1. 15 Investments and Fair Value Accounting
Principles of Financial Accounting, 11e
Reeve • Warren • Duchac

2. Describe why companies invest in debt and equity securities.1
Describe why companies invest in debt and equity securities.
15-4

3. Investing Cash in Current Operations1
Investing Cash in Current Operations
Cash may be used to replace worn out equipment or to purchase new, more efficient, and productive equipment. Cash may be reinvested in the company to expand its current operations. Cash may be used to pay suppliers or other creditors.

4. Investing Cash in Temporary Investments1
Investing Cash in Temporary Investments
Debt securities are notes and bonds that pay interest and have a fixed maturity date. Equity securities are preferred and common stock that represent ownership in a company and do not have a fixed maturity date.

5. Investing Cash in Temporary Investments1
Investing Cash in Temporary Investments
These debt securities and equity securities are termed Investments, or Temporary Investments, and are reported in the Current Assets section of the balance sheet.

6. Investing Cash in Long-Term Investments1
Investing Cash in Long-Term Investments
Long-term investments often involve the purchase of a significant portion of the stock of another company. Such investments have a strategic purpose:
Reduction of costs
Replacement of management
Expansion
Integration

7. Describe and illustrate the accounting for debt investments.2
Describe and illustrate the accounting for debt investments.
15-9

8. 2
Purchase of Bonds
Homer Company purchases $18,000 of U.S. Treasury bonds direct from a Federal Reserve Bank at their par value on March 17, 2010 (45 days after the last interest payment date). The bonds have an interest rate of 6%, payable on July 31 and January 31.
$18,000 × 6% × (45/360)

9. 2
Interest Revenue
On July 31, Homer Company receives a semiannual interest payment of $540 ($18,000 × 6% × ½).
($540 – $135) or [$18,000 × 6% × (135/360)]

10. 2
Accrued Interest
Homer Company’s accounting period ends on December 31. The following adjusted entry is required to record the accrued interest:
Homer Company would report Interest Revenue on its 2010 income statement at $855 ($405 + $450).

11. Semiannual Receipt of Interest2
Semiannual Receipt of Interest
Homer Company receives interest of $540 on January 31, Notice that Interest Receivable is credited for $450 to reflect this is a receivable from Interest Revenue of $90 is the interest earned from January 1 through January 31, 2011.

12. 2
Sale of Bonds
On January 31, 2011, Homer Company sells Treasury bonds at 98. The sale results in a loss of $360.
Proceeds from sale ($18,000 × 98%) $17,640
Less book value (cost) of the bonds 18,000
Loss on sale of bonds $(360)
Reported as part of Other Income (Loss) on the income statement

13. 2 Example Exercise 15-1 Bond Transactions
Journalize the entries to record the following selected bond investment transactions for Tyler Company:
Purchased for cash $40,000 of Tyler Company 10% bonds at 100 plus accrued interest of $320.
Received the first semiannual interest.
Sold $30,000 of the bonds at 102 plus accrued interest of $110.
15-15

14. 2 Follow My Example 15-1 For Practice: PE 15-1A, PE 15-1B 15-16
Example Exercise 15-1 (continued) 2
Follow My Example 15-1
Investments—Tyler Company Bonds…………………… 40,000
Interest Receivable…………………………………………. 320
Cash…………………………………………………….. 40,320
Cash ($40,000 × 10% × ½)………………………………….. 2,000
Interest Receivable…………………………………… 320
Interest Revenue……………………………………… 1,680
Cash [($30,000 × 102%) + $110 accrued interest]………. 30,710
Interest Revenue……………………………………… 110
Gain on Sale of Investments………………………
Investments—Tyler Company Bonds…………… ,000
For Practice: PE 15-1A, PE 15-1B
15-16

15. Describe and illustrate the accounting for equity investments.3
Describe and illustrate the accounting for equity investments.
15-17

16. Accounting for Equity Investments3
Accounting for Equity Investments
A company may invest in the preferred or common stock of another company. The company investing in another company’s stock is the investor. The company whose stock is purchased is the investee.

17. 3
Exhibit 1
Stock Investments

18. 3
Less Than 20% Ownership
Investments of less than 20% of the investee’s outstanding stock are accounted for by using the cost method.

