© 2004 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 12 Investments
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© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Chapter 12
Investments
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-2 Accounting for Investment
Securities
Bonds and notes
(Debt securities)
Bonds and notes
(Debt securities)
Common and preferred stock
(Equity securities)
Common and preferred stock
(Equity securities)
Investments can be accounted for in six different ways, depending on the nature
of the investment relationship.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-3 Reporting Categories for
Investments
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-4
Trading securities Trading securities (TS) are bought and (TS) are bought and held primarily to be held primarily to be
sold in the near term.sold in the near term.
Trading securities Trading securities (TS) are bought and (TS) are bought and held primarily to be held primarily to be
sold in the near term.sold in the near term.
Securities available Securities available for sale (SAS) are for sale (SAS) are
expected to be held expected to be held for an unspecified for an unspecified
period of time.period of time.
Securities available Securities available for sale (SAS) are for sale (SAS) are
expected to be held expected to be held for an unspecified for an unspecified
period of time.period of time.
Reporting Categories for Investments
Held to maturity Held to maturity (HTM) securities (HTM) securities are those where are those where
the investor the investor intends and has intends and has
the ability to hold the ability to hold the security to the security to maturity date.maturity date.
Held to maturity Held to maturity (HTM) securities (HTM) securities are those where are those where
the investor the investor intends and has intends and has
the ability to hold the ability to hold the security to the security to maturity date.maturity date.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-5 Investments Held for an
Unspecified Period of Time
When an investment is held for an unspecified period of time, it is reported
at the fair value of the security on the reporting date.
When an investment is held for an unspecified period of time, it is reported
at the fair value of the security on the reporting date.
Must be “readily determinable”
Must be “readily determinable”
Otherwise, the investment is
reported at cost.
Otherwise, the investment is
reported at cost.
.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-6
Securities Available-for-Sale
Adjustments to fair value are recorded as:
a direct adjustment to the investment account, andan allowance account in the equity section of the
balance sheet called “Unrealized Holding
Gains/Losses”.
Adjustments to fair value are recorded as:
a direct adjustment to the investment account, andan allowance account in the equity section of the
balance sheet called “Unrealized Holding
Gains/Losses”.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-7
Securities Available for Sale
Unrealized holding gains
and losses from
securities available-for-
sale are reported in the equity
section of the balance sheet.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-8 Securities Available for Sale
Example
Foot, Inc. purchased the securities listed below in 2003. They are classified as
Securities Available for Sale (SAS). Prepare the journal entries for Foot, Inc. to adjust
the securities to fair value at Dec. 31, 2003.
Foot, Inc. purchased the securities listed below in 2003. They are classified as
Securities Available for Sale (SAS). Prepare the journal entries for Foot, Inc. to adjust
the securities to fair value at Dec. 31, 2003.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-9 Securities Available for Sale
Example
The Unrealized Holding Gain is reported as an allowance in the Equity
Section.
The Unrealized Holding Gain is reported as an allowance in the Equity
Section.
.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-10
Securities Available for Sale
Occasionally, an Occasionally, an investment’s value investment’s value
will decline for will decline for reason’s that are reason’s that are
“other than “other than temporary”.temporary”.
Occasionally, an Occasionally, an investment’s value investment’s value
will decline for will decline for reason’s that are reason’s that are
“other than “other than temporary”.temporary”.
This is called . . .
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-11
Securities Available for Sale
The new cost The new cost basis (the basis (the
impaired fair impaired fair value) is not value) is not changed for changed for subsequent subsequent recoveries in recoveries in
fair value.fair value.
The new cost The new cost basis (the basis (the
impaired fair impaired fair value) is not value) is not changed for changed for subsequent subsequent recoveries in recoveries in
fair value.fair value.
If the value is impaired . . .
. . . the recorded cost of the security is reduced
to the impaired fair value, and the
difference is included in the current period’s
income.
If the value is impaired . . .
. . . the recorded cost of the security is reduced
to the impaired fair value, and the
difference is included in the current period’s
income.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-12
Trading Securities
Adjustments to fair value are recorded
as:a direct adjustment to
the investment account, and
a net unrealized holding gain/loss on the Income
Statement.
Adjustments to fair value are recorded
as:a direct adjustment to
the investment account, and
a net unrealized holding gain/loss on the Income
Statement.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-13
Trading Securities
Unrealized holding
gains and losses from
trading securities
are reported on the income
statement.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-14 Trading Securities
Example
Foot, Inc. purchased the addition securities Foot, Inc. purchased the addition securities classified as Trading Securities (TS) in 2003. classified as Trading Securities (TS) in 2003.
Prepare the journal entries for Foot, Inc. to adjust Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at 12/31/03.the securities to fair value at 12/31/03.
Foot, Inc. purchased the addition securities Foot, Inc. purchased the addition securities classified as Trading Securities (TS) in 2003. classified as Trading Securities (TS) in 2003.
Prepare the journal entries for Foot, Inc. to adjust Prepare the journal entries for Foot, Inc. to adjust the securities to fair value at 12/31/03.the securities to fair value at 12/31/03.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-15 Trading Securities & Securities
Available for Sale - Example
The Net Unrealized Holding Loss is reported on the Income Statement.
