3. Slide
12-3
1. Discuss why corporations invest in debt and share
securities.
2. Explain the accounting for debt investments.
3. Explain the accounting for share investments.
4. Describe the use of consolidated financial statements.
5. Indicate how debt and share investments are reported in
financial statements.
6. Distinguish between short-term and long-term
investments.
Study Objectives
5. Slide
12-5
Corporations generally invest in debt or share securities
for one of three reasons.
Why Corporations Invest
SO 1 Discuss why corporations invest in debt and share securities.
1. Corporation may have excess cash.
2. To generate earnings from investment income.
3. For strategic reasons.
Illustration 12-1
Temporary
investments
and the
operating cycle
6. Slide
12-6
Pension funds and banks regularly invest in debt and
share securities to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.
Question
Why Corporations Invest
SO 1 Discuss why corporations invest in debt and share securities.
7. Slide
12-7
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
Recording Acquisition of Bonds
Cost includes all expenditures necessary to acquire
these investments, such as the 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.
8. Slide
12-8
Accounting for Debt Instruments
SO 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.
9. Slide
12-9
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,
10-year, $1,000 bonds on January 1, 2011, for $54,000,
including brokerage fees of $1,000. The entry to record the
investment is:
Debt investments 54,000
Cash 54,000
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
Jan. 1
10. Slide
12-10
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,
10-year, $1,000 bonds on January 1, 2011, for $54,000,
including brokerage fees of $1,000. The bonds pay interest
semiannually on July 1 and January 1. The entry for the
receipt of interest on July 1 is:
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
Cash 2,000
Interest revenue 2,000
* ($50,000 x 8% x ½ = $2,000)
*
July 1
11. Slide
12-11
Illustration: If Kuhl Corporation’s fiscal year ends on
December 31, prepare the entry to accrue interest since
July 1.
Accounting for Debt Instruments
SO 2
Interest receivable 2,000
Interest revenue 2,000
Kuhl reports receipt of the interest on January 1 as follows.
Cash 2,000
Interest receivable 2,000
Dec. 31
Jan. 1
12. Slide
12-12
Illustration: Assume that Kuhl corporation receives net
proceeds of $58,000 on the sale of the Doan Inc. bonds on
January 1, 2011, after receiving the interest due. Prepare
the entry to record the sale of the bonds.
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
Cash 58,000
Debt investments 54,000
Gain on sale of debt investments 4,000
Jan. 1
Recording Sale of Bonds
13. Slide
12-13
An event related to an investment in debt securities that
does not require a journal entry is:
a. acquisition of the debt investment.
b. receipt of interest revenue from the debt
investment.
c. a change in the name of the firm issuing the debt
securities.
d. sale of the debt investment.
Question
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
14. Slide
12-14
When bonds are sold, the gain or loss on sale is the
difference between the:
a. sales price and the cost of the bonds.
b. net proceeds and the cost of the bonds.
c. sales price and the market value of the bonds.
d. net proceeds and the market value of the bonds.
Question
Accounting for Debt Instruments
SO 2 Explain the accounting for debt investments.
15. Slide
12-15
0 --------------20% ------------ 50% -------------- 100%
No significant
influence
usually exists
Significant
influence
usually exists
Control usually
exists
Investment
valued using
Cost
Method
Investment
valued using
Equity
Method
Investment valued on
parent’s books using Cost
Method or Equity Method
(investment eliminated in
Consolidation)
Ownership Percentages
Accounting for Share Investments
SO 3 Explain the accounting for share investments.
The accounting depends on the extent of the investor’s influence over
the operating and financial affairs of the issuing corporation.
16. Slide
12-16
Companies record
the investment at cost, and
recognize revenue only when cash dividends are
received.
SO 3 Explain the accounting for share investments.
Holdings of Less than 20% (Cost Method)
Accounting for Share Investments
Cost includes all expenditures necessary to acquire these investments,
such as the price paid plus any brokerage fees (commissions).
17. Slide
12-17
July 1
SO 3 Explain the accounting for share investments.
Holdings of Less than 20%
Illustration: On July 1, 2011, Sanchez Corporation
acquires 1,000 ordinary shares (10% ownership) of Beal
Corporation. Sanchez pays $40 per share plus brokerage
fees of $500. The entry for the purchase is:
Share investments 40,500
Cash 40,500
18. Slide
12-18
Dec. 31
SO 3 Explain the accounting for share investments.
