1InvestmentsInvestments C hapter 14. 2 1. Explain the classification and valuation of investments. 2. Account for investments in debt and equity trading

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InvestmentsInvestmentsInvestmentsInvestments

Chapter14

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1. Explain the classification and valuation of investments.

2. Account for investments in debt and equity trading securities.

3. Account for investments in available-for-sale debt and equity securities.

4. Account for investments in held-to-maturity debt securities, including amortization of bond premiums and discounts.

ObjectivesObjectives

ContinuedContinuedContinuedContinued

3

5. Understand transfers and impairments.

6. Understand disclosures of investments.

7. Explain the conceptual issues regarding investments in marketable securities.

8. Account for investments using the equity method.

9. Describe additional issues for investments.

10. Account for derivatives of financial instruments. (Appendix)

ObjectivesObjectives

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Classification of InvestmentsClassification of Investments

1) Trading securities2) Available-for-sale

securities3) Held-to-maturity

debt securities

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Trading securities are investments in debt and equity securities that are

purchased and held principally for the purpose of selling them in the near term.

Trading securities are investments in debt and equity securities that are

purchased and held principally for the purpose of selling them in the near term.

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Trading SecuritiesTrading Securities

Trading securities are investments in debt and equity securities that are purchased and held principally for the purpose of

selling them in the near term.

Trading securities are investments in debt and equity securities that are purchased and held principally for the purpose of

selling them in the near term.

These securities are reported at their fair market value on the balance sheet date, and unrealized holding gains and losses are included in net income of the period.

These securities are reported at their fair market value on the balance sheet date, and unrealized holding gains and losses are included in net income of the period.

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Investments in available-for-sale securities are (a) debt

securities that are not classified as being held to

maturity, and...

Investments in available-for-sale securities are (a) debt

securities that are not classified as being held to

maturity, and...


…(b) debt and equity securities that are not classified as trading

securities.

…(b) debt and equity securities that are not classified as trading

securities.

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Investments in available-for-sale securities are reported at their fair value on the balance sheet date. The unrealized holding gains or

losses are included in other comprehensive income.

Investments in available-for-sale securities are reported at their fair value on the balance sheet date. The unrealized holding gains or

losses are included in other comprehensive income.

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Therefore, the unrealized holding gains and losses are not included in net income for the available-

for-sale securities.

Therefore, the unrealized holding gains and losses are not included in net income for the available-

for-sale securities.

10


Investments in held-to-maturity debt securities are debt securities for which the company has the

positive intent and ability to hold until they mature.

Investments in held-to-maturity debt securities are debt securities for which the company has the

positive intent and ability to hold until they mature.

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Investments in held-to-maturity debt securities are reported at their

amortized cost on the balance sheet…not their fair value.

Investments in held-to-maturity debt securities are reported at their

amortized cost on the balance sheet…not their fair value.

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Accounting for InvestmentsAccounting for Investments Reporting of

Unrealized Holding Method Gains and Losses

Investment in Equity Securities1. No significant influence

a. Trading Fair value Net Incomeb. Available for sale Fair value Other comprehen-

sive income2. Significant influence Equity method Not recognized3. Control Consolidation Not recognized

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Accounting for InvestmentsAccounting for Investments Reporting of

Unrealized Holding Method Gains and Losses

Investment in Debt Securities1. Trading Fair value Net Income2. Available for sale Fair value Other comprehen-

sive income3. Held to maturity Amortized cost Not recognized

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Investments in Available-for-Sale Debt and Equity SecuritiesInvestments in Available-for-

Sale Debt and Equity Securities

The investment is initially recorded at cost. It is subsequently reported at fair value. Unrealized holding gains and losses are

reported as a component of other comprehensive income.

Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.

The investment is initially recorded at cost. It is subsequently reported at fair value. Unrealized holding gains and losses are

reported as a component of other comprehensive income.

Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.

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• 100 shares of A Company common stock at $50 per share

• 300 shares of B Company common stock at $80 per share

• 200 shares of Company C preferred stock at $120 per share.

• $15,000 Company D 10% bonds

• 100 shares of A Company common stock at $50 per share

• 300 shares of B Company common stock at $80 per share

• 200 shares of Company C preferred stock at $120 per share.

