Intermediate accounting 15e kieso warfield chapter 17

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 and for impairments of debt an

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Prepared by

Intermediat

e Accounting

Intermediat

e Accounting

Prepared by Coby Harmon

INTERMEDIATE ACCOUNTING

F I F T E E N T H E D I T I O N

Prepared by Coby Harmon University of California, Santa Barbara

weygandt warfield

team for success

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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 and for impairments of debt and equity investments.

6 Describe the reporting of reclassification adjustments and the accounting for

transfers between categories.

After studying this chapter, you should be able to:

LEARNING OBJECTIVES

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.

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.

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Companies account for investments based on

 the type of security (debt or equity) and

 their intent with respect to the investment.

Illustration 17-1

Summary of Investment Accounting Approaches

Investment in Debt Securities

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Debt securities represent a creditor relationship:

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Debt Investment Classifications

ILLUSTRATION 17-2

Accounting for Debt Securities by Category

Amortized cost is the acquisition cost adjusted for the amortization of

discount or premium, if appropriate.

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6 Describe the reporting of reclassification

investments.

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Classify a debt security as held-to-maturity only if it has both

1) the positive intent and

2) the ability to hold securities to maturity

Accounted for at amortized cost, not fair value.

Held-to-Maturity Securities

Amortize premium or discount

using the effective-interest

method unless the straight-line

method yields a similar result.

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Illustration: Z-Smith Company purchased $100,000 of 8 percent bonds of Bush Corporation on January 1, 2013, at a discount,

paying $92,278 The bonds mature January 1, 2018 and yield

10%; interest is payable each July 1 and January 1 Z-Smith

records the investment as follows:

January 1, 2013

Debt Investments 92,278

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Illustration: Z-Smith Company records the receipt of the first

semiannual interest payment on July 1, 2013, as follows:

Debt Investments 614

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

interest and amortizes the discount at December 31, 2013, as

follows:

Interest Receivable 4,000Debt Investments 645

Held-to-Maturity Securities

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Reporting of Held-to-Maturity Securities

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Computation of Gain on Sale of Bonds

Interest Revenue (4/6 x $4,000) 2,667

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Companies report available-for-sale securities at

 fair value, with

 unrealized holding gains and losses reported as other

comprehensive income, a separate component of stockholder’s equity, until realized

Any discount or premium is amortized.

Available-for-Sale Securities

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Illustration (Single Security): Graffeo Corporation purchases

$100,000, 10 percent, five-year bonds on January 1, 2013, 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 Graffeo records the purchase of the bonds on January 1, 2013, as follows

Debt Investments 108,111

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Illustration (Single Security): The entry to record interest

revenue on July 1, 2013, is as follows

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Securities

Illustration (Single Security): At December 31, 2013, Graffeo

makes the following entry to recognize interest revenue

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Illustration (Single Security): To apply the fair value method to

these debt securities, assume that at December 31, 2013 the fair

value of the bonds is $105,000 Graffeo makes the following entry.Unrealized Holding Gain or Loss—Equity 1,732

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Illustration (Portfolio of Securities): Herringshaw 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

Securities

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Prepare the adjusting entry Herringshaw would make on December

31, 2014 to record the loss

Unrealized Holding Gain or Loss—Equity 9,537

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Sale of Available-for-Sale Securities

If company sells bonds before maturity date:

 It must make entries to remove from the Debt Investments

account the amortized cost of bonds sold

 Any realized gain or loss on sale is reported in the “Other”

section of the income statement

Securities

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

1, 2015, for $90,000, at which time it had an amortized cost of

$94,214

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Illustration (Sale of Available-for-Sale Securities): Herringshaw reports this realized loss in the “Other expenses and losses”

section of the income statement Assuming no other purchases and sales of bonds in 2015, Herringshaw on December 31, 2015,

prepares the information:

Securities

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Illustration (Sale of Available-for-Sale Securities): Herringshaw records the following at December 31, 2015.

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Financial Statement Presentation Illustration 17-10

Reporting of for-Sale Securities

Available-Available-for-Sale Securities

Securities

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Companies report trading securities at

 fair value, with

 unrealized holding gains and losses reported as part of

net income

Any discount or premium is amortized.

A holding gain or loss is the net change in the fair value of

a security from one period to another, exclusive of dividend or interest revenue recognized but not received.

Trading Securities

Securities

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Illustration: On December 31, 2014, Koopmans Publishing

Corporation determined its trading securities portfolio to be as

follows: Illustration 17-11

Computation of Fair Value Adjustment—Trading Securities Portfolio (2014)

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Illustration: At December 31, Koopmans Publishing makes an

adjusting entry:

Fair Value Adjustment (Trading) 3,750

Unrealized Holding Gain or Loss—Income 3,750

Securities

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Illustration: (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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the fair value of the bonds was $47,400 Prepare the journal

entry for the purchase of the investment

Securities

Debt investments 50,000

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entry for the interest received

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entry for the fair value adjustment.

Securities

Unrealized Holding Loss – Income 2,600

Fair Value Adjustment (Trading) 2,600

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investments.

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Investments in Equity Securities

Represent ownership of capital stock

Cost includes:

 price of the security, plus

 broker’s commissions and fees related to purchase

generally determines the accounting treatment for the

investment subsequent to acquisition.

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0 -20% - 50% - 100%

No significant influence usually exists

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)

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Accounting and Reporting for Equity Securities by Category

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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 *

Holding of Less Than 20%

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Holdings of Less Than 20%

Upon acquisition, companies record available-for-sale securities at cost

Illustration: On November 3, 2014, Republic Corporation

purchased common stock of three companies, each investment

representing less than a 20 percent interest

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Illustration: Republic records these investments on November 3,

as follows

Equity Investments 718,550

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Illustration: On December 6, 2014, Republic receives a cash

dividend of $4,200 from Campbell Soup Co

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

on December 31, 2014:

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Unrealized Holding Gain or Loss—Equity 35,550

Illustration: Prepare the entry Republic would make on December 31,

2014, to record the net unrealized gains and losses

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Illustration: On January 23, 2015, Republic sold all of its

Northwest Industries, Inc common stock receiving net proceeds

of $287,220 Prepare the entry to record the sale

Equity Investments

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Illustration: On February 10, 2015, 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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Fair Value Adjustment (AFS) 99,800

Prepare the entry that Republic would make at December 31,

2015, to adjust its available-for-sale portfolio to fair value,

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investments.

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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 account

for the investment using the equity method.

Holding Between 20% and 50%

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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

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Holdings Between 20% and 50%

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Controlling Interest - When one corporation acquires a voting interest of more than 50 percent in another corporation

 Investor corporation is referred to as the parent

 Investee corporation is referred to as the subsidiary

 Investment in the subsidiary is reported on the parent’s

balance sheet as a long-term investment

 Parent generally prepares consolidated financial

statements

Holding of More Than 50%

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investments.

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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

 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

Additional Measurement Issues

Fair Value Option

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Illustration: McCollum Company purchases stock in Fielder

Company during 2014 that it classifies as available-for-sale At

December 31, 2014, the cost of this security is $100,000; its fair

value at December 31, 2014, is $125,000 If McCollum chooses

the fair value option to account for the Fielder Company stock, it

makes the following entry at December 31, 2014

Equity Investments 25,000

Unrealized Holding Gain or Loss—Income 25,000

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