Chapter

12
Investments
Judith Paquette

Financial Accounting,
Seventh Edition
Slide
12-1

Study Objectives

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12-2

1.

Discuss why corporations invest in debt and stock

securities.

2.

Explain the accounting for debt investments.

3.

Explain the accounting for stock investments.

5.

Indicate how debt and stock investments are reported in

financial statementsvaluing investments

6.

Distinguish between short-term and long-term

investments.

Note: Learning objective #4 is

not included.

Why Corporations Invest

Corporations generally invest in debt or stock
securities for one of three reasons.
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

Slide
12-3

They have Excess Cash $$$$$$$$$$

If you have excess cash, it should be working for
you! (working = earning interest $$$$$$$$)
But, it needs to be readily available when you need it
(a rainy day fund)
Hence: invest in low risk funds that can be liquidated
quickly

Slide
12-4

They want to generate earnings from

investment income
Maybe liquidity isnt an issue.they want to
benefit from dividends and stock
appreciation. So they invest in mutual funds
and stocks.

Slide
12-5

For Strategic Reasonsbuying a related

company
Buying a large amount of stock in a company gives the
company a certain amount of stock voteseven without a
controlling interest, it gives the company an influence.

Which company?
-a related industry e.g.,
Taco Bell buys stock in
Chipotle, its competitor
WHY invest in your
competitor?
Slide
12-6

For Strategic Reasons to influence

Which company? -a related industry e.g., Taco Bell buys stock in Chipotle, its
competitor WHY invest in your competitor?

To expand its influence in its own industry.

Slide
12-7

For Strategic Reasonsbuying an unrelated

company
It still gives you some influence, but also something else.

An Unrelated industry e.g.,

Taco Bell buys stock
in.Pfizer
(pharmaceutical)tacos and
drugs.hmmmm.WHY
would they do that?
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12-8

For Strategic Reasons- to DIVERSIFY

An Unrelated industry e.g., Taco Bell buys stock inPfizer (pharmaceutical)tacos
and drugs. .WHY would they do that?

Diversifying its investment in different industries allows the company to

(possibly) face less market risk by not putting all its investment in the same
industry If fast food sales go down, drug sales may not be affected as much.

Slide
12-9

INVESTING IN ANOTHER COMPANY

You have TWO choices:
1. DEBT LOAN $$ TO A COMPANY - BUY
BONDS
2. EQUITY BECOME AN OWNER - BUY
STOCK
How do you make money with your
investments?

Slide
12-10

INVESTING earning money

You have TWO choices:
1. DEBT Interest Revenue (new account)
2. EQUITY 2 ways:
1. Dividends paid
2. Stock Appreciation (buy at a lower price, sell at a
higher price)

How does a company report its investments?

Slide
12-11

INVESTING Reporting
INVESTMENTS are ASSETS (could be long term on
short term) with a NORMAL BALANCE of DEBIT.
You must clearly understand the difference between:
The Companys own stock or bonds sold =
Common Stock, Equity, normal balance = credit or
Bonds Payable, LT Liabilties, normal balance = credit

AND
The Companys investment in another companys stock or debt
purchased = Investments, Assets, normal balance = debit
Slide
12-12

Accounting for Debt Investments

Investments in government and corporation bonds.

In accounting for debt investments, the required

entries to record:
the

acquisition
the interest revenue
the sale

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12-13

13

Accounting for Debt Investments Acquisition

Recording Acquisition of Bonds
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus
brokerage fees (commissions), if any.
Note: Bonds are recorded at acquisition cost, NOT face
value.

Slide
12-14

SO 2 Explain the accounting for debt investments.

Accounting for Debt Investments Bond

Interest
Recording Bond Interest
Calculate and record interest revenue based upon the
FACE value of the bond times the interest rate times
the portion of the year the bond is outstanding.

Face Value: $1,000 for each bond

Contract Interest Rate: 7% (for example)
Annual interest revenue = 1,000 * .07 = $70
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12-15

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.

Note: if you only sell some of the bonds, you need to

prorate the cost.
If you go back to the chapter on Long
Term Assets, this is the same as how we
retire an asset
Slide
12-16

Accounting for Debt Instruments example - Acquisition

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:

Slide
12-17

Accounting for Debt Instruments example - Acquisition

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:

Jan. 1

Debt Investments

54,000

Cash
Question: What type of account
is Debt Investments?
Hint: watch the wording, if it said plus a
brokerage fee of $1,000 the entry would
be for $55,000.
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12-18

54,000
An asset
account,
normal balance
= debit

Accounting for Debt Instruments - interest

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:

Slide
12-19

Accounting for Debt Instruments - interest

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:
July 1

Cash
Interest revenue

Question: What type of account

is Interest Revenue?
*
Slide
12-20

($50,000 x 8% x = $2,000)

2,000 *
2,000

A revenue
account,
normal balance
= credit

Accounting for Debt Instruments-year end interest

accrual and payment
Illustration: If Kuhl Corporations fiscal year ends on
December 31, prepare the entry to accrue interest since
July 1.

