1. ©CourseCollege.com 1 19 Investments Learning Objectives 1.Account for Trading Investments 2.Account for Debt Investments 3.Account for Stock Investments subject to the Fair Value method 4.Account for Stock Investments subject to the Equity method 5.Analysis: Compute and explain return on total assets Investments purchased can include debt (bonds) as well as stock issued by other firms

2. ©CourseCollege.com 2 Objective 19.1: Account for Trading Investments O19.1 Trading investments are short term investments by a firm in both debt and non-influential* equity securities issued by other firms. * Equity owned must be less than 20% of issuer Trading investments are defined as trading securities if the intent of management is to actively manage them through buying and selling to generate short term profits on changes in price

3. ©CourseCollege.com 3 BALANCE SHEET Investor Account for trading investments O19.1 BALANCE SHEET Issuer Bonds Stock Trading Investments Trading Investments both Debt (Bonds) and Equity (Stock)

4. ©CourseCollege.com 4 Accounting treatment of Trading Investments O19.1 1.Record at cost 2.Gains and losses from sale are reported on the Income Statement 3.Interest and cash dividends earned reported on Income Statement 4.Mark to market at end of period -unrealized gain or loss is reported on the Income Statement 5.Any discount or premium from face value of bonds is not amortized

5. ©CourseCollege.com 5 Accounting treatment of Trading Investments O19.1 Investments are initially recorded at total cost to acquire the asset 1

6. ©CourseCollege.com 6 Gains and losses from the actual sale of Trading Investments are reported on the Income Statement Accounting treatment of Trading Investments O19.1 2

7. ©CourseCollege.com 7 Accounting treatment of Trading Investments O19.1 Interest and cash dividends earned are reported on the Income Statement 3

8. ©CourseCollege.com 8 Accounting treatment of Trading Investments O19.1 End of period financial statement presentation requires trading investments to be adjusted to market values with any unrealized gain or loss reported on the Income Statement 4

9. ©CourseCollege.com 9 Accounting treatment of Trading Investments O19.1 Any discount or premium from face value of bonds is not amortized 5

10. ©CourseCollege.com 10 Accounting treatment of Trading Investments O19.1 Example –Tarpco Corporation (Investor) buys: 1,000 shares of Blitex common stock at $45 per share $50,000 of Blitex 7% bonds. Tarpco intends to manage these investments for short term profits and classifies them as trading securities. To the investor, Tarpco, Trading Investments are assets

11. ©CourseCollege.com 11 Accounting treatment of Trading Investments O19.1 On June 5, Tarpco sells 500 shares of Blitex common stock for $60 per share: The gain from the actual sale is reported on the Income Statement

12. ©CourseCollege.com 12 Trading Investments –mark to market O19.1 The unrealized gain is reported on the Income Statement

13. ©CourseCollege.com 13 Trading Investments –mark to market O19.1 The total value of Trading Investments is increased

14. ©CourseCollege.com 14 Objective 19.2: Account for Debt Investments O19.2 Debt Investments are short term and long term investments made by a firm in debt securities issued by other firms

15. ©CourseCollege.com 15 Account for Debt Investments O19.2 BALANCE SHEET Investor BALANCE SHEET Issuer Bonds Debt Investments both short and long term

16. ©CourseCollege.com 16 Account for Debt Investments O19.2 Classifications of Debt Investments Held to Maturity Available for Sale

17. ©CourseCollege.com 17 Account for Debt Investments O19.2 1)Investments are initially recorded at total cost to acquire the asset 2)Any discount or premium from face value of bonds is amortized 3)Gains and losses from the actual sale are reported on the Income Statement as is interest earned 4)No “mark to market” adjusting entry is made over their holding life 1)Investments are initially recorded at total cost to acquire the asset 2)Any discount or premium from face value of bonds is amortized 3)Gains and losses from the actual sale are reported on the Income Statement as is interest earned 4)No “mark to market” adjusting entry is made over their holding life Held to Maturity

18. ©CourseCollege.com 18 Account for Debt Investments O19.2 1)Investments are initially recorded at total cost to acquire the asset 2)Any discount or premium from face value of bonds is amortized 3)Gains and losses from their actual sale are reported on the Income Statement as is interest earned 4)End of period financial statement presentation requires them to be “marked to market” 5)Any unrealized gain or loss is reported directly to Stockholder’s Equity Available for Sale

19. ©CourseCollege.com 19 Example –Cusip Corporation buys: $1,000,000 of Aaa1 Corporation’s 10 year 6% bonds no premium or discount $500,000 of Baa2 Corporation’s 20 year 13% bonds no premium or discount Cusip Corp intends to hold the Aaa1 bonds until maturity and classifies them as Held to Maturity. The Baa2 bonds are classified as Available for Sale. Account for Debt Investments O19.2

20. ©CourseCollege.com 20 Account for Debt Investments O19.2 Note that these securities are recorded at cost which can costs include broker’s fees and other transaction Investments both short and long term

21. ©CourseCollege.com 21 On April 15, Cusip sells one half of Baa2 Corporation’s 13% bonds for 102. Recall there was no premium or discount, therefore the carrying value equals the face value on Cusip’s books. The proceeds from the sale are: $500,000 x 50% x 1.02 = $255,000. Journal entry follows: Account for Debt Investments O19.2

22. ©CourseCollege.com 22 Account for Debt Investments O19.2 The credit to Gain on Sale of Available for Sale Investments –Debt is a realized gain because the securities were actually sold.