• $15,000 Company D 10% bonds

$ 5,000

24,000

24,00015,000

$ 5,000

24,000

24,00015,000


Sale Debt and Equity SecuritiesKent Company purchases the following securities on May 1, 2003 as an investment in available-for-sale securities:

Total $68,000

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Sale Debt and Equity Securities

Investment in Available-for-Sale Securities 68,000Interest Revenue 625 Cash 68,625


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Sale Debt and Equity SecuritiesAccrued interest on the D Company bond from

November 30, 2002 to May 31, 2003

Accrued interest on the D Company bond from November 30, 2002 to May 31, 2003

May 31, 2003Cash 750 Interest Revenue 750

ContinuedContinuedContinuedContinued$15,000 x 0.10

x 6/12

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Sale Debt and Equity SecuritiesDecember 31, 2003Interest Receivable 125 Interest Revenue 125

Cash 3,000 Dividend Revenue 3,000

$15,000 x 0.10 x 1/12$15,000 x 0.10 x 1/12During 2003 Kent Company receives

dividends of $3,000 from its investment in the stocks of A, B, and C Companies.

During 2003 Kent Company receives dividends of $3,000 from its investment in the

stocks of A, B, and C Companies.

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Sale Debt and Equity SecuritiesThe cost and fair value of the available-for-sale

securities held by the Kent Company is as follows:

The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:

Cumulative 12/31/03 Change Fair in FairSecurity Cost Value Value

100 shares of A Co. common stock $ 5,000 $ 6,000 $1,000 300 shares of B Co. common stock 24,000 23,500 (500 )200 shares of C Co. preferred stock 24,000 26,000 2,000 D Company 10% bonds 15,000 15,500 500 Totals $68,000 $71,000 $3,000

Allowance for Change in ValueAllowance for Change in Value of Investmentof Investment 3,0003,000 Unrealized Increase/DecreaseUnrealized Increase/Decrease in Value of Available-for-in Value of Available-for- Sale SecuritiesSale Securities 3,0003,000


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Sale Debt and Equity SecuritiesThe same securities are held on December 31, 2004.The same securities are held on December 31, 2004.


100 shares of A Co. common stock $ 5,000 $ 6,100 $1,100 300 shares of B Co. common stock 24,000 22,700 (1,300 )200 shares of C Co. preferred stock 24,000 23,200 (800 )D Company 10% bonds 15,000 14,000 (1,000 ) Totals $68,000 $66,000 $(2,000 )

Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 5,0005,000 Allowance for Change in Value ofAllowance for Change in Value of InvestmentInvestment 5,0005,000

Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 5,0005,000 Allowance for Change in Value ofAllowance for Change in Value of InvestmentInvestment 5,0005,000

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Sale of Available-for-Sale Securities


On March 1, 2005 the Kent Company sold 100 shares of A Company stock for $6,000. The fair

value on December 31, 2004 was $6,100.

On March 1, 2005 the Kent Company sold 100 shares of A Company stock for $6,000. The fair

value on December 31, 2004 was $6,100.

Cash 6,000 Investment in Available-for- Sale Securities 5,000 Gain on Sale of Available-for- Sale Securities 1,000

The Unrealized Increase/Decrease in Value and the allowance account are reduced by $1,100.

The Unrealized Increase/Decrease in Value and the allowance account are reduced by $1,100.

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300 shares of B Co. common stock $24,000 $23,500 $(500 )200 shares of C Co. preferred stock 24,000 24,100 100 D Company 10 bonds 15,000 14,700 (300 ) Totals $63,000 $62,300 $(700 )



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Investments in Held-to-Maturity Debt SecuritiesInvestments in Held-to-Maturity Debt Securities

1) The investment is initially recorded at cost.2) It is subsequently reported at amortized cost.3) Unrealized holding gains and losses are not

recorded.4) Interest revenue and realized gains and losses

on sales (if any) are all included in net income.

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A company purchases 9% bonds with a face value of $100,000 on August 1, 2003 at 99 plus accrued

interest, which is payable semiannually.

A company purchases 9% bonds with a face value of $100,000 on August 1, 2003 at 99 plus accrued

interest, which is payable semiannually.

