Chapter 12
This presentation is the property of its rightful owner.
Sponsored Links
1 / 50

Chapter 12 PowerPoint PPT Presentation


  • 113 Views
  • Uploaded on
  • Presentation posted in: General

Chapter 12. Investments. Objectives of The Chapter. To learn the accounting for investments in stock (with ownership less than 20%) and bonds.

Download Presentation

Chapter 12

An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -

Presentation Transcript


Chapter 12

Investments


Objectives of The Chapter

  • To learn the accounting for investments in stock (with ownership less than 20%) and bonds.

  • To learn the accounting for investments in stock with significant influence on investee’s operating and dividend policy (i.e., ownership is between 20% ~ 50%).

  • To learn the accounting for consolidated financial statements (i.e., ownership is more than 50%).


Types of Investments

Equity Investments: invest in corporate Stock (i.e., common stock, preferred stock, and stock options).

Debt Investments: invest in U.S. treasury bills, municipal securities, corporate bonds, commercial papers.

Investment in equity or debt securities provides an opportunity to park cash in a financial instrument with an earning power


Reasons of Investments

  • Invest excess cash for short period of time (i.e., invest in highly liquid securities such as treasury bills).

  • Invest cash in securities to generate earnings (i.e., banks invest in debt securities; mutual funds invest in equity securities).

  • Invest in equity securities of a supplier or a customer to gain influence.


Acquisition of Bonds

  • Initial Recording: at cost.

  • Interest revenue and realized gains (or losses) from sales of investments are reported in the income statement.

  • Example: CGS Corp. Acquires 80 Creative Corp. 6%, 5-year, $1,000 bonds on 12/1/20x7 for the face value plus the brokerage fees of $1,000. Interests are paid semiannually. The related entries for this transaction are:


  • Acquisition of Bonds (contd.)

    • 12/1/x7Investment in bonds 81,000

    • Cash 81,000

    • Purchase of 80 Creative bonds

    • 12/31/07 Interest Receivable 400

    • Interest Revenue 400

    • Record the one-month accrued interest

    • $80,000x 6% x 1/12

    Short-Term Investments & Receivables


    Acquisition of Bonds (contd.)

    • 6/1/x8 CGS collects the 6-month interest:

    • Cash2,400

    • Interest Receivable 400

    • Interest Revenue 2,000

    Short-Term Investments & Receivables


    Sale of Bonds

    • CGS sells the investment in Creative bonds on 6/1/20x8 after receiving the interest due for net proceeds of $90,000 (i.e., sales price minus the brokerage fees). The entry to record this transaction is:

    • Cash 90,000

    • Investment in bonds 81,000

    • Gain on sale of investment in bonds 9,000

    L-T Investments and International Operations


    Acquisition of Stock (Holdings of Less than 20%)

    • Valuation:

      • Initial Recording: at cost.

      • Dividends and realized gains (or losses) from sales of investments are reported in the income statement.

    L-T Investments and International Operations


    Acquisition of Stock (Holdings of Less than 20%) – An Example

    • On11/18/08, EDS acquires 2,000 shares (5% ownership) of Freddy Corp. common stock for $30 per share plus brokerage fees of $1,000.

    • Freddy pays cash dividend $1 per share on 12/2/08. At year end, the market value of Ford stock is $65,000.

    • On 12/27/08, EDS sells Freddy stock for $35 per shares and pays brokerage fees of $1,000.


    Acquisition of Stock- An Example (contd.)

    • 11/18/08 Investments in stock 61,000

    • Cash 61,000

    • 12/2/08 Cash 2,000

    • Dividend revenue 2,000

    • 12/27/08 Cash 69,000*

    • Investment in stock 61,000

    • Gain on sale of inv. In stock 8,000

    • *$35x 2,000-$1,000

    L-T Investments and International Operations


    Categories of Securities and End of Period Reporting for Investments

    Investments in stock (holdings less than 20%) and bonds can be classified into the following three categories:

    • 1. Trading securities: held for sale in the near future (debt or equity securities).

    • 2. Available-for-sale securities: held for sale sometime in the future (debt or equity securities.

