1. 1 Financial Accounting: Tools for Business Decision Making, 2nd Ed. Kimmel, Weygandt, Kieso ELS

2. Appendix D `

3. 3 Chapter 12 Reporting and Analyzing Investments After studying Chapter 12, you should be able to: zIdentify the reasons corporations invest in stocks and debt securities. zExplain the accounting for debt investments. zExplain the accounting for stock investments. zDescribe the purpose and usefulness of consolidated financial statements.

4. 4 After studying chapter 12, you should be able to: zIndicate how debt and stock investments are valued and reported in the financial statements. zDistinguish between short-term and long-term investments. Chapter 12 Reporting and Analyzing Investments

5. Temporary Investments and the Operating Cycle Illustration 12-1

6. Reasons Companies Invest... Illustration 12-2

7. 7 Vertical and Horizontal Acquisition zVertical acquisition would occur if Nike purchased a chain of athletic shoe stores. zHorizontal acquisition would occur if Nike purchased Reebok.

8. 8 Debt Investments... zAre investments in government and corporation bonds. zIn accounting for debt investments, entries are required to record: ythe acquisition ythe interest revenue ythe sale zAre recorded at cost including brokerage fees.

9. 9 Debt Investments Kuhl Corporation acquires 50 Doan, Inc. 12%, 10-year, $1,000 on Jan. 1 for $54,000. Jan 1Debt investments 54,000 Cash54,000 To record purchase of 50 Doan, Inc. bonds

10. 10 Bond Interest zThe bonds pay interest of $3,000 semiannually on July 1 and January 1. zThe entry to record the receipt of interest on July 1 is: July 1Cash3,000 Interest Revenue 3,000 (To record receipt of interest on Doan Inc. bonds)

11. 11 Accrued Bond Interest zIf the buyer’s (Kuhl) fiscal year ends on December 31, the following adjusting entry is needed to accrue interest of $3,000 earned since July 1: Dec. 31 Interest Receivable3,000 Interest Revenue3,000 (To accrue interest on Doan Inc. bonds)

12. 12 Bond Interest zInterest Receivable is reported as a current asset in the balance sheet. zInterest Revenue is reported under Other Revenues and Gains in the income statement. zWhen the interest is received on January 1, the entry is: Jan. 1Cash3,000 Interest Receivable 3,000 (To record receipt of accrued interest)

13. 13 Sale of Bonds zKuhl sells the bonds for $58,000 on January 1, 2002, after receiving the interest due. *The bonds were purchased for $54,000. zKuhl must record a gain of $4,000. The entry to record the sale of the bonds is as follows: 1/1 Cash58,000 Debt Investments 54,000 Gain on sale of Debt Investments 4,000 (To record sale of Doan Inc. bonds)

14. 14 Stock Investments... zAre investments in the capital stock of corporations.  When a company holds stock and/or debt of several different corporations, the group of securities is identified as an investment portfolio. zThe accounting for investments in common stock is based on the extent of the investor's influence over the operating and financial affairs of the issuing corporation (the investee).

15. 15 Stock Investments Factors to consider in determining an investor's influence are whether : (1) the investor has representation on the investee's board of directors. (2) the investor participates in the investee's policy-making process. (3) there are material transactions between the investor and the investee. (4) the common stock held by other stockholders is concentrated or dispersed.

16. Accounting Guidelines - Stock Investments Illustration 12-3

17. 17 Cost Method zUnder the cost method, the investment is recorded at cost, and revenue is recognized only when cash dividends are received. zCost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any.

18. 18 Acquisition of Stock On July 1, 2001, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock at $40 per share plus brokerage fees of $500. July 1Stock Investments 40,500 Cash40,500 (To record purchase of 1,000 shares of Beal common stock)

19. 19 Recording Dividends A $2.00 per share dividend is received by Sanchez Corporation on December 31: Dec. 31Cash (1,000 x $2)2,000 Dividend Revenue 2,000 (To record receipt of cash dividend )

20. 20 Sale of Stock When stock is sold, the difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the stock is recognized as a gain or a loss.

21. 21 Sale of Stock zSanchez Corporation receives net proceeds of $39,500 on the sale of its Beal Corporation stock on February 10, 2002. zSince the stock cost $40,500, a loss of $1,000 has been incurred. 1/1 Cash39,500 Loss on Sale of Stock Investments 1,000 Stock Investments 40,500 (To record sale of Beal common stock)

22. 22 Sale of Stock zA loss would be reported under Other Expenses and Losses in the income statement. zA gain on a sale would be shown under Other Revenues and Gains.

23. 23 Equity Method... Is an accounting method in which the investment in common stock is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee.

24. 24 Equity Method Failure to recognize the investors share of net income until a cash dividend is declared ignores the fact that the investor and investee are, in some sense, one company.

