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Accounting principles chapter 17

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Accounting Principles Second Canadian Edition Weygandt · Kieso · Kimmel · Trenholm Prepared by: Carole Bowman, Sheridan College CHAPTER 17 INVESTMENTS ILLUSTRATION 17-1 TEMPORARY INVESTMENTS AND THE OPERATING CYCLE • At the end of their operating cycles, many companies mayhave temporarily idle cash on hand, pending the start of the nextoperating cycle • Until the cash is needed in operations, these companies may invest the excess funds to earn interest and dividends Invest Cash Accounts Receivable Sell Inventory Temporary Investments TEMPORARY VS LONG-TERM INVESTMENTS • Temporary investments are securities, held by a company, that are (1) readily marketable, and (2) intended to be converted into cash in the near future – Readily marketable means the investment can be sold easily, whenever the need for cash arises – Intention to convert means that management intends to sell the investment if and when the need for cash arises • Investments that not meet both criteria are classified as long-term investments DEBT INVESTMENTS • Investments in government and corporation bonds • In accounting for debt investments, entries are required to record the: – acquisition – interest revenue – sale • Are recorded at cost, including brokerage fees DEBT INVESTMENTS • Accounting differs depending on whether investment is – Temporary – Long-term ACCOUNTING FOR TEMPORARY DEBT INVESTMENTS Kuhl Corporation acquires 50 Doan Inc percent, 10year, $1,000 bonds on January 1, 1999, for $54,000, including brokerage fees of $1,000 The bonds pay interest semi-annually on July and January The entry to record the temporary investment at cost is: 54,000 RECORDING BOND INTEREST Interest receipts are calculated using the bond’s face or principal value, which is $50,000 (50 x $1,000) The interest for July will be $2,000 ($50,000 x 8% x 6/12) The entry on July is: 2,000 2,000 ACCOUNTING FOR LONG-TERM DEBT INVESTMENTS The accounting for temporary and long-term investments is similar The major exception is when bonds are purchased at a premium or discount (above or below its face value) As shown in Chapter 16 with the bond issuer, the investor would also amortize the premium or discount using either the straight-line or effective interest methods Using the previous Kuhl example and assuming an effective interest rate of 7%, the entries are: Date Kuhl Corporation (Investor) (Investee) 50,000 Jan Investment in Doan Bonds 4,000 Premium on Bonds 54,000 Premium on Bonds Cash Payable 2,000 To record purchase of 50 Doan bonds year bonds 110 1,890 July Cash = ($50,000 x 8% x 6/12) 7% x 6/12) Premium on Bonds Doan Inc 54,000 Cash 4,000 50,000 Bonds 1,890 To record issue of 8%, 10 110 2,000 Interest Expense = ($54,000 x Premium on ILLUSTRATION 17-4 ACCOUNTING GUIDELINES FOR EQUITY INVESTMENTS Equity investments are investments in the share capital of corporations Investor’s Ownership Interest in Investee’s Common Shares Presumed Influence on Investee Accounting Guidelines Less than 20% Insignificant Cost method Between 20% and 50% Significant Equity method More than 50% Controlling Equity method for accounting; Consolidated financial statements for financial reporting RECORDING EQUITY INVESTMENTS HOLDINGS LESS THAN 20% • In accounting for equity investments of less than 20 percent, the cost method is used • Under the cost method, the investment is recorded at cost and revenue is recognized only when cash dividends are received RECORDING EQUITY INVESTMENTS HOLDINGS LESS THAN 20% On July 1, 2003, St Amand Corporation acquires 1,000 shares (10 percent ownership) of Beal Corporation at $40 per share plus brokerage fees of $500 The entry for the purchase is: 40,500 RECORDING EQUITY INVESTMENTS HOLDINGS LESS THAN 20% Entries are required for any cash dividends received during the time the shares are held If a $2 per share dividend is received by St Amand Corporation on December 1, 2003, the entry is: 2,000 2,000 RECORDING EQUITY INVESTMENTS HOLDINGS LESS THAN 20% When shares are sold, the difference between the net proceeds from the sale and the cost of the shares is recognized as a gain or loss St Amand Corporation receives net proceeds of $39,500 on the sale of its Beal Corporation common shares on February 10, 2004 Because the shares cost $40,500, a loss of $1,000 has been incurred The entry to record the sale is: 39,500 1,000 ACCOUNTING FOR EQUITY INVESTMENTS HOLDINGS BETWEEN 20% AND 50% • When an investor owns between 20% and 50% of the common shares of a corporation, it is usually presumed that the investor has significant influence over the