INVESTMENTS handout

chap 13

Chapter

13-2

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 Objectives Study Objectives

Accounting for

Debt Investments

Accounting for

Stock Investments

Accounting for

Stock Investments

Valuing and Reporting Investments

Valuing and Reporting Investments

Categories of securities

Balance sheet presentation Realized and unrealized gain or loss Classified balance sheet

Holdings of less than 20%

Holdings between 20%

and 50%

Holdings of more than 50%

Recording acquisition of bonds

Recording bond interest Recording sale of bonds

Investments Investments

Chapter

13-4

Corporations generally invest in debt or stock

securities for one of three reasons.

Why Corporations Invest

Why Corporations Invest

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

1. Corporation may have excess cash

2. To generate earnings from investment income

3. For strategic reasons Illustration 13-1

Temporary

investments

and the

operating cycle

c. meet strategic goals

d. avoid a takeover by disgruntled investors

Question

Why Corporations Invest

Why Corporations Invest

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

Chapter

13-6

Accounting for Debt Instruments

Accounting for Debt Instruments

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 face value of the bond times the interest rate times the portion of the year the bond is outstanding

Chapter

13-7

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Recording 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

13-8

Exercise: Issel Corporation had the following

transactions pertaining to debt investments.

Jan 1 Purchased 60, 8%, $1,000 Hollis Co bonds for

$60,000 cash plus brokerage fees of $900 Interest is

payable semiannually on July 1 and January 1.

July 1 Received semiannual interest on Hollis Co bonds.

July 1 Sold 30 Hollis Co bonds for $34,000 less $500

brokerage fees.

Instructions (a) Journalize the transactions (b)

Prepare the adjusting entry for the accrual of interest at December 31.

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Chapter

13-10

Exercise: July 1 Received semiannual interest on

Hollis Co bonds Sold 30 Hollis Co bonds for $34,000

less $500 brokerage fees.

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Chapter

13-11

Exercise: (b) Prepare the adjusting entry for the

accrual of interest at December 31

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Chapter

13-12

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

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

Chapter

13-13

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

Question

Accounting for Debt Instruments

Accounting for Debt Instruments

SO 2 Explain the accounting for debt investments.

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 Percentages

Accounting for Stock Investments

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

13-15

Cost Method

Cost includes all expenditures necessary to acquire

investment, such as price paid plus brokerage fees

(commissions)

Revenue recognized only when cash dividends are

received

Holdings of Less than 20%

Holdings of Less than 20%

SO 3 Explain the accounting for stock investments.

Chapter

13-16

Exercise: Dossett Company had the following

transactions pertaining to stock investments

Feb 1 Purchased 800 shares of Hippo common stock

(2%) for $8,000 cash, plus brokerage fees of $200

July 1 Received cash dividends of $1 per share on

Hippo common stock

Sept 1 Sold 300 shares of Hippo common stock for

$4,400, less brokerage fees of $100

Instructions: Journalize the transactions.

SO 3 Explain the accounting for stock investments.

Holdings of Less than 20%

Holdings of Less than 20%

Chapter

13-17

Exercise: Feb 1 Purchased 800 shares of Hippo

common stock (2%) for $8,000 cash, plus brokerage

fees of $200 July 1 Received cash dividends of $1

per share on Hippo common stock

SO 3 Explain the accounting for stock investments.

Holdings of Less than 20%

Holdings of Less than 20%

Holdings of Less than 20%

Holdings of Less than 20%

Chapter

13-19

Holdings Between 20% and 50%

Holdings Between 20% and 50%

Equity Method

Record investment at cost and subsequently

adjust amount each period for

 investor’s proportionate share of earnings

(losses) and

 dividends received by investor.

If investor’s share of investee’s losses exceeds carrying amount of investment, investor ordinarily should discontinue applying the

equity method.

SO 3 Explain the accounting for stock investments.

Chapter

13-20

Under the equity method, the investor records

dividends received by crediting:

Holdings Between 20% and 50%

Holdings Between 20% and 50%

SO 3 Explain the accounting for stock investments.

Chapter

13-21

Exercise: (Equity Method) On January 1, 2007,

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 entries for Pennington to record purchase and

any additional entries related to this investment in

Edwards Company in 2007

Holdings Between 20% and 50%

Holdings Between 20% and 50%

SO 3 Explain the accounting for stock investments.

Chapter

13-22

Exercise: Pennington purchased 30% of the common

shares of Edwards for $180,000 Edwards earned net

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

Holdings Between 20% and 50%

Holdings Between 20% and 50%

($20,000 x 30%) ($80,000 x 30%)

SO 3 Explain the accounting for stock investments.

Chapter

13-23

After Pennington posts the transactions for the year, its

investment and revenue accounts will show the following.

Debit Credit

Stock Investments

Debit Credit Investment Revenue

Holdings Between 20% and 50%

Holdings Between 20% and 50%

SO 3 Explain the accounting for stock investments.

