Investments C hapter 15 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting...

Investments

Chapter 15

COPYRIGHT © 2010 South-Western/Cengage Learning

Intermediate AccountingIntermediate Accounting 11th edition11th edition

Nikolai Bazley JonesNikolai Bazley Jones

An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University

2

1. Additional revenues from idle cash

2. Control over another company

3. Beneficial relationship with another company

Why Companies Invest in Other Companies

3

Classification of Investments

1. Trading securities

2. Available-for-sale securities

3. Held-to-maturity debt securities

4

Trading securities are investments in debt and equity securities that are purchased and

held principally for the purpose of selling them in the near term.

Trading securities are investments in debt and equity securities that are purchased and

held principally for the purpose of selling them in the near term.

Trading Securities

These securities are reported at their fair market value on the ending balance sheet,

and unrealized holding gains and losses are included in net income of the current

period.

These securities are reported at their fair market value on the ending balance sheet,

and unrealized holding gains and losses are included in net income of the current

period.

5

Trading Securities

6

Investments in held-to-maturity securities are debt securities for

which the company has the “positive intent and ability to hold those

securities to maturity.”

Investments in held-to-maturity securities are debt securities for

which the company has the “positive intent and ability to hold those

securities to maturity.”

Held-to-Maturity Securities

7

Investments in held-to-maturity securities are reported at their amortized cost on the balance

sheet…not their fair value.

Investments in held-to-maturity securities are reported at their amortized cost on the balance

sheet…not their fair value.

Held-to-Maturity Securities

8

Investments in available-for-sale securities are securities

that are not classified as being held to maturity or trading.

Investments in available-for-sale securities are securities

that are not classified as being held to maturity or trading.

Available-for-Sale Securities

9

Investments in available-for-sale securities are reported at their fair value on the ending balance sheet

date, and the unrealized holding gains or losses are reported as a component of other comprehensive income.

Investments in available-for-sale securities are reported at their fair value on the ending balance sheet

date, and the unrealized holding gains or losses are reported as a component of other comprehensive income.


10

Therefore, the unrealized holding gains and losses for available-for-

sale securities are not included in net income.

Therefore, the unrealized holding gains and losses for available-for-

sale securities are not included in net income.


11

Accounting for Equity Investments

Reporting of Accounting Unrealized Holding

Investment Categories Method Gains and Losses

Investment in Equity Securities

1.No significant influence(less than 20% ownership)a. Trading Fair value Net incomeb. Available for sale Fair value Other

comprehensive income

2.Significant influence Equity method Not recognized(20 to 50% ownership)3.Control Consolidation Not recognized(more than 50% ownership)

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Accounting for Debt Investments

Reporting of Accounting Unrealized Holding

Investment Categories Method Gains and Losses

Investment in Debt Securities

1.Trading Fair value Net income2.Available for sale Fair value Other comprehensive

income3.Held to maturity Amortized cost Not recognized

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Investments Trading Securities

1. The investment is initially recorded at cost.

2. It is subsequently reported at fair value on the ending balance sheet(s).

3. Unrealized holding gains and losses are included in net income of the current period.

4. Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income of the current period.

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Investments in Available-for-Sale Securities


2. It is subsequently reported at fair value on the ending balance sheet(s).

3. Unrealized holding gains and losses are reported as a component of other comprehensive income.

4. The cumulative unrealized holding gains and losses are reported in the accumulated other comprehensive income section of stockholders’ equity

5. Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.

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• 100 shares of A Company common stock at $50 per share

• 300 shares of B Company common stock at $80 per share

• 200 shares of C Company preferred stock at $120 per share

• $15,000 D Company 10% bonds (5/31 & 11/30 dividend dates)

• 100 shares of A Company common stock at $50 per share

• 300 shares of B Company common stock at $80 per share

• 200 shares of C Company preferred stock at $120 per share

• $15,000 D Company 10% bonds (5/31 & 11/30 dividend dates)

$ 5,000

24,000

24,000 15,000

$ 5,000

24,000

24,000 15,000

Kent Company purchases the following securities on Jun 1, 2009 as an investment in available-for-

sale securities:

Total $68,000

Investments in Available-for-Sale Debt and Equity Securities

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Investment in Available-for-Sale Securities 68,000Cash 68,000


Received bond interest payment

on November 1, 2009:

Received bond interest payment

on November 1, 2009:

Cash 750Interest Revenue 750

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December 31, 2009Interest Receivable 125 Interest Revenue 125

Cash 3,000 Dividend Revenue 3,000

During 2009 Kent Company receives dividends of $3,000 from its investment in the stock of A, B,

and C Companies.

