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Chapter 16-1 CHAPTER 16 INVESTMENTS Accounting Principles, Eighth Edition.

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Presentation on theme: "Chapter 16-1 CHAPTER 16 INVESTMENTS Accounting Principles, Eighth Edition."— Presentation transcript:

1 Chapter 16-1 CHAPTER 16 INVESTMENTS Accounting Principles, Eighth Edition

2 Chapter Discuss why corporations invest in debt and stock securities Explain the accounting for debt investments Explain the accounting for stock investments Describe the use of consolidated financial statements Indicate how debt and stock investments are reported in financial statements Distinguish between short-term and long-term investments. Study Objectives

3 Chapter 16-3 Why Corporations Invest Cash management Investment income Strategic reasons Accounting for Debt Investments Accounting for Stock Investments Valuing and Reporting Investments Categories of securities Balance sheet presentation Realized and unrealized gain or loss Classified balance sheet Holdings of less than 20% Holdings between 20% and 50% Holdings of more than 50% Recording acquisition of bonds Recording bond interest Recording sale of bonds Long-Term Liabilities

4 Chapter 16-4 Corporations generally invest in debt or stock securities for one of three reasons. Why Corporations Invest LO 1 Discuss why corporations invest in debt and stock securities. 1. Corporation may have excess cash. 2. To generate earnings from investment income. 3. For strategic reasons. Illustration 16-1 Temporary investments and the operating cycle

5 Chapter 16-5 Accounting for Debt Instruments LO 2 Explain the accounting for debt investments. 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.

6 Chapter 16-6 Accounting for Debt Instruments LO 2 Explain the accounting for debt investments. 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.

7 Chapter 16-7 Exercise: Issel Corporation had the following transactions pertaining to debt investments. Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1. July 1 Received semiannual interest on Hollis Co. bonds. July 1 Sold 30 Hollis 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. Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

8 Chapter 16-8 Exercise: Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1. Debt investment 60,900 Jan 1 Cash 60,900 * ($60,000 + $900 = $60,900) * Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

9 Chapter 16-9 Exercise: July 1 Received semiannual interest on Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000 less $500 brokerage fees. Cash 2,400 July 1 Interest revenue2,400 * ($60,000 x 8% x ½ = $2,400) Cash 33,500 Debt investments30,450 Gain on sale3,050 *** ($60,900 x ½ = $30,450) * *** ** ($34,000 - $500 = $33,500) ** Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

10 Chapter Exercise: (b) Prepare the adjusting entry for the accrual of interest at December 31. Interest receivable 1,200 Dec 31 Interest revenue1,200 * ($30,000 x 8% x ½ = $1,200) * Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

11 Chapter % % % No significant influence usually exists Significant influence usually exists Control usually exists Investment valued using Cost Method Investment valued using Equity Method Investment valued on parents books using Cost Method or Equity Method (investment eliminated in Consolidation) Ownership Percentages Accounting for Stock Investments LO 3 Explain the accounting for stock investments. The accounting depends on the extent of the investors influence over the operating and financial affairs of the issuing corporation.

12 Chapter 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). Holdings of Less than 20% LO 3 Explain the accounting for stock investments.

13 Chapter Exercise: Dossett Company had the following transactions pertaining to stock investments. Feb. 1 Purchased 800 shares of Hippo common stock (2%) for $8,000 cash, plus brokerage fees of $200. July 1 Received cash dividends of $1 per share on Hippo common stock. Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100. Instructions Journalize the transactions. LO 3 Explain the accounting for stock investments. Holdings of Less than 20%

14 Chapter Exercise: Feb. 1 Purchased 800 shares of Hippo common stock (2%) for $8,000 cash, plus brokerage fees of $200. July 1 Received cash dividends of $1 per share on Hippo common stock. LO 3 Explain the accounting for stock investments. Stock investments 8,200 Feb. 1 Cash8,200 * ($8,000 + $200 = $8,200) Cash 800 Dividend revenue800 ** (800 x $1 = $800) * ** July 1 Holdings of Less than 20%

15 Chapter Exercise: Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100. LO 3 Explain the accounting for stock investments. Stock investments 4,300 Sept. 1 Cash3,075 * ($4,400 - $100 = $4,300) ** ($8,200 x 3/8 = $3,075) * Gain on sale1,225 ** Holdings of Less than 20%

16 Chapter Holdings Between 20% and 50% Equity Method Record the investment at cost and subsequently adjust the amount each period for the investors proportionate share of the earnings (losses) and dividends received by the investor. If investors share of investees losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method. LO 3 Explain the accounting for stock investments.

