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C H A P T E R 17

C H A P T E R 17. INVESTMENTS. Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield. Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

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C H A P T E R 17

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  1. C H A P T E R 17 INVESTMENTS Intermediate Accounting 13th Edition Kieso, Weygandt, and Warfield

  2. Identify the three categories of debt securities and describe the accounting and reporting treatment for each category. Understand the procedures for discount and premium amortization on bond investments. Identify the categories of equity securities and describe the accounting and reporting treatment for each category. Explain the equity method of accounting and compare it to the fair value method for equity securities. Learning Objectives

  3. Investments Investments in Debt Securities Investments in Equity Securities Held-to-maturity securities Available-for-sale securities Trading securities Holdings of less than 20% Holdings between 20% and 50% Holdings of more than 50% Fair value option

  4. Investment Accounting Approaches • Different motivations for investing: • To earn a high rate of return e.g. interest revenue from a debt investment or dividend revenue from an equity investment. • To secure certain operating or financing arrangements with another company.

  5. Investment Accounting Approaches • Companies account for investments based on • the type of security (debt or equity) and • their intent with respect to the investment. Illustration 17-1

  6. Investments in Debt Securities Debt securities (creditor relationship with anther entity): Type Accounting Category • government securities • Municipal securities • Corporate bonds • Convertible debt • Commercial paper • Held-to-maturity • Trading • Available-for-sale LO 1 Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

  7. Investments in Debt Securities Accounting for Debt Securities by Category Illustration 17-2 LO 1 Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

  8. Held-to-Maturity Securities • Classify a debt security as held-to-maturityonly if it has both • the positive intent and • the ability to hold securities to maturity. Accounted for atamortized cost, not fair value. Amortize premium or discount using the effective-interest methodunless the straight-line method yields a similar result. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  9. Held-to-Maturity Securities Illustration: KC Company purchased $100,000 of 8 percent bonds of Evermaster Corporation on January 1, 2009, at a discount, paying $92,278. The bonds mature January 1, 2014 and yield 10%; interest is payable each July 1 and January 1. KC records the investment as follows: January 1, 2009 Held-to-Maturity Securities 92,278 Cash 92,278 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  10. Held-to-Maturity Securities Illustration 17-3 Schedule of Interest Revenue and Bond Discount Amortization— Effective-Interest Method LO 2

  11. Held-to-Maturity Securities Illustration: KC Company records the receipt of the first semiannual interest payment on July 1, 2009, as follows: July 1, 2009 Cash 4,000 Held-to-Maturity Securities 614 Interest Revenue 4,614 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  12. Held-to-Maturity Securities Illustration: KC is on a calendar-year basis, it accrues interest and amortizes the discount at December 31, 2009, as follows: December 31, 2009 Interest Receivable 4,000 Held-to-Maturity Securities 645 Interest Revenue 4,645 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  13. Held-to-Maturity Securities Reporting of Held-to-Maturity Securities Illustration 17-4 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  14. Held-to-Maturity Securities Illustration: Assume that KC Company sells its investment in Evermaster bonds on November 1, 2013, at 99,750 plus accrued interest. KC records this discount amortization as follows: November 1, 2013 Held-to-Maturity Securities 635 Interest Revenue 635 $952 x 4/6 = $635 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  15. Held-to-Maturity Securities Computation of the realized gain on sale. Illustration 17-5 Cash 102,417 Interest Revenue (4/6 x $4,000) 2,667 Held-to-Maturity Securities 99,683 Gain on Sale of Securities 67 LO 2

  16. Debt Securities Available-for-Sale Securities • Companies report available-for-sale securities at • fair value, with • unrealized holding gains and losses reported as part of comprehensive income (equity). Any discount or premium is amortized. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  17. Debt Securities Available-for-Sale Securities Illustration(Single Security): Graff Corporation purchases $100,000, 10 percent, five-year bonds on January 1, 2009, with interest payable on July 1 and January 1. The bonds sell for $108,111, which results in a bond premium of $8,111 and an effective interest rate of 8 percent. Graff records the purchase of the bonds on January 1, 2009, as follows. Available-for-Sale Securities 108,111 Cash 108,111 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  18. Debt Securities Available-for-Sale Securities Illustration 17-6 Schedule of Interest Revenue and Bond Premium Amortization— Effective-Interest Method LO 2

  19. Debt Securities Available-for-Sale Securities Illustration(Single Security): The entry to record interest revenue on July 1, 2009, is as follows. Cash 5,000 Available-for-Sale Securities 676 Interest Revenue 4,324 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  20. Debt Securities Available-for-Sale Securities Illustration(Single Security): At December 31, 2009, Graff makes the following entry to recognize interest revenue. Interest Receivable 5,000 Available-for-Sale Securities 703 Interest Revenue 4,297 Graff reports revenue for 2009 of $8,621 ($4,324 + $4,297). LO 2 Understand the procedures for discount and premium amortization on bond investments.

