Investments and Fair Value Accounting Chapter 13 Student Version These slides should be viewed using the presentation mode (left click your mouse on the icon).

Describe why companies invest in debt and equity securities. Learning Objective 1 Describe why companies invest in debt and equity securities.

Investing Cash in Temporary Investments LO 1 Investing Cash in Temporary Investments Instead of letting excess cash remain idle in a checking account, most companies invest this cash in securities such as: Debt securities, which are notes and bonds that pay interest and have a fixed maturity date. Equity securities, which are preferred and common stock that represent ownership in a company and do not have a fixed maturity date.

Investing Cash in Temporary Investments LO 1 Investing Cash in Temporary Investments These debt securities and equity securities are termed investments, or temporary investments, and are reported in the Current Assets section of the balance sheet. The primary objective of investing in temporary investments is to: Earn interest income Receive dividends Realize gains from increases in the market price of the securities

Investing Cash in Long-Term Investments Long-term investments often involve the purchase of a significant portion of the stock of another company. Such investments have a strategic purpose: Reduction of costs Replacement of management Expansion Integration

Describe and illustrate the accounting for debt investments. Learning Objective 2 Describe and illustrate the accounting for debt investments.

LO 2 Purchase of Bonds HOMER Homer Company purchases $18,000 of U.S. Treasury bonds direct from a Federal Reserve Bank at their par value on March 17, 2012, plus accrued interest for 45 days. The bonds have an interest rate of 6%, payable on July 31 and January 31, 2012. $18,000 × 6% × (45/360)

LO 2 Interest Revenue HOMER On July 31, Homer Company receives a semiannual interest payment of $540 ($18,000 × 6% × 1½). The $540 interest includes $135 of accrued interest that Homer Company purchased with the bonds on March 17. ($540 – $135) or [$18,000 × 6% × (135/360)]

LO 2 Interest Revenue HOMER Homer Company’s accounting period ends on December 31. Thus, an adjusting entry must be made to accrue interest for five months. The following adjusting entry records the accrued interest: $18,000 × 6% × 5/12

LO 2 Interest Revenue HOMER Homer Company receives interest of $540 on January 31, 2013. Notice that Interest Receivable is credited for $450 to reflect that this amount is a receivable from 2012. Interest Revenue of $90 is the interest earned from January 1 through January 31, 2013.

LO 2 Sale of Bonds HOMER On January 31, 2013, Homer Company sells the Treasury bonds at 98. The sale results in a loss of $360. Proceeds from sale ($18,000 × 98%) $17,640 Less book value (cost) of the bonds 18,000 Loss on sale of bonds $ (360)

LO 2 Sale of Bonds HOMER There is no accrued interest upon the sale since the interest payment date is also January 31. The entry to record the sale is as follows: Reported as part of Other income (loss) on the income statement

Describe and illustrate the accounting for equity investments. Learning Objective 3 Describe and illustrate the accounting for equity investments.

Accounting for Equity Investments LO 3 Accounting for Equity Investments A company may invest in the preferred or common stock of another company. The company investing in another company’s stock is the investor. The company whose stock is purchased is the investee.

LO 3 Less Than 20% Ownership Investments of less than 20% of the investee’s outstanding stock are accounted for by using the cost method. Under the cost method, entries are recorded for the following transactions: Purchase of stock Receipt of dividends Sale of stock

LO 3 Purchase of Stock BART On May 1, Bart Company purchases 2,000 shares of Lisa Company common stock at $49.90 per share plus a brokerage fee of $200.

LO 3 Receipt of Dividends BART On July 31, Bart Company receives a dividend of $0.40 per share from Lisa Company. Dividend Revenue is reported as part of Other Income on Bart Company’s income statement.

LO 3 Sale of Stock BART On September 1, Bart Company sells 1,500 shares of Lisa Company stock for $54.50 per share, less a $160 commission. The gain is reported as part of Other Income on Bart Company’s income statement.

LO 3 Between 20%─50% Ownership If the investor purchases between 20% and 50% of the outstanding stock of the investee, the investor is considered to have significant influence over the investee, and the investment is accounted for using the equity method.

