BUS 120: Financial Accounting
Chapter 13: Investments
Dr. Al Taccone
Chapter 13: What you should
learn
• Why corporations invest in debt and stock securities
• Accounting for debt investments
* Recording acquisitions of bonds
* Recording bond interest
* Recording sale of bonds
• Accounting for stock investments
* Holdings of less than 20%
* Holdings of between 20% and 50%
* Holdings of greater than 50%
• Balance sheet presentation of investments
Temporary Investments and the
Operating Cycle
• 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 excess funds may be invested to
earn interest and dividends.
WHY CORPORATIONS INVEST
Reason
Typical Investment
To house excess cash until
needed
Low-risk, high-liquidity, short-term
securities such as governmentissued securities
To generate earnings
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
To meet strategic goals
Temporary vs. Long-term
Investments
Temporary investments:
Long-term investments:
• Securities held by a
company that are:
1. Readily marketable
• Investments that do not
meet both criteria for
temporary investments.
2. Intended to be
converted into cash
within the next year or
operating cycle,
whichever is longer.
Debt Investments
• Investments in government and
corporation bonds.
• Entries are required to record:
1. Acquisition of the bonds
2. Interest revenue earned on the bonds
3. Sale of the bonds
• The cost principle applies—cost includes
all expenditures necessary to acquire
ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES AT ACQUISITION
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
54,000
Credit
54,000
ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES FOR BOND INTEREST
The bonds pay $3,000 interest on July 1 and January 1 ($50,000 X 12% 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
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
Dec. 31
Account Titles and Explanation
Interest Receivable
Interest Revenue
(To accrue interest on Doan Inc. bonds)
Debit
Credit
3,000
3,000
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
3,000
3,000
ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES FOR SALE OF BONDS
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
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
STOCK INVESTMENTS
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%
Significant
Equity method
More than 50%
Controlling
Consolidated financial
statements
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS LESS THAN 20%
PURCHASE OF STOCK INVESTMENT
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
HOLDINGS LESS THAN 20%
DIVIDEND REVENUE
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
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 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
HOLDINGS LESS THAN 20%
SALE OF STOCK INVESTMENT (GAINS or LOSSES)
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
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
Accounting for Stock Investments
Holdings Between 20% and 50%
• Usually presumed that the investor has significant
influence over the financial and operating activities of the
investee.
• The investor should record its share of net income of the
investee in the year when it is earned.
• Equity Method:
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 following transactions are required:
1. Debit the investment account and credit revenue for
its share of the investee’s net income.
2. Credit dividends received to the investment account.
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS BETWEEN 20% AND 50%
RECORD THE STOCK INVESTMENT
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
Jan. 1
Account Titles and Explanation
Stock Investments
Cash
(To record purchase of Beck common
stock)
Debit
Credit
120,000
120,000
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS BETWEEN 20% AND 50%
DIVIDEND REVENUE
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
Dec. 31
Date
Dec. 31
Account Titles and Explanation
(1)
Stock Investments
Revenue from Investment in Beck Company
(To record 30% equity in Beck’s 2002 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
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
Holdings of More than 50%
• A company that owns more than 50% of the
common stock of another company is known as
the parent company.
• The company 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 company
due to the stock ownership.
• When one company owns more than 50% of the
common stock of another company,
consolidated financial statements are usually
prepared.
Valuation and Reporting of
Investments
• Debt and stock investments are classified into 3
categories of securities:
1. Trading securities—held with the
intention of selling them in a short
period of time (usually less than a one
month).
2. Available-for-sale securities—may be sold in
the future (usually held beyond one month).
3. Held-to-maturity securities—debt securities that
the investor has the intent and ability to hold to
maturity.
ILLUSTRATION:
COMPREHENSIVE BALANCE SHEET
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 doubtful accounts
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
Equipment
Less: Accumulated depreciation
Total property, plant, and equipment
Intangible assets
Goodwill (Note 1)
Patents
Total intangible assets
Total assets
$
$ 84,000
4,000
21,000
60,000
80,000
130,000
23,000
314,000
100,000
50,000
150,000
300,000
200,000
$ 800,000
200,000
180,000
54,000
600,000
126,000
926,000
100,000
70,000
170,000
$ 1,710,000
ILLUSTRATION:
COMPREHENSIVE BALANCE SHEET
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.
$
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