Chapter 12

Investments

Financial Accounting,
Seventh Edition
Slide
12-1
 Investments

Why Accounting for Accounting for Valuing and

Corporations Debt Stock Reporting
Invest Investments Investments Investments

Cash Recording Holdings of less Categories of

management acquisition of than 20% securities
Investment bonds Holdings Balance sheet
income Recording bond between 20% presentation
Strategic interest and 50% Realized and
reasons Recording sale Holdings of more unrealized gain
of bonds than 50% or loss
Classified
balance sheet

Slide
12-2
 Why Corporations Invest

Corporations generally invest in debt or stock

securities for one of three reasons.
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
12-3 SO 1 Discuss why corporations invest in debt and stock securities.
 Why Corporations Invest

Question
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.

Slide
12-4 SO 1 Discuss why corporations invest in debt and stock securities.
 Accounting for Debt Instruments

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
12-5 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

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
12-6 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

E12-2: KC Corporation had the following transactions

pertaining to debt investments.
Jan. 1 Purchased 50, 8%, $1,000 Choate Co. bonds for
$50,000 cash plus brokerage fees of $900.
Interest is payable semiannually on July 1 and
January 1.
July 1 Received semiannual interest on Choate Co. bonds.
July 1 Sold 30 Choate Co. bonds for $34,000 less $500
brokerage fees.
Instructions: (a) Journalize the transactions. (b) Prepare
the adjusting entry for the accrual of interest at December
31.
Slide
12-7 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

Exercise: Jan. 1 Purchased 50, 8%, $1,000 Choate Co.

bonds for $60,000 cash plus brokerage fees of $900.
Interest is payable semiannually on July 1 and January 1.

Jan 1 Debt investment 50,900 *

Cash 50,900

* ($50,000 + $900 = $50,900)

Slide
12-8 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

Exercise: July 1 Received semiannual interest on

Choate Co. bonds. Sold 30 Choate Co. bonds for
$34,000 less $500 brokerage fees.

July 1 Cash 2,000 *

Interest revenue 2,000

Cash 33,500 **
Debt investments 30,540 ***
Gain on sale 2,960

* ($50,000 x 8% x ½ = $2,000) *** ($50,900 x 3/5 = $30,540)

** ($34,000 - $500 = $33,500)
Slide
12-9 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

Exercise: (b) Prepare the adjusting entry for the

accrual of interest at December 31.

Dec 31 Interest receivable 800 *

Interest revenue 800

* ($20,000 x 8% x ½ = $800)

Slide
12-10 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

Question
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.

Slide
12-11 SO 2 Explain the accounting for debt investments.
 Accounting for Debt Instruments

Question
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.

Slide
12-12 SO 2 Explain the accounting for debt investments.
 Accounting for Stock Investments
Ownership Percentages

0 --------------20% ------------ 50% -------------- 100%

No significant Significant Control
influence influence usually exists
usually exists usually exists

Investment Investment Investment valued on

valued using valued using parent’s books using Cost
Cost Equity Method or Equity Method
Method Method (investment eliminated in
Consolidation)

The accounting depends on the extent of the investor’s influence

over the operating and financial affairs of the issuing corporation.

Slide
12-13 SO 3 Explain the accounting for stock investments.
 Accounting for Stock Investments

Holdings of Less than 20%

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).

Slide
12-14 SO 3 Explain the accounting for stock investments.
 Holdings of Less than 20%

E12-4: Dossett Company had the following transactions

pertaining to stock investments.
Feb. 1 Purchased 600 shares of Goetz common stock (2%)
for $6,000 cash, plus brokerage fees of $200.
July 1 Received cash dividends of $1 per share on Goetz
common stock.
Sept. 1 Sold 300 shares of Goetz common stock for
$4,400, less brokerage fees of $100.
Instructions:
Journalize the transactions.

Slide
12-15 SO 3 Explain the accounting for stock investments.
 Holdings of Less than 20%

E12-4: Feb. 1 Purchased 600 shares of Goetz

common stock (2%) for $6,000 cash, plus brokerage
fees of $200. July 1 Received cash dividends of $1
per share on Goetz common stock.
Feb. 1 Stock investments 6,200 *
Cash 6,200

July 1 Cash 600 **

Dividend revenue 600

* ($6,000 + $200 = $6,200)

** (600 x $1 = $600)
Slide
12-16 SO 3 Explain the accounting for stock investments.
 Holdings of Less than 20%

Exercise: Sept. 1 Sold 300 shares of Goetz common

stock for $4,400, less brokerage fees of $100.

Sept. 1 Stock investments 4,300 *

Cash 3,100 **
Gain on sale 1,200

* ($4,400 - $100 = $4,300)

** ($6,200 x 3/6 = $3,100)
Slide
12-17 SO 3 Explain the accounting for stock investments.
 Accounting for Stock Investments

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
12-18 SO 3 Explain the accounting for stock investments.
 Holdings Between 20% and 50%

Question
Under the equity method, the investor records
dividends received by crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Stock Investments.

Slide
12-19 SO 3 Explain the accounting for stock investments.
 Holdings Between 20% and 50%

E12-7: On January 1, Kwun Corporation purchased 25%

of the common shares of Connors Corporation for
$180,000. During the year, Connors reported net income
of $200,000 and paid dividends of $60,000.

Instructions:
(a) Journalize the transaction
(b) Determine the amount to be reported as an
investment in Connors stock at December 31.

