1. An electronic presentation Pepperdine University14
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Investments
An electronic presentation
by Douglas Cloud
Pepperdine University 1 1 1 1

2. Objectives
1. Explain the classification and valuation of investments.
2. Account for investments in debt and equity trading securities.
3. Account for investments in available-for-sale debt and equity securities.
4. Account for investments in held-to-maturity debt securities, including amortization of bond premiums and discounts.
Continued 2 2 2 4

3. Objectives 5. Understand transfers and impairments.
6. Understand disclosures of investments.
7. Explain the conceptual issues regarding investments in marketable securities.
8. Account for investments using the equity method.
9. Describe additional issues for investments.
10. Account for derivatives of financial instruments. (Appendix)

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

5. Classification of Investments
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.

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

7. Classification of Investments
Investments in available-for-sale securities are (a) debt securities that are not classified as being held to maturity, and...
…(b) debt and equity securities that are not classified as trading securities.

8. Classification of Investments
Investments in available-for-sale securities are reported at their fair value on the balance sheet date. The unrealized holding gains or losses are included in other comprehensive income.

9. Classification of Investments
Therefore, the unrealized holding gains and losses are not included in net income for the available-for-sale securities.

10. Classification of Investments
Investments in held-to-maturity debt securities are debt securities for which the company has the positive intent and ability to hold until they mature.

11. Classification of Investments
Investments in held-to-maturity debt securities are reported at their amortized cost on the balance sheet…not their fair value.

12. Accounting for Investments
Reporting of
Unrealized Holding
Method Gains and Losses
Investment in Equity Securities
1. No significant influence
a. Trading Fair value Net Income
b. Available for sale Fair value Other comprehen-
sive income
2. Significant influence Equity method Not recognized
3. Control Consolidation Not recognized

13. Accounting for Investments
Reporting of
Unrealized Holding
Method Gains and Losses
Investment in Debt Securities
1. Trading Fair value Net Income
2. Available for sale Fair value Other comprehen-
sive income
3. Held to maturity Amortized cost Not recognized

14. Investments in Available-for-Sale Debt and Equity Securities
The investment is initially recorded at cost.
It is subsequently reported at fair value.
Unrealized holding gains and losses are reported as a component of other comprehensive income.
Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.

15. Investments in Available-for-Sale Debt and Equity Securities
Kent Company purchases the following securities on May 1, 2003 as an investment in available-for-sale securities:
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 Company C preferred stock at $120 per share.
$15,000 Company D 10% bonds
$ 5,000
24,000
15,000
Total $68,000

16. Investments in Available-for-Sale Debt and Equity Securities
Investment in Available-for-Sale
Securities 68,000
Interest Revenue 625
Cash 68,625
Continued

17. Investments in Available-for-Sale Debt and Equity Securities
Accrued interest on the D Company bond from November 30, 2002 to May 31, 2003
May 31, 2003
Cash 750
Interest Revenue 750
$15,000 x 0.10 x 6/12
Continued

18. Investments in Available-for-Sale Debt and Equity Securities
December 31, 2003
Interest Receivable 125
Interest Revenue 125
$15,000 x 0.10 x 1/12
During 2003 Kent Company receives dividends of $3,000 from its investment in the stocks of A, B, and C Companies.
Cash 3,000
Dividend Revenue 3,000

19. Investments in Available-for-Sale Debt and Equity Securities
The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:
Cumulative
12/31/ Change
Fair in Fair
Security Cost Value Value
Allowance for Change in Value
of Investment 3,000
Unrealized Increase/Decrease
in Value of Available-for-
Sale Securities 3,000
100 shares of A Co. common stock $ 5,000 $ 6,000 $1,000
300 shares of B Co. common stock 24,000 23,500 (500 )
200 shares of C Co. preferred stock 24,000 26,000 2,000
D Company 10% bonds 15, ,
Totals $68,000 $71,000 $3,000

20. Investments in Available-for-Sale Debt and Equity Securities
The same securities are held on December 31, 2004.
Cumulative
12/31/ Change
Fair in Fair
Security Cost Value Value
Unrealized Increase/Decrease in
Value of Available-for-Sale Securities 5,000
Allowance for Change in Value of
Investment 5,000
100 shares of A Co. common stock $ 5,000 $ 6,100 $1,100
300 shares of B Co. common stock 24,000 22,700 (1,300 )
200 shares of C Co. preferred stock 24,000 23,200 (800 )
D Company 10% bonds , ,000 (1,000 )
Totals $68,000 $66,000 $(2,000 )

21. Sale of Available-for-Sale Securities
On March 1, 2005 the Kent Company sold 100 shares of A Company stock for $6, The fair value on December 31, 2004 was $6,100.
Cash 6,000
Investment in Available-for-
Sale Securities 5,000
Gain on Sale of Available-for-
Sale Securities 1,000
The Unrealized Increase/Decrease in Value and the allowance account are reduced by $1,100.