Holdings of Less than 20%
Illustration: During the time Sanchez owns the shares, it
makes entries for any cash dividends received. If Sanchez
receives a $2 per share dividend on December 31, the
entry is:
Cash 2,000
Dividend revenue 2,000
19. Slide
12-19
Feb. 10
SO 3 Explain the accounting for share investments.
Holdings of Less than 20%
Illustration: Assume that Sanchez Corporation receives
net proceeds of $39,500 on the sale of its Beal shares on
February 10, 2012. Because the shares cost $40,500,
Sanchez incurred a loss of $1,000. The entry to record the
sale is:
Cash 39,500
Loss on sale of share 1,000
Share investments 40,500
20. Slide
12-20
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.
SO 3 Explain the accounting for share investments.
Accounting for Share Investments
21. Slide
12-21
Under the equity method, the investor records
dividends received by crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Share Investments.
Question
Holdings Between 20% and 50%
SO 3 Explain the accounting for share investments.
22. Slide
12-22
Illustration: Milar Corporation acquires 30% of the ordinary
shares of Beck Company for $120,000 on January 1, 2011. For
2011, Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.
Share investments 120,000
Cash 120,000
Cash 12,000
Share investments 12,000
Share investments 30,000
Revenue from investments 30,000
Holdings Between 20% and 50%
($40,000 x 30%)
($100,000 x 30%)
SO 3 Explain the accounting for share investments.
Jan. 1
Dec. 31
Dec. 31
23. Slide
12-23
After Milar posts the transactions for the year, its investment
and revenue accounts will show the following.
Debit Credit
Share Investments
120,000 30,000
Debit Credit
Revenue from Investments
Holdings Between 20% and 50%
SO 3 Explain the accounting for share investments.
30,000 12,000
138,000
Illustration: Milar Corporation acquires 30% of the ordinary
shares of Beck Company for $120,000 on January 1, 2011. For
2011, Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.
24. Slide
12-24
Controlling Interest - When one corporation acquires a voting
interest of more than 50 percent 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.
SO 4 Describe the use of consolidated financial statements.
Holdings of More Than 50%
Accounting for Share Investments
25. Slide
12-25
Consolidated statements indicate the magnitude and scope
of operations of the companies under common control.
SO 4 Describe the use of consolidated financial statements.
Holdings of More Than 50%
Accounting for Share Investments
Illustration 12-5
Examples of consolidated companies and their subsidiaries
27. Slide
12-27
Valuing and Reporting Investments
Categories of Securities
Companies classify debt and share investments into
three categories:
Fair value through profit or loss (FVPL) securities
Available-for-sale (AFS) securities
Held-to-maturity securities
These guidelines apply to all debt securities and all share investments
in which the holdings are less than 20%.
SO 5 Indicate how debt and share investments are
reported in financial statements.
28. Slide
12-28
Valuing and Reporting Investments
Fair Value Through Profit or Loss (FVPL)
Companies hold securities with the intention of selling
them in a short period (< month).
Frequent buying and selling.
Companies report securities at fair value, and report
changes from cost as part of net income.
Changes are reported as unrealized gains or losses.
SO 5 Indicate how debt and share investments are
reported in financial statements.
29. Slide
12-29
Illustration: Investment of Pace classified as fair value through
profit or loss securities on December 31, 2011.
Fair Value Through Profit or Loss (FVPL)
The adjusting entry for Pace Corporation is:
SO 5 Indicate how debt and share investments are
reported in financial statements.
Dec. 31 Market adjustment—FVPL 7,000
Unrealized gain—income 7,000
Illustration 12-7
31. Slide
12-31
Valuing and Reporting Investments
Available-for-Sale (AFS) Securities
Held with the intent of selling these investments
sometime in the future.
Classified as current assets or as non-current assets,
depending on the intent of management.
Report securities at fair value
Report changes from cost as a component of the equity
SO 5 Indicate how debt and share investments are
reported in financial statements.