Slide
12-20 SO 3 Explain the accounting for stock investments.
 Holdings Between 20% and 50%

E12-7: Kwun purchased 25% of the common shares of

Connors for $180,000. Connors earned net income of
$200,000 and paid dividends of $60,000.

Stock investments 180,000

Cash 180,000

Stock investments 50,000

Investment revenue ($200,000 x 25%) 50,000

Cash 15,000
Stock investments ($60,000 x 25%) 15,000

Slide
12-21 SO 3 Explain the accounting for stock investments.
 Holdings Between 20% and 50%

E12-7: Kwun purchased 25% of the common shares of

Connors for $180,000. Connors earned net income of
$200,000 and paid dividends of $60,000.

After Kwun posts the transactions for the year, its

investment and revenue accounts will show the following.

Stock Investments Investment Revenue

Debit Credit Debit Credit
180,000 50,000
50,000 15,000
215,000

Slide
12-22 SO 3 Explain the accounting for stock investments.
 Accounting for Stock Investments

Holdings of More Than 50%

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.

Slide
12-23 SO 4 Describe the use of consolidated financial statements.
 Valuing 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%.

Slide SO 5 Indicate how debt and stock investments

12-24 are reported in financial statements.
 Valuing and Reporting Investments

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 SO 5 Indicate how debt and stock investments

12-25 are reported in financial statements.
 Valuing and Reporting Investments

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 SO 5 Indicate how debt and stock investments

12-26 are reported in financial statements.
 Valuing and Reporting Investments

Question
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

Slide SO 5 Indicate how debt and stock investments

12-27 are reported in financial statements.
 Trading Securities

Problem: Loxley Company has the following portfolio of

securities at September 30, 2011, its last reporting date.

Trading Securities Cost Fair Value

Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000

On Oct. 10, 2011, the Fogelberg shares were sold at a price of

$54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2,
2009. The Dec. 31, 2011, fair values were: Petra $96,000, Los
Tigres $132,000, and the Weisberg common $193,000.

Slide SO 5 Indicate how debt and stock investments

12-28 are reported in financial statements.
 Trading Securities

Problem: Prepare the journal entries to record the sale,

purchase, and adjusting entries related to the trading
securities in the last quarter of 2011.
Portfolio at September 30, 2011
Trading Securities Cost Fair Value
Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000
$ 538,000 $ 519,000

Market Adjustment – Trading (account balance) ($19,000)

Slide SO 5 Indicate how debt and stock investments

12-29 are reported in financial statements.
 Trading Securities

Problem: On Oct. 10, the Fogelberg shares were sold at a

$54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2.
October 10, 2011 (Fogelberg):
Cash (5,000 x $54) 270,000
Trading securities 225,000
Gain on sale 45,000

November 2, 2011 (Los Tigres):

Trading securities (3,000 x $59.50) 178,500
Cash 178,500

Slide SO 5 Indicate how debt and stock investments

12-30 are reported in financial statements.
 Trading Securities

Problem: Portfolio at December 31, 2011

Unrealized
Trading Securities Cost Fair Value Gain (Loss)
Petra, Inc. preferred $ 133,000 $ 96,000 $ (37,000)
Tim Weisberg Corp. common 180,000 193,000 13,000
Los Tigres common 178,500 132,000 (46,500)
$ 491,500 $ 421,000 (70,500)
Prior market adjustment balance (19,000)
Market fair value adjustment $ (51,500)

December 31, 2011:

Unrealized loss - Income 51,500
Market adjustment - Trading 51,500

Slide SO 5 Indicate how debt and stock investments

12-31 are reported in financial statements.
 Available-for-Sale Securities

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.

Slide SO 5 Indicate how debt and stock investments

12-32 are reported in financial statements.
 Available-for-Sale Securities

Problem: Portfolio at December 31, 2011

Unrealized
Trading Securities Cost Fair Value Gain (Loss)
Petra, Inc. preferred $ 133,000 $ 96,000 $ (37,000)
Tim Weisberg Corp. common 180,000 193,000 13,000
Los Tigres common 178,500 132,000 (46,500)
$ 491,500 $ 421,000 (70,500)
Prior market adjustment balance (19,000)
Market fair value adjustment $ (51,500)

December 31, 2011:

Unrealized gain or loss—equity 51,500
Market adjustment – available-for-sale 51,500

Slide SO 5 Indicate how debt and stock investments

12-33 are reported in financial statements.
 Available-for-Sale Securities

Question
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.

Slide SO 5 Indicate how debt and stock investments

12-34 are reported in financial statements.
 Valuing and Reporting Investments

Balance Sheet Presentation

Short-Term Investments

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.

Investments that do not meet both criteria are

classified as long-term investments.

Slide
12-35 SO 6 Distinguish between short-term and long-term investments.
 Balance Sheet Presentation

Presentation of Realized and Unrealized Gain

or Loss
Nonoperating items related to investments
Illustration 12-10

Slide
12-36 SO 6 Distinguish between short-term and long-term investments.
 Balance Sheet Presentation

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
12-37 SO 6 Distinguish between short-term and long-term investments.
 Classified
Balance
Sheet
(partial)

Illustration 12-12

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

Identify where each of the following items would

be reported in the financial statements.

Use the following possible categories:

Current assets Current liabilities
Investments Long-term liabilities
Property, plant, and equipment Stockholders’ equity
Intangible assets Other revenues and gains
Other expenses and losses

Solution on
Slide
notes page SO 6 Distinguish between short-term and long-term investments.
12-39