Chapter 12
Investments
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-2
Accounting for Investment
Securities
Bonds and
notes
(Debt
securities)
Common and
preferred stock
(Equity
securities)
Investments can be accounted for in six
different ways, depending on the nature
of the investment relationship.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-3
Reporting Categories for
Investments
Types of
Securities
Debt
Debt or
Equity
Debt or
Equity
McGraw-Hill/Irwin
Reporting Categories for Investments
Reporting
Reported at
Category
Characteristics
Investor has the
positive intent and
Amortized Cost
Held To Maturity
ability to hold to
maturity
Fair Value (with
unrealized gains
Investments not
Securities
and losses reported
classified in another
Available-for-Sale
in shareholders'
category
equity)
Fair Value (with
Held in active
unrealized gains
trading account for Trading Securities
and losses included
immediate resale
in earnings)
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-4
Reporting Categories for
Investments
Types of
Securities
Debt
Debt or
Equity
Debt or
Equity
McGraw-Hill/Irwin
Reporting Categories for Investments
Reporting
Reported at
Category
Characteristics
Investor has the
positive intent and
Amortized Cost
Held To Maturity
ability to hold to
Securities available
maturity
for sale (SAS) Fair
are Value (with
expected to beunrealized
held
gains
Investments not
Securities
and losses reported
classified in another
for an unspecified
Available-for-Sale
in shareholders'
category
Trading
periodsecurities
of time.
equity)
(TS) are boughtFair
and
Value (with
Held in active
held primarily to
be
gains
unrealized
trading account for Trading Securities
losses included
and
sold in the near
term.
immediate resale
in earnings)
Held to maturity
(HTM) securities
are those where
the investor
intends and has
the ability to hold
the security to
maturity date.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-5
Investments Held for an
Unspecified Period of Time
When an investment is held for an
unspecified period of time, it is reported
at the fair. value of the security on the
reporting date.
Must be “readily
determinable”
McGraw-Hill/Irwin
Otherwise, the
investment is
reported at cost.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-6
Securities Available-for-Sale
Adjustments to fair value
are recorded as:
a direct adjustment to the
investment account, and
an allowance account in
the equity section of the
balance sheet called
“Unrealized Holding
Gains/Losses”.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-7
Securities Available for Sale
Big Company
Partial Balance Sheet
12/31/2003
Stockholders' Equity
Common stock
$ 50,000
Paid-in-capital
125,000
Unrealized holding loss
(8,000)
Retained Earnings
27,000
Total Stockholders' Equity $ 194,000
McGraw-Hill/Irwin
Unrealized
holding gains
and losses
from
securities
available-forsale are
reported in
the equity
section of the
balance sheet.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-8
Securities Available for Sale
Example
Foot, Inc. purchased the securities listed
below in 2003. They are classified as
Securities Available for Sale (SAS). Prepare
the journal entries for Foot, Inc. to adjust
the securities to fair value at Dec. 31, 2003.
No. of Unit
Type
Name
Shares Cost
SAS General Boots
1,000
5
SAS Leather Goods
2,000
10
Net Unrealized Holding Gain
McGraw-Hill/Irwin
Total
Cost
5,000
20,000
Fair
Gain or
Value
(Loss)
9,500 $ 4,500
18,000
(2,000)
$
2,500
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-9
Securities Available for Sale
Example
GENERAL JOURNAL
Date
Description
Dec. 31 Investment in General Boots
Page 34
Post.
Ref.
Debit
Credit
4,500
Unrealized Holding Gain.
2,500
Investment in Leather Goods
2,000
To adjust securities to fair value
The Unrealized Holding Gain is
reported as an allowance in the Equity
Section.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-10
Securities Available for Sale
Occasionally, an
investment’s value
will decline for
reason’s that are
“other than
temporary”.
McGraw-Hill/Irwin
This is called . . .
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-11
Securities Available for Sale
If the value is
impaired . . .
. . . the recorded cost of
the security is reduced
to the impaired fair
value, and the
difference is included in
the current period’s
income.
McGraw-Hill/Irwin
The new cost
basis (the
impaired fair
value) is not
changed for
subsequent
recoveries in
fair value.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-12
Trading Securities
Adjustments to fair
value are recorded
as:
a direct adjustment to
the investment account,
and
a net unrealized holding
gain/loss on the Income
Statement.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-13
Trading Securities
Unrealized
holding
gains and
losses from
trading
securities
are reported
on the
income
statement.
McGraw-Hill/Irwin
Big Company
Partial Income Statement
For the Year Ended 12/31/03
Income from
operations
Unrealized
holding loss
Net loss
$
3,000
$
(8,000)
(5,000)
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-14
Trading Securities
Example
Foot, Inc. purchased the addition securities
classified as Trading Securities (TS) in 2003.
Prepare the journal entries for Foot, Inc. to adjust
the securities to fair value at 12/31/03.
Type
Name
TS Gloves, Inc.
TS SportsWear
No. of Unit
Shares Cost
1,000
$6
1,500
12
Total
Fair
Gain or
Cost
Value
(Loss)
$6,000 $ 6,500 $
500
18,000 16,000
(2,000)
Net Unrealized Holding Loss for TS
McGraw-Hill/Irwin
$ (1,500)
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-15
Trading Securities & Securities
Available for Sale - Example
GENERAL JOURNAL
Date
Description
Dec. 31 Investment in Gloves, Inc.
Unrealized Holding Loss
Investment in Sportswear
Page 34
Post.
Ref.
Debit
Credit
500
1,500
2,000
To adjust securities to fair value
The Net Unrealized Holding Loss is
reported on the Income Statement.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-16
Transfers Between Reporting
Categories
Transfers are
accounted for
at fair value
on the
transfer date.
McGraw-Hill/Irwin
Unrealized holding
gains or losses at
reclassification
should be accounted
for in a manner
consistent with the
classification into
which the security is
being transferred.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-17
Disclosures
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-18
Types of
Securities
Equity
Equity
Equity
McGraw-Hill/Irwin
Reporting Categories for Investments
Reporting
Characteristics
Category
Reported at
Fair value not
determinable and
Cost Method
Cost
the equity method is
not appropriate
The investor can
"significantly
Cost (adjusted for
influence" the
subsequent
Equity Method
operating and
growth in the
financial policies of
investee)
the investee
Consolidated
The investor
Financial
controls the
Consolidation
Statements (as if
investee
they were a single
company)
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-19
Types of
Securities
Equity
Equity
Equity
McGraw-Hill/Irwin
The cost method is
used for investments
in equity securities
when significant
influence is not
present.
Reporting Categories for Investments
Reporting
Characteristics
Category
Reported at
Fair value not
determinable and
Cost Method
Cost
the equity method is
The equity method is
not appropriate
The investor
can for investments in
used
"significantly
Cost (adjusted for
equity
securities
influence" the
subsequent
Equity Method
operating and
growth in the
resulting in significant
Whenofan investment results
financial policies
investee)
influence
(20%-50%).
the investee
in the control of the investee
Consolidated
(generally > 50%), the Financial
The investor
controls
the
Consolidation
Statements (as if
subsidiary
is consolidated
investee
they were a single
with the parent company.
company)
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-20
Equity Method
The investment account is
increased by:
Original investment cost.
 Proportionate share of
investee’s earnings.