22. Sale of Available-for-Sale Securities
Cumulative
12/31/ Change
Fair in Fair
Security Cost Value Value
Allowance for Change in Value
of Investment 2,400
Unrealized Increase/Decrease
in Value of Available-for-
Sale Securities 2,400
300 shares of B Co. common stock $24,000 $23,500 $(500 )
200 shares of C Co. preferred stock 24,000 24,
D Company 10 bonds 15, ,700 (300 )
Totals $63,000 $62,300 $(700 )

23. Investments in Held-to- Maturity Debt Securities
1) The investment is initially recorded at cost.
2) It is subsequently reported at amortized cost.
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.

24. Investments in Held-to- Maturity Debt Securities
A company purchases 9% bonds with a face value of $100,000 on August 1, 2003 at 99 plus accrued interest, which is payable semiannually.
Investment in Held-to-Maturity
Debt Securities 99,000
Interest Revenue 1,500
Cash 100,500
$100,000 x 0.99
$100,000 x 0.09 x 2/12

25. Accounting for Bond Premiums
On January 1, 2003 Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000, paying $102, The stated rate is 13% and the effective interest rate is 12%.
Investment in Held-to-
Maturity Debt Securities 102,458.71
Cash 102,458.71

26. Accounting for Bond Premiums
Colburn Company records the first interest receipt on June 30, 2003 using the effective interest method.
Cash 6,500.00
Investment in Held-to-
Maturity Debt Securities
Interest Revenue 6,147.52
$100,000 x 0.13 x 1/2
$102, x .12 x 1/2

27. Accounting for Bond Discounts
On January 1, 2003 Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000, paying $97, The stated rate is 13% and the effective interest rate is 14%.
Investment in Held-to-
Maturity Debt Securities 97,616.71
Cash 97,616.71

28. Accounting for Bond Discounts
Colburn Company records the first interest receipt on June 30, 2003 using the effective interest method.
Cash 6,500.00
Investment in Held-to-
Maturity Debt Securities
Interest Revenue 6,833.17
$97, x .14 x 1/2

29. Amortization of Bonds Acquired Between Interest Dates
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, 2005.
$200,000 x 0.13 x 3/12
Investment in Held-to-Maturity Debt Securities 204,575.07
Interest Revenue 6,500.00
Cash 211,075.07
Continued

30. Amortization of Bonds Acquired Between Interest Dates
June 30, 2003
Cash 13,000.00
Interest Revenue 12,637.25
Investment in Held-to-Maturity Debt Securities
($204, x 0.12 x ¼) + $6,500
$13,000 – $12,637.25
Continued

31. Amortization of Bonds Acquired Between Interest Dates
December 31, 2003
Cash 13,000.00
Interest Revenue 12,252.74
Investment in Held-to-Maturity Debt Securities
($204, x 0.12 x ¼) + $6,500
$13,000 – $12,252.74

32. Sale of Investment in Bonds Before Maturity
The $100,000 of 13% bonds purchased by the Colburn Company for $97, were sold on March 31, 2004 for $102,000 plus accrued interest.
($2, ÷ 6) x ½
Investment in Held-to-Maturity Debt Securities
Interest Revenue
Continued

33. Sale of Investment in Bonds Before Maturity
Cash 105,250.00
Interest Revenue 3,250.00
Investment in Held-to-Maturity Debt Securities 98,609.76
Gain on Sale of Debt Securities 3,390.24
$102,000 + $3,250
$100,000 x 0.13 x ¼
$98, $198.61

34. Transfers of Investments Between Categories
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.

35. Transfers of Investments Between Categories
In 2005 Kent transfers the Company A securities into the trading category when the fair value is $6,300.
Investment in Trading Securities 6,300
Investment in Available-for-
Sale Securities 5,000
Gain on Transfer of Securities 1,300
Unrealized Increase/Decrease in
Value of Available-for-Sale Securities 1,100
Allowance for Change in Value of
Investment 1,100

36. Transfers of Investments Between Categories
Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500, Devon transfers them to the available-for-sale category.
Investment in Available-for-Sale
Securities 10,000
Investment in Held-to-
Maturity Debt Securities 10,000
Unrealized Increase/Decrease in
Value of Available-for-Sale Securities 500
Allowance for Change in Value of
Investment 500

37. Transfers of Investments Between Categories
Devon Company classifies its bond investment as available for sale and transfers them into the held-to-maturity category. The current market value of the debt securities is $9,500.
Investment in Held-to-Maturity Debt
Securities 9,500
Unrealized Increase/Decrease from
Transfer of Securities 500
Investment in Available-for-
Sale Securities 10,000
Continued

38. Transfers of Investments Between Categories
An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amount 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
Securities 300

39. Impairments
Impairments may be an “other than temporary” decline below the amortized cost of an investment in a debt security classified as available for sale or held to maturity.

40. Impairments
Tracy Company has a bond investment categorized as held to maturity, which has an unamortized carrying amount of $21,500 and a fair value of $6,500. The investment is considered to be “impaired.”
Realized Loss on Decline in Value 15,000
Investment in Held-to-Maturity
Debt Securities 15,000

41. 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 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.

