Weygandt, Kieso, & Kimmel
Prepared by
Gregory K. Lowry
Mercer University
Marianne Bradford
The University of Tennessee
John Wiley & Sons, Inc.

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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 valued and reported on the financial statements.
6 Distinguish between short-term and long-term investments.

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INVESTMENTS
Why Corporations
Invest
Accounting for
Debt Investments

Recording acquisition of bonds
 Recording bond interest
 Recording sale of bonds

Holdings of less than 20%

Holdings between
20% and 50%

Holdings of more than 50%
Valuation and
Reporting of investments

Categories of securities

Balance sheet presentation

Realized and unrealized gain or loss
 Classified Balance sheet

ILLUSTRATION 13-1
TEMPORARY INVESTMENTS AND THE
OPERATING CYCLE

At the end of their operating cycles, many companies may have temporarily idle cash on hand pending the start of the next operating cycle.
 Until the cash is needed in operations, these companies may invest the excess funds to earn interest and dividends.
 The relationship of temporary investments to the operating cycle is depicted below.
Cash
Invest
Sell
Temporary
Investments
Accounts
Receivable
Inventory

13-2
Reason
To house excess cash until needed
To generate earnings
To meet strategic goals
Typical Investment
Low-risk, high-liquidity, short-term securities such as governmentissued securities
Debt securities (banks and other financial institutions); and stock securities (mutual funds and pension funds)
Stocks of companies in a related industry or in an unrelated industry that the company wishes to enter

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

DEBT INVESTMENTS
Debt investments are investments in government and corporation bonds. In accounting for debt investments, entries are required to record the 1 acquisition , 2 interest revenue , and 3 sale . At acquisition – the cost principle applies, and cost includes all expenditures necessary to acquire these investments. Kuhl Corporation acquires 50
Doan Inc. 12% , 10-year , $1,000 bonds on January 1, 2002 , for $54,000 , including brokerage fees of $1,000. The entry to record the investment is:
Date Account Titles and Explanation
Jan. 1 Debt Investments
Cash
(To record purchase of 50 Doan Inc. bonds)
Debit Credit
54,000
54,000

DEBT INVESTMENTS
The bonds pay $3,000 interest on July 1 and January 1 ($50,000 X 12% X ½). The July 1 entry is:
Date Account Titles and Explanation Debit Credit
July 1 Cash
Interest Revenue
(To record receipt of interest on Doan Inc.
bonds)
3,000
3,000
It is necessary to accrue $3,000 interest earned since July 1 at year-end. The December 31 entry is:
Date Account Titles and Explanation Debit Credit
Dec. 31 Interest Receivable
Interest Revenue
(To accrue interest on Doan Inc. bonds)
3,000
3,000
Date
When the interest is received on January 1, the entry is:
Account Titles and Explanation Debit Credit
Jan. 1 Cash
Interest Receivable
(To record receipt of accrued interest)
3,000
3,000

DEBT INVESTMENTS
Any difference between the net proceeds ( sales price less brokerage fees ) from the sale of bonds and the cost of the bonds is recorded as a gain or loss. Kuhl Corporation receives net proceeds of $58,000 on the sale of the Doan
Inc. bonds on January 1, 2003 , after receiving the interest due. Since the securities cost $54,000 , a gain of
$4,000 has been realized. The entry to record the sale is:
Date Account Titles and Explanation
Jan. 1 Cash
Debt Investments
Gain on Sale of Debt Investments
(To record sale of Doan Inc. bonds)
Debit Credit
58,000
54,000
4,000

ILLUSTRATION 13-3
Stock investments are investments in the capital stock of corporations.
When a company holds stock or debt of various corporations, the group of securities is identified as an investment portfolio .
Investor’s Ownership
Interest in Investee’s
Common Stock
Presumed
Influence on Investee
Accounting
Guidelines
Less than 20% Insignificant Cost method
Between 20% and 50%
More than 50%
Significant Equity method
Controlling Consolidated financial statements

