1. Financial Accounting, Sixth Edition
Chapter 13
Investments
Financial Accounting, Sixth Edition

2. Study Objectives
Discuss why corporations invest in debt and stock securities.
Explain the accounting for debt investments.
Explain the accounting for stock investments.
Describe the use of consolidated financial statements.
Indicate how debt and stock investments are reported in financial statements.
Distinguish between short-term and long-term investments.
1. On the topic, “Challenges Facing Financial Accounting,” what did the AICPA Special Committee on Financial Reporting suggest should be included in future financial statements?
Non-financial Measurements (customer satisfaction indexes, backlog information, and reject rates on goods purchases).
Forward-looking Information
Soft Assets (a company’s know-how, market dominance, marketing setup, well-trained employees, and brand image).
Timeliness (no real time financial information)

3. Investments Why Corporations Invest Accounting for Debt Investments
Accounting for Stock Investments
Valuing and Reporting Investments
Cash management
Investment income
Strategic reasons
Recording acquisition of bonds
Recording bond interest
Recording sale of bonds
Holdings of less than 20%
Holdings between 20% and 50%
Holdings of more than 50%
Categories of securities
Balance sheet presentation
Realized and unrealized gain or loss
Classified balance sheet
Service Cost - Actuaries compute service cost as the present value of the new benefits earned by employees during the year. Future salary levels considered in calculation.
Interest on Liability - Interest accrues each year on the PBO just as it does on any discounted debt.
Actual Return on Plan Assets - Increase in pension funds from interest, dividends, and realized and unrealized changes in the fair market value of the plan assets.
Amortization of Unrecognized Prior Service Cost - The cost of providing retroactive benefits is allocated to pension expense in the future, specifically to the remaining service-years of the affected employees.
Gain or Loss - Volatility in pension expense can be caused by sudden and large changes in the market value of plan assets and by changes in the projected benefit obligation. Two items comprise the gain or loss:
difference between the actual return and the expected return on plan assets and,
amortization of the unrecognized net gain or loss from previous periods

4. Why Corporations Invest
Corporations generally invest in debt or stock securities for one of three reasons.
Corporation may have excess cash.
To generate earnings from investment income.
For strategic reasons.
Illustration 13-1
Temporary investments and the operating cycle
SO 1 Discuss why corporations invest in debt and stock securities.

5. Why Corporations Invest
Question
Pension funds and banks regularly invest in debt and stock securities to:
house excess cash until needed.
generate earnings.
meet strategic goals.
avoid a takeover by disgruntled investors.
SO 1 Discuss why corporations invest in debt and stock securities.

6. Accounting for Debt Instruments
Recording Acquisition of Bonds
Cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any.
Recording Bond Interest
Calculate and record interest revenue based upon the face value of the bond times the interest rate times the portion of the year the bond is outstanding.
SO 2 Explain the accounting for debt investments.

7. Accounting for Debt Instruments
Recording Sale of Bonds
Credit the investment account for the cost of the bonds and record as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds.
SO 2 Explain the accounting for debt investments.

8. Accounting for Debt Instruments
Exercise: Issel Corporation had the following transactions pertaining to debt investments.
Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1.
July 1 Received semiannual interest on Hollis Co. bonds.
July 1 Sold 30 Hollis Co. bonds for $34,000 less $500 brokerage fees.
Instructions (a) Journalize the transactions. (b) Prepare the adjusting entry for the accrual of interest at December 31.
SO 2 Explain the accounting for debt investments.

9. Accounting for Debt Instruments
Exercise: Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1.
Jan 1
Debt investment 60,900 *
Cash 60,900
* ($60,000 + $900 = $60,900)
SO 2 Explain the accounting for debt investments.

10. Accounting for Debt Instruments
Exercise: July 1 Received semiannual interest on Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000 less $500 brokerage fees.
July 1
Cash 2,400 *
Interest revenue 2,400
Cash 33,500 **
Debt investments 30,450
***
Gain on sale 3,050
* ($60,000 x 8% x ½ = $2,400)
*** ($60,900 x ½ = $30,450)
** ($34,000 - $500 = $33,500)
SO 2 Explain the accounting for debt investments.

11. Accounting for Debt Instruments
Exercise: (b) Prepare the adjusting entry for the accrual of interest at December 31.
Dec 31
Interest receivable 1,200 *
Interest revenue 1,200
* ($30,000 x 8% x ½ = $1,200)
SO 2 Explain the accounting for debt investments.

12. Accounting for Debt Instruments
Question
An event related to an investment in debt securities that does not require a journal entry is:
acquisition of the debt investment.
receipt of interest revenue from the debt investment.
a change in the name of the firm issuing the debt securities.
sale of the debt investment.
SO 2 Explain the accounting for debt investments.