    • 3. Held-to-maturity securities: debt securities that the investor has the intent and ability to hold to maturity.


    Reporting of Investments in Securities

    • Reporting of Trading Securities (TS):

      • (1) At purchase: Cost.

      • (2) End of Period: Market value.

      • the unrealized gains/ losses reported in the income statement.

    L-T Investments and International Operations


    Reporting of Investments (contd.)

    • Reporting of available-for-sale securities (ASS):

    • (1) At purchase: Cost.

    • (2) End of period: Market value.

    • The unrealized gains/ losses reported in the balance sheet statement as a separate component of stockholders’ equity.

    L-T Investments and International Operations


    Reporting of Investments (contd.)

    • Reporting of Held-to-maturity securities (HTM):

      • (1) At purchase: Cost.

      • (2) End of Period: Amortized cost.

    L-T Investments and International Operations


    Example A: Assume that Camp Corp. acquired the following securities on 1/1/x9

    • Shares$ per share

    • A. Company’s common stock100$50

    • B. Company’s common stock300$80

    • C. Company’s preferred stock200$120

    • D. Company’s 10% bonds with a face value of $15,000 at par.

    • Interests are paid on 6/30 and 12/31.

    • These securities are reported as trading securities by Camp Corp.


    Example A (contd.)

    • 1/1/x9 Initial recording

      • Investment in stock -Trading68,000*

      • Cash68,000

      • * Cost =100 x 50 + 300 x 80 + 200 x 120 + 15,000 = 68,000

    • 6/30/x9

      • Cash750

      • Interest Revenue750

    • 12/31/x9

      • Cash750

      • Interest Revenue750

    • Assuming Kent received $1,000 of dividends in 20x9:

      • Cash1,000

      • Dividends Revenue1,000

    L-T Investments and International Operations


    Example A (contd.)

    • At the end of 20x9, the market value for these securities is $71,000. The following entry is needed to adjust the value of investment in trading securities:

      12/31/x9

      Fair Value Adjustment – Trading Sec. 3,000

      Unrealized Gain*

      on Investment -Income3,000

      To record unrealized gain on trading securities

      *reported in the income statement of 20x9


    Assets

    Investments -

    Trading Securities

    (at market value) $71,000

    Liabilities

    .

    .

    .

    .

    Stockholders’ Equity

    Balance Sheet PresentationBalance Sheet 12/31/x9

    L-T Investments and International Operations


    Example B: Assume that Camp Corp. acquired the following securities on 1/1/x9

    • Shares$ per share

    • A. Company’s common stock100$50

    • B. Company’s common stock300$80

    • C. Company’s preferred stock200$120

    • D. Company’s 10% bonds with a face value of $15,000 at par.

    • Interests are paid on 6/30 and 12/31.

    • These securities are reported as available-for-sale securitiesby Camp Corp.


    Example B (contd.)

    1/1/x9 Initial recording

    Investment in stock –Available-for-Sale 68,000

    Cash 68,000

    6/30/x9

    Cash750

    Interest Revenue750

    12/31/x9

    Cash750

    Interest Revenue750

    Assuming Kent received $1,000 of dividends in 20x9:

    Cash1,000

    Dividends Revenue1,000

    L-T Investments and International Operations


    Example B (contd.)

    • At the end of 20x9, the market value for these securities is $71,000. The following entry is needed to adjust the value of available-for-sale securities market:

      12/31/x9

      Fair Value Adjustment – Avail.-for-Sale 3,000

      Unrealized Gain*

      on Investment –Equity 3,000

      To record unrealized gain on avail.-for-sale securities

      *reported in the balance sheet of 20x9


    Assets

    Investments -

    Available-for-Sale $71,000

    Liabilities

    .

    .

    .

    .

