chapter 14
Investment in
Debt and Equity
Securities
1
Learning Objectives
1. Determine why companies invest in
other companies.
2. Understand the varying classifications
associated with securities.
3. Account for the purchase of debt and
equity securities.
4. Account for the recognition of revenue
from investments.
Continued
2
Learning Objectives
5. Account for the change in value of
securities.
6. Account for the sale of investment
securities.
7. Record the transfer of securities
between categories.
8. Explain the proper classification and
disclosure of investments in securities
Continued
3
Time Line of Business Issues
Involved with Investment Securities
1. DETERMINE purpose of investment
2. CLASSIFY investments
3. PURCHASE securities
4. EARN AND RECOGNIZE a return
5. MONITOR changes in value
6. SELL securities
7. TRANSFER securities between categories
8. DISCLOSE status of portfolio at the end of the period
4
Why Companies Invest in
Other Companies
•Safety Cushion
•Cyclical Cash Needs
•Investment for a Return
•Investment for Influence
•Purchase for Control
5
Investment in Debt and Equity
Securities—2001
Company
Berkshire Hathaway
Microsoft
Coca-Cola
Citigroup
AT&T
Verizon
Total Investment
(in billions)
$69.0
17.7
5.4
160.8
24.5
10.2
Percentage of
Total Assets
42.4%
34.7
24.2
15.3
14.8
6.0
6
Classification of Investment
in Securities
Debt securities typically have the following
characteristics:
1. A maturity value, representing the amount
to be repaid to the debt holder at maturity.
2. An interest rate that specifies the periodic
interest payments.
3. A maturity date, indicating when the debt
obligation will be redeemed.
7
Classification of Investment
in Securities
Equity securities represent ownership in a
company.
 These shares of stock typically carry with
them the right to collect dividends and vote
on corporate matters.
 Equity securities have the potential for
significant increases in price.
8
Classification of Investment
in Securities
Debt/Equity
Securities
Held-toMaturity
Securities purchased with the
intent to hold until maturity.
Trading
Securities purchased for sale
in the near future.
Availablefor-sale
Securities not classified as
trading or held-to-maturity.
9
Classification of Investment
in Securities
Debt
Held-tomaturity
Availablefor-sale
Cost Method
Equity
Trading
Equity
Method
10
Equity Method Securities
These are securities purchased
with the intent to control or
At least 20 percent of the
significantly influence the
outstanding voting stock
operations of the investee.
must be owned to have
this significant influence
or control.
Even then, there may be
evidence to support the fact
that even a 20 percent
investment does not have
significant influence.
11
Different Accounting
Treatments
Classification
of Securities
Held to maturity
Available for sale
Trading
Equity method
Types of
Securities
Disclosure
on the
Balance
Sheet
12
Treatment of
Temporary
Changes in
Value
Debt
Amortized cost
Not recognized
Debt/equity Fair market value Reported in
stockholders’
equity
Debt/equity Fair market value Reported on the
income statement
Equity
Historical cost
Not recognized
adjusted for
changes in the
assets of the investee
Purchases of Debt Securities
On May 1, Douglas Company purchases
$100,000 in U.S. Treasury notes at 104¼,
including brokerage fees. Interest is 9%
payable semiannually on January 1 and July
1. The debt securities are classified by the
purchaser as trading securities.
Accrued interest on May 1 is $3,000, calculated
as follows:
$100,000 x .09 x 4/12 = $3,000
13
Purchases of Debt Securities
Asset Approach
Always
includes
brokerage
fees
Purchase date:
May 1 Investment in
Trading Securities 104,250
Interest Receivable
3,000
Cash
107,250
Continued
14
Purchases of Debt Securities
Revenue Approach
Purchase date:
May 1 Investment in
Trading Securities 104,250
Interest Revenue
3,000
Cash
107,250
Continued
15
Purchases of Debt Securities
Receipt of semiannual payment:
Asset Approach
July 1 Cash
4,500
Interest Receivable
Interest Revenue
3,000
1,500
Revenue Approach
July 1 Cash
Interest Revenue
4,500
4,500
16
Purchase of Equity Securities Available for Sale (AFS)/Trading
Purchased 1,000 shares of AB Company’s
common shares at $2 per share.
Investment in Available-for-Sale*/Trading
Securities - AB Company
2,000
Cash
2,000
* - would be so classified if management has no intention of
holding them for a long period of time and will sell them as soon
as it is economically advantageous
17
Purchase of Equity Securities
– Equity Method
Citty Co. purchased 100,000 shares of AB
Company common shares at $2 per share.
Assume that the 100,000 shares
purchased represents 20 % of the
outstanding voting stock of AB Company.
This investment gives the investor
significant influence over AB Company.
18
Purchase of Equity Securities
- – Equity Method
Purchased 100,000 shares of Dave’s Deli
common shares at $2 per share.