32. Slide
12-32
Marketable securities bought and held primarily for sale
in the near term are classified as:
a. Available-for-sale securities.
b. Held-to-maturity securities.
c. Share securities.
d. Fair value through profit or loss
Question
Valuing and Reporting Investments
SO 5 Indicate how debt and share investments are
reported in financial statements.
33. Slide
12-33
Problem: How would the entries for fair value through
profit or loss securities change if the securities were
classified as available-for-sale?
The entries would be the same except that the
Unrealized Gain or Loss—Equity account is used instead of
Unrealized Gain or Loss—Income.
The unrealized loss would be deducted from equity rather
than charged to income.
Available-for-Sale Securities
SO 5 Indicate how debt and share investments are
reported in financial statements.
34. Slide
12-34
Illustration: Assume that Ingrao Corporation has two securities
that it classifies as available-for-sale.
The adjusting entry for Ingrao Corporation is:
SO 5 Indicate how debt and share investments are
reported in financial statements.
Dec. 31 Unrealized gain or loss—equity 9,537
Market adjustment—AFS 9,537
Illustration 12-8
Available-for-Sale Securities
35. Slide
12-35
An unrealized loss on available-for-sale securities is:
a. reported under other revenue and expenses in the
income statement.
b. closed-out at the end of the accounting period.
c. reported as a separate component of equity.
d. deducted from the cost of the investment.
Question
Available-for-Sale Securities
SO 5 Indicate how debt and share investments are
reported in financial statements.
36. Slide
12-36
Securities held by a company that are
(1) readily marketable and
(2) intended to be converted into cash within the next year
or operating cycle, whichever is longer.
Short-Term Investments
SO 6 Distinguish between short-term and long-term investments.
Investments that do not meet both criteria are classified as
long-term investments.
Statement of Financial Position Presentation
Valuing and Reporting Investments
37. Slide
12-37
Nonoperating items related to investments
Presentation of Realized and Unrealized Gain
or Loss
Statement of Financial Position Presentation
SO 6 Distinguish between short-term and long-term investments.
Illustration 12-10
38. Slide
12-38
Realized and Unrealized Gain or Loss
SO 6 Distinguish between short-term and long-term investments.
Unrealized gain or loss on available-for-sale securities is
reported as a separate component of equity.
Illustration 12-11
Statement of Financial Position Presentation
39. Slide
12-39 SO 6 Distinguish between short-term and long-term investments.
Classified
Statement of
Financial
Position
(partial)
Illustration 12-12
40. Slide
12-40 SO 6 Distinguish between short-term and long-term investments.
Classified
Statement of
Financial
Position
(partial)
Illustration 12-12
41. Slide
12-41
Identify where each of the following items would be
reported in the financial statements.
SO 6 Distinguish between short-term and long-term investments.
Answers on
notes page
Use the following possible categories:
Intangible assets Equity
Property, plant, and equipment Non-current liabilities
Investments Current liabilities
Current assets
Other income and expenses
Statement of Financial Position Presentation
42. Slide
12-42
Both IFRS and GAAP use the same criteria to determine
whether the equity method of accounting should be used—that
is, significant influence with a general guide of over 20%
ownership. GAAP uses the term equity investment whereas
IFRS uses the term associate investment to describe
investments under the equity method.
Under IFRS, both the investor and an associate company
should follow the same accounting policies. As a result, in
order to prepare financial information, adjustments are made to
the associate’s policies to conform to the investor’s books.
GAAP does not have that requirement.
Understanding U.S. GAAP
Key Differences Investments
43. Slide
12-43
The basis for consolidation under IFRS is control. Under GAAP,
a bipolar approach is used, which is a risk-and reward model
(often referred to as a variable-entity approach) and a voting
interest approach. However, under both systems, for
consolidation to occur, the investor company must generally
own 50% of another company.
IFRS specifies the following four types of financial assets:
1. Financial assets at fair value through profit or loss.
2. Held-to-maturity investments.
3. Loans and receivables.
4. Available-for-sale financial assets.
The loans and receivables category does not exist under GAAP.
Understanding U.S. GAAP
Key Differences Investments
44. Slide
12-44
The category of financial asset at fair value through profit or
loss is similar to the trading securities discussed in GAAP. As
noted in the chapter, this category also includes investments
that the company has decided to report at fair value. GAAP also
gives the company the option to report investments at fair value.
