Investments

1. Investments 12

2. Bonds and notes (Debt securities) Common and preferred stock (Equity securities) Accounting for Investment Securities Investments can be accounted for in a variety of ways, depending on the nature of the investment relationship.

3. Reporting Categories for Investments

4. Learning Objectives Demonstrate how to identify and account for investments classified for reporting purposes as held to maturity. LO1

5. Reporting Categories for Investments Held-to-maturity (HTM) securities are investments in debt the investor intends and has the ability to hold until they mature. Securities available for sale (SAS) are expected to be held for an unspecified period of time. Trading securities (TS) are bought and held primarily to be sold in the near term.

6. $885,301 × (12% ÷ 2) = $53,118 Securities to Be Held to Maturity On January 1, 2006, Matrix, Inc. purchased as an investment $1,000,000, of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%, so Matrix paid $885,301 for the bonds. Let’s look at the required journal entries.

7. $114,699 - $3,118 = $111,581 unamortized discount Securities to Be Held to Maturity On January 1, 2006, Matrix, Inc. purchased as an investment $1,000,000, of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%, so Matrix paid $885,301 for the bonds. Let’s look at the required journal entries.

8. When an investment is held for an unspecified period of time, it is reported at the fair valueof the security on the reporting date. Investments Held for an Unspecified Period of Time . Otherwise, the investment is reported at cost. Must be “readily determinable”

9. Learning Objectives Demonstrate how to identify and account for investments classified for reporting purposes as available-for-sale. LO2

10. 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 “Net Unrealized Holding Gains/Losses”. Securities Available-for-Sale

11. Matrix, Inc. purchased the securities listed below in 2006. They are classified as Securities Available for Sale (SAS). The fair value of the securities were determined on December 31, 2006. Prepare the journal entries for Matrix, Inc. to adjust the securities to fair value at December 31, 2006. Securities Available for Sale Example

12. This net unrealized holding gain is reported as an allowance in the equity section of the balance sheet. Securities Available for Sale Example .

13. Other Comprehensive Income When we add other comprehensive income to net income we refer to the result as “comprehensive income.”

14. Securities Available for Sale Accumulated other comprehensive income from securities available-for-saleare reported in the equity section of the balance sheet as part of Accumulated other comprehensive income.

15. Securities Available for Sale This is called . . . Occasionally, an investment’s value will decline for reasons that are “other than temporary”. Impairment of Value

16. 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. The new cost basis (the impaired fair value) is not changed for subsequent recoveries in fair value.

17. Learning Objectives Demonstrate how to identify and account for investments classified for reporting purposes as trading securities. LO3

18. 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. Trading Securities Gains Losses Income Statement

19. Matrix, Inc. purchased the addition securities classified as Trading Securities (TS) in 2006. The fair value amounts were determined on December 31, 2006. Prepare the journal entries for Matrix, Inc. to adjust the securities to fair value at 12/31/06. Trading Securities

20. Trading Securities The Net Unrealized Holding Loss is reported on the Income Statement.

21. Trading Securities Unrealized holding gains and losses from trading securities are reported on the income statement.

22. Transfers Between Reporting Categories Transfers are accounted for atfair valueon the transfer date. 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.

23. Disclosures Gross Realized & Unrealized Holding Gains & Losses Aggregate Fair Value maturities of debt securities The change in net unrealized holding gains & losses Amortized cost basis by major security type

24. Learning Objectives Explain what constitutes significant influence by the investor over the operating and financial policies of the investee. LO4

26. The cost method is used for investments in equity securities when significant influence is not present. The equity method is used for investments in equity securities resulting in significant influence (20%-50%). When an investment results in thecontrolof the investee (generally> 50%), the subsidiary isconsolidatedwith the parent company.

27. Learning Objectives Understand the way investments are recorded and reported by the equity method. LO5

28. The investment account is increased by: Original investment cost. Proportionate share of investee's earnings. The investment account is decreasedby: Dividends received. Equity Method

29. Equity Method • The investment account is reported on the balance sheet as a single amount. • The investor’s share of the investee’s earnings from date of acquisition is reported as a single item on the investor’s income statement.

