Slide 12-1. Slide 12-2 Chapter 12 Investments Financial Accounting, Seventh Edition.

Slide 12-1

Slide 12-2

Chapter 12

InvestmentsInvestments

Financial Accounting, Seventh Edition

Slide 12-3

1. Discuss why corporations invest in debt and stock securities.

2. Explain the accounting for debt investments.

3. Explain the accounting for stock investments.

4. Describe the use of consolidated financial statements.

5. Indicate how debt and stock investments are reported in financial statements.

6. Distinguish between short-term and long-term investments.

Study ObjectivesStudy ObjectivesStudy ObjectivesStudy Objectives

Slide 12-4

Why Why

Corporations Corporations

InvestInvest

Why Why

Corporations Corporations

InvestInvest

Cash Cash managementmanagement

Investment Investment incomeincome

Strategic Strategic reasonsreasons

Accounting for Accounting for

Debt Debt



Debt Debt



Stock Stock



Stock Stock


Valuing and Valuing and

Reporting Reporting


Valuing and Valuing and

Reporting Reporting


Categories of Categories of securitiessecurities

Balance sheet Balance sheet presentationpresentation

Realized and Realized and unrealized gain unrealized gain or lossor loss

Classified Classified balance sheetbalance sheet

Holdings of less Holdings of less than 20%than 20%

Holdings Holdings between 20% between 20% and 50%and 50%

Holdings of more Holdings of more than 50%than 50%

Recording Recording acquisition of acquisition of bondsbonds

Recording bond Recording bond interestinterest

Recording sale Recording sale of bondsof bonds

InvestmentsInvestmentsInvestmentsInvestments

Slide 12-5

Corporations generally invest in debt or stock securities for one of three reasons.

Why Corporations InvestWhy Corporations InvestWhy Corporations InvestWhy Corporations Invest

SO 1 Discuss why corporations invest in debt and stock SO 1 Discuss why corporations invest in debt and stock securities.securities.

1. Corporation may have excess cash.

2. To generate earnings from investment income.

3. For strategic reasons. Illustration 12-1

Temporary investments

and the operating

cycle

Slide 12-6

Pension funds and banks regularly invest in debt and stock securities to:

a. house excess cash until needed.

b. generate earnings.

c. meet strategic goals.

d. avoid a takeover by disgruntled investors.

QuestionQuestion

Why Corporations InvestWhy Corporations InvestWhy Corporations InvestWhy Corporations Invest

SO 1 Discuss why corporations invest in debt and stock SO 1 Discuss why corporations invest in debt and stock securities.securities.

Slide 12-7

Accounting for Debt InstrumentsAccounting for Debt InstrumentsAccounting for Debt InstrumentsAccounting for Debt Instruments

SO 2 Explain the accounting for debt investments.SO 2 Explain the 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.

Recording Bond Interest

Calculate and record interest revenue based upon the carrying value of the bond times the interest rate times the portion of the year the bond is outstanding.

Slide 12-8



Sale of Bonds

Credit the investment account for the cost of the bonds and record as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds.

Slide 12-9

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2011, for $54,000, including brokerage fees of $1,000. The entry to record the investment is:

Debt investments 54,000

Cash 54,000



Jan. 1

Slide 12-10

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2011, for $54,000, including brokerage fees of $1,000. The bonds pay interest semiannually on July 1 and January 1. The entry for the receipt of interest on July 1 is:



Cash 2,000

Interest revenue 2,000

* ($50,000 x 8% x ½ = $2,000)

*July 1

Slide 12-11

Illustration: If Kuhl Corporation’s fiscal year ends on December 31, prepare the entry to accrue interest since July 1.



Interest receivable 2,000

Interest revenue 2,000

Kuhl reports receipt of the interest on January 1 as follows.