19. Purchase of Stock (Cost Method)3
Purchase of Stock (Cost Method)
On May 1, Bart Company purchases 2,000 shares of Lisa Company common stock at $49.90 per share plus a brokerage fee of $200.

20. Receipt of Dividends (Cost Method)3
Receipt of Dividends (Cost Method)
On July 31, Bart Company receives a dividend of $0.40 per share from Lisa Company.
Dividend Revenue is reported as part of Other Income on Bart Company’s income statement.

21. Sale of Stock (Cost Method)3
Sale of Stock (Cost Method)
On September 1, Bart Company sells 1,500 shares of Lisa Company stock for $54.50 per share, less a $160 commission.
Proceeds from sale [(54.50 × 1,500 shares) – $160 $81,590
Book value (cost) of the stock ($100,000/2,000 shares) × 1, ,000
Gain on sale of investments $ 6,590

22. 3 Example Exercise 15-2 Stock Transactions
On September 1, 1,500 shares of Monroe Company are acquired at a price of $24 per share plus a $40 brokerage fee. On October 14, a $0.60 per share dividend was received on the Monroe Company stock. On November 11, 750 shares (half) of Monroe Company’s stock were sold for $20 per share, less a $45 brokerage fee. Prepare the journal entries for the original purchase, dividends, and sale.
15-24

23. 3 Follow My Example 15-2 For Practice: PE 15-2A, PE 15-2B 15-25
Example Exercise 15-2 (continued) 3
Follow My Example 15-2
Sept. 1 Investments—Monroe Company Stock……………. 36,040
Cash…………………………………………………. 36,040*
*(1,500 shares × $24 per share) + $40
Oct. 14 Cash ……………………………………………………….. 900
Dividend Revenue………………………………… 900*
*$0.60 per share × 1,500 shares
Nov. 11 Cash ……………………………………………………….. 14,955*
Loss on Sale of Investments………………………….. 3,065
Investments—Monroe Company Stock………. 18,020**
*(750 shares × $20) – $45
**$36,040 × 1/2
For Practice: PE 15-2A, PE 15-2B
15-25

24. Between 20% and 50% Ownership3
Between 20% and 50% Ownership
If the investor purchases between 20% and 50% of the outstanding stock of the investee, the investor is considered to have significant influence over the investee and the investment is accounted for using the equity method.

25. Purchase of Stock (Equity Method)3
Purchase of Stock (Equity Method)
Simpson Inc. purchased a 40% interest in Flanders Corporation’s common stock on January 2, 2010 for $350,000.

26. Recording Investee Net Income (Equity Method)3
Recording Investee Net Income (Equity Method)
For the year ending on December 31, 2010, Flanders Corporation reported net income of $105,000.
Income of Flanders Corporation, if significant, is reported as Other Income on Simpson Inc.’s income statement.

27. Recording Investee Dividends (Equity Method)3
Recording Investee Dividends (Equity Method)
During the year, Flanders declared and paid cash dividends of $45,000.

28. 3

29. Sale of Stock (Equity Method)3
Sale of Stock (Equity Method)
On January 1, 2011, Simpson Inc. sold Flanders Corporation’s stock for $400,000 a gain of $26,000 calculated as follows:
Proceeds from sale $400,000
Book value of stock investment 374,000
Gain on sale $ 26,000

30. 3 Example Exercise 15-3 Equity Method
On January 2, Olson Company acquired 35% of the outstanding stock of Bryant Company for $140,000. For the year ending December 31, Bryant Company earned income of $44,000 and paid dividends of $20,000. Prepare the entries for Olson Company for the purchase of the stock, share of Bryant income, and dividends received from Bryant Company.
15-32

31. 3 Follow My Example 15-3 For Practice: PE 15-3A, PE 15-3B 15-33
Example Exercise 15-3 (continued) 3
Follow My Example 15-3
Jan. 2 Investment in Bryant Company Stock.……………. 140,000
Cash…………………………………………………. 140,000
Dec. 31 Investment in Bryant Company Stock………………. 15,400*
Income of Bryant Company…………………… ,400
*Record 35% of Bryant income, 35% × $44,000
Dec. 31 Cash……………………………………………………….. 7,000*
Investment in Bryant Company Stock………… 7,000
*35% × $20,000
For Practice: PE 15-3A, PE 15-3B
15-33

32. 3
More Than 50% Ownership
If the investor purchases more than 50% of the outstanding stock of the investee, the investor is considered to have control over the investee. The purchase is termed a business consolidation.

