1. John Wiley & Sons, Inc. Financial A ccounting, 5e Prepared by Kurt M. Hull, MBA CPA California State University, Los Angeles Weygandt, Kieso, & Kimmel

2. CHAPTER 13 INVESTMENTS CHAPTER 13 INVESTMENTS STUDY OBJECTIVES After studying this chapter, you should understand: Why corporations invest in debt and stock securities Consolidated financial Statements Accounting for debt investments Valuation of debt and stock investments Accounting for stock investments Short-term vs. long-term investments

3. ReasonTypical Investment To house excess cash until needed Low-risk, high-liquidity, short-term securities such as government- issued securities To generate earnings I need 1,000 Treasury bills by tonight! Debt securities (banks and other financial institutions); and stock securities (mutual funds and pension funds) To meet strategic goals Stocks of companies in a related industry or in an unrelated industry that the company wishes to enter STUDY OBJECTIVE 1 WHY CORPORATIONS INVEST STUDY OBJECTIVE 1 WHY CORPORATIONS INVEST

4. Debt investments = government and corporate bonds. Entries required for acquisition, interest revenue, and sale. Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2006, for $54,000, including brokerage fees of $1,000. The entry to record the investment is: DateAccount Titles and ExplanationDebitCredit Jan. 1Debt Investments Cash (To record purchase of 50 Doan Inc. bonds) 54,000 STUDY OBJECTIVE 2 ACCOUNTING FOR DEBT INVESTMENTS STUDY OBJECTIVE 2 ACCOUNTING FOR DEBT INVESTMENTS Cost principle applies Cost includes all expenditures to acquire investment.

5. The bonds pay $2,000 interest on July 1 and January 1 ($50,000 x 8% x ½). The July 1 entry is: It is necessary to accrue $2,000 interest earned since July 1 at year-end. The December 31 entry is: DateAccount Titles and ExplanationDebitCredit July 1Cash Interest Revenue (To record receipt of interest on Doan Inc. bonds) 2,000 DateAccount Titles and ExplanationDebitCredit Dec. 31Interest Receivable Interest Revenue (To accrue interest on Doan Inc. bonds) 2,000 RECORDING BOND INTEREST

6. DateAccount Titles and ExplanationDebitCredit Jan. 1Cash Interest Receivable (To record receipt of accrued interest) When the interest is received on January 1, the entry is: 2,000 RECORDING BOND INTEREST

7. On January 1, 2007, Kuhl Corporation receives net proceeds of $58,000 on the sale of the Doan Inc. bonds. The entry to record the sale and recognize the gain is: DateAccount Titles and ExplanationDebitCredit Jan. 1Cash Debt Investments Gain on Sale of Debt Investments (To record sale of Doan Inc. bonds) 58,000 54,000 4,000 RECORDING SALE OF BONDS PROCEEDS – COST = GAIN or LOSS

8. REVIEW QUESTION On February 6, Hanes Company sells debt investments costing $26,000 for $28,000. Prepare the journal entry to record the sale. 26,000 Debt Investments 2,000 Gain on Sale 28,000CashFeb 6 CreditDebitAccountsDate Proceeds – Cost = Gain or Loss

9. Investor’s Ownership Presumed Interest in Investee’s Influence Accounting Common Stock on Investee Guidelines Less than 20% Insignificant Cost method Between 20% Significant Equity method and 50% More than 50% Controlling Consolidated financial statements Stock investments = capital stock of corporations. STUDY OBJECTIVE 3 ACCOUNTING FOR STOCK INVESTMENTS STUDY OBJECTIVE 3 ACCOUNTING FOR STOCK INVESTMENTS

10. On July 1, 2006, Sanchez Corporation acquires 1,000 shares (10%) of Beal Corporation common stock for $40 per share plus brokerage fees of $500. The entry for the purchase is: DateAccount Titles and ExplanationDebitCredit July 1Stock Investments Cash (To record purchase of 1,000 shares of Beal Corporation common stock) 40,500 RECORDING STOCK INVESTMENTS HOLDINGS < 20% RECORDING STOCK INVESTMENTS HOLDINGS < 20% COST METHOD Record investment at cost. Recognize revenue when cash dividends are received.

11. DateAccount Titles and ExplanationDebitCredit Dec. 31Cash (1,000 x $2) Dividend Revenue (To record receipt of a cash dividend) 2,000 RECORDING DIVIDENDS HOLDINGS < 20% RECORDING DIVIDENDS HOLDINGS < 20% On December 31, Sanchez Corporation receives a $2 per share cash dividend. Dividend revenue is reported on the income statement under “Other revenues and gains.”