13. Accounting for Debt Instruments
Question
When bonds are sold, the gain or loss on sale is the difference between the:
sales price and the cost of the bonds.
net proceeds and the cost of the bonds.
sales price and the market value of the bonds.
net proceeds and the market value of the bonds.
SO 2 Explain the accounting for debt investments.

14. Accounting for Stock Investments
Ownership Percentages
% % %
No significant influence usually exists
Significant influence usually exists
Control usually exists
Investment valued using Cost Method
Investment valued using Equity Method
Investment valued on parent’s books using Cost Method or Equity Method (investment eliminated in Consolidation)
Fair Value – next slide
Equity Method -
The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation.
SO 3 Explain the accounting for stock investments.

15. Holdings of Less than 20% Cost Method
Cost includes all expenditures necessary to acquire investment, such as price paid plus brokerage fees (commissions).
Revenue recognized only when cash dividends are received.
SO 3 Explain the accounting for stock investments.

16. Holdings of Less than 20%
Exercise: Dossett Company had the following transactions pertaining to stock investments.
Feb. 1 Purchased 800 shares of Hippo common stock (2%) for $8,000 cash, plus brokerage fees of $200.
July 1 Received cash dividends of $1 per share on Hippo common stock.
Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100.
Instructions: Journalize the transactions.
SO 3 Explain the accounting for stock investments.

17. Holdings of Less than 20%
Exercise: Feb. 1 Purchased 800 shares of Hippo common stock (2%) for $8,000 cash, plus brokerage fees of $200. July 1 Received cash dividends of $1 per share on Hippo common stock.
Feb. 1
Stock investments 8,200 *
Cash 8,200
July 1
Cash 800 **
Dividend revenue 800
* ($8,000 + $200 = $8,200)
** (800 x $1 = $800)
SO 3 Explain the accounting for stock investments.

18. Holdings of Less than 20%
Exercise: Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100.
Sept. 1
Cash 4,300 *
Stock investments 3,075 **
Gain on sale 1,225
* ($4,400 - $100 = $4,300)
** ($8,200 x 3/8 = $3,075)
SO 3 Explain the accounting for stock investments.

19. Holdings Between 20% and 50%
Equity Method
Record investment at cost and subsequently adjust amount each period for
investor’s proportionate share of earnings (losses) and
dividends received by investor.
If investor’s share of investee’s losses exceeds carrying amount of investment, investor ordinarily should discontinue applying the equity method.
SO 3 Explain the accounting for stock investments.

20. Question Holdings Between 20% and 50%
Under the equity method, the investor records dividends received by crediting:
Dividend Revenue.
Investment Income.
Revenue from Investment.
Stock Investments.
SO 3 Explain the accounting for stock investments.

21. Holdings Between 20% and 50%
Exercise: (Equity Method) On January 1, 2007, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000.
Instructions
Prepare entries for Pennington to record purchase and any additional entries related to this investment in Edwards Company in 2007.
SO 3 Explain the accounting for stock investments.

22. Holdings Between 20% and 50%
Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20,000.
Stock investments 180,000
Cash 180,000
Stock investments 24,000
Investment revenue 24,000
($80,000 x 30%)
Cash 6,000
Stock investments 6,000
($20,000 x 30%)
SO 3 Explain the accounting for stock investments.

23. Holdings Between 20% and 50%
Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20,000.
After Pennington posts the transactions for the year, its investment and revenue accounts will show the following.
Stock Investments
Investment Revenue
Debit
Credit
Debit
Credit
180,000
24,000
24,000
6,000
198,000
SO 3 Explain the accounting for stock investments.

24. Holdings of More Than 50%
Controlling Interest - When one corporation acquires a voting interest of more than 50 percent in another corporation
Investor is referred to as the parent.
Investee is referred to as the subsidiary.
Investment in the subsidiary is reported on parent’s books as a long-term investment.
Parent generally prepares consolidated financial statements.
SO 4 Describe the use of consolidated financial statements.

25. Valuing and Reporting Investments
Categories of Securities
Debt and stock investments:
Trading securities
Available-for-sale securities
Held-to-maturity securities
Applies to all debt securities and all stock investments in which the holdings are less than 20%.
SO 5 Indicate how debt and stock investments are reported in financial statements.

26. Valuing and Reporting Investments
Trading Securities
Held with intention of selling in a short period.
Trading means frequent buying and selling.
Report at fair value, and report changes from cost as part of net income.
SO 5 Indicate how debt and stock investments are reported in financial statements.