Investment in Held-to-Maturity Debt Securities 99,000Interest Revenue 1,500 Cash 100,500

Investments in Held-to-Maturity Debt SecuritiesInvestments in Held-to-Maturity Debt Securities

$100,000 x 0.99$100,000 x 0.99$100,000 x 0.09 x 2/12$100,000 x 0.09 x 2/12

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Accounting for Bond PremiumsAccounting for Bond Premiums

On January 1, 2003 Colburn Company invests in bonds that will be held to maturity, with a face

value of $100,000, paying $102,458.71. The stated rate is 13% and the effective interest rate is 12%.



Investment in Held-to- Maturity Debt Securities 102,458.71 Cash 102,458.71

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Accounting for Bond PremiumsAccounting for Bond Premiums

Colburn Company records the first interest receipt on June 30, 2003 using

the effective interest method.



Cash 6,500.00 Investment in Held-to- Maturity Debt Securities 352.48 Interest Revenue 6,147.52

$100,000 x 0.13 x 1/2$100,000 x 0.13 x 1/2

$102,458.71 x .12 x 1/2$102,458.71 x .12 x 1/2

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Accounting for Bond DiscountsAccounting for Bond Discounts





Investment in Held-to- Maturity Debt Securities 97,616.71 Cash 97,616.71

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Accounting for Bond DiscountsAccounting for Bond Discounts





Cash 6,500.00Investment in Held-to- Maturity Debt Securities 333.17 Interest Revenue 6,833.17

$97,616.71 x .14 x 1/2$97,616.71 x .14 x 1/2

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Amortization of Bonds Acquired Between Interest Dates


Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2003. Interest

on these bonds is payable June 30 and December 31, and the bonds mature on December 31, 2005.

Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2003. Interest

on these bonds is payable June 30 and December 31, and the bonds mature on December 31, 2005.

Investment in Held-to-MaturityDebt Securities 204,575.07

Interest Revenue 6,500.00Cash 211,075.07

$200,000 x 0.13 x 3/12

ContinuedContinued

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June 30, 2003Cash 13,000.00

Interest Revenue 12,637.25Investment in Held-to-Maturity Debt Securities 362.75

($204,575.07 x 0.12 x ¼) +

$6,500$13,000 – $12,637.25

ContinuedContinued

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December 31, 2003Cash 13,000.00

Interest Revenue 12,252.74Investment in Held-to-Maturity Debt Securities 362.75

($204,575.07 x 0.12 x ¼) +

$6,500$13,000 – $12,252.74

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Sale of Investment in Bonds Before Maturity


The $100,000 of 13% bonds purchased by the Colburn Company for $97,616.71 were sold on March 31, 2004

for $102,000 plus accrued interest.

The $100,000 of 13% bonds purchased by the Colburn Company for $97,616.71 were sold on March 31, 2004

for $102,000 plus accrued interest.

Investment in Held-to-MaturityDebt Securities 198.61

Interest Revenue 198.61

($2,383.29 ÷ 6) x ½

ContinuedContinued

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Cash 105,250.00Interest Revenue 3,250.00Investment in Held-to-Maturity Debt Securities 98,609.76Gain on Sale of Debt Securities 3,390.24

$102,000 + $3,250 $100,000 x 0.13

x ¼$98,411.15 +

$198.61

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Transfers of Investments Between Categories


1. A transfer from the trading category.

2. A transfer into the trading category.

3. A transfer into the available for sale category.

4. A transfer of a debt security into the held to maturity category from the available for sale category.

1. A transfer from the trading category.

2. A transfer into the trading category.

3. A transfer into the available for sale category.

4. A transfer of a debt security into the held to maturity category from the available for sale category.

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In 2005 Kent transfers the Company A securities into the trading category when the fair value is $6,300.

In 2005 Kent transfers the Company A securities into the trading category when the fair value is $6,300.

Investment in Trading Securities 6,300 Investment in Available-for- Sale Securities 5,000 Gain on Transfer of Securities 1,300

Unrealized Increase/Decrease in Value of Available-for-Sale Securities 1,100 Allowance for Change in Value of Investment 1,100



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Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500, Devon

transfers them to the available-for-sale category.

Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500, Devon

transfers them to the available-for-sale category.

