Corporate finance accounting 14e by warren reeve duchac chapter investment

Appendix D Investments Corporate Financial Accounting 14e Warren Reeve Duchac ® © 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Investments (slide of 5) • Most companies generate cash from their operations o This cash can be used for the following purposes:  Investing in current operations  Investing in temporary investments to earn additional revenue  Investing in long-term investments in stock of other companies for strategic reasons đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Investments (slide of 5) • Cash is often used to support the current operating activities of a company o For example, cash may be used to replace worn-out equipment or to purchase new, more efficient, and productive equipment • In addition, cash may be reinvested in the company to expand its current operations đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Investments (slide of 5) • A company may temporarily have excess cash that is not needed for use in its current operations o Instead of letting excess cash remain idle in a checking account, most companies invest their excess 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 đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Investments (slide of 5) • Investments in debt securities and equity securities, termed investments or temporary investments, are reported in the current assets section of the balance sheet • The primary objective of investing in temporary investments is to: o earn interest revenue o receive dividends o realize gains from increases in the market price of the securities đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Investments (slide of 5) • Long-term investments often involve the purchase of a significant portion of the stock of another company o Such investments usually have a strategic purpose, such as reduction of costs or expansion into new markets đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Debt Investments at Cost • • • • Debt securities include notes and bonds issued by corporations and governmental organizations Most companies invest excess cash in bonds as investments to earn interest revenue Most bond investments are recorded at cost Typical transactions for bond investments include the following: o Purchase of bonds o Interest revenue o Sale of bonds đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Purchase of Bonds • The purchase of bonds is recorded by debiting an investments account for the cost of acquiring the bonds o • This cost includes any fees charged by a broker in acquiring the bonds If the bonds are purchased between interest dates, the buyer must also pay the seller any accrued interest since the last interest payment date o Any accrued interest is debited to an interest receivable account rather than to the investment account đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Sale of Bonds (slide of 2) • The sale of bond investments normally results in a gain or loss o If the proceeds from the sale exceed the balance of the investment account, then a gain is recorded o If the proceeds are less than the balance of the investment account, a loss is recorded ® © 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Sale of Bonds (slide of 2) • The gain or loss on the sale of bond investments is reported as part of Other revenue (loss) on the income statement đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Equity Method: Between 20%–50% Ownership (slide of 2) • Investment of between 20% and 50% are accounted for using the equity method o Under the equity method, a stock investment is recorded at its initial cost However, the investor’s share of the investee’s operating results and dividends are also recorded in the investment account as follows:  Net Income: The investor records its share of the net income of the investee as an increase (debit) in the investment account Its share of any net loss is recorded as a decrease (credit) in the investment account  Dividends: The investor’s share of cash dividends received from the investee are recorded as decreases (credits) to the investment account đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Consolidation: More Than 50% Ownership (slide of 2) • If the investor purchases more than 50% of the outstanding stock of the investee, the investor is considered to have control over the investee • The purchase of more than 50% ownership of the investee’s stock is termed a business combination • The corporation owning all or a majority of the voting stock of another corporation is called a parent company • The corporation that is controlled is called the subsidiary company đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Consolidation: More Than 50% Ownership (slide of 2) • At the end of the year, the financial statements of the parent and subsidiary are combined and reported as a single company These combined financial statements are called consolidated financial statements đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Reporting Investments • Debt and equity securities are financial assets that are often traded on public exchanges such as the New York Stock Exchange As a result, their market value can be observed and, thus, objectively determined o For this reason, generally accepted accounting principles (GAAP) allows the following securities to be reported at their fair market values:  Trading securities Available-for-sale securities Held-to-maturity securities đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Trading Securities (slide of 4) • Trading securities are debt and equity securities that are purchased to earn shortterm profits from changes in their market prices • Because trading securities are held as a short-term investment, they are reported as a current asset on the balance sheet ® © 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Trading Securities (slide of 4) • Trading securities are valued as a portfolio (group) of securities using the securities’ fair values o Fair value is the market price that the company would receive for a security if it were sold  A change in the