  21. Debt Securities Available-for-Sale Securities Illustration (Single Security): To apply the fair value method to these debt securities, assume that at year-end the fair value of the bonds is $105,000 and that the carrying amount of the investments is $106,732. Graff makes the following entry. Unrealized Holding Gain or Loss—Equity 1,732 Securities Fair Value Adjustment (AFS) 1,732 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  22. Debt Securities Available-for-Sale Securities Illustration(Portfolio of Securities): Webb Corporation has two debt securities classified as available-for-sale. The following illustration identifies the amortized cost, fair value, and the amount of the unrealized gain or loss. Illustration 17-7 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  23. Debt Securities Available-for-Sale Securities Illustration(Portfolio of Securities): Webb makes an adjusting entry to a valuation allowance on December 31, 2010 to record the decrease in value and to record the loss as follows. Unrealized Holding Gain or Loss—Equity 9,537 Securities Fair Value Adjustment (AFS) 9,537 Webb reports the unrealized holding loss of $9,537 as other comprehensive income and a reduction of stockholders’ equity. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  24. Debt Securities Available-for-Sale Securities Sale of Available-for-Sale Securities • If company sells bonds before maturity date: • Must make entry to remove the, • Cost in Available-for-Sale Securities and • Securities Fair Value Adjustment accounts. • Any realized gain or loss on sale is reported in the “Other expenses and losses” section of the income statement. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  25. Debt Securities Available-for-Sale Securities Illustration (Sale of Available-for-Sale Securities): Webb Corporation sold the Watson bonds (from Illustration 17-7) on July 1, 2011, for $90,000, at which time it had an amortized cost of $94,214. Illustration 17-8 Cash 90,000 Loss on Sale of Securities 4,214 Available-for-Sale Securities 94,214 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  26. Debt Securities Available-for-Sale Securities Illustration (Sale of Available-for-Sale Securities): Webb reports this realized loss in the “Other expenses and losses” section of the income statement. Assuming no other purchases and sales of bonds in 2011, Webb on December 31, 2011, prepares the information: Illustration 17-9 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  27. Debt Securities Available-for-Sale Securities Illustration (Sale of Available-for-Sale Securities): Webb records the following at December 31, 2011. Illustration 17-9 Securities Fair Value Adjustment (AFS) 4,537 Unrealized Holding Gain or Loss—Equity 4,537 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  28. Debt Securities Available-for-Sale Securities Financial Statement Presentation Illustration 17-10 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  29. Debt Securities Trading Securities • Companies report trading securities at • fair value, with • unrealized holding gains and losses reported as part of net income. Any discount or premium is amortized. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  30. Debt Securities Trading Securities Illustration: On December 31, 2010, Western Publishing Corporation determined its trading securities portfolio to be as follows: Illustration 17-11 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  31. Debt Securities Trading Securities Illustration: At December 31, Western Publishing makes an adjusting entry: Illustration 17-11 Securities Fair Value Adjustment (Trading) 3,750 Unrealized Holding Gain or Loss—Income 3,750 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  32. Debt Securities Trading Securities BE17-4:(Trading Securities) Hendricks Corporation purchased trading investment bonds for $50,000 at par. At December 31, Hendricks received annual interest of $2,000, and the fair value of the bonds was $47,400. Instructions: • Prepare the journal entry for the purchase of the investment. • Prepare the journal entry for the interest received. • Prepare the journal entry for the fair value adjustment. LO 2 Understand the procedures for discount and premium amortization on bond investments.

  33. Debt Securities Trading Securities BE17-4: Prepare the journal entries for (a) the purchase of the investment, (b) the interest received, and (c) the fair value adjustment. (a) Trading securities 50,000 Cash 50,000 (b) Cash 2,000 Interest revenue 2,000 (c) Unrealized Holding Loss - Income 2,600 Securities Fair Value Adj.- Trading 2,600 LO 2 Understand the procedures for discount and premium amortization on bond investments.