Equity Method Securities
Investment in AB Company Stock 200,000
Cash
200,000
19
Recognizing Revenue from
Debt Securities
On January 1, 2004, Silmaril Technologies
purchased 5-year, 10% bonds with a face
value of $100,000 and interest payable
semiannually on January 1 and July 1. The
market rate on bonds of similar quality and
maturity is 8%.
20
PV/Price of Debt Securities
Present value of principal:
FV = $100,000; N = 10; I = 4%
Present value of interest payments:
$ 67,556
PMT = $5,000; N = 10; I = 4%
Total present value of the bonds
40,554
$108,110
Investment in Trading Securities
Cash
OR
108,100
108,100
Investment in Held-to-Maturity Securities 108,100
Cash
108,100
21
Interest Revenue for Debt
Securities (Trading)
When the first interest payment is
received from Silmaril, the following
entry would be made:
July 1 Cash
Interest Revenue
5,000
5,000
22
Interest Revenue for Debt
Securities (Held-to-Maturity)
When the first interest payment is
received from Silmaril, the following
entry would be made:
July 1 Cash
5,000
Interest Revenue
4,324
Investment in Held-toMaturity Securities
676
23
Recognizing Revenue for Equity
Securities depends on the
Appropriate Accounting Method
Account for as
trading or
available-for-sale
Equity method and
consolidation
Equity
procedures
Ownership
method Percentage
No
significant
influence
0%
20%
Significant
influence
Control
50%
100%
24
Determining the Appropriate
Accounting Method
Ownership
Interest
More than 50%
20% to 50%
Less than 20%
Control or
Degree of
Influence
Control
Accounting
Method
Equity method
and consolidation
procedures
Significant Equity method
influence
No
Account for as
significant trading or
influence
available for sale
25
Applicable
Standard
APB Opinion #18
FASB Exposure
Draft
APB Opinion #18
FASB Statement
No. 115
Revenue for Equity Securities
Classified as Trading and AFS
AB Company announces dividends of
$0.25 per share. Assume that Citty Co.
owns 10,000 of AB’s 200,000 shares
(which represents 5%)
Cash
2,500
Dividend Revenue
2,500
26
Revenue for Equity Securities
Classified as Equity Method
Securities
AB Company announces dividends of
$0.25 per share. Assume that Citty Co.
owns 100,000 which represents 50 % of
the outstanding voting stock.
Cash
25,000
Investment in AB Company
Stock
25,000
27
Revenue for Equity Securities
Classified as Equity Method
Securities
AB Company reports an income of
$250,000 for the year. Again, assume
that Citty Co. owns 50 % of the
outstanding voting stock.
Investment in AB Company
Stock
125,000
Income from Investment
in AB Company Stock
125,000
28
Accounting for Temporary
Changes in Value of Securities (an
extract of slide 12)
Classification
of Security
Disclosed
at
Report FMV
Change On
Trading
Fair market
value
Income
statement
Availablefor-sale
Fair market
value
Stockholder’s
equity
Held-tomaturity
Amortized
cost
Not
recognized
29
Accounting for Temporary
Changes in Value of Securities
30
Eastwood Inc. bought the following securities on March 23, 2005.
Security
Classification
Cost($)
FMV 31/12/05($)
1
Trading
8,000
7,000
2
Trading
3,000
3,500
3
Available for Sale
5,000
6,100
4
Available for Sale
12,000
11,500
5
Held to Maturity
20,000
19,000
Accounting for Temporary
Changes in Value of Securities
Initial Purchase Entry
Investment in Trading Securities
Investment in Available-for-Sale
Securities
Investment in Held-to-Maturity
Securities
Cash
Continued
11,000
17,000
20,000
48,000
31
Accounting for Temporary
Changes in Value of Securities
32
By the end of the year, the value of
the trading securities decreased from
$11,000 to $10,500.
A contra account to the
“investment account”
December 31, 2005:
Unrealized Loss on Trading Securities
Market Adjustment—Trading Securities
500
500
Included in net income
Accounting for Temporary
Changes in Value of Securities
33
By the end of the year, the value of
the available-for-sale securities
increased from $17,000 to $17,600.
Included in stock
holder’s equity =>
Comprehensive income
December 31, 2005:
Market Adjustment—Available-for-Sale
Securities
Unrealized Increase/Decrease in Value
of Available-for-Sale Securities
600
600
Accounting for Temporary
Changes in Value of Securities
Partial Balance Sheet for Eastwood Inc.
Assets
Invest. in trading securities
$11,000
Market adjustment—trading sec.
(500) $10,500
Invest. in available-for-sale sec. $17,000
Market adjustment
600 17,600
Invest. in held-to-maturity sec.
20,000
$48,100
Stockholders’ Equity
Add unrealized increase in
available-for-sale securities
$ 600
34
Accounting for Temporary
Changes in Value of Securities
Partial Income Statement for Eastwood Inc.
Other expenses and losses:
Unrealized loss on trading
securities
$500
35