ACCOUNTING FOR STOCK INVESTMENTS
In accounting for stock investments of less than 20% , the cost method is used. The investment is recorded at cost and revenue is recognized only when cash dividends are received. On July 1, 2002 , Sanchez Corporation acquires
1,000 shares ( 10% ownership ) of Beal Corporation common stock at $40 per share plus brokerage fees of
$500 . The entry for the purchase is:
Date Account Titles and Explanation
July 1 Stock Investments
Cash
(To record purchase of 1,000 shares of Beal
Corporation common stock)
Debit Credit
40,500
40,500

ACCOUNTING FOR STOCK INVESTMENTS
Entries are required for any cash dividends received during the time the stock is held. If a
$2 per share dividend is received by Sanchez
Corporation on December 31 the entry is:
Date Account Titles and Explanation
Dec. 31 Cash (1,000 X $2)
Dividend Revenue
(To record receipt of a cash dividend)
Debit Credit
2,000
2,000
Dividend Revenue is reported under Other
Revenue and Gains in the income statement.
Since dividends do not accrue, adjusting entries are not made to accrue dividends.

ACCOUNTING FOR STOCK INVESTMENTS
When stock is sold, the difference between the net proceeds from the sale and the cost of the stock is recognized as a gain or loss . Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal
Corporation common stock on February 10, 2003 .
Because the stock cost $40,500 , a loss of $1,000 has been incurred. The entry to record the sale is:
Date Account Titles and Explanation
Feb. 10 Cash
Loss on Sale of Stock Investments
Stock Investments
(To record sale of Beal common stock)
Debit Credit
39,500
1,000
40,500

ACCOUNTING FOR STOCK INVESTMENTS
When an investor owns between 20% and 50% of the common stock of a corporation, it is usually presumed that the investor has significant influence over the financial and operating activities of the investee. Subsequently, the investor should record its share of the net income of the investee in the year when it is earned. Under the equity method , the investment in common stock is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee. Each year, the investor 1 debits the investment account and credits revenue for its share of the investee’s net income and 2 credits dividends received to the investment account . Milar
Corporation acquires 30% of the common stock of Beck Company for
$120,000 on January 1, 2002 . The entry to record this transaction is:
Date Account Titles and Explanation
Jan. 1 Stock Investments
Cash
(To record purchase of Beck common
stock)
Debit Credit
120,000
120,000

ACCOUNTING FOR STOCK INVESTMENTS
Beck reports 2002 net income of $100,000 and declares and pays a $40,000 cash dividend . Milar is required to record 1 its share of Beck’s net income, $30,000 (30% X $100,000) and 2 the reduction in the investment account for the dividends received, $12,000 ($40,000 X 30%) . The entries are:
Date Account Titles and Explanation
(1)
Dec. 31 Stock Investments
Revenue from Investment in Beck Company
(To record 30% equity in Beck’s 2002 net
Income)
Date Account Titles and Explanation
Dec. 31 Cash
Stock Investments
(To record dividends received)
Debit Credit
30,000
30,000
Debit Credit
12,000
12,000

ILLUSTRATION 13-4
INVESTMENT AND REVENUE ACCOUNTS
AFTER POSTING
January 1
December 31
December 31 Balance
Stock Investments
120,000 December 31
30,000
138,000
Revenue from Investment in Beck Company
December 31
12,000
30,000
After posting the transactions for the year, the investment and revenue accounts will show the above results. During the year, the investment account has increased by $18,000
– which represents Milar’s
30% equity in the $60,000 increase in Beck’s retained earnings
( $100,000 - $40,000 ). Milar will also report
$30,000 of revenue from its investment, which is 30% of Beck’s net income of
$100,000 . Milar would report only $12,000 ( 30% X $40,000 ) of dividend revenue if the cost method were used.