42. Financial Statement Classification
Current Assets
Temporary investment in available-for-sale
securities (at cost) $29,000
Plus: Allowance for change in value of
investment
securities (at fair value) $29,500
Noncurrent Assets
Investment in available-for-sale securities (at cost) $39,000
Plus: Allowance for change in value of investment 2,500
Investment in available-for-sale securities
(at fair value) $41,500

43. FASB 115: A Conceptual Evaluation
1. Fair value is required in the balance sheet for trading securities and available-for-sale securities, whereas amortized cost is required for held-to-maturity securities.
2. Fair value is not required for certain liabilities.
3. Unrealized holding gains and losses are reported in net income for trading securities, but in other comprehensive income for available-for-sale securities.
4. The classification of securities is based on management intent.
Four Issues

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

45. Equity Method
The equity method--
Acknowledges the existence of a material economic relationship between the investor and the investee.
Is based upon the requirements of accrual accounting.
Reflects the change in stockholders’ equity of the investee company.

46. Equity Method
According to FASB Interpretation No. 35, what are the facts and circumstances that indicate that investors with 20% or more in the investee’s stock should not use the equity method?
Continued

47. Equity Method
Opposition by the investee which challenges the investor’s ability to exercise significant influence.
The investor and investee sign an agreement under which the investor surrenders significant stockholder’s rights.
Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to views of the investor.
Inability to gather information not available to other shareholders.
Failure to obtain representation on investee’s board of directors.

48. Equity Method Investment = Acquisition Cost +
Investor’s Share of Investee Income
Dividends Received- –
where
Investor’s Share of Investee Income
(Investee’s Net Income =
x Ownership %
Adjust-ments –
Continued

49. Total Dividends Paid by Investee
Equity Method
Total Dividends Paid by Investee
and –
– Ownership %
Dividends Received =

50. S Company paid a $20,000 dividend.
Equity Method
Cliborn Company purchases 4,200 shares of the S Company’s outstanding stock (25%) on January 1, 2004 for $125,000 (significant influence).
Investment in Stock: S Company 125,000
Cash 125,000
0.25 x $20,000
S Company paid a $20,000 dividend.
Cash 5,000
Investment in Stock: S Company 5,000
Continued

51. Equity Method
S Company reported net income for 2004 of $81,000, consisting of ordinary income of $73,000 and an extraordinary gain of $8,000.
Investment in Stock: S Company 20,250
Investment Income: Ordinary 18,250
Investment Income: Extraordinary 2,000
25% of $81,000
25% of $73,000
25% of 8,000
Continued

52. Note that this entry results in a deduction from ordinary income.
Equity Method
When acquired by S Company, the investee’s depreciable assets had a fair market value that exceeded book value by $50,000 (10-year life). Cliborn’s share of the depreciable asset value is $12,500 (25%).
Investment Income: Ordinary 1,250
Investment in Stock: S Company 1,250
Note that this entry results in a deduction from ordinary income.
Continued

53. Cliborn calculates its purchased goodwill as follows:
Equity Method
Cliborn calculates its purchased goodwill as follows:
Purchase price $125,000
Book value of net asset acquired $97,500
Adjustments: Increase in depreciable
assets acquired 12,500
Increase in other non-
depreciable assets
acquired 14,000
Increase in liabilities (5,000 )
Fair value of identifiable net assets acquired (119,000 )
Purchased goodwill $ 6,000

54. Equity Method
Cliborn calculates its investment carrying value as follows:
Investment in S Company
Acquisition price January 1, $125,000
Add: Share of 2004 reported ordinary
income $18,250
Share of 2004 reported extraordinary
income 2, ,250
$145,250
Less: Dividends received August 28, 2004 $ 5,000
Depreciation on excess fair market
value of acquired assets 1, (6,250 )
Carrying value $139,000

55. Stock Dividends
Smith Corporation purchased 2,000 shares of Kell Company common stock for $30 per share. Two months later Kell issued a 50% stock dividend.
Memo: Received 1,000 shares of Kell Company common stock as a stock dividend. The cost of the shares is now $20 per share, computed as follows: $60,000 ÷ 3,000 (2, ,000) shares.
Continued

56. Stock Dividends
Subsequently, Smith Corporation sold 500 of the shares for $25 per share, and the fair value at the most recent balance sheet date was $23 per share.
Cash 12,500
Investment in Available-for-Sale
Securities 10,000
Gain on Sale of Investment 2,500
Unrealized Increase/Decrease in Value
of Available-for Sale Securities 1,500
Allowance for Change in Value of
Investment 1,500

57. Cash Surrender Value of Life Insurance
Merle Corporation paid for an annual insurance premium of $5,500 at the beginning of the year to cover the lives of its officers.
Prepaid Insurance 5,500
Cash 5,500
Continued

58. Cash Surrender Value of Life Insurance
According to the terms of the insurance contract, the cash surrender value increases from $7,200 to $8,300 during the year.
Insurance Expense 4,400
Cash Surrender Value of Life
Insurance 1,100
Prepaid Insurance 5,500
$8,300 – $7,200

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