Accounting principles, 13th edition ch16

Accounting Principles Thirteenth Edition Weygandt Kimmel Kieso Chapter 16 Investments Prepared by Coby Harmon University of California, Santa Barbara Westmont College Chapter Outline Learning Objectives LO Explain how to account for debt investments LO Explain how to account for stock investments LO Discuss how debt and stock investments are reported in financial statements Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Why Corporations Invest Corporations purchase investments in debt or stock securities generally for one of three reasons Corporation may have excess cash Generate earnings from investment income For strategic reasons Invest Cash Accounts Receivable LO ILLUSTRATION 16.1 Sell Temporary Investments Inventory Copyright ©2018 John Wiley & Son, Inc Why Corporations Invest Which of the following is not a primary reason why corporations invest in debt and equity securities? a They wish to gain control of a competitor b They have excess cash c They wish to move into a new line of business d They are required to by law LO Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Investments in government and corporation bonds Entries are made to record the acquisition the interest revenue the sale LO Copyright ©2018 John Wiley & Son, Inc 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 Illustration: Kuhl Corporation acquires 50 Doan Inc 8%, 10year, $1,000 bonds on January 1, 2020, for $50,000 The entry to record the investment is: Debt Investments (50 × $1,000) Cash 50,000 LO 50,000 Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Recording Bond Interest Calculate and record interest revenue based upon the carrying value of bond times interest rate times portion of year bond is outstanding LO Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Recording Bond Interest Illustration: The Doan Inc bonds pay interest of $4,000 annually on January ($50,000 × 8%) If Kuhl Corporation’s fiscal year ends on December 31, it accrues the interest earned since January Calculate the accrued interest $50,000 x 8% = $4,000 The adjusting entry is: Interest Receivable 4,000 Interest Revenue 4,000 LO Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Recording Bond Interest Kuhl reports Interest Receivable as a current asset in the balance sheet It reports Interest Revenue under “Other revenues and gains” in the income statement Kuhl reports receipt of the interest on January as follows Cash 4,000 Interest Receivable LO 4,000 Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Recording Bond Interest Assume that Kuhl Corporation receives net proceeds of $54,000 on the sale of the Doan Inc bonds on January 1, 2021, after receiving the interest due Prepare the entry to record the sale of the bonds Cash 54,000 Debt Investments 50,000 Gain on Sale of Debt Investments LO Copyright ©2018 John Wiley & Son, Inc 4,000 10 DO IT! 3a Trading and Available-forSale Debt Securities (3 of 3) Unrealized Trading securities Available-for-sale securities Cost $93,600 $48,800 Fair Value Gain (Loss) $94,900 $1,300 $51,400 $2,600 At December 31, 2019, the Fair Value Adjustment— Trading account had a debit balance of $9,200, and the Fair Value Adjustment—Available-for-Sale account had a credit balance of $5,750 Prepare the journal entries for the AFS securities at December 31, 2020 LO Fair Value Adjustment—AFS ($5,750 + $2,600) 8,350 Unrealized Gain or Loss—Equity 8,350 Copyright ©2018 John Wiley & Son, Inc 40 Reporting Investments in Financial Statements Equity Securities ILLUSTRATION 16.10 Accounting and reporting for equity securities by category Category Holdings less than 20% Valuation Fair value Unrealized Gains or Losses Recognized in net income Holdings between 20% and 50% Equity Not recognized Proportionate share of investee's net income Holdings more than 50% Consolidation Not recognized Not applicable LO Copyright ©2018 John Wiley & Son, Inc Other Income Effects Dividends declared; gains and losses from sale 41 Equity Securities Illustration: Cost and fair values for investments of Shelton Corporation on December 31, 2020 are as follows Investments Twitter Co Campbell Soup Co Totals Cost $259,700 317,500 $577,200 Fair Value $275,000 304,000 $579,000 Unrealized Gain (Loss) $15,300 (13,500) $ 1,800 ILLUSTRATION 16.11 Adjusting entry for Shelton Corporation is: Dec 31 Fair Value Adjustment—Stock Unrealized Gain or Loss—Income LO Copyright ©2018 John Wiley & Son, Inc 1,800 1,800 42 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 not meet both criteria are classified as long-term investments LO Copyright ©2018 John Wiley & Son, Inc 43 Presentation of Realized and Unrealized Gain or Loss Other Revenue and Gains Interest Revenue Dividend Revenue Gain on Sale of Investments Unrealized Gain Other Expenses and Losses Loss on Sale of Investments Unrealized Loss ILLUSTRATION 16.14 Nonoperating items related to investments LO Copyright ©2018 John Wiley & Son, Inc 44 Presentation of Realized and Unrealized Gain or Loss Unrealized gains or losses on available-for-sale securities are reported as a separate component of stockholders’ equity Muzzillo Inc Balance Sheet (partial) Stockholders’ equity Common stock Retained earnings Total paid-in capital and retained earnings Accumulated other comprehensive loss Total stockholders’ equity $3,000,000 1,500,000 4,500,000 (100,000) $4,400,000 ILLUSTRATION 16.15 LO Copyright ©2018 John Wiley & Son, Inc 45 Pace Corporation Balance Sheet (partial) December 31, 2020 Assets Current assets Cash Debt investments (at fair value) Accounts receivable Less: Allowance for doubtful accounts Inventory, at FIFO cost Prepaid insurance Total current assets Investments Debt investments (at fair value) Stock investments (at fair value) Stock investments (at equity) Total investments $ 84,000 4,000 20,000 30,000 150,000 $ 21,000 147,000 80,000 43,000 23,000 314,000 200,000 ILLUSTRATION 16.16 LO Copyright ©2018 John Wiley & Son, Inc 46 Stockholders’ equity Paid-in capital Pace Corporation Balance Sheet (partial) December 31, 2020 Stockholders’ Equity Common stock, $10 par value, 200,000 shares authorized, 80,000 shares issued and outstanding In excess of par—common stock Total paid-in capital Retained earnings Total paid-in capital and retained earnings Add: Accumulated other comprehensive income Total stockholders’ equity Total liabilities and stockholders’ equity 800,000 100,000 900,000 255,000 1,155,000 10,000 1,165,000 $1,710,000 ILLUSTRATION 16.16 LO Copyright ©2018 John Wiley & Son, Inc 47 DO IT! 3b Financial Statement Presentation of Investments Identify where each of the following items would be reported in the financial statements Item Interest earned on investments in bonds Financial Statement Income statement Fair value adjustment—stock Unrealized gain or loss—equity Gain on sale of investments in stock Balance sheet Balance sheet Income statement Unrealized gain—income Income statement LO Copyright ©2018 John Wiley & Son, Inc Category Other revenues and gains Investments Stockholders' equity Other revenues and gains Other revenues and gains 48 A Look at IFRS Key Points Similarities The basic accounting entries to record the acquisition of debt securities, the receipt of interest, and the sale of debt securities are the same under IFRS and GAAP The basic accounting entries to record the acquisition of stock investments, the receipt of dividends, and the sale of stock securities are the same under IFRS and GAAP Both IFRS and GAAP use the same criteria to determine whether the equity method of accounting should be used—that is, significant influence with a general guide of over 20% ownership, IFRS uses the term associate investment rather than equity investment to describe its investment under Copyright the equity method ©2018 John Wiley & Son, Inc 49 LO A Look at IFRS Key Points Similarities Equity investments are generally recorded and reported at fair value under IFRS Equity investments not have a fixed interest or principal payment schedule and therefore cannot be accounted for at amortized cost In general, equity investments are valued at fair value, with all gains and losses reported in income, similar to GAAP LO Copyright ©2018 John Wiley & Son, Inc 50 A Look at IFRS Key Points Differences Under IFRS, both the investor and an associate company should follow the same accounting policies As a result, in order to prepare financial information, adjustments are made to the associate’s policies to conform to the investor’s books GAAP does not have that requirement LO Copyright ©2018 John Wiley & Son, Inc 51 A Look at IFRS Key Points Differences In general, IFRS requires that companies determine how to measure their financial assets based on two criteria: a The company’s business model for managing their financial assets; and b The contractual cash flow characteristics of the financial asset If a company has (1) a business model whose objective is to hold assets in order to collect contractual cash flows and (2) the contractual terms of the financial asset gives specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding, then the company should use cost LO Copyright ©2018 John Wiley & Son, Inc 52 A Look at IFRS Looking to the Future As indicated earlier, the IASB has issued a new revised IFRS which deals with the accounting issues related to investment securities The FASB has also issued a new standard in this area Some differences exist between the IFRS and the FASB regarding investments, but in general they are very similar LO Copyright ©2018 John Wiley & Son, Inc 53 Copyright Copyright © 2018 John Wiley & Sons, Inc All rights reserved Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States 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 Copyright ©2018 John Wiley & Son, Inc 54 ... 4,000 10 Accounting for Debt Investments Debt investments are initially recorded at: a cost b fair value c cost plus accrued interest d face value LO Copyright ©2018 John Wiley & Son, Inc 11 Accounting. .. The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation (investee) LO Copyright ©2018 John Wiley & Son, Inc 19 Accounting. .. to record the acquisition the interest revenue the sale LO Copyright ©2018 John Wiley & Son, Inc Accounting for Debt Investments Recording Acquisition of Bonds Cost includes all expenditures necessary