or Loss—Income

The unrealized holding loss would be deducted from the stockholders’ equity section rather than charged to the income statement

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Holdings Between 20% and 50%

An investment (direct or indirect) of 20 percent or

more of the voting stock of an investee should lead to a presumption that in the absence of evidence to the

contrary, an investor has the ability to exercise

significant influence over an investee.

In instances of “significant influence,” the investor must

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Equity Method

Record the investment at cost and subsequently

adjust the amount each period for

earnings (losses) and

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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E17-17: (Equity Method) On January 1, 2010, Meredith

Corporation purchased 25% of the common shares of Pirates Company for $200,000 During the year, Pirates earned net

income of $80,000 and paid dividends of $20,000

Instructions: Prepare the entries for Meredith to record

the purchase and any additional entries related to this

investment in Pirates Company in 2010

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E17-17: Prepare the entries for Meredith to record the

purchase and any additional entries related to this investment

($20,000 x 25%) ($80,000 x 25%)

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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

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Fair Value Option

Companies have the option to report most financial

instruments at fair value, with all gains and losses related

to changes in fair value reported in the income statement

 Applied on an instrument-by-instrument basis

 Fair value option is generally available only at the time

a company first purchases the financial asset or incurs

a financial liability

 Company must measure this instrument at fair value

until the company no longer has ownership

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Fair Value Option

Illustration: Hardy Company purchases stock in Fielder Company during 2010 that it classifies as available-for-sale At December

31, 2010, the cost of this security is $100,000; its fair value at

December 31, 2010, is $125,000 If Hardy chooses the fair value option to account for the Fielder Company stock, it makes the

following entry at December 31, 2010.

Investment in Fielder Stock 25,000

Unrealized Holding Gain or Loss—Income 25,000

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