  34. Investments in Equity Securities • Represent ownership of capital stock. • Cost includes: • price of the security, plus • broker’s commissions and fees related to purchase. • The degree to which one corporation (investor)acquires an interest in the common stock of another corporation (investee)generally determines the accounting treatment for the investment subsequent to acquisition. LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  35. 0 --------------20% ------------ 50% -------------- 100% Investments in Equity Securities Ownership Percentages SFAS 141, SFAS 142 APBO 18, SFAS 142 SFAS 115 No significant influence usually exists Significant influence usually exists Control usually exists Investment valued using Fair ValueMethod Investment valued using Equity Method Investment valued on parent’s books using Cost Method or Equity Method(investment eliminated in Consolidation) LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  36. Investments in Equity Securities Accounting and Reporting for Equity Securities by Category Illustration 17-13 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  37. Holdings of Less Than 20% Accounting Subsequent to Acquisition Market Price Available Market Price Unavailable Value and report the investment using the fair value method. Value and report the investment using the cost method.* * Securities are reported at cost. Dividends are recognized when received and gains or losses only recognized on sale of securities. LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  38. Holdings of Less Than 20% Available-for-Sale Securities Upon acquisition, companies record available-for-sale securities at cost. Illustration:On November 3, 2010 Republic Corporation purchased common stock of three companies, each investment representing less than a 20 percent interest. LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  39. Holdings of Less Than 20% Available-for-Sale Securities Illustration: Republic records these investments on November 3, 2010, as follows. Available-for-Sale Securities 718,550 Cash 718,550 On December 6, 2010, Republic receives a cash dividend of $4,200 from Campbell Soup Co. Cash 4,200 Dividend revenue 4,200 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  40. Holdings of Less Than 20% Available-for-Sale Securities Illustration: Republic’s available-for-sale equity security portfolio on December 31, 2010: Illustration 17-14 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  41. Holdings of Less Than 20% Available-for-Sale Securities Illustration: On December 31, 2010, Republic records the net unrealized gains and losses related to changes in the fair value of available-for-Sale equity securities in an Unrealized Holding Gain or Loss—Equity account. Unrealized Holding Gain or Loss—Equity 35,550 Securities Fair Value Adjustment (AFS) 35,550 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  42. Holdings of Less Than 20% Available-for-Sale Securities Illustration: On January 23, 2011, Republic sold all of its Northwest Industries, Inc. common stock receiving net proceeds of $287,220. Illustration 17-15 Cash 287,220 Available-for-Sale Securities 259,700 Gain on Sale of Stock 27,520 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  43. Holdings of Less Than 20% Available-for-Sale Securities Illustration: On February 10, 2011, Republic purchased 20,000 shares of Continental Trucking at a price of $12.75 per share plus brokerage commissions of $1,850 (total cost, $256,850). Illustration 17-16 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  44. Holdings of Less Than 20% Available-for-Sale Securities Illustration 17-16 Illustration: Securities Fair Value Adjustment (AFS) 99,800 Unrealized Holding Gain or Loss—Equity 99,800 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  45. Holdings of Less Than 20% P17-6:McElroy Company has the following portfolio of securities at September 30, 2010, its last reporting date. On Oct. 10, 2010, the Horton shares were sold at a price of $54 per share. In addition, 3,000 shares of Patriot common stock were acquired at $54.50 per share on Nov. 2, 2010. The Dec. 31, 2010, fair values were: Monty $106,000, Patriot $132,000, and the Oakwood common $193,000. LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  46. Holdings of Less Than 20% P17-6:Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2010. Portfolio at September 30, 2010 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  47. Holdings of Less Than 20% P17-6:Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2010. October 10, 2010 (Horton): Cash (5,000 x $54) 270,000 Trading securities 215,000 Gain on sale 55,000 November 2, 2010 (Monty): Trading securities(3,000 x $54.50) 163,500 Cash 163,500 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  48. Holdings of Less Than 20% P17-6: Portfolio at December 31, 2010 December 31, 2010: Unrealized holding loss - Income 36,500 Securities fair value adj. - Trading 36,500 LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

  49. Holdings of Less Than 20% P17-6:How would the entries change if the securities were classified as available-for-sale? The entries would be the same except that the • Unrealized Holding Gain or Loss—Equity account is used instead of Unrealized Holding Gain or Loss—Income. • The unrealized holding loss would be deducted from the stockholders’ equity section rather than charged to the income statement. LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

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