Chapter
12
Investments
Judith Paquette
Financial Accounting,
Seventh Edition
Slide
12-1
Study Objectives
Slide
12-2
1.
Discuss why corporations invest in debt and stock
securities.
2.
Explain the accounting for debt investments.
3.
Explain the accounting for stock investments.
5.
Indicate how debt and stock investments are reported in
financial statements—valuing investments
6.
Distinguish between short-term and long-term
investments.
Note: Learning objective #4 is
not included.
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 12-1
Temporary
investments
and the
operating cycle
Slide
12-3
They have Excess Cash $$$$$$$$$$
If you have excess cash, it should be working for
you! (working = earning interest $$$$$$$$)
But, it needs to be readily available when you need it
(a “rainy day” fund)
Hence: invest in low risk funds that can be liquidated
quickly
Slide
12-4
They want to generate earnings from
investment income
Maybe liquidity isn’t an issue….they want to
benefit from dividends and stock
appreciation. So they invest in mutual funds
and stocks.
Slide
12-5
For Strategic Reasons—buying a related
company
Buying a large amount of stock in a company gives the
company a certain amount of stock votes…even without a
controlling interest, it gives the company an influence.
Which company?
-a related industry – e.g.,
Taco Bell buys stock in
Chipotle, its competitor…
WHY invest in your
competitor?
Slide
12-6
For Strategic Reasons –to influence
Which company? -a related industry – e.g., Taco Bell buys stock in Chipotle, its
competitor… WHY invest in your competitor?
To expand its influence in its own industry.
Slide
12-7
For Strategic Reasons—buying an unrelated
company
It still gives you some influence, but also something else.
An Unrelated industry– e.g.,
Taco Bell buys stock
in….Pfizer
(pharmaceutical)…tacos and
drugs….hmmmm….WHY
would they do that?
Slide
12-8
For Strategic Reasons- to DIVERSIFY
An Unrelated industry– e.g., Taco Bell buys stock in…Pfizer (pharmaceutical)…tacos
and drugs…. ….WHY would they do that?
Diversifying its investment in different industries allows the company to
(possibly) face less market risk by not putting all its investment in the same
industry… If fast food sales go down, drug sales may not be affected as much.
Slide
12-9
INVESTING IN ANOTHER COMPANY
You have TWO choices:
1. DEBT – LOAN $$ TO A COMPANY - BUY
BONDS
2. EQUITY – BECOME AN OWNER - BUY
STOCK
How do you make money with your
investments?
Slide
12-10
INVESTING – earning money
You have TWO choices:
1. DEBT – Interest Revenue (new account)
2. EQUITY 2 ways:
1. Dividends paid
2. Stock Appreciation (buy at a lower price, sell at a
higher price)
How does a company report its investments?
Slide
12-11
INVESTING – Reporting
INVESTMENTS are ASSETS (could be long term on
short term) with a NORMAL BALANCE of DEBIT.
You must clearly understand the difference between:
The Company’s own stock or bonds sold =
•Common Stock, Equity, normal balance = credit or
•Bonds Payable, LT Liabilties, normal balance = credit
AND
The Company’s investment in another company’s stock or debt
purchased = Investments, Assets, normal balance = debit
Slide
12-12
Accounting for Debt Investments

Investments in government and corporation bonds.

In accounting for debt investments, the required
entries to record:
 the
acquisition
 the interest revenue
 the sale
Slide
12-13
13
Accounting for Debt Investments – Acquisition
Recording Acquisition of Bonds
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus
brokerage fees (commissions), if any.
Note: Bonds are recorded at acquisition cost, NOT face
value.
Slide
12-14
SO 2 Explain the accounting for debt investments.
Accounting for Debt Investments– Bond
Interest
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.
Face Value: $1,000 for each bond
Contract Interest Rate: 7% (for example)
Annual interest revenue = 1,000 * .07 = $70
Slide
12-15
Accounting for Debt Investments
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.
Note: if you only sell some of the bonds, you need to
prorate the cost.