    Stockholders’ Equity

    Unrealized gain on

    investments3,000

    Balance Sheet PresentationBalance Sheet 12/31/x9

    L-T Investments and International Operations


    Income Statement (skip)for the period ended 12/31/x9

    • Revenues$XXX

    • Expenses (including income tax) (XXX)

    • Net Income$XXX

    • Other Comprehensive Income:

    • Unrealized Gain on

    • Investment3,000

    • Less income tax (40%) (1,200)$1,800

    • Comprehensive Income ........….. $XXX

    L-T Investments and International Operations


    Presentation of Realized and Unrealized Gain and Loss

    • The revenue and gains/losses related to the investments are presented in the income statement as follows (source: Financial Accounting by Weygandt, Kimmel and Kieso)


    Presentation – contd.

    • The unrealized gain/loss – equity(from the valuation of available-for-sale securities) is presented in the stockholders’ equity section of the balance sheet, NOT the income statement.

    • See Illustration 13-12 of WKK textbook for an example of balance sheet presentation on investments and the unrealized gain/loss on available-for-sale securities.

    L-T Investments and International Operations


    Investments in Debt Securities Held to Maturity

    • The GAAP for Investment in Debt securities held to maturity (FASB 115):

      • (a) Initial recording at cost.

      • (i.e., the present value of the investment in debt security).

      • (b) End of period reporting at amortized cost.

      • (c) Unrealized holding gains (or losses): not recognized.

      • (d) Interests and realized gains (Losses) from sale (if any) are included in income.

    L-T Investments and International Operations


    Example C : Held-to-Maturity

    • Assume that Emey Corp. purchases $100,000 of GNC 9% bonds on 7/1/20x1 at 99. Interests on the bond are paid on 7/1 and 12/31. Emey Corp intends to hold the bonds till their maturity date on 7/1/20x6.

    • 7/1/x1 (Initial recording at cost) = 99,000

      • (Face amount - Discount) = 100,000 - 1000

      • Investments in Bonds100,000

      • Cash99,000

      • Discount on Investment in Bonds 1,000

    L-T Investments and International Operations


    Example E (contd.)

    • The discount ($1,000) will be amortized to increase the interest revenue using the effective interest method, unless the use of straight-line method does not result in a material difference on the amount of interest revenue recognized each year.

    L-T Investments and International Operations


    Example E (contd.)

    • The followings are subsequent entries for this investment (assuming the amortization method is straight-line method):

    • 12/31/x1

      • Cash4,500

      • Interest Revenue4,500

      • To recognize interest revenue for 6 months.

      • Discount on Investment in Bonds100

      • Interest Revenue100

      • To amortize discount on bond investment for 6 months.

    L-T Investments and International Operations


    Example E (contd.)

    • 7/1/x2

      • Cash4,500

      • Int. Revenue4,500

      • To receive semiannual interest.

      • Discount on Investment in Bonds 100

      • Interest Revenue100

      • To amortize discount for six months.

      • .

    L-T Investments and International Operations


    Acquisition of Stock (Holding of 20% to 50%)

    • GAAP requires the use of equity method by an investor who is able to exercise significant influence over the operating and financial policies of an investee.

    • In the absence to the contrary, an investment of 20% to 50% in the outstanding common stock of the investee leads to the presumption of significant influence.

    • The investee companies are referred to as affiliates.

    L-T Investments and International Operations


    Equity Method

    • In some cases, the investors hold more than 20% of the outstanding common stock of an investee and do not have significant influence. The equity method should not be used to account for the investment in those cases.

    L-T Investments and International Operations


    Equity Method

    • A survey of 600 companies conducted by Accounting Trends & Techniques indicated 252 (42%) of the corporations surveyed used the equity method to account for their investments.

    L-T Investments and International Operations


    The Accounting Procedures of the Equity Method

    • The investment is recorded at cost of the shares acquired.

    • The investment is subsequently adjusted each period for the changes in the equity of the investee.

    L-T Investments and International Operations


    The Accounting Procedures of the Equity Method

    • For example, the investment account will be increased (decreased) by the investors’ proportionate shares of investees’ earnings (losses) and decreased by the dividends received.*

      • * This is due to investee’s net income will increase investee’s equity while dividends will decrease investee’s equity.

    L-T Investments and International Operations


    The Accounting Procedures of the Equity Method (contd.)