24,000 6,000198,000

Exercise: Pennington purchased 30% of the common

shares of Edwards for $180,000 Edwards earned net

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

Chapter

13-24

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

parent’s books as a long-term investment

 Parent generally prepares consolidated financial

statements

SO 4 Describe the use of consolidated financial statements.

Chapter

13-25

Valuing and Reporting Investments

Valuing and Reporting Investments

Applies to all debt securities and all stock investments in which

the holdings are less than 20%.

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-26

Valuing and Reporting Investments

Valuing and Reporting Investments

Trading Securities

Held with intention of selling in a short period

Trading means frequent buying and selling

Report at fair value, and report changes from cost as part of net income

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-27

Valuing and Reporting Investments

Valuing and Reporting Investments

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Valuing and Reporting Investments

Valuing and Reporting Investments

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-29

Problem: Loxley Company has the following portfolio of

securities at September 30, 2007, its last reporting date.

Trading Securities

Trading Securities

Trading Securities Cost Fair Value Dan Fogelberg, Inc common (5,000 shares) $ 225,000 $ 200,000

Petra, Inc preferred (3,500 shares) 133,000 140,000

Tim Weisberg Corp common (1,000 shares) 180,000 179,000

On Oct 10, 2007, the Fogelberg shares were sold at a price

of $54 per share In addition, 3,000 shares of Los Tigres

common stock were acquired at $59.50 per share on Nov 2,

2007 The Dec 31, 2007, fair values were: Petra $96,000,

Los Tigres $132,000, and the Weisberg common $193,000

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-30

Problem: Prepare the journal entries to record the sale, purchase,

and adjusting entries related to the trading securities in the last quarter of 2007.

Portfolio at September 30, 2007

Trading Securities Cost Fair Value Dan Fogelberg, Inc common (5,000 shares) $ 225,000 $ 200,000 Petra, Inc preferred (3,500 shares) 133,000 140,000 Tim Weisberg Corp common (1,000 shares) 180,000 179,000

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-31

Problem: On Oct 10, the Fogelberg shares were sold at a $54 per

share In addition, 3,000 shares of Los Tigres common stock were acquired at $59.50 per share on Nov 2.

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-32

Problem: Portfolio at December 31, 2007

Unrealized Trading Securities Cost Fair Value Gain (Loss) Petra, Inc preferred $ 133,000 $ 96,000 $ (37,000) Tim Weisberg Corp common 180,000 193,000 13,000 Los Tigres common 178,500 132,000 (46,500)

491,500

$ $ 421,000 (70,500) Prior market adjustment balance (19,000) Market fair value adjustment $ (51,500)

Unrealized loss - Income 51,500

Market adjustment - Trading 51,500

December 31, 2007:

Trading Securities

Trading Securities

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-33

Problem: How would the entries change if the securities

were classified as available-for-sale?

The entries would be the same

The entries would be the same except that the

Unrealized Gain or Loss—Equity account is used

instead of Unrealized Gain or Loss—Income

Unrealized loss would be deducted from stockholders’ equity rather than charged to the income statement

Available-for-Sale Securities

Available-for-Sale Securities

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-34

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

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter

13-35

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 Investments

Balance Sheet Presentation

Balance 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

13-36

Nonoperating items related to investments

(reported in the income statement)

Realized and Unrealized Gain or Loss

Balance Sheet Presentation

Balance Sheet Presentation

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

Illustration 13-10

Chapter

13-37

Realized and Unrealized Gain or Loss

Balance Sheet Presentation

Balance Sheet Presentation

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

Unrealized gain or loss on available-for-sale

securities are reported as a separate component of

stockholders’ equity

Illustration 13-11

Chapter

13-38

Classified Balance Sheet

Balance Sheet Presentation

Balance Sheet Presentation

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

Illustration 13-12

Chapter

13-39

When is a good time to get serious about saving?

A Good Day to Start Saving

Some Facts:

Only about 48% of people in their twenties whose employers have a 401(k) plan participate in that plan

Only 40% of working couples currently are covered

by pension plans, but 61% of workers expect to get income from a company pension plan

All About You

All About You

Chapter

13-40

When is a good time to get serious about saving?

A Good Day to Start Saving

All About You

All About You

Chapter

13-41

When you are 25 years old, if you start putting $300 per month into an investment earning 8%, by the age of 65 you will have accumulated more than $1 million

All About You

All About You

Chapter

13-42

What Do You Think?

You’ve got $3,000 in credit card bills at an 18% interest

rate Your employer has a 401(k) plan in which it will match your contributions, up to 10% of your annual salary Should you pay off your credit card bills before you start putting

money into the 401(k)?

All About You

All About You

Paying off debt, thus avoiding 18% interest payments, is essentially equivalent to earning 18% on investments

Reducing your debts reduces your financial vulnerability.

Take part of the money you would have used to pay off your debt each month and instead put it into the 401(k).

X

Chapter

13-43

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