Investments C hapter 15 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2 1.Additional revenues from idle cash 2.Control over another company 3.Beneficial relationship with another company Why Companies Invest in Other Companies

3 Classification of Investments 1.Trading securities 2.Available-for-sale securities 3.Held-to-maturity debt securities

4 Trading securities are investments in debt and equity securities that are purchased and held principally for the purpose of selling them in the near term. Trading Securities

These securities are reported at their fair market value on the ending balance sheet, and unrealized holding gains and losses are included in net income of the current period. 5 Trading Securities

6 Investments in held-to-maturity securities are debt securities for which the company has the “positive intent and ability to hold those securities to maturity.” Held-to-Maturity Securities

7 Investments in held-to-maturity securities are reported at their amortized cost on the balance sheet…not their fair value. Held-to-Maturity Securities

8 Investments in available-for- sale securities are securities that are not classified as being held to maturity or trading. Available-for-Sale Securities

9 Investments in available-for-sale securities are reported at their fair value on the ending balance sheet date, and the unrealized holding gains or losses are reported as a component of other comprehensive income. Available-for-Sale Securities

10 Therefore, the unrealized holding gains and losses for available-for-sale securities are not included in net income. Available-for-Sale Securities

11 Accounting for Equity Investments Reporting of Accounting Unrealized Holding Investment Categories Method Gains and Losses Investment in Equity Securities 1.No significant influence (less than 20% ownership) a.TradingFair valueNet income b.Available for saleFair valueOther comprehensive income 2.Significant influenceEquity methodNot recognized (20 to 50% ownership) 3.ControlConsolidationNot recognized (more than 50% ownership)

12 Accounting for Debt Investments Reporting of Accounting Unrealized Holding Investment Categories Method Gains and Losses Investment in Debt Securities 1.TradingFair valueNet income 2.Available for saleFair valueOther comprehensive income 3.Held to maturityAmortized costNot recognized

13 Investments Trading Securities 1.The investment is initially recorded at cost. 2.It is subsequently reported at fair value on the ending balance sheet(s). 3.Unrealized holding gains and losses are included in net income of the current period. 4.Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income of the current period.

14 Investments in Available-for-Sale Securities 1.The investment is initially recorded at cost. 2.It is subsequently reported at fair value on the ending balance sheet(s). 3.Unrealized holding gains and losses are reported as a component of other comprehensive income. 4.The cumulative unrealized holding gains and losses are reported in the accumulated other comprehensive income section of stockholders’ equity 5.Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.

shares of A Company common stock at $50 per share 300 shares of B Company common stock at $80 per share 200 shares of C Company preferred stock at $120 per share $15,000 D Company 10% bonds (5/31 & 11/30 dividend dates) 100 shares of A Company common stock at $50 per share 300 shares of B Company common stock at $80 per share 200 shares of C Company preferred stock at $120 per share $15,000 D Company 10% bonds (5/31 & 11/30 dividend dates) $ 5,000 24,000 15,000 $ 5,000 24,000 15,000 Kent Company purchases the following securities on Jun 1, 2009 as an investment in available-for- sale securities: Total $68,000 Investments in Available-for-Sale Debt and Equity Securities

16 Investment in Available-for-Sale Securities68,000 Cash68,000 Investments in Available-for-Sale Debt and Equity Securities Received bond interest payment on November 1, 2009: Received bond interest payment on November 1, 2009: Cash750 Interest Revenue750

17 December 31, 2009 Interest Receivable125 Interest Revenue125 Cash3,000 Dividend Revenue3,000 During 2009 Kent Company receives dividends of $3,000 from its investment in the stock of A, B, and C Companies. Investments in Available-for-Sale Debt and Equity Securities $15,000 × 0.10 × 1/12

18 The cost and fair value of the available-for-sale securities held by the Kent Company is as follows: Cumulative 12/31/09Change Fair in Fair Security Cost Value Value 100 shares of A Company common stock$ 5,000$ 6,000$ 1, shares of B Company common stock24,00023,500(500) 200 shares of C Company preferred stock24,00026,0002,000 $15,000 face value of D Company 10% bonds 15,000 15, Totals$68,000$71,000$3,000 Investments in Available-for-Sale Debt and Equity Securities

19 The cost and fair value of the available-for-sale securities held by the Kent Company is as follows: Cumulative 12/31/09Change Fair in Fair Security Cost Value Value 100 shares of A Company common stock$ 5,000$ 6,000$ 1, shares of B Company common stock24,00023,500(500) 200 shares of C Company preferred stock24,00026,0002,000 $15,000 face value of D Company 10% bonds 15,000 15, Totals$68,000$71,000$3,000 Investments in Available-for-Sale Debt and Equity Securities Allowance for Change in Value of Investment3,000 Unrealized Increase/Decrease in Value of Unrealized Increase/Decrease in Value of Available-for-Sale Securities 3,000 Available-for-Sale Securities 3,000 Allowance for Change in Value of Investment3,000 Unrealized Increase/Decrease in Value of Unrealized Increase/Decrease in Value of Available-for-Sale Securities 3,000 Available-for-Sale Securities 3,000