Cash 2,000

Interest receivable 2,000

Dec. 31

Jan. 1

Slide 12-12

Illustration: Assume that Kuhl corporation receives net proceeds of $58,000 on the sale of the Doan Inc. bonds on January 1, 2011, after receiving the interest due. Prepare the entry to record the sale of the bonds.



Cash 58,000

Debt investments 54,000

Gain on sale of investments 4,000

Jan. 1

Slide 12-13

An event related to an investment in debt securities that does not require a journal entry is:

a. acquisition of the debt investment.

b. receipt of interest revenue from the debt investment.

c. a change in the name of the firm issuing the debt securities.

d. sale of the debt investment.

Question



Slide 12-14

When bonds are sold, the gain or loss on sale is the difference between the:

a. sales price and the cost of the bonds.

b. net proceeds and the cost of the bonds.

c. sales price and the market value of the bonds.

d. net proceeds and the market value of the bonds.

Question



Slide 12-15

0 --------------20% ------------ 50% -------------- 100%0 --------------20% ------------ 50% -------------- 100%No

significant influence

usually exists

Significant influence

usually exists

Control usually exists

Investment valued using

Cost Method

Investment valued using

Equity Method

Investment valued on parent’s books using

Cost Method or Equity Method (investment

eliminated in Consolidation)

Ownership PercentagesOwnership Percentages

Accounting for Stock InvestmentsAccounting for Stock InvestmentsAccounting for Stock InvestmentsAccounting for Stock Investments

SO 3 Explain the accounting for stock investments.SO 3 Explain the accounting for stock investments.

The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation.

Slide 12-16

Companies use the cost method. Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received.

Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).


Holdings of Less than 20%


Slide 12-17

July 1


Holdings of Less than 20%Holdings of Less than 20%Holdings of Less than 20%Holdings of Less than 20%

Illustration: On July 1, 2011, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 pershare plus brokerage fees of $500. The entry for the purchase is:

Stock investments 40,500

Cash 40,500

Slide 12-18

Dec. 31



Illustration: During the time Sanchez owns the stock, it makes entries for any cash dividends received. If Sanchez receives a $2 per share dividend on December 31, the entry is:

Cash 2,000

Dividend revenue 2,000

Slide 12-19

Feb. 10



Illustration: Assume that Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal stock on February 10, 2012. Because the stock cost $40,500, Sanchez incurred a loss of $1,000. The entry to record the sale is:

Cash 39,500

Loss on sale of stock 1,000

Stock investments 40,500

Slide 12-20

Holdings Between 20% and 50% (Equity

Method)

Record the investment at cost and subsequently adjust the amount each period for

the investor’s proportionate share of the earnings (losses) and

dividends received by the investor.

If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method.



Slide 12-21

Under the equity method, the investor records dividends received by crediting:

a. Dividend Revenue.

b. Investment Income.

c. Revenue from Investment.

d. Stock Investments.

Question

Holdings Between 20% and 50%Holdings Between 20% and 50%Holdings Between 20% and 50%Holdings Between 20% and 50%


Slide 12-22

Illustration: Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2011. For 2011, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.

Stock investments 120,000Cash 120,000

Cash 12,000 Stock investments 12,000

Stock investments 30,000 Revenue from investments 30,000


($40,000 x 30%)

($100,000 x 30%)


Jan. 1

Dec. 31

Dec. 31

Slide 12-23

After Milar posts the transactions for the year, its investment and revenue accounts will show the following.

Debit Credit

Stock Investments

120,000120,000 30,00030,000

Debit Credit

Revenue from Investments



30,00030,000 12,00012,000

138,000138,000

Illustration: Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2011. For 2011, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.

Slide 12-24

Controlling Interest - When one corporation acquires

a voting interest of more than 50 percent in another

corporation

Investor is referred to as the parent.

Investee is referred to as the subsidiary.

Investment in the subsidiary is reported on the parent’s

books as a long-term investment.

Parent generally prepares consolidated financial

statements.

SO 4 Describe the use of consolidated financial SO 4 Describe the use of consolidated financial statements.statements.