If you go back to the chapter on Long
Term Assets, this is the same as how we
retire an asset…
Slide
12-16
Accounting for Debt Instruments – example - Acquisition
Illustration: Kuhl Corporation acquires 50 Doan Inc.
8%, 10-year, $1,000 bonds on January 1, 2011, for
$54,000, including brokerage fees of $1,000. The entry
to record the investment is:
Slide
12-17
Accounting for Debt Instruments – example - Acquisition
Illustration:
Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year,
$1,000 bonds on January 1, 2011, for $54,000, including brokerage fees of
$1,000.
The entry to record the investment is:
Jan. 1
Debt Investments
54,000
Cash
Question: What type of account
is Debt Investments?
Hint: watch the wording, if it said “plus a
brokerage fee of $1,000” the entry would
be for $55,000.
Slide
12-18
54,000
An asset
account,
normal balance
= debit
Accounting for Debt Instruments - interest
Illustration:
Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000
bonds on January 1, 2011, for $54,000, including brokerage fees of $1,000. The
bonds pay interest semiannually on July 1 and January 1.
The entry for the receipt of interest on July 1 is:
*
Slide
12-19
Accounting for Debt Instruments - interest
Illustration: Kuhl Corporation acquires 50 Doan Inc.
8%, 10-year, $1,000 bonds on January 1, 2011, for
$54,000, including brokerage fees of $1,000. The
bonds pay interest semiannually on July 1 and January 1.
The entry for the receipt of interest on July 1 is:
July 1
Cash
Interest revenue
Question: What type of account
is Interest Revenue?
*
Slide
12-20
($50,000 x 8% x ½ = $2,000)
2,000 *
2,000
A revenue
account,
normal balance
= credit
Accounting for Debt Instruments-year end interest
accrual and payment
Illustration: If Kuhl Corporation’s fiscal year ends on
December 31, prepare the entry to accrue interest since
July 1.
Kuhl reports receipt of the interest on January 1 as
follows.
Slide
12-21
Accounting for Debt Instruments-year end interest
accrual and payment
Illustration: If Kuhl Corporation’s fiscal year ends on
December 31, prepare the entry to accrue interest since
July 1.
Dec. 31 Interest receivable
Interest revenue
2,000
2,000
Kuhl reports receipt of the interest on January 1 as
follows.
Jan. 1
Slide
12-22
Cash
Interest receivable
2,000
2,000
Accounting for Debt Instruments – sale of investment
Illustration: Assume that Kuhl corporation receives net
proceeds of $58,000 on the sale of the Doan Inc. bonds
on January 1, 2011, after receiving the interest due.
Prepare the entry to record the sale of the bonds.
Jan. 1
Cash
58,000
Debt investments
Gain on sale of investments
Slide
12-23
54,000
4,000
Accounting for Debt Instruments – practice
Let’s Practice: Jubilee Farms acquires $200,000,
Whole Food Market, Inc. 7%, 10-year bonds on January
1, 2011, at face value directly from the company (no
brokerage fees). Record:
a) Jan 1 - The acquisition
b) Jul 1 - The first semiannual interest revenue
c) Dec 31 The accrual of the second interest revenue.
Record these transactions for 2011
Slide
12-24
Accounting for Debt Instruments – practice - continued
Let’s Practice: Assume that Jubilee Farms has only
these bonds and three years have passed. It is now
2014
a) Jan 1 – Received the semiannual interest
b) Jan 1 – Sold $70,000 of Whole Food bonds at 112.
The broker charged $1,500 in fees.
c) Jul 1 - Received semiannual interest revenue
d) Dec 31 The accrued semiannual interest revenue.
Record these transactions for 2014
Slide
12-25
See End of Power
Points for Solution
Accounting for Stock Investments
Investor's
Ownership
Interest in another
Company
Influence
Less than 20%
Insignificant
Between 20-50% Significant
More than 50%
Slide
12-26
CONTROLLING!
Accounting
The accounting depends on the
extent of the investor’s influence
over the operating and financial
affairs of the issuing corporation.