20 The same securities are held on December 31, Cumulative 12/31/10Change Fair in Fair Security Cost Value Value 100 shares of A Company common stock$ 5,000$ 6,100$ 1, shares of B Company common stock24,00022,700(1,300) 200 shares of C Company preferred stock24,00023,200(800) $15,000 face value of D Company 10% bonds 15,000 14,000 (1,000) Totals$68,000$66,000$(2,000) Investments in Available-for-Sale Debt and Equity Securities

21 12/31/09 3,000 5,000 adjusting entry 2,000 12/31/10 Allowance for Change in Value of Investment Unrealized Increase/Decrease in Value of Available-for-Sale Securities5,000 Available-for-Sale Securities5,000 Allowance for Change in Value of Investment5,000 Allowance for Change in Value of Investment5,000 Unrealized Increase/Decrease in Value of Available-for-Sale Securities5,000 Available-for-Sale Securities5,000 Allowance for Change in Value of Investment5,000 Allowance for Change in Value of Investment5,000

22 Sale of Available-for-Sale Securities On March 1, 2011 the Kent Company sold the 100 shares of A Company stock for $6,000. The stock had a fair value on December 31, 2010 of $6,100. Cash6,000 Investment in Available-for-Sale Securities5,000 Gain on Sale of Available-for-Sale Securities1,000 Unrealized Increase/Decrease in Value of Available-for-Sale Securities1,100 Allowance for Change in Value of Investment1,100

23 Cumulative 12/31/11Change Fair in Fair Security Cost Value Value 300 shares of B Company common stock$24,000$23,500$(500) 200 shares of C Company preferred stock24,00024, $15,000 face value of D Company 10% bonds 15,000 14,700 (300) Totals$63,000$62,300$(700) Sale of Available-for-Sale Securities

/31/11 2,400 adjusting entry 2,000 12/31/10 1,100 3/1/11 Allowance for Change in Value of Investment Allowance for Change in Value of Investment2,400 Unrealized Increase/Decrease in Value of Available-for-Sale Securities2,400 Available-for-Sale Securities2,400 Allowance for Change in Value of Investment2,400 Unrealized Increase/Decrease in Value of Available-for-Sale Securities2,400 Available-for-Sale Securities2,400

25 Investments in Held-to-Maturity Debt Securities 1.The investment is initially recorded at cost. 2.It is subsequently reported at amortized cost on the ending balance sheet(s). 3.Unrealized holding gains and losses are not recorded. 4.Interest revenue and realized gains and losses on sales (if any) are all included in net income.

26 A company purchases 9% bonds with a face value of $100,000 on August 1, 2009, at 99 plus accrued interest, which is payable semiannually. Investment in Held-to-Maturity Debt Securities99,000 Interest Revenue1,500 Cash100,500 Investments in Held-to-Maturity Debt Securities $100,000 × 0.09 × 2/12 $100,000 × 0.99

27 Accounting for Bond Premiums On January 1, 2009, the Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000 and paying $102, The stated interest rate is 13% and the effective interest rate is 12%. Investment in Held-to-Maturity Debt Securities102, Cash102,458.71

28 Accounting for Bond Premiums

29 The Colburn Company records the first interest receipt on June 30, 2009, using the effective interest method. Cash6, Investment in Held-to-Maturity Debt Securities Interest Revenue6, Accounting for Bond Premiums $102, × 0.12 × 1/2 $100,000 × 0.13 × 1/2

30 Accounting for Bond Discounts On January 1, 2009, the Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000 and paying $97, The stated interest rate is 13% and the effective interest rate is 14%. Investment in Held-to-Maturity Debt Securities97, Cash97,616.71

31 Accounting for Bond Discounts

32 The Colburn Company records the first interest receipt on June 30, 2009, using the effective interest method. Cash6, Investment in Held-to-Maturity Debt Securities Interest Revenue6, Accounting for Bond Discounts $97, × 0.14 × 1/2

The Tallen Company purchased 13% bonds with a face value of $200,000 for $204, on April 3, Interest on these bonds is payable June 30 and December 31, and the bonds mature on December 31, Investment in Held-to-Maturity Debt Securities204, Interest Revenue6, Cash211, Amortization of Bonds Acquired Between Interest Dates $200,000 × 0.13 × 3/12

34 1.A transfer from the trading category 2.A transfer into the trading category 3.A transfer into the available-for-sale category 4.A transfer of a debt security into the held-to- maturity category from the available-for-sale category Transfers of Investments Between Categories

