Prepared by: Keri Norrie, Camosun College ACCOUNTING PRINCIPLES Third Canadian Edition Prepared by: Keri Norrie, Camosun College

CHAPTER 16 INVESTMENTS

TYPES OF INVESTMENTS Debt securities Equity securities money-market instruments bonds Equity securities preferred shares common shares

WHY CORPORATIONS INVEST Invest excess cash Generate investment income Strategically purchase shares of another company

TEMPORARY AND LONG-TERM INVESTMENTS Temporary investments (1) Readily marketable Readily marketable means the investment can be sold easily, whenever the need for cash arises. (2) Intended to be converted into cash in the near future Intention to convert means that management intends to sell the investment if and when the need for cash arises. Long-term investments Investments that do not meet both criteria

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Money Market Instruments Assume that Cheung Corporation has excess cash on hand and so, on November 30, 2005, it purchases a $5,000 three-month term deposit that pays an annual interest rate of 2%. The journal entry to record Cheung’s temporary investment is as follows: Date Account Titles and Explanation Debit Credit Nov. 30 Temporary Debt Investment—Term Deposit 5,000 Cash To record purchase of three-month, 2% term deposit.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Money Market Instruments Cheung Corporation’s year end is December 31. Assuming that the term deposit pays interest at maturity, it is necessary to accrue interest revenue at year end. $5,000 x 2% x 1/12 months (rounded) Date Account Titles and Explanation Debit Credit Dec. 31 Interest Receivable 8 Interest Revenue To accrue interest on term deposit.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Money Market Instruments On February 28, 2006, when the term deposit matures, Cheung records the interest revenue earned since year end as well as the receipt of cash and elimination of the term deposit. Date Account Titles and Explanation Debit Credit Feb. 28 Cash 5,025 Interest Receivable 8 Interest Revenue ($5,000 x 2% x 2/12) 17 Temporary Debt Investment—Term Deposit 5,000 To record maturation of term deposit.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Bonds Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2005, for $51,000, including brokerage fees of $1,000. The bonds pay interest semi-annually on July 1 and January 1. The entry to record the temporary investment at cost is: Cost includes all expenses to acquire the investment. Date Account Titles and Explanation Debit Credit Jan. 1 Temporary Debt Investment—Doan Bonds 51,000 Cash To record purchase of 50 Doan Bonds.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Bonds The bonds pay interest semi-annually on July 1 and January 1. Interest receipts are calculated using the bond’s face or principal value. The entry on July 1 is: $50,000 x 8% x 6/12 Date Account Titles and Explanation Debit Credit July 1 Cash 2,000 Interest Revenue To record receipt of interest on Doan Bonds.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Bonds If Kuhl’s fiscal year ends on December 31, it is necessary to accrue interest of $2,000 earned since July 1. Date Account Titles and Explanation Debit Credit Dec. 31 Interest Receivable 2,000 Interest Revenue To accrue interest on Doan Bonds.

ACCOUNTING FOR DEBT INVESTMENTS Temporary Debt Investments Bonds Assume Kuhl sells the bond for $55,000 net proceeds (sales price less brokerage fees) on January 1, 2006 after receiving (and recording) the interest due. Net proceeds – the cost of the bond investment = gain (or loss) on sale. Date Account Titles and Explanation Debit Credit Jan. 1 Cash 55,000 Temporary Debt Investment—Doan Bonds 51,000 Gain on Sale of Investment in Doan Bonds 4,000 To record sale of Doan Inc. bonds.

ACCOUNTING FOR DEBT INVESTMENTS LONG-TERM DEBT INVESTMENTS (ILLUSTRATION 16-2) Accounting for long-term and temporary debt investments is similar except for bonds purchased with a premium or discount. To illustrate, assume Khadr Inc. has bought ABC Corporation bonds with a face value of $100,000 at a price of 101. Temporary Investment Long-Term Investment Temporary Debt Investment -ABC Bonds 101,000 Cash 101,000 To record purchase of ABC bonds as a temporary investment. Long-Term Debt Investment -ABC Bonds 100,000 Premium on Bonds 1,000 Cash 101,000 To record purchase of ABC bonds as a long-term investment. A premium (or discount) is recorded as part of the investment cost. A premium (or discount) is separately recorded and is amortized to interest revenue over the bond’s term.

ACCOUNTING FOR DEBT INVESTMENTS LONG-TERM BOND INVESTMENTS (ILLUSTRATION 16-3) Recording a long-term investment in bonds (asset) is basically the opposite of recording long-term bonds payable (liability) discussed in chapter 15. Using the previous Khadr example, the journal entry for Khadr Inc. and ABC Corporation to record the bond is: Khadr Inc. (Investor) ABC Corporation (Investee) Long-Term Debt Investment -ABC Bonds 100,000 Premium on Bonds 1,000 Cash 101,000 To record purchase of ABC bonds as a long-term investment. Cash 101,000 Premium on Bonds 1,000 Bonds Payable 100,000 To record issue of bonds. The premium is recorded as a debit for the investor, Khadr Inc., and a credit for the investee, ABC Corporation.

