Financial Accounting, 5e
Weygandt, Kieso, & Kimmel
Prepared by
Kurt M. Hull, MBA CPA
California State University, Los Angeles
John Wiley & Sons, Inc.
CHAPTER 13
INVESTMENTS
STUDY OBJECTIVES
After studying this chapter, you should understand:
Why corporations invest in
debt and stock securities
Accounting for
debt investments
Accounting for
stock investments
Consolidated financial
Statements
Valuation of debt and
stock investments
Short-term vs. long-term
investments
STUDY OBJECTIVE 1
WHY CORPORATIONS INVEST
Reason
To house excess
cash until needed
To generate earnings
I need 1,000
Treasury bills
by tonight!
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
STUDY OBJECTIVE 2
ACCOUNTING FOR DEBT INVESTMENTS
Debt investments = government and corporate bonds.
Cost principle applies
Entries required for acquisition, interest revenue, and sale.
Cost includes all expenditures to acquire investment.
Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000
bonds on January 1, 2006, for $54,000, including brokerage
fees of $1,000. The entry to record the investment is:
Date
Jan. 1
Account Titles and Explanation
Debt Investments
Cash
(To record purchase of 50 Doan Inc. bonds)
Debit
Credit
54,000
54,000
RECORDING BOND INTEREST
The bonds pay $2,000 interest on July 1 and January 1
($50,000 x 8% x ½). The July 1 entry is:
Date
July 1
Account Titles and Explanation
Cash
Interest Revenue
(To record receipt of interest on Doan Inc.
bonds)
Debit
Credit
2,000
2,000
It is necessary to accrue $2,000 interest earned since July 1
at year-end. The December 31 entry is:
Date
Dec. 31
Account Titles and Explanation
Interest Receivable
Interest Revenue
(To accrue interest on Doan Inc. bonds)
Debit
Credit
2,000
2,000
RECORDING BOND INTEREST
When the interest is received on January 1, the entry is:
Date
Jan. 1
Account Titles and Explanation
Cash
Interest Receivable
(To record receipt of accrued interest)
Debit
Credit
2,000
2,000
RECORDING SALE OF BONDS
On January 1, 2007, Kuhl Corporation receives net
proceeds of $58,000 on the sale of the Doan Inc. bonds.
PROCEEDS – COST = GAIN or LOSS
The entry to record the sale and recognize the gain is:
Date
Jan. 1
Account Titles and Explanation
Cash
Debt Investments
Gain on Sale of Debt Investments
(To record sale of Doan Inc. bonds)
Debit
Credit
58,000
54,000
4,000
REVIEW QUESTION
On February 6, Hanes Company sells
debt investments costing $26,000 for $28,000.
Proceeds – Cost = Gain or Loss
Prepare the journal entry to record the sale.
Date
Accounts
Feb 6
Cash
Gain on Sale
Debt Investments
Debit
Credit
28,000
2,000
26,000
STUDY OBJECTIVE 3
ACCOUNTING FOR STOCK INVESTMENTS
Stock investments = capital stock of corporations.
Investor’s Ownership
Interest in Investee’s
Common Stock
Less than 20%
Presumed
Influence
on Investee
Accounting
Guidelines
Insignificant
Cost method
Between 20%
and 50%
Significant
More than 50%
Controlling
Equity method
Consolidated financial
statements
RECORDING STOCK INVESTMENTS
HOLDINGS < 20%
COST METHOD
Record investment at cost.
Recognize revenue when cash dividends are received.
On July 1, 2006, Sanchez Corporation acquires
1,000 shares (10%) of Beal Corporation common
stock for $40 per share plus brokerage fees of $500.
The entry for the purchase is:
Date
July 1
Account Titles and Explanation
Stock Investments
Cash
(To record purchase of 1,000 shares of Beal
Corporation common stock)
Debit
Credit
40,500
40,500
RECORDING DIVIDENDS
HOLDINGS < 20%
On December 31, Sanchez Corporation
receives a $2 per share cash dividend.
Date
Dec. 31
Account Titles and Explanation
Cash (1,000 x $2)
Dividend Revenue
(To record receipt of a cash dividend)
Debit
Credit
2,000
2,000
Dividend revenue is reported on the income
statement under “Other revenues and gains.”
RECORDING A SALE
HOLDINGS < 20%
On February 10, 2007, Sanchez Corporation receives
net proceeds of $39,500 on the sale of its Beal stock.