ACCOUNTING FOR STOCK INVESTMENTS

A company that owns more than 50% of the common stock of another entity is known as a parent company .

The entity whose stock is owned by the parent company is called the subsidiary ( affiliated ) company .

The parent company is perceived to have a controlling interest in the subsidiary due to its stock ownership.

When one company owns more than 50% of the common stock of another company, consolidated financial statements are usually prepared.

ILLUSTRATION 13-5
Fair value is the amount for which a security could be sold in a normal market and offers the best approach at investment valuation since it represents the expected cash realizable value of the securities.
Trading
We’ll sell within ten days.
Available-for-Sale
We’ll hold the stock for a while to see how it performs.
Held-to-Maturity
We intend to hold until maturity.
At amortized cost At fair value with changes reported in net income
At fair value with changes reported in the stockholders’ equity section

For purposes of valuation and reporting at a financial statement date, debt and stock investments are classified into the following three categories of securities:
1
Trading securities - held with the intention of selling them in a short period of time (generally less than a month).
2
Available-for-sale securities - may be sold in the future.
3
Held-to-maturity securities - debt securities that the investor has the intent and ability to hold to maturity.

ILLUSTRATION 13-6

Trading securities are held with the intention of selling them in a short period of time (usually less than a month ).

Trading securities are reported at fair value , and changes from cost are reported as part of net income.
 The changes are reported as unrealized gains or losses since the securities have not been sold.
 The unrealized gain or loss is the difference between the total cost of the securities in the category and their total fair value .

Pace Corporation has the following costs and fair values for its investments classified as trading securities:
Trading Securities, December 31, 2002
Yorkville Company bonds $ 50,000 $ 48,000
Kodak Company stock 90,000 99,000
Total
Investments Cost Fair Value Unrealized Gain (Loss)
$ 140,000 $ 147,000
$ (2,000)
9,000
$ 7,000

Pace Corporation has an unrealized gain of $7,000 because total fair value
( $147,000 ) is $7,000 greater than total cost ( $140,000 ). Fair value and the unrealized gain or loss are recorded through an adjusting entry at the time financial statements are prepared. A valuation allowance account, Market
Adjustment - Trading , is used to record the difference between the total cost and the total fair value of the securities. The adjusting entry for Pace Corporation is:
Date Account Titles and Explanation Debit Credit
Dec. 31 Market Adjustment – Trading
Unrealized Gain – Income
(To record unrealized gain on trading
securities)
7,000
7,000
1 The fair value of the securities is the amount reported on the balance sheet .
2 The unrealized gain is reported on the income statement in the Other
Revenues and Gains section. 3 The unrealized loss is reported on the income statement in the Other Expenses and Losses section.

ILLUSTRATION 13-7

Available-for-sale securities are held with the intention of selling them in the near future.

Available-for-sale securities are reported at fair value , and changes from cost are reported as part of net income.
 The changes are reported as unrealized gains or losses since the securities have not been sold.
 The unrealized gain or loss is the difference between the total cost of the securities in the category and their total fair value .

Elbert Corporation has the following costs and fair values for its investments classified as available-for-sale securities:
Available-for-Sa le Securities, December 31, 2002
Campbell Soup Corporation 8% bonds $ 93,537 $ 103,600
Hershey Corporation stock 200,000 180,400
Total
Investments Cost Fair Value Unrealized Gain (Loss)
$ 293,537 $ 284,000
$ 10,063
(19,600)
$ ( 9,537)

VALUATION AND REPORTING OF INVESTMENTS
Elbert Corporation has an unrealized loss of $9,537 because total fair value
( $284,000 ) is $9,537 less than total cost ( $293,537 ). Fair value and the unrealized gain or loss are recorded through an adjusting entry at the time financial statements are prepared. A valuation allowance account, Market Adjustment -
Available-for-Sale , is used to record the difference between the total cost and the total fair value of the securities. The adjusting entry for Elbert Corporation is:
Date Account Titles and Explanation
Dec. 31 Unrealized Loss
– Equity
Market Adjustment
– Available-for-Sale
(To record unrealized loss on available-for-sale securities)
Debit Credit
9,537
9,537
1 The fair value of the securities is the amount reported on the balance sheet .
2 The unrealized gain or loss is reported as a separate component of stockholders’ equity
.

