1. 4/20/2017
Chapter 12
Investments

2. 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%).

3. 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

4. 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.

5. 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:

6. Acquisition of Bonds (contd.)
12/1/x7 Investment in bonds ,000
Cash ,000
Purchase of 80 Creative bonds
12/31/07 Interest Receivable
Interest Revenue
Record the one-month accrued interest
$80,000x 6% x 1/12
Short-Term Investments & Receivables

7. Acquisition of Bonds (contd.)
6/1/x8 CGS collects the 6-month interest:
Cash 2,400
Interest Receivable
Interest Revenue ,000
Short-Term Investments & Receivables

8. L-T Investments and International Operations
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

9. 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

10. Acquisition of Stock (Holdings of Less than 20%) – An Example
4/20/2017
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.

11. 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

12. 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.

13. 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

14. 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

15. 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

16. Example A: Assume that Camp Corp
Example A: Assume that Camp Corp. acquired the following securities on 1/1/x9
Shares $ per share
A. Company’s common stock 100 $50
B. Company’s common stock 300 $80
C. Company’s preferred stock 200 $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.

17. L-T Investments and International Operations
Example A (contd.)
1/1/x9 Initial recording
Investment in stock -Trading 68,000 *
Cash 68,000
* Cost = 100 x x x ,000 = 68,000
6/30/x9
Cash 750
Interest Revenue 750
12/31/x9
Assuming Kent received $1,000 of dividends in 20x9:
Cash 1,000
Dividends Revenue 1,000
L-T Investments and International Operations

18. 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 -Income 3,000
To record unrealized gain on trading securities
*reported in the income statement of 20x9

19. Balance Sheet Presentation Balance Sheet 12/31/x9
Assets
Investments -
Trading Securities
(at market value) $71,000
Liabilities .
Stockholders’ Equity
L-T Investments and International Operations

20. Example B: Assume that Camp Corp
Example B: Assume that Camp Corp. acquired the following securities on 1/1/x9
Shares $ per share
A. Company’s common stock 100 $50
B. Company’s common stock 300 $80
C. Company’s preferred stock 200 $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 securities by Camp Corp.

21. L-T Investments and International Operations
Example B (contd.)
1/1/x9 Initial recording
Investment in stock –Available-for-Sale ,000
Cash ,000
6/30/x9
Cash 750
Interest Revenue 750
12/31/x9
Assuming Kent received $1,000 of dividends in 20x9:
Cash 1,000
Dividends Revenue 1,000
L-T Investments and International Operations

22. 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 ,000
To record unrealized gain on avail.-for-sale securities
*reported in the balance sheet of 20x9

23. Balance Sheet Presentation Balance Sheet 12/31/x9
Assets
Investments -
Available-for-Sale $71,000
Liabilities .
Stockholders’ Equity
Unrealized gain on
investments 3,000
L-T Investments and International Operations

24. 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
Investment 3,000
Less income tax (40%) (1,200) $1,800
Comprehensive Income … $XXX
L-T Investments and International Operations

25. 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)
Other Revenue and Gains
Other Expenses and Losses
Interest Revenue
Dividend Revenue
Gain on Sale of Investments
Loss on Sale of Investments
Unrealized Gain – Income
Unrealized Loss - Income

26. L-T Investments and International Operations
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 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

27. 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

28. Example C : Held-to-Maturity
Assume that Emey Corp. purchases $100,000 of GNC 9% bonds on 7/1/20x1 at 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,
Investments in Bonds 100,000
Cash 99,000
Discount on Investment in Bonds 1,000
L-T Investments and International Operations

29. 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

30. 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
Cash 4,500
Interest Revenue 4,500
To recognize interest revenue for 6 months.
Discount on Investment in Bonds 100
Interest Revenue 100
To amortize discount on bond investment for 6 months.
L-T Investments and International Operations

31. L-T Investments and International Operations
Example E (contd.)
7/1/x2
Cash 4,500
Int. Revenue 4,500
To receive semiannual interest.
Discount on Investment in Bonds 100
Interest Revenue 100
To amortize discount for six months. .
L-T Investments and International Operations

32. 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

33. 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

34. 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

35. 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

36. 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

37. 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

38. 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

39. Equity Method Example (contd.)
To record the investment on 1/1/x9:
Investment in stock 125,000
Cash 125,000
2. To record the receipt of dividends on 3/28/x9:
Cash (20,000 x 25%) 5,000
Investment in stock ,000
L-T Investments and International Operations

40. 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 Revenue 20,250
L-T Investments and International Operations

41. Presentation on the B/S and I/S:
Balance Sheet
12/31/x9
Assets
Investment in Sam’s stock, at equity 140,250
Income Statement
for the year ended 12/31/x9
Other Revenue:
Investment Revenue 20,250
L-T Investments and International Operations

42. 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

43. 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.
Cash 30,000
Investment in stock 28,050 *
Gain on Sale of Investment 1,950
* 140,250 x 20% = 28,050
L-T Investments and International Operations

44. 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

45. 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

46. 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

47. 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

48. 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

49. 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

50. 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