Chapter
16-1
CHAPTER 16
INVESTMENTS
Accounting Principles, Eighth Edition
Chapter
16-2
Study Objectives
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.
Chapter
16-3
Long-Term Liabilities
Why
Corporations
Invest
Accounting for
Debt
Investments
Accounting for
Stock
Investments
Valuing and
Reporting
Investments
Cash
management
Recording
acquisition of
bonds
Recording
bond interest
Recording sale
of bonds
Holdings of
less than 20%
Categories of
securities
Holdings
between 20%
and 50%
Holdings of
more than 50%
Balance sheet
presentation
Realized and
unrealized gain
or loss
Investment
income
Strategic
reasons
Classified
balance sheet
Chapter
16-4
Why Corporations Invest
Corporations generally invest in debt or stock
securities for one of three reasons.
1.
Corporation may have excess cash.
2. To generate earnings from investment income.
3. For strategic reasons.
Illustration 16-1
Temporary
investments
and the
operating cycle
Chapter
16-5
LO 1 Discuss why corporations invest in debt and stock securities.
Why Corporations Invest
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.
Chapter
16-6
LO 1 Discuss why corporations invest in debt and stock securities.
Accounting for Debt Instruments
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
carrying value of the bond times the interest rate
times the portion of the year the bond is outstanding.
Chapter
16-7
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
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
16-8
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
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.
Chapter
16-9
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Exercise: 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.
Jan 1
Debt investment
Cash
60,900 *
60,900
* ($60,000 + $900 = $60,900)
Chapter
16-10
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Exercise: July 1 Received semiannual interest on
Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000
less $500 brokerage fees.
July 1
Cash
Interest revenue
Cash
Debt investments
Gain on sale
* ($60,000 x 8% x ½ = $2,400)
** ($34,000 - $500 = $33,500)
Chapter
16-11
2,400 *
2,400
33,500 **
30,450 ***
3,050
*** ($60,900 x ½ = $30,450)
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Exercise: (b) Prepare the adjusting entry for the
accrual of interest at December 31.
Dec 31 Interest receivable
Interest revenue
1,200 *
1,200
* ($30,000 x 8% x ½ = $1,200)
Chapter
16-12
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
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.
Chapter
16-13
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
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.
Chapter
16-14
LO 2 Explain the accounting for debt investments.
Accounting for Stock Investments
Ownership Percentages
0 --------------20% ------------ 50% -------------- 100%
No significant
influence
usually exists
Significant
influence
usually exists
Investment
valued using
Cost
Method
Investment
valued using
Equity
Method
Control
usually exists
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.
Chapter
16-15
LO 3 Explain the accounting for stock investments.
Holdings of Less than 20%
Companies use the cost method. Under the cost
method, companies record the investment at cost,
and recognize revenue only when cash dividends are
received.
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus any
brokerage fees (commissions).
Chapter
16-16
LO 3 Explain the accounting for stock investments.
Holdings of Less than 20%
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.
Chapter
16-17
LO 3 Explain the accounting for stock investments.
Holdings of Less than 20%
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.
Feb. 1
Stock investments
8,200 *
Cash
July 1
8,200
Cash
Dividend revenue
800 **
800
* ($8,000 + $200 = $8,200)
** (800 x $1 = $800)
Chapter
16-18
LO 3 Explain the accounting for stock investments.
Holdings of Less than 20%
Exercise: Sept. 1 Sold 300 shares of Hippo common
stock for $4,400, less brokerage fees of $100.
Sept. 1
Cash
Stock investments
Gain on sale
4,300 *
3,075 **
1,225
* ($4,400 - $100 = $4,300)
** ($8,200 x 3/8 = $3,075)
Chapter
16-19
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
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 method.
Chapter
16-20
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
Question
Under the equity method, the investor records
dividends received by crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Stock Investments.
Chapter
16-21
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
Exercise: (Equity Method) On January 1, 2008,
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 the entries for Pennington to record the
purchase and any additional entries related to this
investment in Edwards Company in 2008.
Chapter
16-22
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
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.
Stock investments
180,000
Cash
180,000
Stock investments
24,000
Investment revenue
Cash
6,000
Stock investments
Chapter
16-23
24,000
($80,000 x 30%)
($20,000 x 30%)
6,000
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
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.
After Pennington posts the transactions for the year, its
investment and revenue accounts will show the following.
Stock Investments
Investment Revenue
Debit
Debit
180,000
24,000
Credit
Credit
24,000
6,000
198,000
Chapter
16-24
LO 3 Explain the accounting for stock investments.
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 the
parent’s books as a long-term investment.