    • Therefore, the investor’s investment account = Acquisition Cost + Investor’s Share of Investee’s Income - Dividends Received

    L-T Investments and International Operations


    Equity Method: An Example

    • On 1/1/x9, Clibron Company purchases 4,200 shares of common stock of the Sam Corporation which has 16,800 shares of common stock outstanding on 1/1/x9. Thus, Cliborn has 25% of the ownership and significant influence is presumed to exist. The acquisition cost for the 4,200 shares is $125,000 (including $2,000 brokerage fees).

    • Also, Sam Corp. paid $20,000 dividends on 8/28/x9, and reported net income of 81,000 for 20x9. These events are recorded on Cliborn Company’s book as follows:

    L-T Investments and International Operations


    Equity Method Example (contd.)

    • To record the investment on 1/1/x9:

      Investment in stock125,000

      Cash125,000

      2. To record the receipt of dividends on 3/28/x9:

      Cash (20,000 x 25%)5,000

      Investment in stock 5,000

    L-T Investments and International Operations


    Equity Method Example (contd.)

    • 3. To record Cliborn Company’s 25% share in the year’s net income:

      • 12/31/x9

      • Investment in stock

      • ($81,000 x 25%)20,250

      • Investment Revenue20,250

    L-T Investments and International Operations


    Presentation on the B/S and I/S:

    • Balance Sheet

      • 12/31/x9

      • Assets

      • Investment in Sam’s stock, at equity140,250

    • Income Statement

      • for the year ended 12/31/x9

      • Other Revenue:

      • Investment Revenue20,250

    L-T Investments and International Operations


    Gain or Loss on Sales of an Equity-Method Investment (Skip p22, p23)

    • Gain or loss on sales of an equity-method investment is measured as the difference between the sale proceeds and the carrying amount of the investment.

    L-T Investments and International Operations


    Sale of Equity Investment: An Example (skip)

    • On 1/3/10, Clibor Sells 20% of its holding of Sam Corp. for net proceeds of $30,000.

      • Cash30,000

      • Investment in stock28,050*

      • Gain on Sale of Investment1,950

      • * 140,250 x 20% = 28,050

    L-T Investments and International Operations


    Joint Venture

    • A joint venture is a separate entity or business project owned by a small group of investors.

    • A Joint venturer usually accounts for its investments using the equity method even if their shares are less than 20%.

    • This is because a joint venturer usually has significant influence on the investee company.

    L-T Investments and International Operations


    Accounting for Consolidated Subsidiaries

    • When a parent company purchased more than 50% of the outstanding common stock of subsidiary corporations, consolidated financial statements (F/S) should be prepared.

    • The consolidated F/S will combine the F/S of the parent company with those of majority-owned subsidiaries as if the parent and its subsidiaries were a single entity.

    L-T Investments and International Operations


    Income of A Consolidated Entity

    • The income of a consolidated entity is the net income of the parent plus the parent’s share (proportion) of the subsidiary’s net income.

    L-T Investments and International Operations


    Accounting for Consolidated Subsidiaries (contd.)

    • A work sheet is used to facilitate the combining of the financial statements of the parent company and the subsidiaries.

      • A. Parent corporation owns all of subsidiary’s stock.

      • B. Parent company owns less than 100% of subsidiary’s stock.

    L-T Investments and International Operations


    A. Parent Corporation Owns All of Subsidiary’s Stock

    • Some accounts are eliminated:

    • a. the parent company’s investment in subsidiary account and the subsidiary’s equity accounts because these two accounts represent the same thing – subsidiary’s equity which is also represented by assets and liabilities of the subsidiary in the combined financial statements).

    L-T Investments and International Operations


    Parent Corporation Owns All of Subsidiary’s Stock (contd.)

    • b. The reciprocal of note receivable/payable accounts of the parent and subsidiary.

    • For an example of the consolidated balance sheet, see illustration 13-A2 on p616 of the textbook

    L-T Investments and International Operations


    B. Parent Company Owns Less Than 100% of Subsidiary’s Stock

    • A minority interest account (on the credit side as a liability) is used to account for the subsidiary’s equity which is held by stockholders other than the parent company.

    L-T Investments and International Operations


  • Login