30. On January 1, 2006, Matrix, Inc. acquired 45% of the equity securities of Apex, Inc. for $1,350,000. On the acquisition date, Apex’s net assets had a fair value of $3,000,000. During 2006, Apex cash paid dividends of $150,000 and reported net income of $1,750,000. What amount will Matrix, Inc. report on the balance sheet as Investment in Apex, Inc.? Equity Method

31. Equity Method

32. Equity Method

33. Equity Method Investment in Apex, Inc. Investment 1,350,000 67,500 45% Dividends 45% Earnings 787,500 Reported amount 2,070,000 If the subsidiary had a loss, the investment account would have been reduced.

34. Learning Objectives Explain the adjustments made in the equity method when the fair value of the net assets underlying an investment exceeds their book value at acquisition. LO6

35. 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 ASSETS. Equity Method

36. Equity Method On January 1, 2006, Matrix, Inc. purchase 25% of the common stock of Apex, Inc. for $200,000. At the date of acquisition, the book value of the net assets of Apex was $480,000, and the net fair value of these assets is $600,000. During 2006, Apex paid cash dividends of $40,000, and reported earnings of $100,000. Let’s prepare the journal entries to reflect the acquisition and other events during 2006.

37. Equity Method Assume that of the $50,000 excess of purchase price over fair value of the net asset acquired, 75% is attributable to depreciable assets with a remaining life of 20 years and the remainder is considered goodwill. Matrix uses the straight-line method of depreciation on similar owned assets.

38. Equity Method Remember, goodwill is not amortized.

39. At the transfer date, the carrying value of the investment under the equity method is regarded as cost. Changing From Equity To Cost When the investor’s level of influence changes, it may be necessary to change from the equity method to another method.

40. 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. Changing From Equity To Cost

41. When ownership level increases to a significant influence, the investor may 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. Changing From Cost To Equity

42. 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. Changing From Cost To Equity

43. Financial Instruments & Derivatives Financial Instruments: Cash. Evidence of an ownership interest in an entity. Contracts meeting certain conditions. Derivatives: Hedges created to offset risks created by other financial investments or transactions. Value is derived from other securities.

44. Other Investments Appendix 12A

45. Special Purpose Funds • It is often convenient for companies to set aside money to be used for specific purposes. In the short-term funds may be set aside for • Petty cash funds. • Payroll accounts. • In the long-run funds are often set aside to: • Pay long-term debt when it comes due. • Acquire treasury stock. • Special purpose funds set aside for the long-term are classified as investments.

46. Investment in Life Insurance Policies It is a common practice for companies to purchase life insurance policies on key officers. The company pays the premium and is the beneficiary of the policy. If the officer dies the company receives the proceeds from the policy. Some types of policies build a portion of each premium as cash surrender value. The cash surrender value of such a policy is classified as an investment on the balance sheet of the company.

47. Impairment of a Receivable Due to a Troubled Debt Restructuring Appendix 12B

48. When the Receivable is Settled Outright When the original terms of a debt agreement are changed as a result of financial difficulties experienced by the debtor, the new arrangement is referred to as a troubled debt restructuring. Sometimes a troubled debt is settled in full when the debtor transfers to the creditor assets or equities. The creditor usually recognized a loss on the settlement. Such a settlement is not considered unusual or infrequent and is not an extraordinary item.

49. When the Receivable is Settled Outright Creditor, Inc. is owed $1,000,000 by Debtor Company. Because of financial difficulties, Debtor Company is unable to pay the $1,000,000 due or the accrued interest of $42,500. Creditor, Inc. agrees to accept a parcel of land with a fair market value of $615,000 in full settlement of the debt and the accrued interest.

50. When the Receivable is Continued, But with Modified Terms Creditor, Inc. is owed $1,000,000 by Debtor Company. Because of financial difficulties, Debtor Company is unable to pay the $1,000,000 due or the accrued interest of $42,500. Creditor, Inc. agrees to forgive the accrued interest of $42,500, and reduce the principal amount to $800,000. Interest of $40,000 is due at the end of each year and the principal amount is due in full at the end of five years. Creditor discounts future cash inflows at 6%.