Kuhl reports receipt of the interest on January 1 as

follows.

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12-21

Accounting for Debt Instruments-year end interest

accrual and payment
Illustration: If Kuhl Corporations fiscal year ends on
December 31, prepare the entry to accrue interest since
July 1.
Dec. 31 Interest receivable

2,000

Interest revenue

2,000

Kuhl reports receipt of the interest on January 1 as

follows.
Jan. 1

Slide
12-22

Cash
Interest receivable

2,000
2,000

Accounting for Debt Instruments sale of investment

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.
Jan. 1

Cash

58,000

Debt investments
Gain on sale of investments

Slide
12-23

54,000
4,000

Accounting for Debt Instruments practice

Lets Practice: Jubilee Farms acquires $200,000,

Whole Food Market, Inc. 7%, 10-year bonds on January
1, 2011, at face value directly from the company (no
brokerage fees). Record:

a) Jan 1 - The acquisition

b) Jul 1 - The first semiannual interest revenue
c) Dec 31 The accrual of the second interest revenue.

Record these transactions for 2011

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12-24

Accounting for Debt Instruments practice - continued

Lets Practice: Assume that Jubilee Farms has only

these bonds and three years have passed. It is now
2014
a) Jan 1 Received the semiannual interest
b) Jan 1 Sold $70,000 of Whole Food bonds at 112.
The broker charged $1,500 in fees.
c) Jul 1 - Received semiannual interest revenue
d) Dec 31 The accrued semiannual interest revenue.

Record these transactions for 2014

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12-25

See End of Power

Points for Solution

Accounting for Stock Investments

Investor's
Ownership
Interest in another
Company

Influence

Less than 20%

Insignificant

Between 20-50% Significant

More than 50%

Slide
12-26

CONTROLLING!

Accounting
The accounting depends on the
extent of the investors influence
over the operating and financial
affairs of the issuing corporation.

Accounting for Stock Investments

For this class, you are ONLY responsible
for learning about holdings of Less than
20%
When do you get to learn about:
Holdings between 20-50%?
Holdings of OVER 50%?
In greater detail:
--Intermediate Accounting
--Advanced Accounting
--or.you can read about it in the textbook as a more
general topic
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12-27

Accounting for Stock Investments

Holdings of Less than 20%
Companies use the cost method. Under the cost
method, companies record the investment at cost, and
recognize revenue only when cash dividends are
received. --This is similar to debt investments
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus any
brokerage fees (commissions).

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12-28

Accounting for Stock Investments

Investments in a corporations common stock.

In accounting for common stock investments, the

required entries to record:
the

acquisition
the dividend revenue
the sale

Slide
12-29

29

Holdings of Less than 20% - acquisition

Illustration: On July 1, 2011, Sanchez Corporation
acquires 1,000 shares (10% ownership) of Kali
Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the
purchase is:

Slide
12-30

Holdings of Less than 20% - acquisition

Illustration: On July 1, 2011, Sanchez Corporation
acquires 1,000 shares (10% ownership) of Kali
Corporation common stock. Sanchez pays $40 per
share plus brokerage fees of $500. The entry for the
purchase is:
July 1

Stock investments

Cash

Slide
12-31

40,500

40,500

Holdings of Less than 20% - dividends earned

Illustration: During the time Sanchez owns the stock,
it makes entries for any cash dividends received. If
Sanchez receives a $2 per share dividend on December
31, the entry is:

Slide
12-32

SO 3 Explain the accounting for stock investments.