LO 3 Between 20%─50% Ownership Under the equity method, the investment account is adjusted for the investor’s share of the net income and dividends of the investee. These adjustments are as follows: Net income: recorded as an increase in the investment account. Dividends: decrease the investment account.

LO 3 Purchase of Stock S Simpson Inc. purchased a 40% interest in Flanders Corporation’s common stock on January 2, 2012 for $350,000.

Recording Investee Net Income LO 3 Recording Investee Net Income S For the year ended December 31, 2012, Flanders Corporation reported net income of $105,000. Income of Flanders Corporation may be reported separately or as part of Other Income on Simpson Inc.’s income statement.

Recording Investee Dividends LO 3 Recording Investee Dividends S During the year, Flanders declared and paid cash dividends of $45,000.

LO 3 Sale of Stock S On January 1, 2013, Simpson Inc. sold Flanders Corporation’s stock for $400,000, a gain of $26,000, calculated as follows:

LO 3 More Than 50% Ownership If the investor purchases more than 50% of the outstanding stock of the investee, the investor is considered to have control over the investee. The purchase is termed a business combination.

LO 3 More Than 50% Ownership A corporation owning all or a majority of the voting stock of another corporation is called a parent company. The corporation that is controlled is called the subsidiary company. At the end of the year, the financial statements of the parent and subsidiary are combined, and consolidated financial statements are issued.

Learning Objective 4 Describe and illustrate valuing and reporting investments in the financial statements.

LO 4 Trading Securities Trading securities are debt and equity securities that are purchased and sold to earn short-term profits from changes in their market prices.

LO 4 Trading Securities Trading securities are reported as current assets on the balance sheet. Trading securities are valued as a portfolio (group) of securities using their fair values. Fair value is the market price that would be received for a security if it were sold. Changes in fair value of the portfolio are recognized as an unrealized gain or loss for the period.

LO 4 Trading Securities Maggie Company purchased a portfolio of trading securities during 2012. On December 31, 2012, the cost and fair values of the securities were as follows:

LO 4 Trading Securities The adjusting entry on December 31, 2012, to record the fair value of the securities ($25,300) is as follows: Unrealized Gain on Trading Investments is reported on the income statement.

Available-for-Sale Securities LO 4 Available-for-Sale Securities Available-for-sale securities are debt and equity securities that are neither held for trading, held to maturity, or held for strategic reasons.

Available-for-Sale Securities LO 4 Available-for-Sale Securities Maggie Company purchased three securities during 2012 as available-for-sale securities. On December 31, 2012, the cost and fair values of the securities were as follows:

Available-for-Sale Securities LO 4 Available-for-Sale Securities On December 31, the adjusting entry credits a stockholders’ equity account instead of an income statement account. The $1,300 increase in fair value is credited to Unrealized Gain (Loss) on Available-for-Sale Investments. Added to current assets Added to stockholders’ equity

Held-To-Maturity Securities LO 4 Held-To-Maturity Securities Held-to-maturity securities are debt investments, such as notes or bonds, that a company intends to hold until their maturity date.

Describe fair value accounting and its implications for the future. Learning Objective 5 Describe fair value accounting and its implications for the future.

LO 5 Fair Value Accounting Fair value is the price that would be received for selling an asset or paying off a liability. Fair value assumes that the asset is sold or the liability paid off under normal rather than distressed conditions. A current trend for the FASB and other accounting regulators is to adopt accounting principles using fair values for valuing and reporting assets and liabilities.

Trend to Fair Value Accounting LO 5 Trend to Fair Value Accounting Potential disadvantages of using fair values: Fair values may not be readily obtainable for some assets or liabilities. Fair values make it more difficult to compare companies if companies use different methods of measuring fair values. Using fair values could result in more fluctuations in accounting reports because fair values change from year to year.

Describe and illustrate the computation of dividend yield. Learning Objective 6 Describe and illustrate the computation of dividend yield.

LO 6 Dividend Yield The dividend yield measures the rate of return to stockholders based on cash dividends distributed. Dividend yield is calculated as follows: Dividend Yield = Dividends per Share of Common Stock Market Price per Share of Common Stock News Corporation: Dividend Yield = $0.12 $15.50 = 0.77%

Investments and Fair Value Accounting The End