During 2009 Kent Company receives dividends of $3,000 from its investment in the stock of A, B,

and C Companies.


$15,000 $15,000 × 0.10 × 1/12× 0.10 × 1/12$15,000 $15,000 × 0.10 × 1/12× 0.10 × 1/12

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The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:


Cumulative 12/31/09 Change

Fair in Fair

Security Cost Value Value

100 shares of A Company common stock $ 5,000 $ 6,000 $ 1,000 300 shares of B Company common stock 24,000 23,500 (500)200 shares of C Company preferred stock 24,000 26,000 2,000 $15,000 face value of D Company 10% bonds 15,000 15,500 500 Totals $68,000 $71,000 $3,000


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Fair in Fair

Security Cost Value Value 100 shares of A Company common stock $ 5,000 $ 6,000 $ 1,000 300 shares of B Company common stock 24,000 23,500 (500)200 shares of C Company preferred stock 24,000 26,000 2,000 $15,000 face value of D Company 10% bonds 15,000 15,500 500 Totals $68,000 $71,000 $3,000


Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 3,0003,000 Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale Securities Available-for-Sale Securities

3,0003,000

Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 3,0003,000 Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale Securities Available-for-Sale Securities

3,0003,000

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The same securities are held on December 31, 2010.

The same securities are held on December 31, 2010.


Fair in Fair


100 shares of A Company common stock $ 5,000 $ 6,100 $ 1,100 300 shares of B Company common stock 24,000 22,700 (1,300)200 shares of C Company preferred stock 24,000 23,200 (800) $15,000 face value of D Company 10% bonds 15,000 14,000 (1,000) Totals $68,000 $66,000 $(2,000)


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12/31/09 3,000 5,000 adjusting entry

2,000 12/31/10

Allowance for Change in Value of Investment

Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale SecuritiesAvailable-for-Sale Securities 5,0005,000 Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment

5,0005,000

Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale SecuritiesAvailable-for-Sale Securities 5,0005,000 Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment

5,0005,000

22

Sale of Available-for-Sale Securities

On March 1, 2011 the Kent Company sold the 100 shares of A Company stock for $6,000. The stock had a fair value on December 31, 2010 of $6,100.

On March 1, 2011 the Kent Company sold the 100 shares of A Company stock for $6,000. The stock had a fair value on December 31, 2010 of $6,100.

Cash 6,000 Investment in Available-for-Sale Securities 5,000 Gain on Sale of Available-for-Sale Securities 1,000

Unrealized Increase/Decrease in Value of Available-for-Sale Securities 1,100

Allowance for Change in Value of Investment 1,100

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Fair in Fair


300 shares of B Company common stock $24,000 $23,500 $(500)200 shares of C Company preferred stock 24,000 24,200 100 $15,000 face value of D Company 10% bonds 15,000 14,700 (300) Totals $63,000 $62,300 $(700)

Sale of Available-for-Sale Securities

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700 12/31/11

2,400 adjusting entry2,000 12/31/10 1,100 3/1/11

Allowance for Change in Value of Investment

Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 2,4002,400 Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale SecuritiesAvailable-for-Sale Securities

2,4002,400

Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 2,4002,400 Unrealized Increase/Decrease in Value ofUnrealized Increase/Decrease in Value of Available-for-Sale SecuritiesAvailable-for-Sale Securities

2,4002,400

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Investments in Held-to-Maturity Debt Securities


2. It is subsequently reported at amortized cost on the ending balance sheet(s).

3. Unrealized holding gains and losses are not recorded.

4. Interest revenue and realized gains and losses on sales (if any) are all included in net income.

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A company purchases 9% bonds with a face value of $100,000 on August 1, 2009, at 99 plus accrued

interest, which is payable semiannually.

A company purchases 9% bonds with a face value of $100,000 on August 1, 2009, at 99 plus accrued

interest, which is payable semiannually.

