Financial accounting tools for business decision making 9 KIeso ppt app h

Accounting for Debt Investments• Consist of investments in government and corporation bonds • Entries are made to record • the acquisition • the interest revenue, and • the sale... Recor

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Financial Accounting: Tools for Business Decision Making

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Chapter Outline:

Learning Objectives

LO 1 Explain how to account for debt investments

LO 2 Explain how to account for stock investments

LO 3 Discuss how debt and stock investments are reported in the financial statements

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Learning Objective 1

Explain How to Account for Debt Investments

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Corporations purchase investments in debt or stock securities generally for one of three

reasons

1. Corporation may have excess cash

2. Generate earnings from investment income

3. For strategic reasons

Reasons Corporations Invest

Cash

Temporary Investments

Inventory

Accounts Receivable

Invest Sell

LO1

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Why Corporations Invest (1 of 2)

Review Question

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

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Why Corporations Invest (2 of 2)

Review Question

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

LO1

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Accounting for Debt Investments

• Consist of investments in government and corporation bonds

• Entries are made to record

• the acquisition

• the interest revenue, and

• the sale

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Recording the Acquisition of Bonds

• Cost includes all expenditures necessary to acquire these investments

• Such as the price paid plus brokerage fees (commissions)

Illustration: Kuhl Corporation acquires 50 Doan Inc 8%, 10-year, $1,000 bonds on January 1, 2022,

for $50,000

Entry to record the investment

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Recording Bond Interest (1 of 3)

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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Kuhl Corporation acquires 50 Doan Inc 8%, 10-year, $1,000 bonds on January 1, 2022, for $50,000 The bonds pay interest annually on January 1 If Kuhl Corporation’s fiscal year ends on December

31, prepare the entry to accrue interest earned by December 31

Bond Interest = $50,000 × 8% = $4,000

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• At December 31

• Interest Receivable reported as a current asset in the balance sheet

• Interest Revenue reported under “Other revenues and gains” in the income statement

Entry for receipt of the interest on January 1 of the following year

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Recording Sale of Bond Investments (1 of 2)

• Credit investment account for cost of bonds

• Record as a gain or loss any difference between

• Net proceeds from sale (sales price less brokerage fees), and

• Cost of bonds

LO1

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Recording Sale of Bond Investments (2 of 2)

Assume that Kuhl corporation receives net proceeds of $53,000 on the sale of the Doan Inc bonds

on January 1, 2023, after receiving the interest due Prepare the entry to record the sale of the

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Accounting for Debt Investments (1 of 4)

Review Question

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

LO1

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Review Question

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

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Review Question

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

LO1

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Review Question

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

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Explain How to Account for Stock Investments

LO2

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Accounting for Stock Investments

Investment valued using

Equity Method

Control usually exists (50%+ owned)

Investment valued on parent’s books using Cost

Method or Equity Method (investment eliminated in Consolidation)

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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Stock Investments – Less than 20% (1 of 3)

• Companies use the cost method

• Investment is recorded at cost and revenue recognized only when cash dividends are

received

• Cost includes all expenditures necessary to acquire these investments, such as price paid plus any brokerage fees (commissions), if any

LO2

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Stock Investments Less Than 20% (1 of 3)

Recording Acquisition of Stock

Illustration: On July 1, 2022, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal

Corporation common stock Sanchez pays $40 per share

Entry for the purchase

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Recording Dividends

Illustration: During the time Sanchez owns the stock it makes entries for any cash dividends

received Sanchez receives a $2 per share dividend on December 31

Entry for receipt of dividends

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Recording Sale of Stock

Illustration: Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale of its

Beal stock on February 10, 2023 Because the stock cost $40,000, Sanchez incurred a loss of $500 Entry to record the sale on February 10

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If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor

ordinarily should discontinue applying the equity method

Stock Investments 20% to 50% (1 of 4)

LO2

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Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1,

