1. BUS 120: Financial Accounting Chapter 13: Investments
Dr. Al Taccone

2. Chapter 13: What you should learn
Why corporations invest in debt and stock securities
Accounting for debt investments
* Recording acquisitions of bonds
* Recording bond interest
* Recording sale of bonds
Accounting for stock investments
* Holdings of less than 20%
* Holdings of between 20% and 50%
* Holdings of greater than 50%
Balance sheet presentation of investments

3. Temporary Investments and the Operating Cycle
Many companies may have temporarily idle cash on hand pending the start of the next operating cycle.
Until the cash is needed in operations, these excess funds may be invested to earn interest and dividends.

4. WHY CORPORATIONS INVEST

5. Temporary vs. Long-term Investments
Temporary investments:
Securities held by a company that are:
1. Readily marketable
2. Intended to be converted into cash within the next year or operating cycle, whichever is longer.
Long-term investments:
Investments that do not meet both criteria for temporary investments.

6. Debt Investments Investments in government and corporation bonds.
Entries are required to record:
1. Acquisition of the bonds
2. Interest revenue earned on the bonds
3. Sale of the bonds
The cost principle applies—cost includes all expenditures necessary to acquire these investments.

7. ACCOUNTING FOR DEBT INVESTMENTS ENTRIES AT ACQUISITION
Kuhl Corporation acquires 50 Doan Inc. 12%, 10-year, $1,000 bonds on January 1, 2002, for $54,000, including brokerage fees of $1,000. The entry to record the investment is:
54, ,000 4

8. ACCOUNTING FOR DEBT INVESTMENTS ENTRIES FOR BOND INTEREST
The bonds pay $3,000 interest on July 1 and January 1 ($50,000 X 12% X ½). The July 1 entry is:
It is necessary to accrue $3,000 interest earned since July 1 at year-end. The December 31 entry is:
When the interest is received on January 1, the entry is:
3, ,000 5

9. ACCOUNTING FOR DEBT INVESTMENTS ENTRIES FOR SALE OF BONDS
Any difference between the net proceeds (sales price less brokerage fees) from the sale of bonds and the cost of the bonds is recorded as a gain or loss. Kuhl Corporation receives net proceeds of $58,000 on the sale of the Doan Inc. bonds on January 1, 2003, after receiving the interest due. Since the securities cost $54,000, a gain of $4,000 has been realized. The entry to record the sale is:
58, , ,000 6

10. STOCK INVESTMENTS
Stock investments are investments in the capital stock of corporations. When a company holds stock or debt of various corporations, the group of securities is identified as an investment portfolio. 7

11. ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS LESS THAN 20%
PURCHASE OF STOCK INVESTMENT
In accounting for stock investments of less than 20%, the cost method is used. The investment is recorded at cost and revenue is recognized only when cash dividends are received. On July 1, 2002, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock at $40 per share plus brokerage fees of $500. The entry for the purchase is:
40, ,500

12. ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS LESS THAN 20%
DIVIDEND REVENUE
Entries are required for any cash dividends received during the time the stock is held. If a $2 per share dividend is received by Sanchez Corporation on December 31 the entry is:
2, ,000
Dividend Revenue is reported under Other Revenue and Gains in the income statement. Since dividends do not accrue, adjusting entries are not made to accrue dividends. 9

13. ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS LESS THAN 20%
SALE OF STOCK INVESTMENT (GAINS or LOSSES)
When stock is sold, the difference between the net proceeds from the sale and the cost of the stock is recognized as a gain or loss. Sanchez Corporation receives net proceeds of $39,500 on the sale of its Beal Corporation common stock on February 10, Because the stock cost $40,500, a loss of $1,000 has been incurred. The entry to record the sale is:
39, , ,500 17

14. Accounting for Stock Investments Holdings Between 20% and 50%
Usually presumed that the investor has significant influence over the financial and operating activities of the investee.
The investor should record its share of net income of the investee in the year when it is earned.
Equity Method:
investment in common stock is initially recorded at cost, and the investment account is adjusted annually to show the investor’s equity in the investee.
Each year the following transactions are required:
1. Debit the investment account and credit revenue for its share of the investee’s net income.
2. Credit dividends received to the investment account.

15. ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS BETWEEN 20% AND 50%
RECORD THE STOCK INVESTMENT
Milar Corporation acquires 30% of the common stock of Beck Company for $120,000 on January 1, The entry to record this transaction is:
120, ,000

16. ACCOUNTING FOR STOCK INVESTMENTS HOLDINGS BETWEEN 20% AND 50%
DIVIDEND REVENUE
Beck reports 2002 net income of $100,000 and declares and pays a $40,000 cash dividend. Milar is required to record 1 its share of Beck’s net income, $30,000 (30% X $100,000) and 2 the reduction in the investment account for the dividends received, $12,000 ($40,000 X 30%). The entries are:
Date
Account Titles and Explanation
Debit
Credit
(1)
Dec. 31
Stock Investments
30, ,000
12, ,000
Revenue from Investment in Beck Company
(To record 30% equity in Beck’s net
Income) 27

17. INVESTMENT AND REVENUE ACCOUNTS AFTER POSTING
After posting the transactions for the year, the investment and revenue accounts will show the above results. During the year, the investment account has increased by $18,000 – which represents Milar’s 30% equity in the $60,000 increase in Beck’s retained earnings ($100,000 - $40,000). Milar will also report $30,000 of revenue from its investment, which is 30% of Beck’s net income of $100,000. Milar would report only $12,000 (30% X $40,000) of dividend revenue if the cost method were used.

18. Accounting for Stock Investments Holdings of More than 50%
A company that owns more than 50% of the common stock of another company is known as the parent company.
The company whose stock is owned by the parent company is called the subsidiary (affiliated) company.
The parent company is perceived to have a controlling interest in the subsidiary company due to the stock ownership.
When one company owns more than 50% of the common stock of another company, consolidated financial statements are usually prepared.

19. Valuation and Reporting of Investments
Debt and stock investments are classified into 3 categories of securities:
1. Trading securities—held with the
intention of selling them in a short
period of time (usually less than a one
month).
2. Available-for-sale securities—may be sold in
the future (usually held beyond one month).
3. Held-to-maturity securities—debt securities that the investor has the intent and ability to hold to maturity.

20. ILLUSTRATION: COMPREHENSIVE BALANCE SHEET
PACE CORPORATION
Balance Sheet
December 31, 2002
The comprehensive balance sheet for Pace Corporation includes the following assets:
1 Temporary Investments,
2 Investments of less than 20%, and
3 Investments of % - 50%.
Assets
Current assets
Cash
$ ,000
Temporary investments, at fair value
60,000
Accounts receivable
$ 84,000
Less: Allowance for doubtful accounts
4,000
80,000
Merchandise inventory, at FIFO cost
130,000
Prepaid insurance
23,000
Total current assets
314,000
Investments
Investment in bonds
100,000
Investments in stock of less than 20% owned companies,
at fair value
50,000
Investment in stock of 20% – 50% owned company, at
equity
150,000
Total investments
300,000
Property, plant, and equipment
Land
200,000
Buildings
$ 800,000
Less: Accumulated depreciation
200,000
600,000
Equipment
180,000
Less: Accumulated depreciation
54,000
126,000
Total property, plant, and equipment
926,000
Intangible assets
Goodwill (Note 1)
100,000
Patents
70,000
Total intangible assets
170,000
Total assets
$ 1,710,000

21. ILLUSTRATION: COMPREHENSIVE BALANCE SHEET
The comprehensive balance sheet for Pace Corporation includes the following element of stockholders’ equity: Unrealized Gain on Available-for-Sale Securities. Reporting the unrealized gain or loss in the stockholders’ equity section: 1 reduces the volatility of net income due to fluctuations in fair value and 2 still informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value. 15