Holdings of More Than 50%


Slide 12-25

Slide 12-26

Valuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing and Reporting InvestmentsValuing and Reporting Investments

Categories of Securities

Companies classify debt and stock investments

into three categories:

Trading securities

Available-for-sale securities

Held-to-maturity securities

These guidelines apply to all debt securities and all stock investments in which the holdings are less than 20%.

SO 5 Indicate how debt and stock SO 5 Indicate how debt and stock investments are reported in investments are reported in financial statements.financial statements.

Slide 12-27


Trading Securities

Companies hold trading securities with the

intention of selling them in a short period.

Trading means frequent buying and selling.

Companies report trading securities at fair value,

and report changes from cost as part of net

income.


Slide 12-28


Available-for-Sale Securities

Companies hold available-for-sale securities with the intent of selling these investments sometime in the future.

These securities can be classified as current assets or as long-term assets, depending on the intent of management.

Companies report securities at fair value, and report changes from cost as a component of the stockholders’ equity section.


Slide 12-29

Marketable securities bought and held primarily for sale in the near term are classified as:

a. available-for-sale securities.

b. held-to-maturity securities.

c. stock securities.

d. trading securities

Question



Slide 12-30

Illustration: Investment of Pace classified as trading securities on December 31, 2011.

Trading SecuritiesTrading SecuritiesTrading SecuritiesTrading Securities

The adjusting entry for Pace Corporation is:


Dec. 31 Market adjustment—trading 7,000

Unrealized gain—income 7,000

Illustration 12-7

Slide 12-31

Problem: How would the entries change if the securities were classified as available-for-sale?

The entries would be the same except that the

Unrealized Gain or Loss—Equity account is used instead

of Unrealized Gain or Loss—Income.

The unrealized loss would be deducted from the

stockholders’ equity section rather than charged to the

income statement.

Available-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale Securities


Slide 12-32

Illustration: Assume that Ingrao Corporation has two securities that it classifies as available-for-sale.

The adjusting entry for Ingrao Corporation is:


Dec. 31 Unrealized gain or loss—equity 9,537

Market adjustment—available-for-sale 9,537

Illustration 12-8


Slide 12-33

An unrealized loss on available-for-sale securities is:

a. reported under Other Expenses and Losses in the income statement.

b. closed-out at the end of the accounting period.

c. reported as a separate component of stockholders' equity.

d. deducted from the cost of the investment.

Question



Slide 12-34

Slide 12-35

Also called marketable securities, are securities held

by a company that are

(1) readily marketable and

(2) intended to be converted into cash within the next

year or operating cycle, whichever is longer.

Short-Term Investments

SO 6 Distinguish between short-term and long-term investments.

Investments that do not meet both criteria are classified as long-term investments.

Balance Sheet Presentation


Slide 12-36

Nonoperating items related to investments

Presentation of Realized and Unrealized Gain or Loss

Balance Sheet PresentationBalance Sheet PresentationBalance Sheet PresentationBalance Sheet Presentation


Illustration 12-10

Slide 12-37

Realized and Unrealized Gain or Loss



Unrealized gain or loss on available-for-sale securities are reported as a separate component of stockholders’ equity.

Illustration 12-11

Slide 12-38 SO 6 Distinguish between short-term and long-term investments.

Classified Balance Sheet (partial)

Illustration 12-12

Slide 12-39

Identify where each of the following items

would be reported in the financial

statements.


SO 6 Distinguish between short-term and long-term investments.Solution on notes page

Use the following possible categories:Current assets Current liabilitiesInvestments Long-term liabilitiesProperty, plant, and equipment Stockholders’ equityIntangible assets Other revenues and gains Other expenses and losses

Slide 12-40

Only about 48% of people in their twenties whose employers have a 401(k) plan participate in that plan. [401(k) plans allow you to put part of your pretax salary into investments. The investment and its earnings are not taxed until you withdraw them in retirement.] Many employers automatically enroll employees in 401(k) plans when they hire them.

