1. Investment in Debt and Equity Securities
chapter 14
Investment in Debt and Equity Securities

2. Learning Objectives
1. Determine why companies invest in other companies.
2. Understand the varying classifications associated with securities.
3. Account for the purchase of debt and equity securities.
4. Account for the recognition of revenue from investments.
Continued

3. Learning Objectives
5. Account for the change in value of securities.
6. Account for the sale of investment securities.
Record the transfer of securities between categories.
Explain the proper classification and disclosure of investments in securities
Continued

4. Time Line of Business Issues Involved with Investment Securities
DETERMINE purpose of investment
CLASSIFY investments
PURCHASE securities
EARN AND RECOGNIZE a return
MONITOR changes in value
SELL securities
TRANSFER securities between categories
DISCLOSE status of portfolio at the end of the period

5. Why Companies Invest in Other Companies
Safety Cushion
Cyclical Cash Needs
Investment for a Return
Investment for Influence
Purchase for Control

6. Investment in Debt and Equity Securities—2001
Total Investment Percentage of
Company (in billions) Total Assets
Berkshire Hathaway $ %
Microsoft
Coca-Cola
Citigroup
AT&T
Verizon

7. Classification of Investment in Securities
Debt securities typically have the following characteristics:
1. A maturity value, representing the amount to be repaid to the debt holder at maturity.
2. An interest rate that specifies the periodic interest payments.
3. A maturity date, indicating when the debt obligation will be redeemed.

8. Classification of Investment in Securities
Equity securities represent ownership in a company.
These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.
Equity securities have the potential for significant increases in price.

9. Classification of Investment in Securities
Debt/Equity
Securities
Held-to-Maturity
Securities purchased with the
intent to hold until maturity.
Trading
Securities purchased for sale
in the near future.
Available-for-sale
Securities not classified as
trading or held-to-maturity.

10. Classification of Investment in Securities
Debt
Equity
Held-to-maturity
Available-for-sale
Trading
Equity Method
Cost Method

11. Equity Method Securities
These are securities purchased with the intent to control or significantly influence the operations of the investee.
At least 20 percent of the outstanding voting stock must be owned to have this significant influence or control.
Even then, there may be evidence to support the fact that even a 20 percent investment does not have significant influence.

12. Different Accounting Treatments
Disclosure on the Balance Sheet
Treatment of Temporary Changes in Value
Classification of Securities
Types of Securities
Held to maturity Debt Amortized cost Not recognized
Available for sale Debt/equity Fair market value Reported in stockholders’ equity
Trading Debt/equity Fair market value Reported on the income statement
Equity method Equity Historical cost Not recognized adjusted for changes in the assets of the investee

13. Purchases of Debt Securities
On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9% payable semiannually on January 1 and July 1. The debt securities are classified by the purchaser as trading securities.
Accrued interest on May 1 is $3,000, calculated as follows:
$100,000 x .09 x 4/12 = $3,000

14. Always includes brokerage fees
Purchases of Debt Securities
Asset Approach
Always includes brokerage fees
Purchase date:
May 1 Investment in Trading Securities 104,250
Interest Receivable 3,000
Cash 107,250
Continued

15. Purchases of Debt Securities
Revenue Approach
Purchase date:
May 1 Investment in Trading Securities 104,250
Interest Revenue 3,000
Cash 107,250
Continued

16. Purchases of Debt Securities
Receipt of semiannual payment:
July 1 Cash 4,500
Interest Receivable 3,000
Interest Revenue 1,500
Asset Approach
July 1 Cash 4,500
Interest Revenue 4,500
Revenue Approach

17. Purchase of Equity Securities - Available for Sale (AFS)/Trading
Purchased 1,000 shares of AB Company’s common shares at $2 per share.
Investment in Available-for-Sale*/Trading
Securities - AB Company 2,000
Cash 2,000
* - would be so classified if management has no intention of holding them for a long period of time and will sell them as soon as it is economically advantageous

18. Purchase of Equity Securities – Equity Method
Citty Co. purchased 100,000 shares of AB Company common shares at $2 per share.
Assume that the 100,000 shares purchased represents 20 % of the outstanding voting stock of AB Company. This investment gives the investor significant influence over AB Company.

19. Purchase of Equity Securities - – Equity Method
Purchased 100,000 shares of Dave’s Deli common shares at $2 per share.
Equity Method Securities
Investment in AB Company Stock 200,000
Cash 200,000

20. Recognizing Revenue from Debt Securities
On January 1, 2004, Silmaril Technologies purchased 5-year, 10% bonds with a face value of $100,000 and interest payable semiannually on January 1 and July 1. The market rate on bonds of similar quality and maturity is 8%.