ILLUSTRATION 13-9

Temporary investments are listed immediately below cash in the current asset section of the balance sheet due to their liquidity.

Temporary investments are reported at fair value .

Long-term investments are typically reported in a separate section of the balance sheet immediately below current assets .

In the income statement, the items below are reported in the nonoperating section :
Other Revenues and Gains
Interest Revenue
Dividend Revenue
Gain on Sale of Investments
Unrealized Gain – Income
Other Expenses and Losses
Loss on Sale of Investments
Unrealized Loss – Income

ILLUSTRATION 13-10

An unrealized gain or loss on available-for-sale securities is reported as a separate component of stockholders’ equity.

Dawson Inc. has common stock of $3,000,000 , retained earnings of $1,500,000 , and an unrealized loss on available-for-sale securities of $100,000 .

The statement presentation of the unrealized loss is shown below.
Stockholders’ equity
Common stock
Retained earnings
$ 3,000,000
1,500,000
Total paid-in capital and retained earnings 4,500,000
Less: Unrealized loss on available-for-sale securities ( 100,000)
Total stockholders’ equity $ 4,400,000

ILLUSTRATION 13-11
PACE CORPORATION
Balance Sheet
December 31, 2002
The comprehensive balance sheet for Pace
Corporation includes the following assets:
1 Temporary
Investments ,
2 Investments of less than 20% , and
3 Investments of
20% - 50% .
Assets
Current assets
Cash
Temporary investments, at fair value
Accounts receivable
Less: Allowance for doubful accounts
$ 84,000
4,000
Merchandise inventory, at FIFO cost
Prepaid insurance
Total current assets
Investments
Investment in bonds
Investments in stock of less than 20% owned companies, at fair value
Investment in stock of 20% – 50% owned company, at equity
Total investments
Property, plant, and equipment
Land
Buildings
Less: Accumulated depreciation
100,000
50,000
150,000
200,000
$ 800,000
200,000 600,000
180,000
54,000 126,000
Equipment
Less: Accumulated depreciation
Total property, plant, and equipment
Intangible assets
Goodwill (Note 1)
Patents
Total intangible assets
Total assets
100,000
70,000
$ 21,000
60,000
80,000
130,000
23,000
314,000
300,000
926,000
170,000
$ 1,710,000

ILLUSTRATION 13-11
The comprehensive balance sheet for Pace Corporation includes the following element of stockholders’ equity:
Unrealized Gain on Availablefor-Sale Securities . Reporting the unrealized gain or loss in the stockholders’ equity section: 1 reduces the volatility of net income due to fluctuations in fair value and 2 still informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value .
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
Bond interest payable
Federal income taxes payable
Total current liabilities
Long-term liabilities
Bonds payable, 10%, due 2010
Less: Discount on bonds
Total Long-term liabilities
Total liabilities
Stockholders’ equity
Paid-in capital
Common stock, $10 par value, 200,000 shares
authorized, 80,000 issued and outstanding
Paid-in capital in excess of par value
Total paid-in capital
Retained earnings (Note 2)
Total paid-in capital and retained earnings
Add: Unrealized gain on available-for-sale securities
Total stockholders’ equity
Total liabilities and stockholders’ equity
Note 1. Goodwill is amortized by the straight-line over 40 years.
Note 2. Retained earnings of $100,000 is restricted for plant expansion.
$ 300,000
10,000
$ 185,000
10,000
60,000
255,000
290,000
545,000
800,000
100,000
900,000
255,000
1,155,000
10,000
1,165,000
$ 1,710,000

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