1 chapter 14 Investment inDebt and Equity Securities
2 Learning Objectives1. Determine why companies invest in other companies.2. Understand the varying classifications associated with securities.3. Account for the purchase of debt and equity securities.4. Account for the recognition of revenue from investments. Continued
3 Learning Objectives5. Account for the change in value of securities.6. Account for the sale of investment securities. Record the transfer of securities between categories. Explain the proper classification and disclosure of investments in securities Continued
Time Line of Business Issues 4 Involved with Investment Securities1. DETERMINE purpose of investment2. CLASSIFY investments3. PURCHASE securities4. EARN AND RECOGNIZE a return5. MONITOR changes in value6. SELL securities7. TRANSFER securities between categories8. DISCLOSE status of portfolio at the end of the period
Why Companies Invest in 5 Other Companies •Safety Cushion •Cyclical Cash Needs •Investment for a Return •Investment for Influence •Purchase for Control
Investment in Debt and Equity 6 Securities—2001 Total Investment Percentage of Company (in billions) Total AssetsBerkshire Hathaway $69.0 42.4%Microsoft 17.7 34.7Coca-Cola 5.4 24.2Citigroup 160.8 15.3AT&T 24.5 14.8Verizon 10.2 6.0
Classification of Investment 7 in SecuritiesDebt securities typically have the followingcharacteristics:1. A maturity value, representing the amount to be repaid to the debt holder at maturity.2. An interest rate that specifies the periodic interest payments.3. A maturity date, indicating when the debt obligation will be redeemed.
Classification of Investment 8 in SecuritiesEquity securities represent ownership in acompany. These shares of stock typically carry with them the right to collect dividends and vote on corporate matters. Equity securities have the potential for significant increases in price.
Classification of Investment 9 in SecuritiesDebt/Equity Securities Held-to- Securities purchased with the Maturity intent to hold until maturity. Securities purchased for sale Trading in the near future. Available- Securities not classified as for-sale trading or held-to-maturity.
Classification of Investment 10 in Securities Debt EquityHeld-to- Available Equity Tradingmaturity -for-sale Method Cost Method
11 Equity Method SecuritiesThese are securities purchased with the intent to control or At least 20 percent of the significantly influence the outstanding voting stock operations of the investee. must be owned to have this significant influence or control. Even then, there may be evidence to support the fact that even a 20 percent investment does not have significant influence.
Different Accounting 12 Treatments Disclosure Treatment of on the Temporary Classification Types of Balance Changes in of Securities Securities Sheet ValueHeld to maturity Debt Amortized cost Not recognizedAvailable for sale Debt/equity Fair market value Reported in stockholders’ equityTrading Debt/equity Fair market value Reported on the income statementEquity method Equity Historical cost Not recognized adjusted for changes in the assets of the investee
13 Purchases of Debt Securities On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9%payable semiannually on January 1 and July 1. The debt securities are classified by the purchaser as trading securities.Accrued interest on May 1 is $3,000, calculatedas follows: $100,000 x .09 x 4/12 = $3,000
14 Purchases of Debt Securities Asset Approach Always includesPurchase date: brokerageMay 1 Investment in fees Trading Securities 104,250 Interest Receivable 3,000 Cash 107,250 Continued
15 Purchases of Debt Securities Revenue ApproachPurchase date:May 1 Investment in Trading Securities 104,250 Interest Revenue 3,000 Cash 107,250 Continued
Purchase of Equity Securities - 17 Available for Sale (AFS)/Trading Purchased 1,000 shares of AB Company’s common shares at $2 per share.Investment in Available-for-Sale*/TradingSecurities - AB Company 2,000 Cash 2,000 * - would be so classified if management has no intention of holding them for a long period of time and will sell them as soon as it is economically advantageous
Purchase of Equity Securities 18 – Equity MethodCitty Co. purchased 100,000 shares of ABCompany common shares at $2 per share. Assume that the 100,000 shares purchased represents 20 % of the outstanding voting stock of AB Company. This investment gives the investor significant influence over AB Company.
Purchase of Equity Securities 19 - – Equity Method Purchased 100,000 shares of Dave’s Deli common shares at $2 per share. Equity Method SecuritiesInvestment in AB Company Stock 200,000 Cash 200,000
Recognizing Revenue from 20 Debt SecuritiesOn January 1, 2004, Silmaril Technologies purchased 5-year, 10% bonds with a face value of $100,000 and interest payablesemiannually on January 1 and July 1. Themarket rate on bonds of similar quality and maturity is 8%.