27. Valuing and Reporting Investments
Available-for-Sale Securities
Held with intent of selling sometime in the future.
Classified as current assets or as long-term assets, depending on intent of management.
Report at fair value, and report changes from cost as a component of stockholders’ equity section.
SO 5 Indicate how debt and stock investments are reported in financial statements.

28. Question Valuing and Reporting Investments
Marketable securities bought and held primarily for sale in the near term are classified as:
available-for-sale securities.
held-to-maturity securities.
stock securities.
trading securities
SO 5 Indicate how debt and stock investments are reported in financial statements.

29. Trading Securities
Problem: Loxley Company has the following portfolio of securities at September 30, 2007, its last reporting date.
On Oct. 10, 2007, the Fogelberg shares were sold at a price of $54 per share. In addition, 3,000 shares of Los Tigres common stock were acquired at $59.50 per share on Nov. 2, The Dec. 31, 2007, fair values were: Petra $96,000, Los Tigres $132,000, and the Weisberg common $193,000.
SO 5 Indicate how debt and stock investments are reported in financial statements.

30. Trading Securities
Problem: Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2007.
Portfolio at September 30, 2007
Market Adjustment – Trading (account balance) ($19,000)
SO 5 Indicate how debt and stock investments are reported in financial statements.

31. Trading Securities
Problem: On Oct. 10, the Fogelberg shares were sold at a $54 per share. In addition, 3,000 shares of Los Tigres common stock were acquired at $59.50 per share on Nov. 2.
October 10, 2007 (Fogelberg):
Cash (5,000 x $54) 270,000
Trading securities 225,000
Gain on sale 45,000
November 2, 2007 (Los Tigres):
Trading securities (3,000 x $59.50) 178,500
Cash 178,500
SO 5 Indicate how debt and stock investments are reported in financial statements.

32. Trading Securities Problem: Portfolio at December 31, 2007
Unrealized loss - Income 51,500
Market adjustment - Trading 51,500
SO 5 Indicate how debt and stock investments are reported in financial statements.

33. Available-for-Sale Securities
Problem: How would the entries change if the securities were classified as available-for-sale?
The entries would be the same except that the
Unrealized Gain or Loss—Equity account is used instead of Unrealized Gain or Loss—Income.
Unrealized loss would be deducted from stockholders’ equity rather than charged to the income statement.
SO 5 Indicate how debt and stock investments are reported in financial statements.

34. Question Available-for-Sale Securities
An unrealized loss on available-for-sale securities is:
reported under Other Expenses and Losses in the income statement.
closed-out at the end of the accounting period.
reported as a separate component of stockholders' equity.
deducted from the cost of the investment.
SO 5 Indicate how debt and stock investments are reported in financial statements.

35. Balance Sheet Presentation
Short-Term Investments
Also called marketable securities, are securities held by a company that are
readily marketable and
intended to be converted into cash within the next year or operating cycle, whichever is longer.
Investments that do not meet both criteria are classified as long-term investments.
SO 6 Distinguish between short-term and long-term investments.

36. Balance Sheet Presentation
Realized and Unrealized Gain or Loss
Nonoperating items related to investments (reported in the income statement).
Illustration 13-10
SO 6 Distinguish between short-term and long-term investments.

37. Balance Sheet Presentation
Realized and Unrealized Gain or Loss
Unrealized gain or loss on available-for-sale securities are reported as a separate component of stockholders’ equity.
Illustration 13-11
SO 6 Distinguish between short-term and long-term investments.

38. Balance Sheet Presentation
Classified Balance Sheet
Illustration 13-12
SO 6 Distinguish between short-term and long-term investments.

39. All About You A Good Day to Start Saving
When is a good time to get serious about saving?
Some Facts:
Only about 48% of people in their twenties whose employers have a 401(k) plan participate in that plan.
Only 40% of working couples currently are covered by pension plans, but 61% of workers expect to get income from a company pension plan.

40. All About You A Good Day to Start Saving
When is a good time to get serious about saving?
More Facts:
More than half of workers age 55 and older have less than $50,000 in retirement savings.
80% of individuals between the ages of 18 to 26 said that, if given $10,000, they would deposit the money into a traditional bank savings account rather than invest in the stock market.

41. All About You
When you are 25 years old, if you start putting $300 per month into an investment earning 8%, by the age of 65 you will have accumulated more than $1 million.

42. All About You What Do You Think?
You’ve got $3,000 in credit card bills at an 18% interest rate. Your employer has a 401(k) plan in which it will match your contributions, up to 10% of your annual salary. Should you pay off your credit card bills before you start putting money into the 401(k)?
Paying off debt, thus avoiding 18% interest payments, is essentially equivalent to earning 18% on investments. Reducing your debts reduces your financial vulnerability.
Take part of the money you would have used to pay off your debt each month and instead put it into the 401(k). X

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