Investment in Held-to-Maturity Debt Securities 99,000Interest Revenue 1,500 Cash 100,500

Investments in Held-to-Maturity Debt Securities

$100,000 $100,000 ×× 0.09 0.09 ×× 2/122/12

$100,000 $100,000 ×× 0.09 0.09 ×× 2/122/12

$100,000 $100,000 × × 0.990.99

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Accounting for Bond Premiums

On January 1, 2009, the Colburn Company invests in bonds that will be held to maturity, with a face

value of $100,000 and paying $102,458.71. The stated interest rate is 13% and the effective

interest rate is 12%.




Investment in Held-to-Maturity Debt Securities 102,458.71 Cash 102,458.71

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The Colburn Company records the first interest receipt on June 30, 2009, using the effective interest

method.

The Colburn Company records the first interest receipt on June 30, 2009, using the effective interest

method.

Cash 6,500.00 Investment in Held-to-Maturity Debt

Securities 352.48 Interest Revenue 6,147.52


$102,458.71 $102,458.71 ×× 0.12 0.12 ×× 1/2 1/2$102,458.71 $102,458.71 ×× 0.12 0.12 ×× 1/2 1/2

$100,000 $100,000 ×× 0.13 0.13 ×× 1/2 1/2$100,000 $100,000 ×× 0.13 0.13 ×× 1/2 1/2

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Accounting for Bond Discounts







Investment in Held-to-Maturity Debt Securities 97,616.71 Cash 97,616.71

31


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The Colburn Company records the first interest receipt on June 30, 2009, using the effective

interest method.

The Colburn Company records the first interest receipt on June 30, 2009, using the effective

interest method.

Cash 6,500.00Investment in Held-to-Maturity Debt Securities 333.17 Interest Revenue 6,833.17


$97,616.71 $97,616.71 ×× 0.14 0.14 ×× 1/2 1/2$97,616.71 $97,616.71 ×× 0.14 0.14 ×× 1/2 1/2

The Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2009. Interest on these bonds is payable June 30

and December 31, and the bonds mature on December 31, 2011.

The Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2009. Interest on these bonds is payable June 30

and December 31, and the bonds mature on December 31, 2011.

Investment in Held-to-Maturity Debt Securities 204,575.07Interest Revenue 6,500.00

Cash 211,075.07

Amortization of Bonds Acquired Between Interest Dates

$200,000 $200,000 ×× 0.13 0.13 ×× 3/12 3/12$200,000 $200,000 ×× 0.13 0.13 ×× 3/12 3/12

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1. A transfer from the trading category

2. A transfer into the trading category

3. A transfer into the available-for-sale category

4. A transfer of a debt security into the held-to-maturity category from the available-for-sale category

Transfers of Investments Between Categories

35

In 2010, the Kent Company transfers the Company A securities into the trading category when their

fair value is $6,300.

In 2010, the Kent Company transfers the Company A securities into the trading category when their

fair value is $6,300.

Investment in Trading Securities 6,300 Investment in Available-for-Sale Securities 5,000 Gain on Transfer of Securities 1,300

Unrealized Increase/Decrease in Value of Available-for-Sale Securities 1,100 Allowance for Change in Value of Investment 1,100

Transfer into Trading Category from Available-for-Sale Category

36

The Devon Company has $10,000 in bonds that were purchased at par. When the fair value is

$9,500, Devon transfers them into the available-for-sale category.

The Devon Company has $10,000 in bonds that were purchased at par. When the fair value is

$9,500, Devon transfers them into the available-for-sale category.

Investment in Available-for-Sale Securities 10,000 Investment in Held-to-Maturity Debt Securities 10,000

Unrealized Increase/Decrease in Value of Available-for-Sale Securities 500 Allowance for Change in Value of Investment 500

Transfer into Available-for-Sale Category from Held-to-Maturity Category

37

The Devon Company classifies its bond investment as available for sale with a previous fair value of

$9,700, and transfers them into the held-to-maturity category when the current market value

of the debt securities is $9,500.

The Devon Company classifies its bond investment as available for sale with a previous fair value of

$9,700, and transfers them into the held-to-maturity category when the current market value

of the debt securities is $9,500.

Investment in Held-to-Maturity Debt Securities 9,500Unrealized Increase/Decrease from Transfer of Securities 500 Investment in Available-for-Sale Securities 10,000

Transfer into Held-to-Maturity Category from Available-for-Sale Category

ContinuedContinuedContinuedContinued

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An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amounts in the Allowance and

Unrealized Increase/Decrease accounts.

An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amounts in the Allowance and

Unrealized Increase/Decrease accounts.

