2. Chapter 16-1 CHAPTER 16 INVESTMENTS Accounting Principles, Eighth Edition

3. Chapter 16-2 Why Corporations Invest Cash management Investment income Strategic reasons Accounting for Debt Investments Accounting for Stock Investments Valuing and Reporting Investments Categories of securities Balance sheet presentation Realized and unrealized gain or loss Classified balance sheet Holdings of less than 20% Holdings between 20% and 50% Holdings of more than 50% Recording acquisition of bonds Recording bond interest Recording sale of bonds Long-Term Liabilities

4. Chapter 16-3 Why Corporations Invest LO 1 Discuss why corporations invest in debt and stock securities. WE are investing!!! We are not borrowing funds or issuing bonds!!!

5. Chapter 16-4 Corporations generally invest in debt or stock securities for one of three reasons. Why Corporations Invest LO 1 Discuss why corporations invest in debt and stock securities. 1. Corporation may have excess cash. 2. To generate earnings from investment income. 3. For strategic reasons.

6. Chapter 16-5 LO 1 Discuss why corporations invest in debt and stock securities.

7. Chapter 16-6 Accounting for Debt Instruments LO 2 Explain the accounting for debt investments. Three entries required: 1)acquisition- the cost principle applies 2) interest revenue earned 3) Sale of the debt instrument

8. Chapter 16-7 Accounting for Debt Instruments LO 2 Explain the accounting for debt investments. Recording Acquisition of Bonds Cost includes price paid plus brokerage fees (commissions), if any. Recording Bond Interest Calculate and record interest revenue based upon the carrying value of the bond times the interest rate times the portion of the year the bond is outstanding.

9. Chapter 16-8 Accounting for Debt Instruments LO 2 Explain the accounting for debt investments. Sale of Bonds Credit the investment account for the cost of the bonds and… record as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds.

10. Chapter 16-9 Exercise: Issel Corporation had the following transactions pertaining to debt investments. Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1. July 1 Received semiannual interest on Hollis Co. bonds. July 1 Sold 30 Hollis Co. bonds for $34,000 less $500 brokerage fees. Instructions (a) Journalize the transactions. (b) Prepare the adjusting entry for the accrual of interest at December 31. Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

11. Chapter 16-10 Exercise: Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for $60,000 cash plus brokerage fees of $900. Interest is payable semiannually on July 1 and January 1. Debt investment 60,900 Jan 1 Cash 60,900 * ($60,000 + $900 = $60,900) * Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

12. Chapter 16-11 Exercise: July 1 Received semiannual interest on Hollis Co. bonds. July 1 Sold 30 Hollis Co. bonds for $34,000 less $500 brokerage fees. Cash 2,400 July 1 Interest revenue2,400 * ($60,000 x 8% x ½ = $2,400) Cash 33,500 Debt investments30,450 Gain on sale3,050 *** ($60,900 x ½ = $30,450) * *** ** ($34,000 - $500 = $33,500) ** Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

13. Chapter 16-12 Exercise: (b) Prepare the adjusting entry for the accrual of interest at December 31. Interest receivable 1,200 Dec 31 Interest revenue1,200 * ($30,000 x 8% x ½ = $1,200) * Accounting for Debt Instruments LO 2 Explain the accounting for debt investments.

14. Chapter 16-13

15. Chapter 16-14 Companies use the cost method. Under the cost method, companies record the stock investment at cost, and recognize revenue only when cash dividends are received. Remember!: Cost includes price paid plus any brokerage fees (commissions). Holdings of Less than 20% LO 3 Explain the accounting for stock investments.

16. Chapter 16-15 Exercise: Dossett Company had the following transactions pertaining to stock investments. Feb. 1 Purchased 800 shares of Hippo common stock (2%) for $8,000 cash, plus brokerage fees of $200. July 1 Received cash dividends of $1 per share on Hippo common stock. Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100. Instructions Journalize the transactions. LO 3 Explain the accounting for stock investments. Holdings of Less than 20%

17. Chapter 16-16 Exercise: Feb. 1 Purchased 800 shares of Hippo common stock (2% of the company) for $8,000 cash, plus brokerage fees of $200. July 1 Received cash dividends of $1 per share on Hippo common stock. LO 3 Explain the accounting for stock investments. Stock investments 8,200 Feb. 1 Cash8,200 * ($8,000 + $200 = $8,200) Cash 800 Dividend revenue800 ** (800 x $1 = $800) * ** July 1 Holdings of Less than 20%

18. Chapter 16-17 Exercise: Sept. 1 Sold 300 shares of Hippo common stock for $4,400, less brokerage fees of $100. LO 3 Explain the accounting for stock investments. Cash 4,300 Sept. 1 Stock investments3,075 * ($4,400 - $100 = $4,300) ** ($8,200 x 3/8 = $3,075) * Gain on sale1,225 ** Holdings of Less than 20%

19. Chapter 16-18 Holdings Between 20% and 50% Equity Method Record the investment at cost and subsequently adjust the amount each period for  the investor’s proportionate share of the earnings (losses) and  dividends received by the investor. If investor’s share of investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method. LO 3 Explain the accounting for stock investments.

20. Chapter 16-19 Exercise: Exercise: (Equity Method) On January 1, 2011, Pennington Corporation purchased 30% of the common shares of Edwards Company for $180,000. During the year, Edwards earned net income of $80,000 and paid dividends of $20,000. Instructions Prepare the entries for Pennington to record the purchase and any additional entries related to this investment in Edwards Company in 2011. Holdings Between 20% and 50% LO 3 Explain the accounting for stock investments.

21. Chapter 16-20 Exercise: Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20,000. Stock investments 180,000 Cash 180,000 Cash6,000 Stock investments6,000 Stock investments 24,000 Investment revenue24,000 Holdings Between 20% and 50% ($20,000 x 30%) ($80,000 x 30%) LO 3 Explain the accounting for stock investments. Purchase Income Dividends

22. Chapter 16-21 After Pennington posts the transactions for the year, its investment and revenue accounts will show the following. DebitCredit Stock Investments 180,000 24,000 DebitCredit Investment Revenue Holdings Between 20% and 50% LO 3 Explain the accounting for stock investments. Exercise: Exercise: Pennington purchased 30% of the common shares of Edwards for $180,000. Edwards earned net income of $80,000 and paid dividends of $20,000. 24,000 6,000 198,000

23. Chapter 16-22 Holdings of More Than 50% Controlling Interest - When one corporation acquires 50%+ in another corporation  Investor is referred to as the parent.  Investee is referred to as the subsidiary.  Investment in the subsidiary is reported on the parent’s books as a long-term investment.  Parent generally prepares consolidated financial statements. LO 4 Describe the use of consolidated financial statements.