Accounting for Stock Investments
For this class, you are ONLY responsible
for learning about holdings of Less than
20%
When do you get to learn about:
Holdings between 20-50%?
Holdings of OVER 50%?
In greater detail:
--Intermediate Accounting
--Advanced Accounting
--or….you can read about it in the textbook as a more
general topic…
Slide
12-27
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. --This is similar to debt investments
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus any
brokerage fees (commissions).
Slide
12-28
Accounting for Stock Investments

Investments in a corporation’s common stock.

In accounting for common stock investments, the
required entries to record:
 the
acquisition
 the dividend revenue
 the sale
Slide
12-29
29
Holdings of Less than 20% - acquisition
Illustration: On July 1, 2011, Sanchez Corporation
acquires 1,000 shares (10% ownership) of Kali
Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the
purchase is:
Slide
12-30
Holdings of Less than 20% - acquisition
Illustration: On July 1, 2011, Sanchez Corporation
acquires 1,000 shares (10% ownership) of Kali
Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the
purchase is:
July 1
Stock investments
Cash
Slide
12-31
40,500
40,500
Holdings of Less than 20% - dividends earned
Illustration: During the time Sanchez owns the stock,
it makes entries for any cash dividends received. If
Sanchez receives a $2 per share dividend on December
31, the entry is:
Slide
12-32
SO 3 Explain the accounting for stock investments.
Holdings of Less than 20% - dividends earned
Illustration: During the time Sanchez owns the stock,
it makes entries for any cash dividends received. If
Sanchez receives a $2 per share dividend on December
31, the entry is:
Dec. 31
Cash
Dividend revenue
Slide
12-33
2,000
2,000
Holdings of Less than 20% - sale of stock
Illustration: Assume that Sanchez Corporation
receives net proceeds of $39,500 on the sale of its
Beal stock on February 10, 2012. Because the stock
cost $40,500, Sanchez incurred a loss of $1,000. The
entry to record the sale is:
Slide
12-34
Holdings of Less than 20% - sale of stock
Illustration: Assume that Sanchez Corporation
receives net proceeds of $39,500 on the sale of its
Beal stock on February 10, 2012. Because the stock
cost $40,500, Sanchez incurred a loss of $1,000. The
entry to record the sale is:
Feb. 10
Cash
Loss on sale of stock
Stock investments
Slide
12-35
39,500
1,000
40,500
Slide
12-36
Accounting for Stock Instruments – practice - continued
Let’s Practice: Frank’s Produce Conglomerate Company had the
following transactions pertaining to stock investments.
Feb. 1 - Purchased 500 shares of Jordan Company common stock (2%
ownership position) for $5,000 cash, plus brokerage fees of $250.
July 1 - Received cash dividends of $1 per share on Jordan common stock.
Sept. 1 - Sold 250 shares of Jordan common stock for $3,000, less
brokerage fees of $75.
Dec. 1 - Received cash dividends of $1 per share on Jordan common stock.
Record these transactions
Slide
12-37
See End of Power
Points for Solution
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%.
Slide
12-38
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, e.g., “day
trading.”
Companies report trading securities at fair value,
and report changes from cost as part of net income.
This is called “mark to market” because it adjusts
the value of the trading security to the market
price.
Slide
12-39
TRADING SECURITIES – ALERT!
Trading Securities
Because they are valued at FAIR VALUE….
This is a departure from the Cost Principle (see
Chapter 1 where assets are recorded at their historic cost)
The change in trading securities’ “fair value” affects
net income, even though they haven’t been sold!
This is called an “unrealized gain or loss”, but it still
affects net income.
Slide
12-40
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—does NOT impact net
income
Slide
12-41
Trading Securities - example
Illustration: Pace Company invests in two stocks classified as
trading securities. On December 31, 2011 (when its fiscal year
ends, it classified these securities at their current fair value:.
The adjusting entry for Pace Corporation is:
Dec. 31 Market adjustment—trading
7,000
Unrealized gain—income
Slide
12-42
7,000
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.