Allowance for Change in Value of Investment 300 Unrealized Increase/Decrease in Value of

Available-for-Sale Securities 300

Transfer into Held-to-Maturity Category from Available-for-Sale Category

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Disclosures1. Trading Securities. A company must disclose the change

in the net unrealized holding gain or loss that is included in each income statement.

2. Available-for-Sale Securities. For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and (amortized) cost by major security types.

3. Held-to-Maturity Debt Securities. For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains, gross unrealized holding losses, and amortized cost by major security types.

40

IFRS vs. U.S. GAAP

IFRS also use the trading, available-for-sale, and held-to-maturity categories.

The valuation methods are the same for each category as under U.S. GAAP.

IFRS also apply these categories to all financial instruments, such as loans and receivables.

IFRS allow for the reversal of impairment losses related to held-to-maturity securities and available-for-sale securities.

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Equity Method

When an investor corporation owns a significantly large

percentage of common stock, it is able to exert

significant influence over the operating and financial policies of the investee

corporation. The equity method is used to account

for this investment.

When an investor corporation owns a significantly large

percentage of common stock, it is able to exert

significant influence over the operating and financial policies of the investee

corporation. The equity method is used to account

for this investment.

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Acknowledges the existence of a material economic relationship between the investor and the investee

Is based upon the requirements of accrual accounting

Supplies more relevant information for decision makers who rely on financial statements

Equity Method

In the absence of evidence to the contrary, an investment of

20% or more in the outstanding common stock of

the investee leads to the presumption of significant

influence.

In the absence of evidence to the contrary, an investment of

20% or more in the outstanding common stock of

the investee leads to the presumption of significant

influence.

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Equity Method

44

Equity Method

Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1,

2010 for $125,000 (significant influence).

Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1,

2010 for $125,000 (significant influence).

Investment in Stock: S Company 125,000 Cash 125,000

S Company pays a $20,000 dividend on August 27, 2010.

S Company pays a $20,000 dividend on August 27, 2010.

Cash 5,000 Investment in Stock: S Company 5,000

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S Company reported net income for 2010 of $81,000.

S Company reported net income for 2010 of $81,000.

Investment in Stock: S Company 20,250 Investment Income: Ordinary 20,250

Equity Method

25% of $84,00025% of $84,00025% of $84,00025% of $84,000

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Financial Statement Disclosures—Carrying Value

Acquisition price January 1, 2010 $125,000Add: Share of 2010 reported ordinary income 20,250

$145,250

Less: Dividends received August 27, 2010 (5,000)Carrying value $140,250

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When an investor currently using the fair value method acquires enough additional common shares during a year to exercise significant influence over the investee, the investor is required to adopt the equity method of accounting.

When the equity method is adopted, the investor restates its investment in the investee by debiting the Investment account and crediting Retained Earnings for its previous percentage of investee income (less dividends) for the period from the original date of acquisition to the date that significant influence was obtained.

This is a retrospective restatement (adjustment).

Change to Equity Method

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The company also eliminates any amounts included in the allowance and unrealized increase/decrease amounts that it used to record these shares at fair value.

Thereafter, the equity method is applied in the usual manner based on the current percentage of ownership.


49

Assume that on January 2, 2009, Short Company purchased as its only investment 15% of the outstanding common stock of J

Corporation for $150,000 (when the book value of net assets was $1,000,000). At the end of 2009, the J Corporation reported net income of $300,000 and paid dividends of $60,000; at this time,

the market value of the shares was $186,000 so the company wrote up the carrying value of the investment (using an

allowance account) to fair value. On January 2, 2020, to exert significant influence on J Corporation, Short purchased an additional 25% of the outstanding common stock of the J

Corporation for $310,000.


ExampleExample

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x 15% =x 15% =x 15% =

51

IFRS vs. U.S. GAAP

The application of the equity method is generally the same under IFRS and U. S. GAAP. One major terminology difference is that IFRS use the term “associate” to refer to what would be called an “equity method investee” under U.S. GAAP. In addition, IFRS do not address whether an investor’s interest which is represented by something other than an equity instrument but that is similar in substance to equity instruments (e.g., in-substance common stock) gives rise to significant influence over the investee. U.S. GAAP contains more detailed guidance on such nonequity interests. U.S. GAAP also requires more detailed disclosures than required under IFRS.

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Chapter 15

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