The cost of the Beal stock was $40,500 on July 1, 2006.
PROCEEDS – COST = GAIN or LOSS
The entry to record the sale and loss is:
Date
Feb. 10
Account Titles and Explanation
Cash
Loss on Sale of Stock Investments
Stock Investments
(To record sale of Beal common stock)
Debit Credit
39,500
1,000
40,500
RECORDING STOCK INVESTMENTS
HOLDINGS BETWEEN 20% & 50%
EQUITY METHOD
Record investment at cost.
Investment account adjusted
annually for dividends received
and share of investee net income.
Debit
Credit
Cost of investment
Dividends received
Percent of investee net income
Percent of investee net loss
RECORDING ACQUISITIONS
HOLDINGS BETWEEN 20% & 50%
On January 1, 2006, Milar Corporation
acquires 30% of the common stock of Beck
Company for $120,000. The entry to record
this transaction is:
Date
Jan. 1
Account Titles and Explanation
Stock Investments
Cash
(To record purchase of Beck common
stock)
Debit
120,000
Credit
120,000
RECORDING NET INCOME & DIVIDENDS
HOLDINGS BETWEEN 20% & 50%
Beck reports 2006 net income of $100,000
and declares and pays a $40,000 cash dividend.
The entries are:
Date
Dec. 31
Date
Dec. 31
Account Titles and Explanation
Stock Investments
Revenue from Investment in Beck Company
( To record 30% equity in Beck’s 2006
net income)
Account Titles and Explanation
Cash
Stock Investments
(To record dividends received)
Debit
Credit
30,000
30,000
Debit
Credit
12,000
12,000
INVESTMENT AND REVENUE
ACCOUNTS AFTER POSTING
Stock Investments
January 1
120,000
December 31
December 31 Balance
December 31
12,000
30,000
138,000
Revenue from Investment in Beck Company
December 31
Milar’s share of Beck’s net income is
$30,000. This increases the investment.
Milar does not receive any cash.
30,000
Dividends received
From Beck reduce
the investment. Milar
receives $12,000 in cash.
If Beck reports a net loss, Milar’s share would reduce the investment.
STUDY OBJECTIVE 4
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS > 50% - CONSOLIDATIONS
A PARENT COMPANY
owns more than 50%
of the common stock of a
SUBSIDIARY COMPANY.
PARENT
OWNS
The parent company has a
CONTROLLING INTEREST
in the subsidiary company.
CONSOLIDATED FINANCIAL
STATEMENTS
are usually prepared.
50% OF
SUB
A
60% OF
SUB
B
75% OF
SUB
C
RECORDING STOCK INVESTMENTS
MANAGEMENT PERSPECTIVE
Time Warner, Inc. owns 100% of HBO common stock. The common stockholders
of Time Warner elect the BOD of the company, who, in turn, select the officers
and managers of the company. The Board of Directors controls the property
owned by the corporation, including the HBO common stock.
Controlling
Group
Time Warner, Inc.
Board of Directors
Separate Legal
Entities
Single
Economic Entity
Control
Time Warner, Inc.
Time Warner, Inc.
Home Box Office
Board of Directors
Control
Home Box Office
Corporation
STUDY OBJECTIVE 5
VALUING AND REPORTING INVESTMENTS
FAIR MARKET VALUE
Fair value = expected cash realizable value of the
securities sold in normal market conditions.
Trading
We’ll sell
within ten days.
At fair value with
changes reported in net
income
Available-forSale
Held-to-Maturity
We’ll hold the stock
for a while to see
how it performs.
At fair value with
changes reported in the
stockholders’ equity
section
We intend to hold
these bonds until
maturity.
At amortized
cost
TRADING SECURITIES
Held with the intention of selling them in a short period.
Reported at fair value.
Changes from cost are reported as unrealized
gains or losses and included in NET INCOME.
Pace Corporation holdings are illustrated below:
Trading Securities, December 31, 2006
Investments
Yorkville Company bonds
Kodak Company stock
Total
Cost
Fair Value Unrealized Gain (Loss)
$ 50,000 $ 48,000
$ (2,000)
90,000
99,000
9,000
$ 140,000 $ 147,000
$ 7,000
VALUATION AND REPORTING
OF TRADING SECURITIES
FAIR VALUE – COST = UNREALIZED GAIN (LOSS)
Trading securities are adjusted to
market value at the balance sheet date.