33. 3
More Than 50% Ownership
A corporation owning all or a majority of the voting stock of another company is called a parent company. The corporation that is controlled is called the subsidiary company.

34. 4
Describe and illustrate valuing and reporting investments in the financial statements.
15-36

35. 4
Trading Securities
Trading securities are debt and equity securities that are purchased and sold to earn short-term profits from changes in their market prices.

36. 4
Maggie Company purchased a portfolio of trading securities during On December 31, 2009, the cost and fair values of the securities were as follows:

37. 4
The adjusting entry on December 31, 2009, to record the fair value of the securities is as follows:
The Unrealized Gain on Trading Investments, if significant, is reported on the income statement.

38. 4

39. 4
On September 10, 2010, Maggie Company purchases 300 shares of Zane Inc. as a trading security for $12 per share, including a brokerage commission.

40. 4
On December 31, 2010, the cost and fair valuation of the portfolio of trading securities are as follows:

41. 4
Based on the above analysis, the adjusting entry on December 31, 2010, is as follows:

42. Valuation Allowance for Trading Investments4
The valuation allowance for trading investments account after the December 31, 2010 adjusting entry, has a credit balance of $3,100.
Valuation Allowance for Trading Investments
2009
Dec. 31 Adj. 1,300
Dec. 31 Bal. 1,300
2010
Jan Bal. 1,300
Dec. 31 Adj. 4,400
Dec. 31 Bal. 3,100

43. 4

44. 4 Example Exercise 15-4 Valuing Trading Securities at Fair Value
On January 1, 2010, Valuation Allowance for Investments had a debit balance of $23,500. On December 31, 2010, the cost of the trading securities portfolio was $79,200, and the fair value was $95,000.
Prepare the December 31, 2010, adjusting journal entry to record the unrealized gain or loss on trading investments.
15-46

45. 4 Follow My Example 15-4 For Practice: PE 15-4A, PE 15-4B 15-47
Example Exercise 15-4 (continued) 4
Follow My Example 15-4
2010
Dec. 31 Unrealized Loss on Trading Investments………….. 7,700
Valuation Allowance for Trading Investments 7,700*
To record decrease in fair value of
trading investments.
Valuation allowance for trading investments, January 1, $23,500 Dr.
Trading investments at cost, December 31, 2010 $79,200
Trading investments at fair value, December 31, ,000
Valuation allowance for trading investments, December 31, ,800 Dr.
*Adjustment $ 7,700 Cr.
For Practice: PE 15-4A, PE 15-4B
15-47

46. Held-To-Maturity Securities4
Held-To-Maturity Securities
Held-to-maturity securities are debt investments, such as notes or bonds, that a company intends to hold until their maturity date.

47. Available-For-Sale Securities4
Available-For-Sale Securities
Available-for-sale securities are debt and equity securities that are not classified as trading or held-for-maturity securities.

48. 4
Maggie Company purchased securities during 2009 as available-for-sale securities instead of trading securities. On December 31, 2009, the cost and fair values of the securities are as follows:

49. 4
The adjusting entry on December 31, 2009, to record the fair value of the securities is as follows:

50. 4
A credit balance in Unrealized Gain (Loss) on Available-for-Sale Investments is added to stockholders’ equity, while a debit balance is subtracted from stockholders’ equity.

51. 4

52. 4
On September 10, 2010, Maggie Company purchases 300 shares of Zane Inc. as an available-for-sale security for $12 per share, including brokerage commission.

53. 4
On December 31, 2010, the cost and fair valuation of the portfolio of available-for-sale securities are as follows:

54. Calculating the Adjustment Amount for the Valuation Account4
Calculating the Adjustment Amount for the Valuation Account
Valuation allowance for
available-for-sale $1,300 Dr.
Available-for-sale investments at cost $27,600
Available-for-sale
investments at fair value 24,500
available-for-sale investments,
December 31, ,100 Cr.
Adjustment $4,400 Cr.