ACCOUNTING FOR EQUITY INVESTMENTS Investments in the preferred or common shares of another corporation may be held: To earn dividend income For share price appreciation To influence relationships between companies

ACCOUNTING FOR EQUITY INVESTMENTS The accounting for equity investments is based on how much influence the investor has over the operating and financial affairs of the investee. The following guideline is followed: Less than 20% ownership of the investee’s common shares Cost method of accounting No significant influence 20% or more ownership of the investee’s common shares Equity method of accounting Significant influence

ACCOUNTING FOR EQUITY INVESTMENTS NO SIGNIFICANT INFLUENCE On July 1, 2005, St. Amand Corporation acquires 1,000 shares (10 % ownership) of Beal Corporation at $40 per share plus brokerage fees of $500. The entry for the purchase is: All temporary equity investments would also use the cost method. Under the cost method, the investment is recorded at cost, which includes all expenses to acquire it. Date Account Titles and Explanation Debit Credit July 1 Long-Term Equity Investment—Beal Common Shares 40,500 Cash [(1,000 x $40) + $500] To record purchase of 1,000 common shares of Beal Corporation.

ACCOUNTING FOR EQUITY INVESTMENTS NO SIGNIFICANT INFLUENCE Under the cost method, revenue is recognized only when cash dividends are received. If a $2 per share dividend is received by St. Amand Corporation on December 1, 2005, the entry is: Date Account Titles and Explanation Debit Credit Dec. 1 Cash (1,000 x $2) 2,000 Dividend Revenue To record receipt of cash dividend. Unlike interest, dividends do not accrue before they are declared.

ACCOUNTING FOR EQUITY INVESTMENTS NO SIGNIFICANT INFLUENCE When sold, the difference between the net proceeds and cost is recognized as a gain or loss. Assume Armand sells its Beal common shares for $39,500 net proceeds (sales price less brokerage fees) on October 10, 2006. Date Account Titles and Explanation Debit Credit Oct. 10 Cash 39,500 Loss on Sale of Equity Investment 1,000 Long-Term Equity Investment—Beal Common Shares 40,500 To record sale of Beal common shares.

ACCOUNTING FOR EQUITY INVESTMENTS SIGNIFICANT INFLUENCE Similar to the cost method, the acquisition of the share investment is recorded at cost for the equity method. Assume Milar Corporation acquires 30 percent of the common shares of Beck Company for $120,000 on January 1, 2005. The entry to record this transaction is: Date Account Titles and Explanation Debit Credit Jan. 1 Long-Term Equity Investment—Beck Common Shares 120,000 Cash To record purchase of Beck common shares.

ACCOUNTING FOR EQUITY INVESTMENTS SIGNIFICANT INFLUENCE With significant influence over the financial and operating activities of the investee, the investor records its share of the net income of the investee in the same year that it is earned. Assuming that Beck reports net income of $100,000 for 2005, Milar would record: Net income increases Beck’s shareholders’ equity by $100,000. With the equity method, Milar increases its investment in Beck’s equity by its 30% portion. Date Account Titles and Explanation Debit Credit Dec. 31 Long-Term Equity Investment—Beck Common Shares (30% x 100,000) 30,000 Revenue from Investment in Beck To record 30% equity in Beck’s common shares.

ACCOUNTING FOR EQUITY INVESTMENTS SIGNIFICANT INFLUENCE Dividends reduce the shareholders’ equity (retained earnings) of the investee and under the equity method, reduces the investor’s investment in that equity. Assuming that Beck declares and pays a $40,000 cash dividend for 2005, Milar would record: Date Account Titles and Explanation Debit Credit Dec. 31 Cash ($40,000 x 30%) 12,000 Long-Term Equity Investment—Beck Common Shares To record dividends received. In 2005, Milar’s investment has increased from $120,000 to $138,000. This $18,000 increase is Milar’s 30% equity in the $60,000 increase in Beck’s retained earnings ($100,000 net income – $40,000 dividends).

ACCOUNTING FOR EQUITY INVESTMENTS CONSOLIDATED FINANCIAL STATEMENTS If an investor (also called the parent company) has voting control (usually owns more than 50% of the common shares) of the investee (also called the subsidiary), the investor must prepare consolidated financial statements. Consolidated statements present the total assets and liabilities controlled by the parent company. Parent’s financial statements Subsidiary’s financial statements Consolidated financial statements +

VALUATION AND REPORTING OF INVESTMENTS For temporary investments, the investments must be reported at the lower of cost or market based on the conservatism principle. The entry would be: Date Account Titles Debit Credit xxx Loss on Decline in Value of Investment Allowance to Reduce Cost to Market Value A contra asset account is used to record the decrease in the asset’s value. For long-term investments, the investments are only reduced for permanent declines in value.

COMPREHENSIVE BALANCE SHEET (ILLUSTRATION 16-8)

COMPREHENSIVE BALANCE SHEET (ILLUSTRATION 16-8)

CHANGING STANDARDS Effective 2005, Canadian accounting standards are expected to change to require the use of market values for some investments to harmonize with international standards. The revaluation of investments to market value will result in unrealized gains and losses. In addition, the new proposed standards will classify investments into three broad categories: - Trading securities - Available-for-sale securities - Held-to-maturity securities

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