 Parent generally prepares consolidated financial
statements.
Chapter
16-25
LO 4 Describe the use of consolidated financial statements.
Valuing and Reporting Investments
Categories of Securities
Companies classify debt and stock investments
into three categories:
 Trading securities
 Available-for-sale securities
 Held-to-maturity securities
These guidelines apply to all debt securities and all stock
investments in which the holdings are less than 20%.
Chapter
16-26
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Valuing and Reporting Investments
Trading Securities
Companies hold trading securities with the
intention of selling them in a short period.
Trading means frequent buying and selling.
Companies report trading securities at fair
value, and report changes from cost as part of
net income.
Chapter
16-27
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Valuing and Reporting Investments
Available-for-Sale Securities
Companies hold available-for-sale securities
with the intent of selling these investments
sometime in the future.
These securities can be classified as current
assets or as long-term assets, depending on the
intent of management.
Companies report securities at fair value, and
report changes from cost as a component of the
stockholders’ equity section.
Chapter
16-28
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Valuing and Reporting Investments
Question
Marketable securities bought and held primarily for
sale in the near term are classified as:
a. available-for-sale securities.
b. held-to-maturity securities.
c. stock securities.
d. trading securities
Chapter
16-29
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Trading Securities
Problem: Loxley Company has the following portfolio of
securities at September 30, 2008, its last reporting date.
Trading Securities
Dan Fogelberg, Inc. common (5,000 shares)
Petra, Inc. preferred (3,500 shares)
Tim Weisberg Corp. common (1,000 shares)
Cost
$ 225,000
133,000
180,000
Fair Value
$ 200,000
140,000
179,000
On Oct. 10, 2008, 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,
2008. The Dec. 31, 2008, fair values were: Petra $96,000,
Los Tigres $132,000, and the Weisberg common $193,000.
Chapter
16-30
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Trading Securities
Problem: Prepare the journal entries to record the sale,
purchase, and adjusting entries related to the trading
securities in the last quarter of 2008.
Portfolio at September 30, 2008
Trading Securities
Dan Fogelberg, Inc. common (5,000 shares)
Petra, Inc. preferred (3,500 shares)
Tim Weisberg Corp. common (1,000 shares)
Cost
$ 225,000
133,000
180,000
$ 538,000
Market Adjustment – Trading (account balance)
Chapter
16-31
Fair Value
$ 200,000
140,000
179,000
$ 519,000
($19,000)
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Trading Securities
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.
October 10, 2008 (Fogelberg):
Cash (5,000 x $54)
270,000
Trading securities
225,000
Gain on sale
45,000
November 2, 2008 (Los Tigres):
Trading securities (3,000 x $59.50)
Cash
Chapter
16-32
178,500
178,500
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Trading Securities
Problem: Portfolio at December 31, 2008
Trading Securities
Petra, Inc. preferred
Tim Weisberg Corp. common
Los Tigres common
$
$
Cost
133,000
180,000
178,500
491,500
Prior market adjustment balance
Market fair value adjustment
Fair Value
$ 96,000
193,000
132,000
$ 421,000
Unrealized
Gain (Loss)
$ (37,000)
13,000
(46,500)
(70,500)
$
(19,000)
(51,500)
December 31, 2008:
Unrealized loss - Income
Market adjustment - Trading
Chapter
16-33
51,500
51,500
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Available-for-Sale Securities
Problem: How would the entries change if the securities
were classified as available-for-sale?
The entries would be the same except that the
Unrealized Gain or Loss—Equity account is used
instead of Unrealized Gain or Loss—Income.
The unrealized loss would be deducted from the
stockholders’ equity section rather than charged to
the income statement.
Chapter
16-34
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Available-for-Sale Securities
Question
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
stockholders' equity.
d. deducted from the cost of the investment.
Chapter
16-35
LO 5 Indicate how debt and stock investments
are reported in financial statements.
Balance Sheet Presentation
Short-Term Investments
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.
Investments that do not meet both criteria are
classified as long-term investments.
Chapter
16-36
LO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation
Presentation of Realized and Unrealized Gain
or Loss
Nonoperating items related to investments
Chapter
16-37
Illustration 16-10
LO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation
Realized and Unrealized Gain or Loss
Unrealized gain or loss on available-for-sale
securities are reported as a separate component of
Illustration 16-11
stockholders’ equity.
Chapter
16-38
LO 6 Distinguish between short-term and long-term investments.
Balance Sheet Presentation
Classified Balance Sheet (partial)
Chapter
16-39
Illustration 16-12
LO 6 Distinguish between short-term and long-term investments.
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Chapter
16-40