12. On February 10, 2007, Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal stock. The cost of the Beal stock was $40,500 on July 1, 2006. The entry to record the sale and loss is: DateAccount Titles and ExplanationDebit Credit Feb. 10Cash Loss on Sale of Stock Investments Stock Investments (To record sale of Beal common stock) 39,500 1,000 40,500 RECORDING A SALE HOLDINGS < 20% RECORDING A SALE HOLDINGS < 20% PROCEEDS – COST = GAIN or LOSS

13. RECORDING STOCK INVESTMENTS HOLDINGS BETWEEN 20% & 50% RECORDING STOCK INVESTMENTS HOLDINGS BETWEEN 20% & 50% EQUITY METHOD Record investment at cost. Investment account adjusted annually for dividends received and share of investee net income. Percent of investee net lossPercent of investee net income Dividends receivedCost of investment CreditDebit

14. On January 1, 2006, Milar Corporation acquires 30% of the common stock of Beck Company for $120,000. The entry to record this transaction is: DateAccount Titles and ExplanationDebitCredit Jan. 1Stock Investments Cash (To record purchase of Beck common stock) 120,000 RECORDING ACQUISITIONS HOLDINGS BETWEEN 20% & 50% RECORDING ACQUISITIONS HOLDINGS BETWEEN 20% & 50%

15. Beck reports 2006 net income of $100,000 and declares and pays a $40,000 cash dividend. The entries are: Date Account Titles and Explanation Debit Credit Dec. 31 Stock Investments Revenue from Investment in Beck Company (To record 30% equity in Beck’s 2006 net income) 30,000 DateAccount Titles and ExplanationDebitCredit Dec. 31Cash Stock Investments (To record dividends received) 12,000 RECORDING NET INCOME & DIVIDENDS HOLDINGS BETWEEN 20% & 50% RECORDING NET INCOME & DIVIDENDS HOLDINGS BETWEEN 20% & 50%

16. INVESTMENT AND REVENUE ACCOUNTS AFTER POSTING INVESTMENT AND REVENUE ACCOUNTS AFTER POSTING Milar’s share of Beck’s net income is $30,000. This increases the investment. Milar does not receive any cash. Dividends received From Beck reduce the investment. Milar receives $12,000 in cash. If Beck reports a net loss, Milar’s share would reduce the investment.

17. A PARENT COMPANY owns more than 50% of the common stock of a SUBSIDIARY COMPANY. The parent company has a CONTROLLING INTEREST in the subsidiary company. CONSOLIDATED FINANCIAL STATEMENTS are usually prepared. PARENT OWNS 50% OF SUB A 60% OF SUB B 75% OF SUB C STUDY OBJECTIVE 4 ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS > 50% - CONSOLIDATIONS STUDY OBJECTIVE 4 ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS > 50% - CONSOLIDATIONS

18. Controlling Group Home Box Office Board of Directors Time Warner, Inc. Board of Directors Home Box Office Corporation Time Warner, Inc. Control Separate Legal Entities Single Economic Entity Time Warner, Inc. owns 100% of HBO common stock. The common stockholders of Time Warner elect the BOD of the company, who, in turn, select the officers and managers of the company. The Board of Directors controls the property owned by the corporation, including the HBO common stock. RECORDING STOCK INVESTMENTS MANAGEMENT PERSPECTIVE RECORDING STOCK INVESTMENTS MANAGEMENT PERSPECTIVE

19. Trading We’ll sell within ten days. Available-for- Sale We’ll hold the stock for a while to see how it performs. Held-to-Maturity We intend to hold these bonds until maturity. At fair value with changes reported in net income At fair value with changes reported in the stockholders’ equity section At amortized cost Fair value = expected cash realizable value of the securities sold in normal market conditions. STUDY OBJECTIVE 5 VALUING AND REPORTING INVESTMENTS STUDY OBJECTIVE 5 VALUING AND REPORTING INVESTMENTS FAIR MARKET VALUE

20. Held with the intention of selling them in a short period. Reported at fair value. Changes from cost are reported as unrealized gains or losses and included in NET INCOME. Pace Corporation holdings are illustrated below: Trading Securities, December 31, 2006 Investments Cost Fair Value Unrealized Gain (Loss) Yorkville Company bonds $ 50,000 $ 48,000 $ (2,000) Kodak Company stock 90,000 99,000 9,000 Total $ 140,000 $ 147,000 $ 7,000 TRADING SECURITIES