23. ©CourseCollege.com 23 Account for Debt Investments O19.2 Cusip’s (FYE 6/30) prepares a worksheet to follow the “mark to market” rule for the Available for Sale Investments–Debt.

24. ©CourseCollege.com 24 Account for Debt Investments O19.2 Cusip’s market adjustment journalized below will cause a reduction in the recorded value of the Available for Sale Invesment –Debt The loss is unrealized, however the adjustment reduces Equity Equity account

25. ©CourseCollege.com 25 Account for Debt Investments O19.2 The Market Adjustment account is a separate companion account to the Available for Sale Investments –Debt account. The Unrealized Holding Loss recorded reduces Equity

26. ©CourseCollege.com 26 Account for Debt Investments O19.2 On September 1, Cusip received the first six month interest coupon on: $1,000,000 of Aaa1 Corporation’s 10 year 6% bonds $500,000 of Baa2 Corporation’s 20 year 13% bonds The interest calculation is: $1,000,000 x.06 / 2 = $30,000 for the Aaa1 Corp bonds and, $500,000 x.13 / 2 = $32,500 for the Baa2 Corp bonds. The interest calculation is: $1,000,000 x.06 / 2 = $30,000 for the Aaa1 Corp bonds and, $500,000 x.13 / 2 = $32,500 for the Baa2 Corp bonds.

27. ©CourseCollege.com 27 Objective 19.3: Account for Stock Investments subject to the Fair value method O19.3 Stock Investments are investments by a firm in stock issued by other firms. If the investor does not have significant influence over the management decisions of the Issuer, these investments are accounted for using the Fair value (market) method.

28. ©CourseCollege.com 28 Account for Stock Investments subject to the Fair value method O19.3 In general, ownership of less than 20% of the stock of the Issuer implies no significant influence. The market method requires these investments to be classified as Available for Sale and reported at fair or market values.

29. ©CourseCollege.com 29 Account for Stock Investments subject to the Fair value method O19.3 BALANCE SHEET Investor BALANCE SHEET Issuer Stock Investments of less than 20% of Issuer Stock

30. ©CourseCollege.com 30 Account for Stock Investments subject to the Fair value method O19.3 Stock Investments which do not give the Investor significant influence over the operations of the Issuer are classified as: Available for Sale –Stock In general, stock owned is< 20% of total outstanding stock of the Issuer

31. ©CourseCollege.com 31 Account for Stock Investments subject to the Fair value method O19.3 1)Investments recorded at total cost to acquire 2)Gains and losses from their actual sale are reported on the Income Statement as are cash dividends earned 3)End of period financial statement presentation requires them to be “marked to market” 4)Any unrealized gain or loss is reported directly to Stockholder’s Equity Available for Sale Stock < 20% of Issuer

32. ©CourseCollege.com 32 Account for Stock Investments subject to the Fair value method O19.3 Blue Note Corporation currently has 40,000 shares of common stock outstanding, therefore, Lemley does not have significant influence over Blue Note management. Therefore this investment is classified as Available for Sale and is accounted for using the fair (market) value method. Lemley Corporation’s (Investor) purchases 3,000 shares of Blue Note Corporation’s (Issuer) common stock at $52 per share.

33. ©CourseCollege.com 33 Account for Stock Investments subject to the Fair value method O19.3 On October 18, Lemley sells 1,000 shares of Blue Note Corporation stock for $58 per share. The proceeds from the sale are: 1,000 x $58 = $58,000. The cost of the shares sold is calculated at: 1,000 x $52 = $52,000. The proceeds from the sale are: 1,000 x $58 = $58,000. The cost of the shares sold is calculated at: 1,000 x $52 = $52,000.

34. ©CourseCollege.com 34 Account for Stock Investments subject to the Fair value method O19.3 Lemley’s fiscal year end is December 31. They continue to hold the remaining Stock Investments at that date. In the preparation of their fiscal year end financial statements they must follow the “mark to market” rule for the Available for Sale Investments–Stock

35. ©CourseCollege.com 35 Account for Stock Investments subject to the Fair value method O19.3 Lemley ‘s prepares a cost versus market worksheet for Available for Sale Investments–Stock

36. ©CourseCollege.com 36 Assets and Equity are increase by $12,000 Account for Stock Investments subject to the Fair value method O19.3

37. ©CourseCollege.com 37 The mark to market adjustment has no effect on the Income Statement Account for Stock Investments subject to the Fair value method O19.3

38. ©CourseCollege.com 38 Account for Stock Investments subject to the Fair value method O19.3 The firm reports $500 additional income In February, Lemley receives $500 cash dividends from Blue Note Corporation from Lemley’s ownership of Blue Note common stock

39. ©CourseCollege.com 39 Objective 19.4: Account for Stock investments subject to the Equity method O19.4 Stock Investments are investments by a firm in stock issued by other firms. If the investor does have significant influence over the management decisions of the Issuer, these investments are accounted for using the Equity method.