Investment in Available-for-Sale Securities 10,000 Investment in Held-to- Maturity Debt Securities 10,000Unrealized Increase/Decrease in Value of Available-for-Sale Securities 500 Allowance for Change in Value of Investment 500

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Devon Company classifies its bond investment as available for sale and transfers them into the held-to-

maturity category. The current market value of the debt securities is $9,500.

Devon Company classifies its bond investment as available for sale and transfers them into the held-to-

maturity category. The current market value of the debt securities is $9,500.

Investment in Held-to-Maturity Debt Securities 9,500Unrealized Increase/Decrease from Transfer of Securities 500 Investment in Available-for- Sale Securities 10,000


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An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amount in the allowance and

unrealized increase/decrease accounts.

An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amount in the allowance and

unrealized increase/decrease accounts.

Allowance for Change in Value of Investment 300 Unrealized Increase/Decrease in Value of Available-for-Sale Securities 300

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ImpairmentsImpairments

Impairments may be an “other than temporary” decline below the

amortized cost of an investment in a debt security classified as available for

sale or held to maturity.

Impairments may be an “other than temporary” decline below the

amortized cost of an investment in a debt security classified as available for

sale or held to maturity.

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ImpairmentsImpairments

Tracy Company has a bond investment categorized as held to maturity, which has an unamortized carrying amount of $21,500 and a fair value of $6,500. The

investment is considered to be “impaired.”

Tracy Company has a bond investment categorized as held to maturity, which has an unamortized carrying amount of $21,500 and a fair value of $6,500. The

investment is considered to be “impaired.”

Realized Loss on Decline in Value 15,000 Investment in Held-to-Maturity Debt Securities 15,000

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DisclosuresDisclosures1. Trading Securities—A company must disclose the change

in the net unrealized holding gain or loss that is included in each income statement.

2. Available-for-Sale Securities—For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses and (amortized cost) by major types.

3. Held-to-Maturity Debt Securities—For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains, gross unrealized holding losses, and amortized cost by major security types.

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Financial Statement ClassificationFinancial Statement Classification

Current AssetsTemporary investment in available-for-sale securities (at cost) $29,000Plus: Allowance for change in value of investment 500Temporary investment in available-for-sale securities (at fair value) $29,500Noncurrent AssetsInvestment in available-for-sale securities (at cost) $39,000Plus: Allowance for change in value of investment 2,500Investment in available-for-sale securities (at fair value) $41,500

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FASB 115: A Conceptual EvaluationFASB 115: A Conceptual Evaluation

1. Fair value is required in the balance sheet for trading securities and available-for-sale securities, whereas amortized cost is required for held-to-maturity securities.

2. Fair value is not required for certain liabilities.3. Unrealized holding gains and losses are reported in

net income for trading securities, but in other comprehensive income for available-for-sale securities.

4. The classification of securities is based on management intent.

Four IssuesFour Issues

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Equity MethodEquity Method

When an investor corporation owns a significantly large

percentage of common stock, it is able to exert

significant influence over the policies of the investee

corporation. The equity method is used to account

for this investment.

When an investor corporation owns a significantly large

percentage of common stock, it is able to exert

significant influence over the policies of the investee

corporation. The equity method is used to account

for this investment.

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Acknowledges the existence of a material economic relationship between the investor and the investee.

Is based upon the requirements of accrual accounting.

Reflects the change in stockholders’ equity of the investee company.


The equity method--

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According to FASB Interpretation No. 35, what

are the facts and circumstances that indicate that investors with 20% or

more in the investee’s stock should not use the equity

method?

According to FASB Interpretation No. 35, what

are the facts and circumstances that indicate that investors with 20% or

more in the investee’s stock should not use the equity

method?


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• Opposition by the investee which challenges the investor’s ability to exercise significant influence.

• The investor and investee sign an agreement under which the investor surrenders significant stockholder’s rights.

• Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to views of the investor.

• Inability to gather information not available to other shareholders.

• Failure to obtain representation on investee’s board of directors.


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Investment = Acquisition Cost +

Investor’s Share of Investee Income

Dividends Received-

–

whereInvestor’s Share of Investee Income

(Investee’s Net Income= x Ownership % Adjust-

ments–

ContinuedContinued

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Dividends Received =

Total Dividends

Paid by Investee

– Ownership %–and

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Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1,

2004 for $125,000 (significant influence).

Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1,

2004 for $125,000 (significant influence).