2022 For 2022, Beck reports net income of $100,000 and paid dividends of $40,000.

Entry to record purchase

Dec 31 Stock Investments ($100,000 × 30%) 30,000

Entry to record share of net income

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2022 For 2022, Beck reports net income of $100,000 and paid dividends of $40,000

Entry to record dividends received

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2022 For 2022, Beck reports net income of $100,000 and paid dividends of $40,000

Balances in investment and revenue accounts after posting:

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Review Question

The equity method of accounting for long-term investments in stock should be used when the

investor has significant influence over an investee and owns:

a. between 20% and 50% of the investee’s common stock

b. 20% or more of the investee’s common stock

c. more than 50% of the investee’s common stock

d. less than 20% of the investee’s common stock

LO 2

Holdings Between 20% and 50% (3 of 4)

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Review Question

The equity method of accounting for long-term investments in stock should be used when the

investor has significant influence over an investee and owns:

a. between 20% and 50% of the investee’s common stock

b. 20% or more of the investee’s common stock

c. more than 50% of the investee’s common stock

d. less than 20% of the investee’s common stock

Holdings Between 20% and 50% (4 of 4)

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Holdings of More than 50%

another corporation

Investor is referred to as parent

Investee is referred to as subsidiary

Investment in subsidiary is reported on parent’s books as a long-term investment

Parent generally prepares consolidated financial statements

Accounting for Stock Investments

LO2

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Consolidated statements indicate the magnitude and scope of operations of the companies under common control.

Holdings of More than 50%

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Discuss How Debt and Stock Investments Are Reported in the

Financial Statements

LO3

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For purposes of valuation and reporting, debt investments are classified into three categories:

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Companies hold with intention of selling in a short period of time

Trading means frequent buying and selling

Reported at fair value

Changes from cost are reported in the income statement as unrealized gains or losses

Trading Debt Securities (1 of 2)

LO3

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Investments Cost Fair Value

Unrealized Gain (Loss)

Illustration: Cost and fair values for investments of Pace Corporation classified as trading securities on

December 31, 2022.

Trading Debt Securities (2 of 2)

Adjusting entry for Pace Corporation

Dec 31 Fair Value Adjustment—Trading 7,000

Unrealized Gain or Loss—Income 7,000

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a. Held with intent of selling sometime in future

b. Classified as current assets or as long-term assets, depending on intent of management

c. Reported at fair value

d. Changes from cost are reported in stockholders’ equity as unrealized gains or losses

Available-for-Sale Debt Securities (1 of 3)

LO3

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Investments Cost Fair Value

Unrealized Gain (Loss)

Illustration: Assume that Shelton Corporation has two securities that are classified as available-for-sale.

Available-for-Sale Securities (2 of 3)

Adjusting entry for Shelton

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Shelton Corporation Comprehensive Income Statement For the Year Ended December 31, 2022

Other comprehensive income

follows

Available-for-Sale Securities (3 of 3)

LO3

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Reporting Equity Investments in Financial Statements

Holdings more

than 50%

Consolidation Not recognized Not applicable

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Short-term investments

Also called marketable securities, are securities held by a company that are

a. readily marketable and

b. intended to be converted into cash within the next year or operating cycle, whichever is

longer

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

Balance Sheet Presentation

LO3

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Presentation of Realized and Unrealized Gain or Loss (1 of 2)

Interest Revenue Loss on Sale of Investments

Dividend Revenue Unrealized Loss

Gain on Sale of Investments

Unrealized Gain

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Presentation of Realized and Unrealized Gain or Loss (2 of 2)

Unrealized gains or losses on available-for-sale securities are reported as a separate component of

stockholders’ equity.

LO3

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Pace Corporation Balance Sheet (partial) December 31, 2022

Investments

Investments on the Balance Sheet (1 of 2)

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Pace Corporation Balance Sheet (partial) December 31, 2022

Stockholders’ Equity

Stockholders’ equity

Paid-in capital

Common stock, $10 par value, 200,000

shares authorized, 80,000 shares

Total paid-in capital and retained earnings 1,155,000

Investments on the Balance Sheet (2 of 2)

LO3

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