40. ©CourseCollege.com 40 Account for Stock Investments subject to the Equity method O19.3 In general: Ownership of 20% and greater of the stock of the Issuer implies significant influence. The Equity method must be used to account for these investments. In general: Ownership of 20% and greater of the stock of the Issuer implies significant influence. The Equity method must be used to account for these investments.

41. ©CourseCollege.com 41 Account for Stock Investments subject to the Equity method O19.3 Ownership greater than 50% implies control by the Investor over the Issuer. Consolidated (combined*) financial statements must be used to account for these investments. * A separate statement of the Investor could be prepared using the Equity method

42. ©CourseCollege.com 42 Account for Stock Investments subject to the Equity method O19.3 Where control exists (Greater than 50% ownership). Where control exists (Greater than 50% ownership). INVESTOR PARENT SUBSIDIARY ISSUER

43. ©CourseCollege.com 43 Account for Stock Investments subject to the Equity method O19.3 Ownership percentage determines accounting method* 20% 50% 100% 0% Fair Value Method Equity Method Consolidated Statements * In general, the percentage of outstanding stock of the Issuer owned by the Investor

44. ©CourseCollege.com 44 Account for Stock Investments subject to the Equity method O19.3 1)Investments recorded at total cost to acquire 2)Gains and losses from their actual sale are reported on the Income Statement 3)Cash dividends received are credited to investment asset 4)No mark to market 5)Investor’s share of issuer’s profits and losses are reported by the investor on the Income Statement appropriately increasing or decreasing the investment account Equity method investments with significant influence

45. ©CourseCollege.com 45 Account for Stock Investments subject to the Equity method O19.4 BALANCE SHEET Investor BALANCE SHEET Issuer Stock Investments of 20% and greater of Issuer* Stock * When ownership exceeds 50%, consolidated statements are required.

46. ©CourseCollege.com 46 Account for Stock Investments subject to the Equity method O19.4 Wise Corporation (Investor) purchased 60,000 shares of Old Town Corporation (Issuer) common stock at $26 per share Old Town currently has 200,000 shares of common stock outstanding (60/200 = 30%), therefore, Wise Corp does have significant influence over Old Town management. The cost to acquire the investment can include transaction costs

47. ©CourseCollege.com 47 Account for Stock Investments subject to the Equity method O19.4 On December 31 Old Town reports net income for the year of $156,000. Wise Corporation calculated their percentage increase in the Old Town Corp Stock Investment account is: $156,000 x 30% = $46,800 The investment increases and earnings are reported

48. ©CourseCollege.com 48 Account for Stock Investments subject to the Equity method O19.4 On March 31, Wise Corporation received a $6,000 dividend check from Old Town Corporation for dividends declared by Old Town’s Board of Directors The investment decreases with the receipt of dividends Why decrease?? Because we are following the Issuer’s Equity which also decreased with the payment of these dividends

49. ©CourseCollege.com 49 Account for Stock Investments subject to the Equity method O19.4 Wise Corp.’s updated ledger balance in the Old Town investment is shown below Wise Corp’s share of Old Town’s Earnings Wise Corp’s receives cash dividends from Old Town

50. ©CourseCollege.com 50 Account for Stock Investments subject to the Equity method O19.4 On April 3, Wise Corp sold 10,000 shares of Old Town Corporation stock for $27 per share. The proceeds from the sale are: 10,000 x $27 = $270,000. The cost of the share sold is calculated at: $1,600,800/60,000 x 10,000 shares = $266,800 On April 3, Wise Corp sold 10,000 shares of Old Town Corporation stock for $27 per share. The proceeds from the sale are: 10,000 x $27 = $270,000. The cost of the share sold is calculated at: $1,600,800/60,000 x 10,000 shares = $266,800 The Gain is realized, therefore it is reported on the Income Statement

51. ©CourseCollege.com 51 Account for Stock Investments subject to the Equity method O19.4 Wise Corp.’s updated ledger balance in the Old Town investment is shown below Sale of Old Town stock Remaining balance

52. ©CourseCollege.com 52 Objective 19.5: Analysis: Compute and explain return on total assets O19.5 Return on Total Assets =Net Income *Average Total Assets *Average Total Assets = Beginning of year Total Assets +End of year Total Assets 2 Return on total assets indicates how well managers are utilizing assets to produce income for the firm

53. ©CourseCollege.com 53 O19.5 Example –Return on total assets Valenzuela Company earned 3% on average assets in 2010

54. ©CourseCollege.com 54 End Unit 19