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May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Learning Objectives

1. Describe why companies invest in debt and equity

securities.
2. Describe and illustrate the accounting for debt
investments.
3. Describe and illustrate the accounting for equity
investments.
4. Describe and illustrate valuing and reporting
investments in the financial statements.
5. Describe fair value accounting and its implications
for the future.
6. Describe and illustrate the computation of dividend
yield.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Investing Cash in Current Operations

o Cash may be used to replace worn-out

equipment or to purchase new, more efficient,
and productive equipment.
o Cash may be reinvested in the company to
expand its current operations.
o Cash may be used to pay suppliers or other
creditors.
Investing Cash in Temporary Investments

o Instead of letting excess cash remain idle in a

checking account, most companies invest this
cash in securities such as:
 Debt securities, which are notes and bonds that
pay interest and have a fixed maturity date.
 Equity securities, which are preferred and
common stock that represent ownership in a
company and do not have a fixed maturity date.
Investing Cash in Temporary Investments

o These debt securities and equity securities are

termed Investments, or Temporary Investments,
and are reported in the Current Assets section
of the balance sheet.
Investing Cash in Temporary Investments

o The primary objective of investing in

temporary investments is to:
 earn interest income
 receive dividends
 realize gains from increases in the market price of
the securities.
Investing Cash in Long-Term Investments

o Long-term investments often involve the

purchase of a significant portion of the stock
of another company. Such investments have a
strategic purpose:
 Reduction of costs
 Replacement of management
 Expansion
 Integration
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Purchase of Bonds
o Homer Company purchases $18,000 of U.S.
Treasury bonds direct from a Federal Reserve
Bank at their par value on March 17, 2014, plus
accrued interest for 45 days. The bonds have
an interest rate of 6%, payable on July 31 and
January 31, 2015.

$18,000 × 6% × (45/360)
Interest Revenue

o On July 31, Homer Company receives a

semiannual interest payment of $540 ($18,000
× 6% × 1½). The $540 interest includes $135 of
accrued interest that Homer Company
purchased with the bonds on March 17.

($540 – $135) or [$18,000 × 6% × (135/360)]

INTEREST REVENUE

(continued)
INTEREST REVENUE
Interest Revenue

o Homer Company’s accounting period ends on

December 31. Thus, an adjusting entry must be
made to accrue interest for five months. The
following adjusting entry records the accrued
interest:

$18,000 × 6% × 5/12
Interest Revenue

o For the year ended December 31, 2014, Homer

Company would report Interest revenue of
$855 ($405 + $450) as part of Other income on
the income statement.
Interest Revenue

o Homer Company receives interest of $540 on

January 31, 2015. Notice that Interest
Receivable is credited for $450 to reflect that
this amount is a receivable from 2014. Interest
Revenue of $90 is the interest earned from
January 1 through January 31, 2015.
Sale of Bonds

o On January 31, 2015, Homer Company sells the

Treasury bonds at 98. The sale results in a loss
of $360.
Proceeds from sale
($18,000 × 98%) $17,640
Less book value (cost)
of the bonds 18,000
Loss on sale of bonds $ (360)
Sale of Bonds

o There is no accrued interest upon the sale

since the interest payment date is also January
31. The entry to record the sale is as follows:

Reported as part of Other

income (loss) on the income
statement
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Accounting for Equity Investments

o A company may invest in the preferred or

common stock of another company. The
company investing in another company’s stock
is the investor.
o The company whose stock is purchased is the
investee.
ACCOUNTING FOR
EQUITY
INVESTMENTS
Less Than 20% Ownership

o Investments of less than 20% of the investee’s

outstanding stock are accounted for by using
the cost method. Under the cost method,
entries are recorded for the following
transactions:
 Purchase of stock
 Receipt of dividends
 Sale of stock
Purchase of Stock

o On May 1, Bart Company purchases 2,000

shares of Lisa Company common stock at
$49.90 per share plus a brokerage fee of $200.
Receipt of Dividends

o On July 31, Bart Company receives a dividend

of $0.40 per share from Lisa Company.

o Dividend Revenue is reported as part of Other

Income on Bart Company’s income statement.
Sale of Stock

o On September 1, Bart Company sells 1,500

shares of Lisa Company stock for $54.50 per
share, less a $160 commission.

The gain is reported as part of Other income on Bart

Company’s income statement.
Between 20%─50% Ownership

o If the investor purchases between 20% and

50% of the outstanding stock of the investee,
the investor is considered to have significant
influence over the investee, and the investment
is accounted for using the equity method.
Between 20%─50% Ownership

o Under the equity method, the investment

account is adjusted for the investor’s share of
the net income and dividends of the investee.
These adjustments are as follows:
 Net income: Recorded as an increase in the
investment account.
 Dividends: Decrease the investment account.
Purchase of Stock

Simpson Inc. purchased a 40% interest in

Flanders Corporation’s common stock on January
2, 2014 for $350,000.
Recording Investee Net Income

For the year ended December 31, 2014, Flanders

Corporation reported net income of $105,000.