fair value of the portfolio (group) of trading securities is recognized as an unrealized gain or loss for the period đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Trading Securities (slide of 4) • An adjusting entry is made on December 31, 20Y1, to record the fair value of the portfolio of trading securities o Valuation Allowance for Trading Investments is created to maintain a record of the original cost of the securities o If the fair value of the portfolio of trading securities is more than the cost:  o The adjustment debits Valuation Allowance for Trading Investments and credits Unrealized Gain on Trading Investments for the difference – Unrealized Gain on Trading Investments is reported separately or as Other revenue on the income statement – Valuation Allowance for Trading Investments is shown on the balance sheet as an addition to Trading Investments (at cost) If the fair value of the portfolio of trading securities is less than the cost:  The adjustment debits Unrealized Loss on Trading Investments and credits Valuation Allowance for Trading Investments for the difference – Unrealized Loss on Trading Investments is reported on the income statement as Other expenses – Valuation Allowance for Trading Investments is shown on the balance sheet as a deduction from Trading Investments (at cost) đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Trading Securities (slide of 4) • Over time, the valuation allowance account is adjusted to reflect the difference between the cost and fair value of the portfolio o Thus, increases in the valuation allowance account from the beginning of the period will result in an adjustment to record an unrealized gain o Likewise, decreases in the valuation allowance account from the beginning of the period will result in an adjustment to record an unrealized loss đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Available-for-Sale Securities (slide of 3) • Available-for-sale securities are debt and equity securities that are recorded at fair value but are not classified as trading securities • Changes in the fair values of available-for-sale securities are not reported on the income statement, but are reported directly in stockholders equity đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Available-for-Sale Securities (slide of 3) • An adjusting entry is made on December 31, 20Y1, to record the fair value of the available-for-sale securities o If the fair value of the portfolio of available-for-sale securities is more than the cost:  The adjustment debits Valuation Allowance for Available-for-Sale Investments and credits Unrealized Gain on Available-for-Sale Investments for the difference o – Unrealized Gain (Loss) on Available-for-Sale Investments is reported as an addition in the stockholders’ equity section on the balance sheet – Valuation Allowance for Available-for-Sale Investments is shown on the balance sheet as an addition to Available-for-Sale Investments (at cost) If the fair value of the portfolio of available-for-sale securities is less than the cost:  The adjustment debits Unrealized Gain (Loss) on Available-for-Sale Investments and credits Valuation Allowance for Available-for-Sale Investments for the difference – Unrealized Gain (Loss) on Available-for-Sale Investments is reported as a deduction in the stockholders’ equity section on the balance sheet – Valuation Allowance for Available-for-Sale Investments is shown on the balance sheet as a deduction from Available-for-Sale Investments (at cost) đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Available-for-Sale Securities (slide of 3) • Over time, the valuation allowance account is adjusted to reflect the difference between the cost and the fair value of the portfolio o Thus, increases in the valuation allowance from the beginning of the period will result in an adjustment to record an increase in the valuation and unrealized gain (loss) accounts o Likewise, decreases in the valuation allowance from the beginning of the period will result in an adjustment to record decreases in the valuation and unrealized gain (loss) accounts đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Held-To-Maturity Securities (slide of 3) • Held-to-maturity securities are debt investments, such as notes or bonds, that a company intends to hold until their maturity date • Held-to-maturity securities are primarily purchased to earn interest revenue đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Held-To-Maturity Securities (slide of 3) • If a held-to-maturity security will mature within a year, it is reported as a current asset on the balance sheet Held-to-maturity securities maturing beyond a year are reported as noncurrent assets • Only securities with maturity dates, such as corporate notes and bonds, are classified as held-to-maturity securities o Equity securities are not held-to-maturity securities because they have no maturity date ® © 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Held-To-Maturity Securities (slide of 3) • • Held-to-maturity bond investments are recorded at their cost If the interest rate on the bonds differs from the market rate of interest, the bonds may be purchased at a premium or discount o • In such cases, the premium or discount is amortized over the life of the bonds Held-to-maturity bond investments are reported on the balance sheet at their amortized cost đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Summary of Valuing and Reporting of Investments đ â 2017 Cengage Learning May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ... accessible website, in whole or in part Investments (slide of 5) • Investments in debt securities and equity securities, termed investments or temporary investments, are reported in the current... website, in whole or in part Investments (slide of 5) • Long-term investments often involve the purchase of a significant portion of the stock of another company o Such investments usually have a... part Debt Investments at Cost • • • • Debt securities include notes and bonds issued by corporations and governmental organizations Most companies invest excess cash in bonds as investments