1. Investments and Fair Value Accounting
Chapter 13
Student Version
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2. Describe why companies invest in debt and equity securities.
Learning Objective 1
Describe why companies invest in debt and equity securities.

3. 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.

4. 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

5. 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

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

7. 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)

8. 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)]

9. 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

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

11. 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)

12. 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

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

14. 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.

15. 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

16. 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.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

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

24. 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:

25. 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.

26. 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.

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

28. 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.

29. 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.

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

31. 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.

32. 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.

33. 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:

34. 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

35. 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.

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

37. 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.

38. 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.

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

40. 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%

41. Investments and Fair Value Accounting
The End