35 In 2010, the Kent Company transfers the Company A securities into the trading category when their fair value is $6,300. Investment in Trading Securities6,300 Investment in Available-for-Sale Securities5,000 Gain on Transfer of Securities1,300 Unrealized Increase/Decrease in Value of Available-for-Sale Securities1,100 Allowance for Change in Value of Investment1,100 Transfer into Trading Category from Available-for-Sale Category

36 The Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500, Devon transfers them into the available- for-sale category. Investment in Available-for-Sale Securities10,000 Investment in Held-to-Maturity Debt Securities10,000 Unrealized Increase/Decrease in Value of Available-for-Sale Securities500 Allowance for Change in Value of Investment500 Transfer into Available-for-Sale Category from Held-to-Maturity Category

37 The Devon Company classifies its bond investment as available for sale with a previous fair value of $9,700, and transfers them into the held-to- maturity category when the current market value of the debt securities is $9,500. Investment in Held-to-Maturity Debt Securities9,500 Unrealized Increase/Decrease from Transfer of Securities500 Investment in Available-for-Sale Securities10,000 Transfer into Held-to-Maturity Category from Available-for-Sale Category ContinuedContinued

38 An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amounts in the Allowance and Unrealized Increase/Decrease accounts. Allowance for Change in Value of Investment 300 Unrealized Increase/Decrease in Value of Available-for-Sale Securities300 Transfer into Held-to-Maturity Category from Available-for-Sale Category

39 Disclosures 1.Trading Securities. A company must disclose the change in the net unrealized holding gain or loss that is included in each income statement. 2.Available-for-Sale Securities. For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and (amortized) cost by major security types. 3.Held-to-Maturity Debt Securities. For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains, gross unrealized holding losses, and amortized cost by major security types.

40 IFRS vs. U.S. GAAP  IFRS also use the trading, available-for-sale, and held-to-maturity categories.  The valuation methods are the same for each category as under U.S. GAAP.  IFRS also apply these categories to all financial instruments, such as loans and receivables.  IFRS allow for the reversal of impairment losses related to held-to-maturity securities and available-for-sale securities.

41 Equity Method When an investor corporation owns a significantly large percentage of common stock, it is able to exert significant influence over the operating and financial policies of the investee corporation. The equity method is used to account for this investment.

42  Acknowledges the existence of a material economic relationship between the investor and the investee  Is based upon the requirements of accrual accounting  Supplies more relevant information for decision makers who rely on financial statements Equity Method

In the absence of evidence to the contrary, an investment of 20% or more in the outstanding common stock of the investee leads to the presumption of significant influence. 43 Equity Method

44 Equity Method Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1, 2010 for $125,000 ( significant influence ). Investment in Stock: S Company125,000 Cash125,000 S Company pays a $20,000 dividend on August 27, Cash5,000 Investment in Stock: S Company5,000

45 S Company reported net income for 2010 of $81,000. Investment in Stock: S Company20,250 Investment Income: Ordinary20,250 Equity Method 25% of $84,000

46 Financial Statement Disclosures—Carrying Value Acquisition price January 1, 2010$125,000 Add: Share of 2010 reported ordinary income20,250 $145,250 Less:Dividends received August 27, 2010(5,000) Carrying value$140,250

47  When an investor currently using the fair value method acquires enough additional common shares during a year to exercise significant influence over the investee, the investor is required to adopt the equity method of accounting.  When the equity method is adopted, the investor restates its investment in the investee by debiting the Investment account and crediting Retained Earnings for its previous percentage of investee income (less dividends) for the period from the original date of acquisition to the date that significant influence was obtained.  This is a retrospective restatement (adjustment). Change to Equity Method

48  The company also eliminates any amounts included in the allowance and unrealized increase/decrease amounts that it used to record these shares at fair value.  Thereafter, the equity method is applied in the usual manner based on the current percentage of ownership. Change to Equity Method

49 Assume that on January 2, 2009, Short Company purchased as its only investment 15% of the outstanding common stock of J Corporation for $150,000 (when the book value of net assets was $1,000,000). At the end of 2009, the J Corporation reported net income of $300,000 and paid dividends of $60,000; at this time, the market value of the shares was $186,000 so the company wrote up the carrying value of the investment (using an allowance account) to fair value. On January 2, 2020, to exert significant influence on J Corporation, Short purchased an additional 25% of the outstanding common stock of the J Corporation for $310,000. Change to Equity Method Example

50 Change to Equity Method x 15% =

51 IFRS vs. U.S. GAAP The application of the equity method is generally the same under IFRS and U. S. GAAP. One major terminology difference is that IFRS use the term “associate” to refer to what would be called an “equity method investee” under U.S. GAAP. In addition, IFRS do not address whether an investor’s interest which is represented by something other than an equity instrument but that is similar in substance to equity instruments (e.g., in-substance common stock) gives rise to significant influence over the investee. U.S. GAAP contains more detailed guidance on such nonequity interests. U.S. GAAP also requires more detailed disclosures than required under IFRS.

52 C hapter 15 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.