25. 25 Acquisition of Stock zMilar Corporation acquires 30% of the common stock of Beck Company of $120,000 on January 1,2001. Jan. 1 Stock Investments 120,000 Cash120,000 (To record purchase of Beck common stock)

26. 26 Revenue and Dividends zFor 2001 Beck reports net income of $100,000 and declares and pays a $40,000 cash dividend. zMilar is required to record: (1) its share of Beck's income, $30,000 (100,000 x 30%), and (2) the reduction in the investment account for the dividends received, $12,000 ($40,000 x 30%).

27. 27 Revenue and Dividends 12/31 Stock Investments30,000 Revenue from Investment in Beck Company 30,000 To record 30% equity in Beck's 1998 net income 12/31 Cash 12,000 Stock Investments12,000 (To record dividends received) During the year the investment account has increased by $18,000 ($30,000 - $12,000).

28. 28 Holdings of More than 50% zA company that owns more than 50% of the common stock of another entity is known as the parent company. zThe entity whose stock is owned by the parent company is called the subsidiary (affiliated) company.

29. 29 Consolidated Financial Statements... zAre usually prepared when a company owns more than 50% of the common stock of another. zPresent the assets and liabilities controlled by the parent company and the aggregate profitability of the subsidiary companies. zAre prepared in addition to the financial statements for each of the individual parent and subsidiary companies. zAre useful to the stockholders, board of directors, and management of the parent company. zInform creditors, prospective investors, and regulatory agencies as to the magnitude and scope of operations of the companies under common control.

30. 30 Valuation And Reporting Of Investments zMany argue that fair value - the amount for which a security could be sold in a normal market - offers the best approach because it represents the expected cash realizable value of securities. zOthers contend that unless a security is going to be sold soon, the fair value is not relevant because the price of the security will likely change again.

31. 31 Valuation And Reporting Of Investments Debt and stock investments are classified into the following three categories: êTrading securities ê Available-for-sale securities ê Held-to-maturity securities

32. 32 Trading Securities... zAre securities bought and held primarily for sale in the near term to generate income on short-term price differences. zAre reported at fair value referred to as mark-to-market accounting. zChanges from cost are reported in net income. Illustration 12-5

33. 33 Available-for-Sale Securities... zAre securities that may be sold in the future. zAre reported at fair value. zChanges from cost are reported in the stockholders’ equity section. Illustration 12-5

34. 34 Held-to-Maturity Securities... zAre debt securities that the investor has the intent and the ability to hold to maturity. zMore will be covered in advanced courses. Illustration 12-5

35. 35 Investment Portfolio zUnder the accounting standards for reporting investments in debt securities and equity investments of less than 20% that were introduced in 1993, companies can choose which of the three categories of securities to use for an investment. zUnfortunately, under these new standards, companies can "window-dress" their reported earnings results--that is make net income look better than it really was.

36. 36 Investment Portfolio zGains and losses on investments classified as available-for-sale are not included in income, but rather are recorded an adjustment to equity. zA company wanting to manage its reported income can sell those available-for-sale investments that have unrealized losses, and not sell those available-for-sale investments that have unrealized losses, deferring the losses until a later period.

37. 37 Temporary And Long-term Investments For balance sheet presentation, investments must be classified as either temporary or long-term.

38. 38 Temporary Investments zShort-term investments are securities held by a company that are: yreadily marketable - (can be sold easily whenever the need for cash arises) and yintended to be converted into cash within the next year or operating cycle, whichever is longer.

39. 39 Temporary Investments zBecause of their high liquidity, short-term investments (at fair value) are listed immediately below Cash in the current asset section of the balance sheet.

40. 40 Long-Term Investments zLong-term investments-are generally reported in a separate section of the balance sheet immediately below Current Assets. zLong-term investments in available-for- sale securities are reported at fair value, and investments in common stock accounted for under the equity method are report at equity.

41. 41 Gains and Losses on Investments zGains and losses on investments, whether realized or unrealized, must be presented in the financial statements. zIn the income statement, gains and losses, as well as interest and dividend revenue, are reported in the nonoperating section under the following categories: Illustration 12-9 Other Revenue and Gains Other Expenses and Losses Interest RevenueLoss on Sales of Investments Dividend RevenueUnrealized Loss--Income Gain on Sale of Investments Unrealized Gain--Income

42. 42 Gains and Losses on Investments zEarlier, it was noted that an unrealized gain or loss on available- for-sale securities is reported as a separate component of stockholders' equity. zDawson Inc. has common stock of $3,000,000, retained earnings of $1,500,000, and an unrealized loss on available-for-sale securities of $100,000.

43. 43 Gains and Losses on Investments DAWSON INC. Balance Sheet (partial) Stockholders' equity Common stock$ 3,000,000 Retained earnings 1,500,000 Total paid-in capital 4,500,000 and retained earnings Less: Unrealized loss on (100,000) available-for-sale securities Total stockholders' equity$ 4,400,000 Illustration 12-10

44. 44 Gains and Losses on Investments zNote that the presentation of the loss is similar to the presentation of the cost of treasury stock in the stockholders' equity section. zReporting the unrealized gain or loss in the stockholders' equity section serves two important purposes: yIt reduces the volatility of net income due to fluctuations in fair value, and yIt informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value.

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