E-1 REPORTING AND ANALYZING INVESTMENTS E-2 E Financial Accounting, Seventh Edition Learning Learning Objectives Objectives After studying this chapter, you should be able to: E-3 Identify the reasons corporations invest in stocks and debt securities Explain the accounting for debt investments Explain the accounting for stock investments Describe the purpose and usefulness of consolidated financial statements Indicate how debt and stock investments are valued and reported in financial statements Distinguish between short-term and long-term investments Why Why Corporations Corporations Invest 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 E-1 Temporary investments and the operating cycle E-4 LO Identify the reasons corporations invest in stocks and debt securities Why Why Corporations Corporations Invest Invest Question Pension funds and banks regularly invest in debt and stock securities to: a house excess cash until needed b generate earnings c meet strategic goals d avoid a takeover by disgruntled investors E-5 LO Identify the reasons corporations invest in stocks and debt securities Accounting Accounting for for Debt Debt Instruments 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 carrying value of the bond times the interest rate times the portion of the year the bond is outstanding E-6 LO Explain the accounting for debt investments Accounting Accounting for for Debt Debt Instruments 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 E-7 LO Explain the accounting for debt investments Accounting Accounting for for Debt Debt Instruments Instruments Illustration: Kuhl Corporation acquires 50 Doan Inc 8%, 10year, $1,000 bonds on January 1, 2014, for $50,000 The entry to record the investment is: Jan Debt investments Cash E-8 50,000 50,000 LO Explain the accounting for debt investments Accounting Accounting for for Debt Debt Instruments Instruments Illustration: Kuhl Corporation acquires 50 Doan Inc 8%, 10year, $1,000 bonds on January 1, 2014, for $50,000 The bonds pay interest semiannually on July and January The entry for the receipt of interest on July is: July 2,000 * Cash Interest revenue * E-9 2,000 ($50,000 x 8% x ½ = $2,000) LO Explain the accounting for debt investments Accounting Accounting for for Debt Debt Instruments Instruments Illustration: If Kuhl Corporation’s fiscal year ends on December 31, prepare the entry to accrue interest since July Dec 31 Interest receivable 2,000 Interest revenue 2,000 Kuhl reports receipt of the interest on January as follows Jan Cash 2,000 Interest receivable E-10 2,000 LO Explain the accounting for debt investments Holdings Holdings Between Between 20% 20% and and 50% 50% Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2014 For 2014, 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 Illustration E-4 E-22 LO Explain the accounting for stock investments Holdings Holdings of of More More Than Than 50% 50% Controlling Interest - When one corporation acquires a voting interest of more than 50 percent in another corporation E-23 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 LO Describe the use of consolidated financial statements Valuing Valuing and and Reporting Reporting Investments 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% E-24 LO Indicate how debt and stock investments are valued and reported in financial statements Valuing Valuing and and Reporting Reporting Investments Investments Trading Securities E-25 Companies hold trading securities with the intention of selling them in a short period Trading means frequent buying and selling Companies adjust trading securities to fair value at the end of the period (an approach referred to as mark-tomarket accounting), and report changes from cost as part of net income LO Indicate how debt and stock investments are valued and reported in financial statements Valuing Valuing and and Reporting Reporting Investments Investments Available-for-Sale Securities E-26 Companies hold 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 LO Indicate how debt and stock investments are valued and reported in financial statements Valuing Valuing and and Reporting Reporting Investments Investments Question Marketable securities bought and held primarily for sale in the near term are classified as: a available-for-sale securities b held-to-maturity securities c stock securities d trading securities E-27 LO Indicate how debt and stock investments are valued and reported in financial statements Trading Trading Securities Securities Illustration: Investment of Pace classified as trading securities on December 31, 2014 Illustration E-7 The adjusting entry for Pace Corporation is: Dec 31 Fair value adjustment—trading Unrealized gain—income E-28 7,000 7,000 LO Indicate how debt and stock investments are valued and reported in financial statements Available-for-Sale Available-for-Sale Securities 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 E-29 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 LO Indicate how debt and stock investments are valued and reported in financial statements Available-for-Sale Available-for-Sale Securities Securities Illustration: Assume that Elbert Corporation has two securities that it classifies as available-for-sale Illustration E-8 provides information on their valuation Illustration E-8 The adjusting entry for Elbert Corporation is: Dec 31 Unrealized gain or