The investment account is
decreased by:

Dividends received.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-21
Equity Method
The investment account is
reported on the balance
sheet as a single amount.
The investor’s share of
the investee’s earnings is
reported as a single item
on the investor’s income
statement.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-22
Equity Method
If the investor acquires the equity
securities of an investee by paying
more than the fair value of net
assets . . .
. . . the difference is allocated
between GOODWILL and
identifiable intangible assets.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-23
Equity Method
Example
Rings & More acquired 45% of the equity
securities of Diamonds Galore for
$1,350,000. On the acquisition date,
Diamonds Galore’s net assets had a fair
value of $3,000,000. During the year,
Diamonds Galore paid dividends of $150,000
and net income of $1,750,000.
What amount will Rings & More report on the
balance sheet as Investment in Diamonds
Galore?
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-24
Equity Method
Example
Investment in
Diamonds Galore
Investment
1,350,000
45% Earnings
787,500
67,500 45% Dividends
Reported Value 2,070,000
If the subsidiary had a
loss, the investment
account would have
been reduced.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-25
Reporting the Investment
When the Investee Reports a Net
Loss

The investment account is decreased.
When the Investment if Acquired in
Mid-Year

The investment account is adjusted only
for the income (loss) since the date of
acquisition.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-26
Changing From Equity Method
To Cost Method
At the transfer
date, the carrying
value of the
investment under
the equity method
is regarded as
cost.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-27
Changing From Equity Method
To Cost Method
Any difference between cost and fair
value is recorded in a valuation
account and is recognized as an
unrealized holding gain or loss.
After the transfer, the investment is
treated as a trading security or a
security available for sale, depending
on management’s intent.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-28
Changing From Cost Method To
Equity Method
When ownership level increases to a
significant influence, the investor must
change to the equity method.
At the transfer date, the recorded value is
the initial cost of the investment
adjusted for the investor’s equity in the
undistributed earnings of the investee
since the original investment.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-29
Changing From Cost Method To
Equity Method
The original cost, the unrealized
holding gain or loss, and the
valuation account are closed.
A retroactive change is recorded to
recognize the investor’s share of the
investee’s earnings since the original
investment.
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-30
Financial Instruments &
Derivatives
Financial
Instruments:
 Cash.
 Evidence of an
ownership interest
in an entity.
 Contracts meeting
certain conditions.
McGraw-Hill/Irwin
Derivatives:
 Hedges created to
offset risks created
by other financial
investments or
transactions.
 Value is derived from
other securities.
© 2004 The McGraw-Hill Companies, Inc.
Slide
12-31
End of Chapter 12
McGraw-Hill/Irwin
© 2004 The McGraw-Hill Companies, Inc.