financial and operating activities of the investee • Under the equity method, the investment in common shares is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee • Each year, the investor 1) debits the investment account and credits revenue for its share of the investee’s net income and 2) credits dividends received to the investment account ACCOUNTING FOR EQUITY INVESTMENTS HOLDINGS BETWEEN 20% AND 50% • Milar Corporation acquires 30 percent of the common shares of Beck Company for $120,000 on January 1, 2003 The entry to record this transaction is: 120,000 120,000 ACCOUNTING FOR EQUITY INVESTMENTS HOLDINGS BETWEEN 20% Beck reports 2003 netAND income50% of $100,000 and declares and pays a $40,000 cash dividend Milar is required to record 1) its share of Beck’s net income, $30,000 (30% x $100,000) and 2) the reduction in the investment account for the dividends received, $12,000 ($40,000 x 30%) The entries are: #1 30,000 30,000 #2 12,000 12,000 RECORDING EQUITY INVESTMENTS HOLDINGS OF MORE THAN 50% • A company that controls (e.g., owns more than 50 %) of the common shares of another entity is known as a parent company • The entity whose shares are owned by the parent company is called the subsidiary (affiliated) company • When one company controls of the common shares of another company, the equity method of accounting is used to account for the investment and consolidated financial statements are prepared RECORDING EQUITY INVESTMENTS HOLDINGS OF MORE THAN 50% • Consolidated financial statements present the assets and liabilities controlled by the parent company and the combined profitability of the subsidiary companies • They are prepared in addition to the financial statements for each of the individual parent and subsidiary companies VALUATION AND REPORTING OF INVESTMENTS • The value of debt and equity investments may fluctuate greatly during the time they are held • Conservatism principle requires accountants to use the lower of cost and market (LCM) rule • Application of the LCM rule varies depending upon whether the investment is temporary or long-term VALUATION AND REPORTING OF TEMPORARY INVESTMENTS • The decline in value from cost to market is reported as a loss • An Allowance to Reduce Cost to Market Value account is used to record the difference between the cost and market value of the securities • The Allowance account is a contra asset and is therefore deducted from the cost of the investments to arrive at the LCM valuation reported on the balance sheet for temporary investments VALUATION AND REPORTING OF LONG-TERM INVESTMENTS • Long-term investments have longer maturities than temporary investments, therefore, their carrying values should not be adjusted to reflect temporary fluctuations in market value • When market value falls below cost and the drop is not due to temporary fluctuations, the investment must be reduced to its market value • Any write-down to market value is accounted for on the income statement as a permanent loss No allowance account is used • Long-term investments are reported in a separate section of the balance sheet, immediately below current assets ILLUSTRATION 17-8 COMPREHENSIVE BALANCE SHEET ILLUSTRATION 17-8 COMPREHENSIVE BALANCE SHEET Liabilities and Shareholders’ Equity Current liabilities Accounts payable Bond interest payable Income tax payable Total current liabilities Long-term liabilities Bonds payable, 7%, due 2010 $ 300,000 Less: Discount on bonds 10,000 Total long-term liabilities Total liabilities Shareholders’ equity Common shares, no par value, 200,000 shares authorized, 80,000 issued $900,000 Retained earnings (of which 265,000 $100,000 is restricted for plant expansion) Total shareholders’ equity Total liabilities and shareholders’ equity $ 185,000 10,000 60,000 255,000 290,000 545,000 1,165,000 $ 1,710,000 COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd All rights reserved Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd The purchaser may make back-up copies for his / her own use only and not for distribution or resale The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein .. .CHAPTER 17 INVESTMENTS ILLUSTRATION 17- 1 TEMPORARY INVESTMENTS AND THE OPERATING CYCLE • At the end of their operating... bonds • In accounting for debt investments, entries are required to record the: – acquisition – interest revenue – sale • Are recorded at cost, including brokerage fees DEBT INVESTMENTS • Accounting. .. July will be $2,000 ($50,000 x 8% x 6/12) The entry on July is: 2,000 2,000 ACCOUNTING FOR LONG-TERM DEBT INVESTMENTS The accounting for temporary and long-term investments is similar The major exception

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