55. 4
Based on the calculations on Slide 56, the following December 31, 2010, adjusting entry should be made:

56. 4

57. 4
Example Exercise 15-5
Valuing Available-for-Sale Securities at Fair Value
On January 1, 2010, Valuation Allowance for Available-for-Sale Securities has a credit balance of $9,000. On December 31, 2010, the cost of the available-for-sale securities was $45,700 and the fair value was $37,200.
Prepare the adjusting journal entry to record the unrealized gain or loss for available-for-sale investments on December 31, 2010.
15-59

58. 4 Follow My Example 15-5 15-60 For Practice: PE 15-5A, PE 15-5B
Example Exercise 15-5 (continued) 4
Follow My Example 15-5
2010
Dec. 31 Valuation Allowance for Available-for-Sale
Investments 500*
Unrealized Gain (Loss) on Available-for-
Sale Investments 500
To record increase in fair value of
available-for-sale securities.
Valuation allowance for available-for-sale investments,
January 1, $9,000 Cr.
Available-for-sale investments at cost, December 31, 2010 $45,700
Available-for-sale investments at fair value, December 31, ,200
December 31, ,500 Cr.
*Adjustment $ Dr.
15-60
For Practice: PE 15-5A, PE 15-5B

59. 4
Exhibit 2
Summary of Valuing and Reporting Investments

60. 4

61. 4

62. Describe fair value accounting and its implications for the future.5
Describe fair value accounting and its implications for the future.
15-64

63. 5
Fair Value Accounting
Fair value is the price that would be received for selling an asset or paying off a liability. Fair value assumes that the asset is sold or the liability paid off under normal rather than under distress conditions.

64. Trends to Fair Value Accounting5
Trends to Fair Value Accounting
A current trend for the FASB and other accounting regulators is to adopt accounting principles using fair values for valuing and reporting assets and liabilities.

65. Trends to Fair Value Accounting5
Trends to Fair Value Accounting
Factors contributing to this trend include the following:
Current generally accepted accounting principles are a hybrid of varying measurement methods that often conflict with each other.
(continued)

66. 5
A greater percentage of the total assets of many companies consists of financial assets such as receivables and securities.
The world economy has created pressure on accounting regulators to adopt a worldwide set of accounting principles and standards.

67. Disadvantages of Fair Value Accounting5
Disadvantages of Fair Value Accounting
Several potential disadvantages include the following:
Fair value may not be readily obtainable for some assets or liabilities resulting in subjectivity.
(continued)

68. 5
Fair values make it more difficult to compare companies if companies use different methods of determining (measuring) fair values.
Using fair values will result in more fluctuations in accounting reports because fair values normally change from year to year.

69. 5
Effect of Fair Value Accounting on the Financial Statements—Balance Sheet
When an asset or liability is reported at its fair value, any difference between the asset’s original cost or prior period’s fair value must be recorded.
The unrealized gain or loss on changes in fair value must be recorded. One method reports these as part of stockholders’ equity.

70. 5
Effect of Fair Value Accounting on the Financial Statements—Income Statement
Instead of recording the unrealized gain or loss on changes in fair value as part of stockholders’ equity, the unrealized gains or losses may be reported on the income statement.

71. 5
Dividend Yield
The dividend yield indicates the rate of return to stockholders in terms of cash dividends distributed.
Dividend Yield =
Dividends per Share of Common Stock
Market Price per Share of Common Stock
Mattel:
Dividend Yield =
$0.75
$19.09
= 3.93%

72. Appendix 1: Accounting for Held-to-Maturity Investments
15-75

73. Prices of Bonds
If the bond rate of interest is more than the market rate of interest for equivalent investments, bonds are purchased at a premium.
If the bond rate of interest is less than the market rate of interest for equivalent investments, bonds are purchased at a discount.

74. Amortization of a Premium on a Bond Investment

75. Amortization of a Discount on a Bond Investment

76. Purchase of bonds on April 1, 2010.
Receipt of semiannual interest on October 1.
(continued)

77. Adjusting entry for accrued interest on December 31.
Adjusting entry for amortization of discount on December 31 using the straight-line method.
(continued)

78. The bonds mature on April 1, 2020.