Fair value
on balance sheet
Date
Dec. 31
Unrealized gain/loss
on income statement
Account Titles and Explanation
Market Adjustment — Trading
Unrealized Gain — Income
(To record unrealized gain on trading
securities)
Debit
Credit
7,000
7,000
REVIEW QUESTION
At the end of the first year of operations, the total cost of
a trading securities portfolio is $120,000. Fair value is $115,000.
Income Statement
Prepare the journal entry to adjust the securities to fair value.
Date
Accounts
Dec 31
Unrealized loss on trading securities
Short-term investments
(to adjust trading portfolio to market)
Debit
Credit
5,000
5,000
AVAILABLE FOR SALE SECURITIES
Held with the intention of
selling them in the near future.
Reported at fair value.
Changes from cost are reported as
a component of stockholders equity.
Elbert Corporation holdings are illustrated below:
Available -for-Sale Securities, December 31, 200 6
Investments
Campbell Soup Corporation 8% bonds
Hersey Corporation stock
Total
Cost
Fair Value Unrealized Gain (Loss)
$ 93,537
$ 103,600
$ 10,063
200,000
180,400
(19,600)
$ 293,537
$ 284,000
$ ( 9,537)
VALUATION AND REPORTING
OF AVAILABLE FOR SALE SECURITIES
FAIR VALUE – COST = UNREALIZED GAIN (LOSS)
Available for sale securities are adjusted to
market value at the balance sheet date.
Fair value
on balance sheet
Date
Dec. 31
Unrealized gain/loss
in stockholders’ equity
Account Titles and Explanation
Unrealized Loss — Equity
Market Adjustment — Available-for-Sale
(To record unrealized loss on
available-for-sale securities)
Debit
Credit
9,537
9,537
STUDY OBJECTIVE 6
SHORT-TERM vs. LONG-TERM INVESTMENTS
1.
2.
3.
4.
Short-term investments are readily marketable, and
Intended to be converted into cash within the next year
or operating cycle, whichever is longer.
Listed on balance sheet immediately below cash.
Reported at fair value.
PACE CORPORATION
Balance Sheet (partial)
Current assets
Cash
Short-term Investments at fair value
$ 21,000
147,000
LONG-TERM INVESTMENTS
BALANCE SHEET PRESENTATION
Long-term investments are reported on the
balance sheet immediately below current assets.
In the income statement, the items below are
reported in the non-operating 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
UNREALIZED LOSS IN
STOCKHOLDERS’ EQUITY
An unrealized gain or loss on
available-for-sale securities is reported as a
separate component of stockholders’ equity.
The statement presentation of
the unrealized loss is shown below.
DAWSON INC.
Partial Balance Sheet
Stockholders’ equity
Common stock
$ 3,000,000
Retained earnings
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
CLASSIFIED BALANCE SHEET
Pace Corporation
classified balance
sheet includes:
1 Short-term
Investments,
2 Investments of
less than 20%,
3 Investments of
20% - 50%.
PACE CORPORATION
Balance Sheet
December 31, 2006
Assets
Current assets
Cash
Short-term investments, at fair value
Accounts receivable
Less: Allowance for doubtful accounts
Merchandise inventory, at FIFO cost
Prepaid insurance
Total current assets
Investments
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
$ 800,000
Less: Accumulated depreciation
200,000
Equipment
180,000
Less: Accumulated depreciation
54,000
Total property, plant, and equipment
Intangible assets
Goodwill (Note 1)
Total intangible assets
Total assets
$
$ 84,000
4,000
21,000
147,000
80,000
43,000
23,000
314,000
50,000
150,000
200,000
200,000
600,000
126,000
926,000
270,000
270,000
$ 1,710,000
CLASSIFIED BALANCE SHEET
Pace Corporation
balance sheet includes:
1.
Unrealized gain
available-for-sale
securities
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
$
185,000
10,000
60,000
255,000
$ 300,000
10,000
290,000
545,000
800,000
100,000
900,000
255,000
1,155,000
10,000
1,165,000
$ 1,710,000
Note 1. Goodwill is amortized by the
- straight line over 40 years.
Note 2. Retained earnings of $100,000 is restricted for plant expansion.
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of the information contained herein.
CHAPTER 13
INVESTMENTS