loss—equity 9,537 Fair value adjustment—available-for-sale E-30 9,537 LO Indicate how debt and stock investments are valued and reported in financial statements Available-for-Sale Available-for-Sale Securities Securities Question An unrealized loss on available-for-sale securities is: a reported under Other Expenses and Losses in the income statement b closed-out at the end of the accounting period c reported as a separate component of stockholders' equity d deducted from the cost of the investment E-31 LO Indicate how debt and stock investments are valued and reported in financial statements Balance Balance Sheet Sheet Presentation Presentation Short-Term Investments Also called marketable securities, are securities held by a company that are (1) readily marketable and (2) intended to be converted into cash within the next year or operating cycle, whichever is longer Investments that not meet both criteria are classified as long-term investments E-32 LO Distinguish between short-term and long-term investments Presentation Presentation of of Realized Realized and and Unrealized Unrealized Gain Gain or or Loss Loss Nonoperating items related to investments Illustration E-11 E-33 LO Distinguish between short-term and long-term investments Presentation Presentation of of Realized Realized and and Unrealized Unrealized Gain Gain or or Loss Loss 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 E-12 E-34 LO Distinguish between short-term and long-term investments Statement Statement of of Cash Cash Flows Flows Presentation Presentation Illustration E-13 E-35 LO Distinguish between short-term and long-term investments Copyright Copyright “Copyright © 2013 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc The purchaser may make back-up copies for his/her own use only and not for distribution or resale The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.” E-36 [...]... applying the equity method E- 19 LO 3 Explain the accounting for stock investments Holdings Holdings Between Between 20% 20% and and 50% 50% Question Under the equity method, the investor records dividends received by crediting: a Dividend Revenue b Investment Income c Revenue from Investment d Stock Investments E- 20 LO 3 Explain the accounting for stock investments Holdings Holdings Between Between 20%... period c reported as a separate component of stockholders' equity d deducted from the cost of the investment E- 31 LO 5 Indicate how debt and stock investments are valued and reported in financial statements Balance Balance Sheet Sheet Presentation Presentation Short-Term Investments Also called marketable securities, are securities held by a company that are (1) readily marketable and (2) intended... debt investments Accounting Accounting for for Debt Debt Instruments Instruments Question When bonds are sold, the gain or loss on sale is the difference between the: a sales price and the cost of the bonds b net proceeds and the cost of the bonds c sales price and the market value of the bonds d net proceeds and the market value of the bonds E- 13 LO 2 Explain the accounting for debt investments Accounting. .. Indicate how debt and stock investments are valued and reported in financial statements Valuing Valuing and and Reporting Reporting Investments Investments Question Marketable securities bought and held primarily for sale in the near term are classified as: a available-for-sale securities b held-to-maturity securities c stock securities d trading securities E- 27 LO 5 Indicate how debt and stock investments. .. 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 E- 32 LO 6 Distinguish between short-term and long-term investments Presentation Presentation of of Realized Realized and and Unrealized Unrealized Gain Gain or or Loss Loss Nonoperating items related to investments Illustration E- 11 E- 33... subsidiary Investment in the subsidiary is reported on the parent’s books as a long-term investment Parent generally prepares consolidated financial statements LO 4 Describe the use of consolidated financial statements Valuing Valuing and and Reporting Reporting Investments Investments Categories of Securities Companies classify debt and stock investments into three categories: Trading securities Available-for-sale... 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% E- 24 LO 5 Indicate how debt and stock investments are valued and reported in financial statements Valuing Valuing and and Reporting Reporting Investments Investments Trading Securities E- 25 Companies hold trading securities with the... Reporting Investments Investments Available-for-Sale Securities E- 26 Companies hold 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... between short-term and long-term investments Presentation Presentation of of Realized Realized and and Unrealized Unrealized Gain Gain or or Loss Loss 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 E- 12 E- 34 LO 6 Distinguish between short-term and long-term investments Statement... Unrealized gain or loss—equity 9,537 Fair value adjustment—available-for-sale E- 30 9,537 LO 5 Indicate how debt and stock investments are valued and reported in financial statements Available-for-Sale Available-for-Sale Securities Securities Question An unrealized loss on available-for-sale securities is: a reported under Other Expenses and Losses in the income statement b closed-out at the end of the accounting