17 Chapter Exercise: Exercise: (Equity Method) On January 1, 2008, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000. Instructions Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in Holdings Between 20% and 50% LO 3 Explain the accounting for stock investments.

18 Chapter Exercise: Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20,000. Stock investments 180,000 Cash 180,000 Cash6,000 Stock investments6,000 Stock investments 24,000 Investment revenue24,000 Holdings Between 20% and 50% ($20,000 x 30%) ($80,000 x 30%) LO 3 Explain the accounting for stock investments.

19 Chapter After Pennington posts the transactions for the year, its investment and revenue accounts will show the following. DebitCredit Stock Investments 180,000 24,000 DebitCredit Investment Revenue Holdings Between 20% and 50% LO 3 Explain the accounting for stock investments. Exercise: Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20, ,000 6, ,000

20 Chapter 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 parents books as a long-term investment. Parent generally prepares consolidated financial statements. LO 4 Describe the use of consolidated financial statements.

21 Chapter 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%. LO 5 Indicate how debt and stock investments are reported in financial statements.

22 Chapter 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. LO 5 Indicate how debt and stock investments are reported in financial statements.

23 Chapter 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. LO 5 Indicate how debt and stock investments are reported in financial statements.

24 Chapter Problem: Problem: Loxley Company has the following portfolio of securities at September 30, 2008, its last reporting date. Trading Securities On Oct. 10, 2008, 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, The Dec. 31, 2008, fair values were: Petra $96,000, Los Tigres $132,000, and the Weisberg common $193,000. LO 5 Indicate how debt and stock investments are reported in financial statements.

25 Chapter Problem: Problem: Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of Portfolio at September 30, 2008 Market Adjustment – Trading (account balance)($19,000) Trading Securities LO 5 Indicate how debt and stock investments are reported in financial statements.

26 Chapter Problem: 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. Cash (5,000 x $54) 270,000 Trading securities 225,000 October 10, 2008 (Fogelberg): Gain on sale 45,000 Trading securities (3,000 x $59.50) 178,500 Cash 178,500 November 2, 2008 (Los Tigres): Trading Securities LO 5 Indicate how debt and stock investments are reported in financial statements.

27 Chapter Problem: Problem: Portfolio at December 31, 2008 Unrealized loss - Income51,500 Market adjustment - Trading 51,500 December 31, 2008: Trading Securities LO 5 Indicate how debt and stock investments are reported in financial statements.

28 Chapter Problem: Problem: How would the entries change if the securities were classified as available-for-sale? The entries would be the same The entries would be the same except that the Unrealized Gain or LossEquity account is used instead of Unrealized Gain or LossIncome. The unrealized loss would be deducted from the stockholders equity section rather than charged to the income statement. Available-for-Sale Securities LO 5 Indicate how debt and stock investments are reported in financial statements.

29 Chapter 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. Short-Term Investments Balance Sheet Presentation LO 6 Distinguish between short-term and long-term investments. Investments that do not meet both criteria are classified as long-term investments.

30 Chapter Nonoperating items related to investments Presentation of Realized and Unrealized Gain or Loss Balance Sheet Presentation LO 6 Distinguish between short-term and long-term investments. Illustration 16-10

31 Chapter Realized and Unrealized Gain or Loss Balance Sheet Presentation LO 6 Distinguish between short-term and long-term investments. Unrealized gain or loss on available-for-sale securities are reported as a separate component of stockholders equity. Illustration 16-11

32 Chapter Balance Sheet Presentation LO 6 Distinguish between short-term and long-term investments. Illustration Classified Balance Sheet (partial)


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