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Chapter 17 Notes INVESTMENTS

This document discusses different types of investments and how companies account for them. It covers investments in debt securities such as bonds, and equity securities such as common stock. For debt securities, companies classify them as held-to-maturity, available-for-sale, or trading based on intent and ability to hold. Equity securities under 20% ownership are reported at fair value, while 20-50% use the equity method and over 50% are consolidated. The document provides examples of accounting entries for various investment activities.

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118 views

Chapter 17 Notes INVESTMENTS

This document discusses different types of investments and how companies account for them. It covers investments in debt securities such as bonds, and equity securities such as common stock. For debt securities, companies classify them as held-to-maturity, available-for-sale, or trading based on intent and ability to hold. Equity securities under 20% ownership are reported at fair value, while 20-50% use the equity method and over 50% are consolidated. The document provides examples of accounting entries for various investment activities.

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Business Administration Department
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Chapter 17 INVESTMENTS

Investment in Debt Securities


Different motivations for investing:
 To earn a high rate of return.
 To secure certain operating or financing arrangements with
another company.

Companies account for investments based on


 the type of security (debt or equity) and
 their intent with respect to the investment.

Type
 U.S. government securities
 Municipal securities
 Corporate bonds
 Convertible debt
 Commercial paper

Accounting Category
 Held-to-maturity
 Trading
 Available-for-sale
Debt Investment Classifications

Held-to-Maturity Securities

Classify a debt security as held-to-maturity only if it has both


1) the positive intent and
2) the ability to hold securities to maturity.

Example: Z-Smith Company purchased $100,000 of 8 percent bonds of Bush


Corporation on January 1, 2013, at a discount, paying $92,278. The bonds mature
January 1, 2018 and yield 10%; interest is payable each July 1 and January 1. Z-
Smith records the investment as follows:

January 1, 2013
Debt Investments 92,278
Cash 92,278
Illustration: Z-Smith Company records the receipt of the first semiannual interest
payment on July 1, 2013, as follows:
Cash 4,000
Debt Investments 614
Interest Revenue 4,614
Reporting of Held-to-Maturity Securities

Example: Assume Z-Smith sells its investment in Bush bonds on November 1,


2017, at 99¾ plus accrued interest. Z-Smith records discount amortization as
follows:

Calculation of amortization = $952 x 4/6 = $635


Debt Investments 635
Interest Revenue 635
+
Computation of Gain on Sale of Bonds

Cash (99,750+2,667) 102,417


Interest Revenue (4/6 x $4,000) 2,667
Debt Investments 99,683
Gain on Sale of Securities 67
.
Available-for-Sale Securities
Companies report available-for-sale securities at
 fair value, with
 unrealized holding gains and losses reported as other
comprehensive income, a separate component of stockholder’s
equity, until realized.

Any discount or premium is amortized.


Example: Graffeo Corporation purchases $100,000, 10 percent, five-year bonds
on January 1, 2013, with interest payable on July 1 and January 1. The bonds sell
for $108,111, which results in a bond premium of $8,111 and an effective interest
rate of 8 percent. Graffeo records the purchase of the bonds on January 1, 2013, as
follows.
Debt Investments 108,111
Cash 108,111
.
The entry to record interest revenue on July 1, 2013, is as follows.
Cash 5,000
Debt Investments 676
Interest Revenue 4,324

At December 31, 2013, Graffeo makes the following entry to recognize interest
revenue.
Interest Receivable 5,000
Debt Investments 703
Interest Revenue 4,297
To apply the fair value method to these debt securities, assume that at December
31, 2013 the fair value of the bonds is $105,000. Graffeo makes the following
entry
Unrealized Holding Gain or Loss—Equity (106,732-105,000) 1,732
Fair Value Adjustment (AFS) 1,732

.
Herringshaw Corporation has two debt securities classified as available-for-sale.
The following illustration identifies the amortized cost, fair value, and the amount
of the unrealized gain or loss

Prepare the adjusting entry Herringshaw would make on December 31, 2014 to
record the loss.
Unrealized Holding Gain or Loss—Equity 9,537
Fair Value Adjustment (AFS) 9,537

.
Sale of Available-for-Sale Securities
If company sells bonds before maturity date:
- It must make entries to remove from the Debt Investments account the
amortized cost of bonds sold.
- Any realized gain or loss on sale is reported in the “Other expenses and
losses” section of the income statement.

Example: Herringshaw Corporation sold the Watson bonds (from Illustration 17-
7) on July 1, 2015, for $90,000, at which time it had an amortized cost of $94,214.

Cash 90,000
Loss on Sale of Investments 4,214
Debt Investments 94,214

Herringshaw reports this realized loss in the “Other expenses and losses” section of
the income statement. Assuming no other purchases and sales of bonds in 2015,
Herringshaw on December 31, 2015, prepares the information:

Fair Value Adjustment (AFS) 4,537


Unrealized Holding Gain or Loss—Equity 4,537
Financial Statement Presentation

.
Trading Securities
On December 31, 2014, Koopmans Publishing Corporation determined its trading
securities portfolio to be as follows:

At December 31, Koopmans Publishing makes an adjusting entry:


Fair Value Adjustment (Trading) 3,750
Unrealized Holding Gain or Loss—Income 3,750
Example: Hendricks Corporation purchased trading investment bonds for $50,000
at par. At December 31, Hendricks received annual interest of $2,000, and the fair
value of the bonds was $47,400.
Instructions:
a) Prepare the journal entry for the purchase of the investment.
b) Prepare the journal entry for the interest received.
c) Prepare the journal entry for the fair value adjustment.

a) Debt investments 50,000


Cash 50,000

b) Cash 2,000
Interest Revenue 2,000
Unrealized Holding Loss – Income 2,600
Fair Value Adjustment (Trading) 2,600

Investment Value in Equity Securities

Ownership Percentages

< 20% Use Fair Value Method


20% to 50% Use Equity Method
> 50% Consolidate using Cost or Equity method
Holdings of Less Than 20% Avail-For Sale

On November 3, 2014, Republic Corporation purchased common stock of three


companies, each investment representing less than a 20 percent interest.

Republic records these investments on November 3, as follows.


Equity Investments 718,550
Cash 718,550
On December 6, 2014, Republic receives a cash dividend of $4,200 from Campbell
Soup Co.
Cash 4,200
Dividend revenue 4,200
.
Prepare the entry Republic would make on December 31, 2014, to record the net
unrealized gains and losses.
Unrealized Holding Gain or Loss—Equity 35,550
Fair Value Adjustment (AFS) 35,550

On January 23, 2015, Republic sold all of its Northwest Industries, Inc. common
stock receiving net proceeds of $287,220. Cost was $259,700. Gain of $27,520.
Prepare the entry to record the sale
Cash 287,220
Equity Investments 259,700
Gain on Sale of Investments 27,520

Holding 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.
See page 965 in textbook
.
Holding of More Than 50%

Controlling Interest - When one corporation acquires a voting interest of more


than 50 percent in another corporation
 Investor corporation is referred to as the parent.
 Investee corporation is referred to as the subsidiary.
 Investment in the subsidiary is reported on the parent’s
balance sheet as a long-term investment.
 Parent generally prepares consolidated financial
statements.

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