BUS 120: Financial Accounting

Chapter 13: Investments

Dr. Al Taccone
 Chapter 13: What you should
learn
• Why corporations invest in debt and stock securities
• Accounting for debt investments
* Recording acquisitions of bonds
* Recording bond interest
* Recording sale of bonds
• Accounting for stock investments
* Holdings of less than 20%
* Holdings of between 20% and 50%
* Holdings of greater than 50%
• Balance sheet presentation of investments
 Temporary Investments and the
Operating Cycle
• Many companies may have temporarily
idle cash on hand pending the start of the
next operating cycle.

• Until the cash is needed in operations,

these excess funds may be invested to
earn interest and dividends.
 WHY CORPORATIONS INVEST

Reason Typical Investment

To house excess cash until Low-risk, high-liquidity, short-term

needed securities such as government-
issued securities
To generate earnings Debt securities (banks and other
financial institutions); and stock
securities (mutual funds and
pension funds)
To meet strategic goals Stocks of companies in a related
industry or in an unrelated industry
that the company wishes to enter
 Temporary vs. Long-term
Investments
Temporary investments: Long-term investments:

• Securities held by a • Investments that do not

company that are: meet both criteria for
1. Readily marketable temporary investments.

2. Intended to be
converted into cash
within the next year or
operating cycle,
whichever is longer.
 Debt Investments
• Investments in government and corporation
bonds.

• Entries are required to record:

1. Acquisition of the bonds
2. Interest revenue earned on the bonds
3. Sale of the bonds

• The cost principle applies—cost includes all

expenditures necessary to acquire these
investments.
 ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES AT
ACQUISITION
Kuhl Corporation acquires 50 Doan Inc. 12%, 10-year,
$1,000 bonds on January 1, 2002, for $54,000, including
brokerage fees of $1,000. The entry to record the
investment is:

54,000

54,000
 ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES FOR BOND
INTEREST
The bonds pay $3,000 interest on July 1 and January 1 ($50,000 X 12% X ½). The July 1 entry is:

3,000

3,000

It is necessary to accrue $3,000 interest earned since July 1 at year-end. The December 31 entry is:

3,000

3,000

When the interest is received on January 1, the entry is:

3,000

3,000
ACCOUNTING FOR DEBT INVESTMENTS
ENTRIES FOR SALE OF
BONDS
Any difference between the net proceeds (sales price less
brokerage fees) from the sale of bonds and the cost of
the bonds is recorded as a gain or loss. Kuhl
Corporation receives net proceeds of $58,000 on the sale
of the Doan Inc. bonds on January 1, 2003, after
receiving the interest due. Since the securities cost
$54,000, a gain of $4,000 has been realized. The entry to
record the sale is:

58,000

54,000

4,000
 STOCK INVESTMENTS

Stock investments are investments in the capital stock of corporations.

When a company holds stock or debt of various corporations, the group
of securities is identified as an investment portfolio.
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS LESS THAN 20%
PURCHASE OF STOCK INVESTMENT

In accounting for stock investments of less than 20%,

the cost method is used. The investment is recorded at
cost and revenue is recognized only when cash dividends
are received. On July 1, 2002, Sanchez Corporation
acquires 1,000 shares (10% ownership) of Beal
Corporation common stock at $40 per share plus
brokerage fees of $500. The entry for the purchase is:

40,500

40,500
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS LESS THAN 20%
DIVIDEND REVENUE

Entries are required for any cash dividends

received during the time the stock is held. If a
$2 per share dividend is received by Sanchez
Corporation on December 31 the entry is:

2,000

2,000

Dividend Revenue is reported under Other

Revenue and Gains in the income statement.
Since dividends do not accrue, adjusting entries
are not made to accrue dividends.
ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS LESS THAN 20%
SALE OF STOCK INVESTMENT (GAINS or LOSSES)
When stock is sold, the difference between the net
proceeds from the sale and the cost of the stock is
recognized as a gain or loss. Sanchez Corporation
receives net proceeds of $39,500 on the sale of its Beal
Corporation common stock on February 10, 2003.
Because the stock cost $40,500, a loss of $1,000 has been
incurred. The entry to record the sale is:

39,500

1,000

40,500
 Accounting for Stock Investments
Holdings Between 20% and 50%
• Usually presumed that the investor has significant
influence over the financial and operating activities of the
investee.
• The investor should record its share of net income of the
investee in the year when it is earned.
• Equity Method:
investment in common stock is initially recorded at cost,
and the investment account is adjusted annually to show
the investor’s equity in the investee.
• Each year the following transactions are required:
1. Debit the investment account and credit revenue for
its share of the investee’s net income.
2. Credit dividends received to the investment account.
 ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
RECORD
Milar Corporation THE
acquires 30%STOCK INVESTMENT
of the common stock of Beck Company for
$120,000 on January 1, 2002. The entry to record this transaction is:

120,000

120,000
 ACCOUNTING FOR STOCK INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
DIVIDEND REVENUE
Beck reports 2002 net income of $100,000 and declares and pays a $40,000
cash dividend. Milar is required to record 1 its share of Beck’s net
income, $30,000 (30% X $100,000) and 2 the reduction in the investment
account for the dividends received, $12,000 ($40,000 X 30%). The entries
are:
Date Account Titles and Explanation Debit Credit
(1)
Dec. 31 Stock Investments 30,000

Revenue from Investment in Beck Company 30,000

(To record 30% equity in Beck’s 2002 net

Income)

12,000

12,000
 INVESTMENT AND REVENUE ACCOUNTS
AFTER POSTING

After posting the transactions for the year, the investment and revenue accounts
will show the above results. During the year, the investment account has
increased by $18,000 – which represents Milar’s 30% equity in the $60,000
increase in Beck’s retained earnings ($100,000 - $40,000). Milar will also report
$30,000 of revenue from its investment, which is 30% of Beck’s net income of
$100,000. Milar would report only $12,000 (30% X $40,000) of dividend revenue
if the cost method were used.
 Accounting for Stock Investments
Holdings of More than 50%
• A company that owns more than 50% of the
common stock of another company is known as
the parent company.
• The company whose stock is owned by the
parent company is called the subsidiary
(affiliated) company.
• The parent company is perceived to have a
controlling interest in the subsidiary company due
to the stock ownership.
• When one company owns more than 50% of the
common stock of another company, consolidated
financial statements are usually prepared.
 Valuation and Reporting of
Investments
• Debt and stock investments are classified into 3
categories of securities:

1. Trading securities—held with the

intention of selling them in a short
period of time (usually less than a one
month).
2. Available-for-sale securities—may be sold in
the future (usually held beyond one month).
3. Held-to-maturity securities—debt securities that
the investor has the intent and ability to hold to
maturity.
 ILLUSTRATION:
COMPREHENSIVE BALANCE SHEET

PACE CORPORATION
Balance Sheet
December 31, 2002

The comprehensive Current assets

Assets

balance sheet for Pace

Cash $ 21,000
Temporary investments, at fair value 60,000
Accounts receivable $ 84,000
Corporation includes Less: Allowance for doubtful accounts
Merchandise inventory, at FIFO cost
4,000 80,000
130,000

the following assets: Prepaid insurance

Total current assets
23,000
314,000
Investments
1 Temporary Investment in bonds
Investments in stock of less than 20% owned companies,
100,000

Investments, at fair value

Investment in stock of 20% – 50% owned company, at
50,000

equity 150,000

2 Investments of less Total investments

Property, plant, and equipment
300,000

Land 200,000
than 20%, and Buildings
Less: Accumulated depreciation
$ 800,000
200,000 600,000
Equipment 180,000
3 Investments of Less: Accumulated depreciation 54,000 126,000
Total property, plant, and equipment 926,000
20% - 50%. Intangible assets
Goodwill (Note 1) 100,000
Patents 70,000
Total intangible assets 170,000
Total assets $ 1,710,000
 ILLUSTRATION:
COMPREHENSIVE BALANCE SHEET

The comprehensive balance

sheet for Pace Corporation
includes the following element
of stockholders’ equity:
Unrealized Gain on Available-
for-Sale Securities. Reporting
the unrealized gain or loss in
the stockholders’ equity
section: 1 reduces the
volatility of net income due to
fluctuations in fair value and 2
still informs the financial
statement user of the gain or
loss that would occur if the
securities were sold at fair
value.