21. PV/Price of Debt Securities
Present value of principal:
FV = $100,000; N = 10; I = 4% $ 67,556
Present value of interest payments:
PMT = $5,000; N = 10; I = 4% ,554
Total present value of the bonds $108,110
Investment in Trading Securities ,100
Cash 108,100 OR
Investment in Held-to-Maturity Securities 108,100
Cash 108,100

22. Interest Revenue for Debt Securities (Trading)
When the first interest payment is received from Silmaril, the following entry would be made:
July 1 Cash 5,000
Interest Revenue 5,000

23. Interest Revenue for Debt Securities (Held-to-Maturity)
When the first interest payment is received from Silmaril, the following entry would be made:
July 1 Cash 5,000
Interest Revenue 4,324
Investment in Held-to-
Maturity Securities 676
$108,110 x .04

24. Recognizing Revenue for Equity Securities depends on the Appropriate Accounting Method
Account for as trading or available-for-sale
Equity method and consolidation procedures
Equity method
Ownership Percentage No
significant
influence
Significant
influence
Control 0%
20%
50%
100%

25. Control or Degree of Influence
Determining the Appropriate Accounting Method
Control or Degree of Influence
Ownership Interest
Accounting Method
Applicable Standard
More than 50% Control Equity method APB Opinion #18 and consolidation FASB Exposure procedures Draft
20% to 50% Significant Equity method APB Opinion #18 influence
Less than 20% No Account for as FASB Statement significant trading or No influence available for sale

26. Revenue for Equity Securities Classified as Trading and AFS
AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares (which represents 5%)
Cash 2,500
Dividend Revenue 2,500

27. Revenue for Equity Securities Classified as Equity Method Securities
AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 100,000 which represents 50 % of the outstanding voting stock.
Cash 25,000
Investment in AB Company
Stock 25,000

28. Revenue for Equity Securities Classified as Equity Method Securities
AB Company reports an income of $250,000 for the year. Again, assume that Citty Co. owns 50 % of the outstanding voting stock.
Investment in AB Company
Stock 125,000
Income from Investment
in AB Company Stock 125,000

29. Accounting for Temporary Changes in Value of Securities (an extract of slide 12)
Classification
of Security
Disclosed at
Report FMV
Change On
Fair market
Income
Trading
value
statement
Available-
for-sale
Fair market
value
Stockholder’s
equity
Held-to-
maturity
Amortized
cost
Not
recognized

30. Accounting for Temporary Changes in Value of Securities
Eastwood Inc. bought the following securities on March 23, 2005.
Security
Classification
Cost($)
FMV 31/12/05($) 1
Trading
8,000
7,000 2
3,000
3,500 3
Available for Sale
5,000
6,100 4
12,000
11,500 5
Held to Maturity
20,000
19,000

31. Accounting for Temporary Changes in Value of Securities
Initial Purchase Entry
Investment in Trading Securities 11,000
Investment in Available-for-Sale
Securities 17,000
Investment in Held-to-Maturity
Securities 20,000
Cash 48,000
Continued

32. A contra account to the “investment account”
Accounting for Temporary Changes in Value of Securities
By the end of the year, the value of the trading securities decreased from $11,000 to $10,500.
A contra account to the “investment account”
December 31, 2005:
Unrealized Loss on Trading Securities 500
Market Adjustment—Trading Securities 500
Included in net income

33. Included in stock holder’s equity => Comprehensive income
Accounting for Temporary Changes in Value of Securities
By the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600.
Included in stock holder’s equity => Comprehensive income
December 31, 2005:
Market Adjustment—Available-for-Sale
Securities 600
Unrealized Increase/Decrease in Value
of Available-for-Sale Securities 600

34. Accounting for Temporary Changes in Value of Securities
Partial Balance Sheet for Eastwood Inc.
Assets
Invest. in trading securities $11,000
Market adjustment—trading sec (500) $10,500
Invest. in available-for-sale sec. $17,000
Market adjustment ,600
Invest. in held-to-maturity sec ,000
$48,100
Stockholders’ Equity
Add unrealized increase in
available-for-sale securities $ 600

35. Accounting for Temporary Changes in Value of Securities
Partial Income Statement for Eastwood Inc.
Other expenses and losses:
Unrealized loss on trading
securities $500