Investments and Fair Value Accounting Chapter 15 Student Version These Theseslides slidesshould shouldbe beviewed viewedusing usingthe thepresentation presentation mode mode(click (clickthe the icon icontotostart startpresentation) presentation) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University Learning Objective 1 Describe why companies invest in debt and equity securities © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Investing Cash in Temporary Investments Instead of letting excess cash remain idle in a checking account, most companies invest this cash in securities such as: Debt securities, which are notes and bonds that pay interest and have a fixed maturity date Equity securities, which are preferred and common stock that represent ownership in a company and not have a fixed maturity date © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 The primary objective of investing in temporary investments is to: earn interest income receive dividends realize gains from increases in the market price of the securities © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Describe why companies invest in debt and equity securities Describe and illustrate the accounting for debt investments © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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, 2012, plus accrued interest for 45 days The bonds have an interest rate of 6%, payable on July 31 and January 31, 2012 $18,000 × 6% × (45/360) © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Interest Revenue On July 31, Homer Company receives a semiannual interest payment of $540 ($18,000 × 6% × 1½) The $540 interest includes $135 of accrued interest that Homer Company purchased with the bonds on March 17 ($540 – $135) or [$18,000 × 6% × (135/360)] © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Interest Revenue Homer Company’s accounting period ends on December 31 Thus, an adjusting entry must be made to accrue interest for five months The following adjusting entry records the accrued interest: $18,000 × 6% × 5/12 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Interest Revenue Homer Company receives interest of $540 on January 31, 2013 Notice that Interest Receivable is credited for $450 to reflect that this amount is a receivable from 2012 Interest Revenue of $90 is the interest earned from January through January 31, 2013 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Describe why companies invest in debt and equity securities Describe and illustrate the accounting for debt investments Describe and illustrate the accounting for equity investments Describe and illustrate valuing and reporting investments in the financial statements © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Trading Securities Trading securities are reported as current assets on the balance sheet Trading securities are valued as a portfolio (group) of securities using their fair values Fair value is the market price that would be received for a security if it were sold Changes in fair value of the portfolio are recognized as an unrealized gain or loss for the period © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Trading Securities Maggie Company purchased a portfolio of trading securities during 2012 On December 31, 2012, the cost and fair values of the securities were as follows: © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Trading Securities The adjusting entry on December 31, 2012, to record the fair value of the securities ($25,300) is as follows: : Unrealized Gain on Trading Investments is reported on the income statement © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Available-for-Sale Securities Available-for-sale securities are debt and equity securities that are neither held for trading, held to maturity, or held for strategic reasons © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Available-for-Sale Securities Maggie Company purchased three securities during 2012 as available-for-sale securities On December 31, 2012, the cost and fair values of the securities were as follows: © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Available-for-Sale Securities On December 31, the adjusting entry credits a stockholders’ equity account instead of an income statement account The $1,300 increase in fair value is credited to Unrealized Gain (Loss) on Availablefor-Sale Investments Added to current assets Added to stockholders’ equity © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Describe why companies invest in debt and equity securities Describe and illustrate the accounting for debt investments Describe and illustrate the accounting for equity investments Describe and illustrate valuing and reporting investments in the financial statements Describe fair value accounting and its implications for the future © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO 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 distressed conditions 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 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Trend to Fair Value Accounting Potential disadvantages of using fair values: Fair values may not be readily obtainable for some assets or liabilities Fair values make it more difficult to compare companies if companies use different methods of measuring fair values Using fair values could result in more fluctuations in accounting reports because fair values change from year to year © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Learning Objective Describe why companies invest in debt and equity securities Describe and illustrate the accounting for debt investments Describe and illustrate the accounting for equity investments Describe and illustrate valuing and reporting investments in the financial statements Describe fair value accounting and its implications for the future Describe and illustrate the computation of dividend yield © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use LO Dividend Yield The dividend yield measures the rate of return to stockholders based on cash dividends distributed Dividend yield is calculated as follows: Dividend Yield = Dividends per Share of Common Stock Market Price per Share of Common Stock News Corporation: $0.12 = 0.77% Dividend Yield = $15.50 © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use Investments and Fair Value Accounting The End Student Version Prepared by: C Douglas Cloud Professor Emeritus of Accounting Pepperdine University © 2011 Cengage Learning All Rights Reserved May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use ... and illustrate the accounting for debt investments Describe and illustrate the accounting for equity investments Describe and illustrate valuing and reporting investments in the financial statements... called the subsidiary company At the end of the year, the financial statements of the parent and subsidiary are combined, and consolidated financial statements are issued © 2011 Cengage Learning... invest in debt and equity securities Describe and illustrate the accounting for debt investments Describe and illustrate the accounting for equity investments © 2011 Cengage Learning All Rights