Unrealized gains and losses related to available-for-sale
securities are reported in other comprehensive income under
GAAP and IFRS. These gains and losses that accumulate are
then reported in the equity section. Under IFRS, they are
frequently reported in a line item labeled “Reserves” whereas
under GAAP, they are reported in accumulated other
comprehensive income.
Understanding U.S. GAAP
Key Differences Investments
45. Slide
12-45
Looking to the Future
Understanding U.S. GAAP
As indicated earlier, both the FASB and IASB have indicated that
they believe that all financial instruments should be reported at fair
value and that changes in fair value should be reported as part of
net income. It seems likely, as more companies choose the fair
value option for financial instruments, that we will eventually arrive
at fair value measurement for all financial instruments.
Investments
46. Slide
12-46
Consolidated Statement of
Financial Position
Preparing Consolidated Financial Statements
Companies prepare consolidated statements of
financial position from the individual statements of their
affiliated companies.
Transactions between the affiliated companies are
eliminated.
Appendix
47. Slide
12-47
Preparing Consolidated Financial Statements
Illustration: Assume that on January 1, 2011, Powers
Construction Company pays $150,000 in cash for 100% of
Serto Brick Company’s ordinary shares. Powers Company
records the investment at cost, as required by the cost
principle.
The combined totals do not represent a consolidated
statement of financial position, because there has been a
double counting of assets and equity in the amount of
$150,000.
Consolidated Statement of Financial Position
49. Slide
12-49
Use of a Worksheet—Cost Equal to Book Value
Preparing Consolidated Financial Statements
Illustration 12A-2
SO 7
50. Slide
12-50
Use of a Worksheet—Cost Above Book Value
Preparing Consolidated Financial Statements
SO 7 Describe the content of a worksheet for a
consolidated statement of financial position.
Illustration: Assume the same data used above, except
that Powers Company pays $165,000 in cash for 100% of
Serto’s ordinary shares. The excess of cost over book
value is $15,000 ($165,000 - $150,000).
52. Slide
12-52
Consolidated Statement of Financial Position
Preparing Consolidated Financial Statements
SO 8 Explain the form and content of consolidated financial statements.
Illustration: The prior worksheet shows an excess of cost
over book value of $15,000. In the consolidated statement
of financial position, Powers first allocates this amount to
specific assets, such as inventory and plant equipment, if
their fair market values on the acquisition date exceed their
book values. Any remainder is considered to be goodwill.
For Serto Company, assume that the fair market value of
property and equipment is $155,000.Thus, Powers
allocates $10,000 of the excess of cost over book value to
property and equipment, and the remainder, $5,000, to
goodwill.
53. Slide
12-53
Preparing Consolidated Financial Statements
SO 8 Explain the form and content of consolidated financial statements.
Illustration 12A-4
Consolidated Statement of Financial Position
54. Slide
12-54
Consolidated Income Statement
Preparing Consolidated Financial Statements
Statement shows the results of operations of affiliated
companies as though they are one economic unit.
All intercompany revenue and expense transactions
must be eliminated.
A worksheet facilitates the preparation of consolidated
income statements in the same manner as it does for
the statement of financial position.
Appendix
SO 8 Explain the form and content of consolidated financial statements.
p. 563 How Procter & Gamble Accounts for Gillette
Q: Where on Procter & Gamble’s statement of financial position will you find its investment in Gillette Company?
A: Because Procter & Gamble owns nearly all of the shares of Gillette, Procter & Gamble does not report Gillette in the investment section of its statement of financial position. Instead, Gillette’s assets and liabilities are included and commingled with the assets and liabilities of Procter & Gamble.
p. 567 And the Correct Way to Report Investments Is . . . ?
Q: Why might the use of the equity method not lead to full disclosure in the financial statements?
A: Under the equity method, the investment in ordinary shares of another company is initially recorded at cost. After that, the investment account is adjusted at each reporting date to show the investor’s equity in the associate. However, on the investor’s statement of financial position, only the investment account is shown. The pro-rata share of the associate’s assets and liabilities are not reported. Because the pro-rata share of the associate’s assets and liabilities are not shown, some argue that the full disclosure principle is violated.