The Net Unrealized Holding Loss is reported on the Income Statement.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-16 Transfers Between Reporting
Categories
Transfers are accounted for at fair value
on the transfer date.
Transfers are accounted for at fair value
on the transfer date.
Unrealized holding gains or losses at
reclassification should be accounted for in a
manner consistent with the classification into which the security is being transferred.
Unrealized holding gains or losses at
reclassification should be accounted for in a
manner consistent with the classification into which the security is being transferred.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-17
Disclosures
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-18
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-19
When an investment results in the control of the investee
(generally > 50%), the subsidiary is consolidated with the parent company.
When an investment results in the control of the investee
(generally > 50%), the subsidiary is consolidated with the parent company.
The cost method is used for investments in equity securities
when significant influence is not
present.
The cost method is used for investments in equity securities
when significant influence is not
present.
The equity method is used for investments in
equity securities resulting in significant influence (20%-50%).
The equity method is used for investments in
equity securities resulting in significant influence (20%-50%).
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-20
Equity Method
The investment account is increased by: Original investment cost. Proportionate share of
investee’s earnings.
The investment account is decreased by: Dividends received.
The investment account is increased by: Original investment cost. Proportionate share of
investee’s earnings.
The investment account is decreased by: Dividends received.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-21
Equity Method
The investment account is reported on the balance sheet as a single amount.
The investor’s share of the investee’s earnings is reported as a single item on the investor’s income statement.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-22
Equity Method
If the investor acquires the equity securities of an investee by paying
more than the fair value of net assets . . .
. . . the difference is allocated between GOODWILL and
identifiable intangible assets.
If the investor acquires the equity securities of an investee by paying
more than the fair value of net assets . . .
. . . the difference is allocated between GOODWILL and
identifiable intangible assets.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-23 Equity Method
Example
Rings & More acquired 45% of the equity securities of Diamonds Galore for
$1,350,000. On the acquisition date, Diamonds Galore’s net assets had a fair
value of $3,000,000. During the year, Diamonds Galore paid dividends of $150,000
and net income of $1,750,000.
What amount will Rings & More report on the balance sheet as Investment in Diamonds
Galore?
Rings & More acquired 45% of the equity securities of Diamonds Galore for
$1,350,000. On the acquisition date, Diamonds Galore’s net assets had a fair
value of $3,000,000. During the year, Diamonds Galore paid dividends of $150,000
and net income of $1,750,000.
What amount will Rings & More report on the balance sheet as Investment in Diamonds
Galore?
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-24 Equity Method
Example
Investment in Diamonds Galore
Investment 1,350,000 67,500 45% Dividends
45% Earnings 787,500
Reported Value 2,070,000
If the subsidiary had a loss, the investment account would have
been reduced.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-25
Reporting the Investment
When the Investee Reports a Net Loss The investment account is decreased.
When the Investment if Acquired in Mid-Year The investment account is adjusted only
for the income (loss) since the date of acquisition.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-26 Changing From Equity Method
To Cost Method
At the transfer date, the carrying
value of the investment under the equity method
is regarded as cost.
At the transfer date, the carrying
value of the investment under the equity method
is regarded as cost.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-27 Changing From Equity Method
To Cost Method
Any difference between cost and fair value is recorded in a valuation account and is recognized as an unrealized holding gain or loss.
After the transfer, the investment is treated as a trading security or a
security available for sale, depending on management’s intent.
Any difference between cost and fair value is recorded in a valuation account and is recognized as an unrealized holding gain or loss.
After the transfer, the investment is treated as a trading security or a
security available for sale, depending on management’s intent.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-28 Changing From Cost Method To
Equity Method
When ownership level increases to a significant influence, the investor must
change to the equity method.
At the transfer date, the recorded value is the initial cost of the investment
adjusted for the investor’s equity in the undistributed earnings of the investee
since the original investment.
When ownership level increases to a significant influence, the investor must
change to the equity method.
At the transfer date, the recorded value is the initial cost of the investment
adjusted for the investor’s equity in the undistributed earnings of the investee
since the original investment.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-29 Changing From Cost Method To
Equity Method
The original cost, the unrealized holding gain or loss, and the valuation account are closed.
A retroactive change is recorded to recognize the investor’s share of the investee’s earnings since the original
investment.
The original cost, the unrealized holding gain or loss, and the valuation account are closed.
A retroactive change is recorded to recognize the investor’s share of the investee’s earnings since the original
investment.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-30 Financial Instruments &
Derivatives
Financial Instruments:
Cash. Evidence of an ownership interest
in an entity. Contracts meeting
certain conditions.
Financial Instruments:
Cash. Evidence of an ownership interest
in an entity. Contracts meeting
certain conditions.
Derivatives:Derivatives: Hedges created to Hedges created to
offset risks created offset risks created by other financial by other financial
investments or investments or transactions.transactions.
Value is derived from Value is derived from other securities.other securities.
Derivatives:Derivatives: Hedges created to Hedges created to
offset risks created offset risks created by other financial by other financial
investments or investments or transactions.transactions.
Value is derived from Value is derived from other securities.other securities.
© 2004 The McGraw-Hill Companies, Inc.McGraw-Hill/Irwin
Slide12-31
End of Chapter 12
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