Income of Flanders Corporation may be reported

separately or as part of Other Income on Simpson
Inc.’s income statement.
Recording Investee Dividends

During the year, Flanders declared and paid cash

dividends of $45,000.
RECORDING
INVESTEE
DIVIDENDS
Sale of Stock

On January 1, 2015, Simpson Inc. sold Flanders

Corporation’s stock for $400,000, a gain of
$26,000, calculated as follows:
More Than 50% Ownership

o If the investor purchases more than 50% of the

outstanding stock of the investee, the investor
is considered to have control over the investee.
The purchase is termed a business
combination.
More Than 50% Ownership

o A corporation owning all or a majority of the

voting stock of another corporation is called a
parent company. The corporation that is
controlled is called the subsidiary company.
o At the end of the year, the financial statements
of the parent and subsidiary are combined,
and consolidated financial statements are
issued.
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Trading Securities

o Trading securities are debt and equity

securities that are purchased and sold to earn
short-term profits from changes in their market
prices.
Trading Securities

o Trading securities are reported as current

assets on the balance sheet.
o Trading securities are valued as a portfolio
(group) of securities using their fair values.
Fair value is the market price that would be
received for a security if it were sold.
o Changes in fair value of the portfolio are
recognized as an unrealized gain or loss for the
period.
Trading Securities

o Maggie Company purchased a portfolio of

trading securities during 2014. On December
31, 2014, the cost and fair values of the
securities were as follows:
Trading Securities

o The adjusting entry on December 31, 2014, to

record the fair value of the securities ($25,300)
is as follows: :

Unrealized Gain on Trading Investments is

reported on the income statement.
 TRADING
SECURITIES
Available-for-Sale Securities

o Available-for-sale securities are debt and

equity securities that are neither held for
trading, held to maturity, nor held for strategic
reasons.
Available-for-Sale Securities

o Maggie Company purchased three securities

during 2014 as available-for-sale securities. On
December 31, 2014, the cost and fair values of
the securities were as follows:
Available-for-Sale Securities

o On December 31, the adjusting entry credits a

stockholders’ equity account instead of an
income statement account. The $1,300 increase
in fair value is credited to Unrealized Gain
(Loss) on Available-for-Sale Investments.

Added to current
assets
Added to
stockholders’ equity
AVAILABLE-FOR-
SALE SECURITIES

Equal
Held-To-Maturity Securities

o Held-to-maturity securities are debt

investments, such as notes or bonds, that a
company intends to hold until their maturity
date.
SUMMARY
SUMMARY
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Fair Value Accounting

o Fair value is the price that would be received

for selling an asset or paying off a liability.
o Fair value assumes that the asset is sold or the
liability is paid off under normal rather than
distressed conditions.
Trends to Fair Value Accounting

o A current trend for the FASB and other

accounting regulators is to adopt accounting
principles using fair values for valuing and
reporting assets and liabilities.
Trends to Fair Value Accounting

o Factors contributing to this trend include the

following:
 Current generally accepted accounting principles
are a hybrid of varying measurement methods
that often conflict with one other.
 A greater percentage of the total assets of many
companies consists of financial assets such as
receivables and securities.
 The world economy has created pressure on
accounting regulators to adopt a worldwide set of
accounting principles and standards.
Trend to Fair Value Accounting

o Potential disadvantages of using fair values:

 Fair values may not be readily obtainable for some
assets or liabilities.
 Fair values make it more difficult to compare
companies if companies use different methods of
measuring fair values.
 Using fair values could result in more fluctuations in
accounting reports because fair values change from
year to year.
Statement Effect of Fair Value Accounting

 Balance Sheet. When an asset or liability is reported

at its fair value, any difference between the asset’s
original cost or prior period’s fair value must be
recorded.
 Balance Sheet. The unrealized gain or loss on
changes in fair value must also be recorded. One
method reports these as part of stockholders’ equity
on the balance sheet.

(continued)
Statement Effect of Fair Value Accounting

o Income Statement. Instead of recording the

unrealized gain or loss on changes in fair
values as part of stockholders’ equity, the
unrealized gains or losses may be reported on
the income statement.
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Dividend Yield

o The dividend yield measures the rate of return

to stockholders based on cash dividends
distributed. Dividend yield is calculated as
follows:
Dividends per Share of Common Stock
Dividend Yield =
Market Price per Share of Common Stock
News Corporation:
$0.19
Dividend Yield = = 1.1%
$16.98
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.
Comprehensive Income

o Comprehensive income is defined as all

changes in stockholders’ equity during a
period, except those resulting from dividends
and stockholders’ investments.
Comprehensive Income

o Other comprehensive income items include

unrealized gains and losses on available-for-
sale securities as well as other items such as
foreign currency and pension liability
adjustments.
o The cumulative effect of other comprehensive
income is reported on the balance sheet, as
accumulated other comprehensive income.
Comprehensive Income

o Companies may report comprehensive income

in the financial statements as follows:
 On the income statement
 In a separate statement of comprehensive income
 In the statement of stockholders’ equity
COMPREHENSIVE
INCOME
COMPREHENSIVE
INCOME
c. 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, or posted to a publicly accessible website, in whole or in part.