Investment in Stock: S Company 125,000 Cash 125,000

S Company paid a $20,000 dividend.S Company paid a $20,000 dividend.

Cash 5,000 Investment in Stock: S Company 5,000


0.25 x $20,000

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S Company reported net income for 2004 of $81,000, consisting of ordinary income of $73,000 and an

extraordinary gain of $8,000.

S Company reported net income for 2004 of $81,000, consisting of ordinary income of $73,000 and an

extraordinary gain of $8,000.

Investment in Stock: S Company 20,250 Investment Income: Ordinary 18,250 Investment Income: Extraordinary 2,000


25% of $81,00025% of $81,00025% of $73,00025% of $73,000

25% of 8,00025% of 8,000

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When acquired by S Company, the investee’s depreciable assets had a fair market value that

exceeded book value by $50,000 (10-year life). Cliborn’s share of the depreciable asset

value is $12,500 (25%).

When acquired by S Company, the investee’s depreciable assets had a fair market value that

exceeded book value by $50,000 (10-year life). Cliborn’s share of the depreciable asset

value is $12,500 (25%).

Investment Income: Ordinary 1,250 Investment in Stock: S Company 1,250

Note that this entry results in a Note that this entry results in a deduction from ordinary income.deduction from ordinary income.Note that this entry results in a Note that this entry results in a

deduction from ordinary income.deduction from ordinary income.ContinuedContinuedContinuedContinued

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Cliborn calculates its purchased goodwill as follows:Cliborn calculates its purchased goodwill as follows:

Purchase price $125,000 Book value of net asset acquired $97,500 Adjustments: Increase in depreciable

assets acquired 12,500 Increase in other non- depreciable assets acquired 14,000 Increase in liabilities (5,000 )

Fair value of identifiable net assets acquired (119,000 )Purchased goodwill $ 6,000

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Investment in S CompanyAcquisition price January 1, 2004 $125,000 Add: Share of 2004 reported ordinary

income $18,250 Share of 2004 reported extraordinary

income 2,000 20,250 $145,250

Less: Dividends received August 28, 2004 $ 5,000Depreciation on excess fair market value of acquired assets 1,250 (6,250 )

Carrying value $139,000

Cliborn calculates its investment carrying value as follows:Cliborn calculates its investment carrying value as follows:

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Stock DividendsStock Dividends

Smith Corporation purchased 2,000 shares of Kell Company common stock for $30 per share. Two months later Kell issued a 50% stock dividend.

Smith Corporation purchased 2,000 shares of Kell Company common stock for $30 per share. Two months later Kell issued a 50% stock dividend.

Memo: Received 1,000 shares of Kell Company common stock as a stock dividend. The cost of the shares is now $20 per share, computed as follows: $60,000 ÷ 3,000 (2,000 + 1,000) shares.


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Stock DividendsStock Dividends

Subsequently, Smith Corporation sold 500 of the shares for $25 per share, and the fair value at the most

recent balance sheet date was $23 per share.

Subsequently, Smith Corporation sold 500 of the shares for $25 per share, and the fair value at the most

recent balance sheet date was $23 per share.

Cash 12,500 Investment in Available-for-Sale Securities 10,000 Gain on Sale of Investment 2,500Unrealized Increase/Decrease in Value of Available-for Sale Securities 1,500 Allowance for Change in Value of Investment 1,500

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Cash Surrender Value of Life Insurance


Merle Corporation paid for an annual insurance premium of $5,500 at the beginning

of the year to cover the lives of its officers.

Merle Corporation paid for an annual insurance premium of $5,500 at the beginning

of the year to cover the lives of its officers.

Prepaid Insurance 5,500 Cash 5,500

ContinuedContinued

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Insurance Expense 4,400Cash Surrender Value of Life Insurance 1,100 Prepaid Insurance 5,500

According to the terms of the insurance contract, the cash surrender value increases

from $7,200 to $8,300 during the year.

According to the terms of the insurance contract, the cash surrender value increases

from $7,200 to $8,300 during the year.

$8,300 – $7,200$8,300 – $7,200

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Chapter14

The EndThe EndThe EndThe End

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Documents

1InvestmentsInvestments C hapter 14. 2 1. Explain the classification and valuation of investments. 2. Account for investments in debt and equity trading