1. Accounting Principles, Ninth Edition
Chapter 16
Investments
Accounting Principles, Ninth 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. Long-Term Liabilities
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 16-1
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 Investments
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 carrying 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 Investments
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 Investments
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2010, for $54,000, including brokerage fees of $1,000. The entry to record the investment is:
Jan. 1
Debt investments 54,000
Cash 54,000
SO 2 Explain the accounting for debt investments.

9. Accounting for Debt Investments
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2010, for $54,000, including brokerage fees of $1,000. The bonds pay interest semiannually on July 1 and January 1. The entry for the receipt of interest on July 1 is:
July 1
Cash 2,000 *
Interest revenue 2,000
* ($50,000 x 8% x ½ = $2,000)
SO 2 Explain the accounting for debt investments.

10. Accounting for Debt Investments
Illustration: If Kuhl Corporation’s fiscal year ends on December 31, prepare the entry to accrue interest since July 1.
Dec. 31
Interest receivable 2,000
Interest revenue 2,000
Kuhl reports receipt of the interest on January 1 as follows.
Jan. 1
Cash 2,000
Interest receivable 2,000
SO 2 Explain the accounting for debt investments.

11. Accounting for Debt Investments
Illustration: Assume that Kuhl corporation receives net proceeds of $58,000 on the sale of the Doan Inc. bonds on January 1, 2011, after receiving the interest due. Prepare the entry to record the sale of the bonds.
Jan. 1
Cash 58,000
Debt investments 54,000
Gain on sale of investments 4,000
SO 2 Explain the accounting for debt investments.

12. Accounting for Debt Investments
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 Investments
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%
Companies use the cost method. Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received.
Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).
SO 3 Explain the accounting for stock investments.

16. Holdings of Less than 20%
Illustration: On July 1, 2010, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the purchase is:
July 1
Stock investments 40,500
Cash 40,500
SO 3 Explain the accounting for stock investments.

17. Holdings of Less than 20%
Illustration: During the time Sanchez owns the stock, it makes entries for any cash dividends received. If Sanchez receives a $2 per share dividend on December 31, the entry is:
Dec. 31
Cash 2,000
Dividend revenue 2,000
SO 3 Explain the accounting for stock investments.

18. Holdings of Less than 20%
Illustration: Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal stock on February 10, Because the stock cost $40,500, Sanchez incurred a loss of $1,000. The entry to record the sale is:
Feb. 10
Cash 39,500
Loss on sale of stock 1,000
Stock investments 40,500
SO 3 Explain the accounting for stock investments.

19. Holdings Between 20% and 50%
Equity Method
Record the investment at cost and subsequently adjust the amount each period for
the investor’s proportionate share of the earnings (losses) and
dividends received by the investor.
If investor’s share of investee’s losses exceeds the carrying amount of the investment, the 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, 2010, 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 the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2008.
SO 3 Explain the accounting for stock investments.

22. Holdings Between 20% and 50%
Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, For 2010, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.
Jan. 1
Stock investments 120,000
Cash 120,000
Dec. 31
Stock investments 30,000
($100,000 x 30%)
Revenue from investments 30,000
Dec. 31
Cash 12,000
($40,000 x 30%)
Stock investments 12,000
SO 3 Explain the accounting for stock investments.

23. Revenue from Investments
Holdings Between 20% and 50%
Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, For 2010, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.
After Milar posts the transactions for the year, its investment and revenue accounts will show the following.
Stock Investments
Revenue from Investments
Debit
Credit
Debit
Credit
120,000
30,000
30,000
12,000
138,000
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 the parent’s books as a long-term investment.
Parent generally prepares consolidated financial statements.
SO 4 Describe the use of consolidated financial statements.

26. Valuing and Reporting Investments
Categories of Securities
Companies classify debt and stock investments into three categories:
Trading securities
Available-for-sale securities
Held-to-maturity securities
These guidelines apply 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.

27. Valuing and Reporting Investments
Trading Securities
Companies hold trading securities with the intention of selling them in a short period.
Trading means frequent buying and selling.
Companies report trading securities 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.

28. Valuing and Reporting Investments
Available-for-Sale Securities
Companies hold available-for-sale securities with the intent of selling these investments sometime in the future.
These securities can be classified as current assets or as long-term assets, depending on the intent of management.
Companies report securities at fair value, and report changes from cost as a component of the stockholders’ equity section.
SO 5 Indicate how debt and stock investments are reported in financial statements.

29. 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.

30. Trading Securities
Illustration: Investment of Pace classified as trading securities on December 31, 2010.
Illustration 16-7
The adjusting entry for Pace Corporation is:
Dec. 31
Market adjustment—trading 7,000
Unrealized gain—income 7,000
SO 5 Indicate how debt and stock investments are reported in financial statements.

31. 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.
The unrealized loss would be deducted from the stockholders’ equity section rather than charged to the income statement.
SO 5 Indicate how debt and stock investments are reported in financial statements.

32. Available-for-Sale Securities
Illustration: Assume that Ingrao Corporation has two securities that it classifies as available-for-sale. Illustration 16-8 provides information on their valuation.
Illustration 16-8
The adjusting entry for Ingrao Corporation is:
Dec. 31
Unrealized gain or loss—equity 9,537
Market adjustment—available-for-sale 9,537
SO 5 Indicate how debt and stock investments are reported in financial statements.

33. 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
Presentation of Realized and Unrealized Gain or Loss
Nonoperating items related to investments
Illustration 16-10
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 16-11
SO 6 Distinguish between short-term and long-term investments.

38. Balance Sheet Presentation
Classified Balance Sheet (partial)
Illustration 16-12
SO 6 Distinguish between short-term and long-term investments.

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