21 PV/Price of Debt SecuritiesPresent value of principal: FV = $100,000; N = 10; I = 4% $ 67,556Present value of interest payments: PMT = $5,000; N = 10; I = 4% 40,554Total present value of the bonds $108,110Investment in Trading Securities 108,100 Cash 108,100 ORInvestment in Held-to-Maturity Securities 108,100 Cash 108,100
Interest Revenue for Debt 22 Securities (Trading) When the first interest payment is received from Silmaril, the following entry would be made:July 1 Cash 5,000 Interest Revenue 5,000
Interest Revenue for Debt 23 Securities (Held-to-Maturity) When the first interest payment is received from Silmaril, the following entry would be made:July 1 Cash 5,000 Interest Revenue 4,324 Investment in Held-to- Maturity Securities 676 $10 8,11 0x .04
Recognizing Revenue for Equity 24 Securities depends on the Appropriate Accounting Method Account for as trading or Equity method andavailable-for-sale consolidation Equity procedures Ownership Percentage method No Significant significant Control influence influence 0% 20% 50% 100%
Determining the Appropriate 25 Accounting Method Control or Ownership Degree of Accounting Applicable Interest Influence Method StandardMore than 50% Control Equity method APB Opinion #18 and consolidation FASB Exposure procedures Draft20% to 50% Significant Equity method APB Opinion #18 influenceLess than 20% No Account for as FASB Statement significant trading or No. 115 influence available for sale
Revenue for Equity Securities 26 Classified as Trading and AFS AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 10,000 of AB’s 200,000 shares (which represents 5%)Cash 2,500 Dividend Revenue 2,500
Revenue for Equity Securities 27 Classified as Equity Method Securities AB Company announces dividends of $0.25 per share. Assume that Citty Co. owns 100,000 which represents 50 % of the outstanding voting stock.Cash 25,000 Investment in AB Company Stock 25,000
Revenue for Equity Securities 28 Classified as Equity Method Securities AB Company reports an income of $250,000 for the year. Again, assume that Citty Co. owns 50 % of the outstanding voting stock.Investment in AB Company Stock 125,000 Income from Investment in AB Company Stock 125,000
Accounting for Temporary 29 Changes in Value of Securities (an extract of slide 12)Classification Disclosed Report FMV of Security at Change On Fair market IncomeTrading value statementAvailable- Fair market Stockholder’sfor-sale value equityHeld-to- Amortized Notmaturity cost recognized
Accounting for Temporary 30 Changes in Value of SecuritiesEastwood Inc. bought the following securities on March 23, 2005.Security Classification Cost($) FMV 31/12/05($) 1 Trading 8,000 7,000 2 Trading 3,000 3,500 3 Available for Sale 5,000 6,100 4 Available for Sale 12,000 11,500 5 Held to Maturity 20,000 19,000
Accounting for Temporary 31 Changes in Value of Securities Initial Purchase EntryInvestment in Trading Securities 11,000Investment in Available-for-Sale Securities 17,000Investment in Held-to-Maturity Securities 20,000 Cash 48,000 Continued
Accounting for Temporary 32 Changes in Value of Securities By the end of the year, the value of the trading securities decreased from $11,000 to $10,500. A contra account to the “investment account”December 31, 2005:Unrealized Loss on Trading Securities 500 Market Adjustment—Trading Securities 500 Included in net income
Accounting for Temporary 33 Changes in Value of Securities By the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600. Included in stock holder’s equity =>December 31, 2005: Comprehensive incomeMarket Adjustment—Available-for-SaleSecurities 600 Unrealized Increase/Decrease in Value of Available-for-Sale Securities 600
Accounting for Temporary 34 Changes in Value of Securities Partial Balance Sheet for Eastwood Inc.Assets Invest. in trading securities $11,000 Market adjustment—trading sec. (500) $10,500 Invest. in available-for-sale sec. $17,000 Market adjustment 600 17,600 Invest. in held-to-maturity sec. 20,000 $48,100Stockholders’ Equity Add unrealized increase in available-for-sale securities $ 600
Accounting for Temporary 35 Changes in Value of SecuritiesPartial Income Statement for Eastwood Inc. Other expenses and losses: Unrealized loss on trading securities $500