Only 40% of working couples currently are covered by pension plans, but 61% of workers expect to get income from a company pension plan.

A Good Day to Start Starving

Slide 12-41

More than half of workers age 55 and older have less than

$50,000 in retirement savings.

80% of individuals between the ages of 18 to 26 said that,

if given $10,000, they would deposit the money into a

traditional bank savings account rather than invest in the

stock market. Many stated that they are intimidated by

the stock market, and choose to give up the added

returns the stock market offers over the long run, rather

than face the market.

Slide 12-42

The message to start saving early has been presented in many different ways. The chart below presents the facts in very blunt terms. When you are 25 years old, if you start putting $300 per month into an investment earning 8%, by the age of 65 you will have accumulated more than $1 million. But if you wait until age 55, you will accumulate only about $55,000. Notice the sharp drop-off between ages 25 and 35.

Slide 12-43

You’ve got $3,000 in credit card bills at an 18% interest rate.

Your employer has a 401(k) plan in which it will match your

contributions, up to 10% of your annual salary. Should you pay

off your credit card bills before you start putting money into

the 401(k)?YES: Paying off an 18% debt, and thus avoiding 18% interest

payments, is essentially equivalent to earning 18% on

investments. Reducing your debts reduces your financial

vulnerability.

NO: You need to get in the savings habit as soon as possible.

You should take part of the money you would have used to

pay off your debt each month and instead put it into the

401(k).

Slide 12-44

Consolidated Balance Sheet

Preparing Consolidated Financial Preparing Consolidated Financial StatementsStatementsPreparing Consolidated Financial Preparing Consolidated Financial StatementsStatements

Companies prepare consolidated balance sheets

from the individual balance sheets of their

affiliated companies.

Transactions between the affiliated companies

are eliminated.

Appendix

Slide 12-45



Illustration: Assume that on January 1, 2011, Powers Construction Company pays $150,000 in cash for 100% of Serto Brick Company’s common stock. Powers Company records the investment at cost, as required by the cost principle.

The combined totals do not represent a consolidated balance sheet, because there has been a double counting of assets and owners’ equity in the amount of $150,000.

Slide 12-46



Illustration 12A-1

Slide 12-47

Use of a Worksheet—Cost Equal to Book Value


Illustration 12A-2

SO 7 Describe the content of a worksheet for a consolidated balance sheet.

Slide 12-48

Use of a Worksheet—Cost Above Book Value



Illustration: Assume the same data used above, except that Powers Company pays $165,000 in cash for 100% of Serto’s common stock. The excess of cost over book value is $15,000 ($165,000 $150,000).

Slide 12-49


Illustration 12A-3


Use of a Worksheet—Cost Above Book Value

Slide 12-50

Content of a Consolidated Balance Sheet


SO 8 Explain the form and content of consolidated financial statements.

Illustration: The prior worksheet shows an excess of cost over book value of $15,000. In the consolidated balance sheet, Powers first allocates this amount to specific assets, such as inventory and plant equipment, if their fair market values on the acquisition date exceed their book values. Any remainder is considered to be goodwill. For Serto Company, assume that the fair market value of property and equipment is $155,000.Thus, Powers allocates $10,000 of the excess of cost over book value to property and equipment, and the remainder, $5,000, to goodwill.

Slide 12-51

Content of a Consolidated Balance Sheet



Illustration 12A-4

Slide 12-52

Consolidated Income Statement


Statement shows the results of operations of

affiliated companies as though they are one

economic unit.

All intercompany revenue and expense

transactions must be eliminated.

A worksheet facilitates the preparation of

consolidated income statements in the same

manner as it does for the balance sheet.

Appendix


Slide 12-53

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Slide 12-1. Slide 12-2 Chapter 12 Investments Financial Accounting, Seventh Edition.

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