Slide
12-43
Available-for-Sale Securities - Example
Illustration: Assume that Ingrao Corporation has two
securities that it classifies as available-for-sale.
Illustration 12-8
The adjusting entry for Ingrao Corporation is:
Dec. 31 Unrealized gain or loss—equity
9,537
Market adjustment—available-for-sale
Slide
12-44
9,537
Too many accounts?
Remember:
If it is a GAIN, it will be a credit balance (like revenue)
If it is a LOSS, it will be a debit balance (like expense)
If it is a GAIN or LOSS account, its balance will vary
(debit for Loss, credit for Gain.
Slide
12-45
Accounting for Debt Instruments – JUBILEE FARMS continued
Remember the earlier practice problem:
Jubilee Farms
acquires $200,000, Whole Food Market, Inc. 7%, 10-year bonds on January
1, 2011, at face value directly from the company (no brokerage fees).
Now, let’s add the Year-end adjustment.
Slide
12-46
Accounting for Debt Instruments – practice - continued
Let’s Practice: On December 31, 2011: Assume that
the FAIR VALUE of the bonds on Dec 31, 2011 WAS
$192,000. These bonds are categorized as “availablefor-sale securities.
Prepare the adjusting journal entry for 2011.
See End of Power Points for Solution
Slide
12-47
Slide
12-48
Valuing and Reporting Investments
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.
Long-Term Investments
Investments that do not meet both criteria are
classified as long-term investments.
Slide
12-49
Income Statement Presentation – Gains/Losses
Presentation of Realized and Unrealized Gain
or Loss
Nonoperating items related to investments
Non Operating section of Income Statement
Other Revenue and Gains:
Other Expenses and Losses:
Interest Revenue
Loss on Sale of Debt Investments
Dividend Revenue
Loss on Sale of Stock Investments
Gain on Sale of Debt Investments
Unrealized Loss - Income
Gain on Sale of Stock Investments
Unrealized Gain - Income
Slide
12-50
Balance Sheet Presentation – Avail. For Sale
Realized and Unrealized Gain or Loss
Unrealized gain or loss on available-for-sale securities are
reported as a separate component of stockholders’
equity.
Illustration 12-11
Slide
12-51
Classified
Balance
Sheet
(partial)
Illustration 12-12
Slide
12-52
End of Chapter 12
Good Bye and Good Luck.
Solutions to Coursepack problems to
follow
Slide
12-53
SOLUTION TO JUBILEE FARMS:
a) 2011
Jan. 1 Debt Investments
Cash
200,000
200,000
To record purchase
July 1
Cash ($200,000 X .07 X 1/2)
Interest Revenue
7,000
7,000
To record dividends
Dec. 31
Interest Receivable
Interest Revenue
7,000
7,000
To record dividends accrual
2014
Jan. 1
Cash
Interest Receivable
7,000
7,000
To record dividends payment
1
Cash [($70,000 X 1.12) – $1,500]
Debt Investments
Gain on Sale of Debt
Investments
76,900
70,000
6,900
To record sales of bonds.
July 1
Cash ($130,000 X .07 X 1/2)
Interest Revenue
4,550
4,550
To record dividends
Dec. 31
Interest Receivable
Interest Revenue
4,550
4,550
To record dividends accrual
(b) 2011
Dec. 31
Slide
12-54
Unrealized Gain or Loss—Equity
Market Adjustment—
Available-for-Sale
To record market adjustment of bonds
8,000
8,000
SOLUTION TO FRANK’S PRODUCE CONGLOMERATE:
(a) Feb. 1
Stock Investments
Cash ($5,000 + $250)
5,250
5,250
To record purchase
July 1
Cash (500 X $1)
Dividend Revenue
500
500
To record dividend payment
Sept. 1
Cash ($3,000 – $75)
Stock Investments
($5,250 X 1/2)
Gain on Sale of Stock Investments
($2,925-2,625)
2,925
2,625
300
To record sale of stock
Dec. 1
Cash (250 X $1)
Dividend Revenue
To record dividend payment
Slide
12-55
250
250