21. Trading securities are adjusted to market value at the balance sheet date. DateAccount Titles and ExplanationDebitCredit Dec. 31Market Adjustment — Trading Unrealized Gain— Income (To record unrealized gain on trading securities) 7,000 VALUATION AND REPORTING OF TRADING SECURITIES VALUATION AND REPORTING OF TRADING SECURITIES FAIR VALUE – COST = UNREALIZED GAIN (LOSS) Fair value on balance sheet Unrealized gain/loss on income statement

22. REVIEW QUESTION At the end of the first year of operations, the total cost of a trading securities portfolio is $120,000. Fair value is $115,000. Prepare the journal entry to adjust the securities to fair value. Income Statement (to adjust trading portfolio to market) 5,000 Short-term investments 5,000Unrealized loss on trading securitiesDec 31 CreditDebitAccountsDate

23. Held with the intention of selling them in the near future. Reported at fair value. Changes from cost are reported as a component of stockholders equity. Elbert Corporation holdings are illustrated below: Available-for-Sale Securities, December 31, 2006 Investments Cost Fair Value Unrealized Gain (Loss) Campbell Soup Corporation 8% bonds $ 93,537 $ 103,600 $ 10,063 Hersey Corporation stock 200,000 180,400 (19,600) Total $ 293,537 $ 284,000 $ ( 9,537) AVAILABLE FOR SALE SECURITIES

24. DateAccount Titles and ExplanationDebitCredit Dec. 31Unrealized Loss— Equity Market Adjustment — Available-for-Sale (To record unrealized loss on available-for-sale securities) 9,537 Available for sale securities are adjusted to market value at the balance sheet date. FAIR VALUE – COST = UNREALIZED GAIN (LOSS) Fair value on balance sheet Unrealized gain/loss in stockholders’ equity VALUATION AND REPORTING OF AVAILABLE FOR SALE SECURITIES VALUATION AND REPORTING OF AVAILABLE FOR SALE SECURITIES

25. 1.Short-term investments are readily marketable, and 2.Intended to be converted into cash within the next year or operating cycle, whichever is longer. 3.Listed on balance sheet immediately below cash. 4.Reported at fair value. PACE CORPORATION Balance Sheet (partial) Current assets Cash $ 21,000 Short-term Investments at fair value 147,000 STUDY OBJECTIVE 6 SHORT-TERM vs. LONG-TERM INVESTMENTS STUDY OBJECTIVE 6 SHORT-TERM vs. LONG-TERM INVESTMENTS

26. Long-term investments are reportedon the balance sheet immediately below current assets. In the income statement, the items below are reported in the non-operating section: LONG-TERM INVESTMENTS BALANCE SHEET PRESENTATION LONG-TERM INVESTMENTS BALANCE SHEET PRESENTATION

27. An unrealized gain or loss on available-for-sale securities is reported as a separate component of stockholders’ equity. The statement presentation of the unrealized loss is shown below. DAWSON INC. Partial Balance Sheet Stockholders’ equity Common stock$ 3,000,000 Retained earnings 1,500,000 Total paid-in capital and retained earnings 4,500,000 Less:Unrealized loss on available-for-sale securities ( 100,000) Total stockholders’ equity $ 4,400,000 UNREALIZED LOSS IN STOCKHOLDERS’ EQUITY UNREALIZED LOSS IN STOCKHOLDERS’ EQUITY

28. Pace Corporation classified balance sheet includes: 1 Short-term Investments, 2 Investments of less than 20%, 3 Investments of 20% - 50%. Total property, plant, and equipment 926,000 Intangible assets Goodwill (Note 1) 270,000 Total intangible assets 270,000 Total assets $ 1,710,000 CLASSIFIED BALANCE SHEET

29. Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 185,000 Bond interest payable 10,000 Federal income taxes payable 60,000 Total current liabilities 255,000 Long-term liabilities Bonds payable, 10%, due 2010 $ 300,000 Less: Discount on bonds 10,000 Total Long-term liabilities 290,000 Total liabilities 545,000 Stockholders’ equity Paid-in capital Common stock, $10 par value, 200,000 shares authorized, 80,000 issued and outstanding 800,000 Paid-in capital in excess of par value 100,000 Total paid-in capital 900,000 Retained earnings (Note 2) 255,000 Total paid-in capital and retained earnings 1,155,000 Add: Unrealized gain on availablefor-sale securities 10,000 Total stockholders’ equity 1,165,000 Total liabilities and stockholders’ equity $ 1,710,000 Note 1. Goodwill is amortized by the straight-line over 40 years. Note 2. Retained earnings of $100,000 is restricted for plant expansion. Pace Corporation balance sheet includes: 1.Unrealized gain available-for-sale securities CLASSIFIED BALANCE SHEET

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31. CHAPTER 13 INVESTMENTS