Holdings of Less than 20% - dividends earned

Illustration: During the time Sanchez owns the stock,
it makes entries for any cash dividends received. If
Sanchez receives a $2 per share dividend on December
31, the entry is:

Dec. 31

Cash
Dividend revenue

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12-33

2,000
2,000

Holdings of Less than 20% - sale of stock

Illustration: Assume that Sanchez Corporation
receives net proceeds of $39,500 on the sale of its
Beal stock on February 10, 2012. Because the stock
cost $40,500, Sanchez incurred a loss of $1,000. The
entry to record the sale is:

Slide
12-34

Holdings of Less than 20% - sale of stock

Illustration: Assume that Sanchez Corporation
receives net proceeds of $39,500 on the sale of its
Beal stock on February 10, 2012. Because the stock
cost $40,500, Sanchez incurred a loss of $1,000. The
entry to record the sale is:
Feb. 10

Cash

Loss on sale of stock

Stock investments

Slide
12-35

39,500

1,000
40,500

Slide
12-36

Accounting for Stock Instruments practice - continued

Lets Practice: Franks Produce Conglomerate Company had the

following transactions pertaining to stock investments.
Feb. 1 - Purchased 500 shares of Jordan Company common stock (2%
ownership position) for $5,000 cash, plus brokerage fees of $250.
July 1 - Received cash dividends of $1 per share on Jordan common stock.
Sept. 1 - Sold 250 shares of Jordan common stock for $3,000, less
brokerage fees of $75.
Dec. 1 - Received cash dividends of $1 per share on Jordan common stock.

Record these transactions

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12-37

See End of Power

Points for Solution

Valuing and Reporting Investments

Categories of Securities
Companies classify debt and stock investments into
three categories:
Trading securities
Available-for-sale securities
Held-to-maturity securities
These guidelines apply to all debt securities and all stock
investments in which the holdings are less than 20%.
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12-38

Valuing and Reporting Investments

Trading Securities
Companies hold trading securities with the intention

of selling them in a short period.

Trading means frequent buying and selling, e.g., day

trading.

Companies report trading securities at fair value,

and report changes from cost as part of net income.
This is called mark to market because it adjusts

the value of the trading security to the market

price.
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12-39

TRADING SECURITIES ALERT!

Trading Securities
Because they are valued at FAIR VALUE.

This is a departure from the Cost Principle (see

Chapter 1 where assets are recorded at their historic cost)

The change in trading securities fair value affects

net income, even though they havent been sold!

This is called an unrealized gain or loss, but it still

affects net income.

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12-40

Valuing and Reporting Investments

Available-for-Sale Securities
Companies hold available-for-sale securities with the
intent of selling these investments sometime in the
future.
These securities can be classified as current assets
or as long-term assets, depending on the intent of
management.
Companies report securities at fair value, and report
changes from cost as a component of the
stockholders equity sectiondoes NOT impact net

income
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12-41

Trading Securities - example

Illustration: Pace Company invests in two stocks classified as
trading securities. On December 31, 2011 (when its fiscal year
ends, it classified these securities at their current fair value:.

The adjusting entry for Pace Corporation is:

Dec. 31 Market adjustmenttrading
7,000
Unrealized gainincome
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12-42

7,000

Available-for-Sale Securities
Problem: How would the entries change if the securities
were classified as available-for-sale?
The entries would be the same except that the
Unrealized Gain or LossEquity account is used instead of
Unrealized Gain or LossIncome.

The unrealized loss would be deducted from the stockholders

equity section rather than charged to the income statement.

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12-43

Available-for-Sale Securities - Example

Illustration: Assume that Ingrao Corporation has two
securities that it classifies as available-for-sale.
Illustration 12-8

The adjusting entry for Ingrao Corporation is:

Dec. 31 Unrealized gain or lossequity

9,537

Market adjustmentavailable-for-sale
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12-44

9,537

Too many accounts?

Remember:
If it is a GAIN, it will be a credit balance (like revenue)
If it is a LOSS, it will be a debit balance (like expense)
If it is a GAIN or LOSS account, its balance will vary
(debit for Loss, credit for Gain.

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12-45

Accounting for Debt Instruments JUBILEE FARMS continued

Remember the earlier practice problem:

Jubilee Farms
acquires $200,000, Whole Food Market, Inc. 7%, 10-year bonds on January
1, 2011, at face value directly from the company (no brokerage fees).

Now, lets add the Year-end adjustment.

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12-46

Accounting for Debt Instruments practice - continued

Lets Practice: On December 31, 2011: Assume that

the FAIR VALUE of the bonds on Dec 31, 2011 WAS
$192,000. These bonds are categorized as availablefor-sale securities.

Prepare the adjusting journal entry for 2011.

See End of Power Points for Solution

Slide
12-47

Slide
12-48

Valuing and Reporting Investments

Balance Sheet Presentation
Short-Term Investments
Also called marketable securities, are 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.

Long-Term Investments

Investments that do not meet both criteria are

classified as long-term investments.
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12-49

Income Statement Presentation Gains/Losses

Presentation of Realized and Unrealized Gain
or Loss
Nonoperating items related to investments
Non Operating section of Income Statement

Other Revenue and Gains:

Other Expenses and Losses:

Interest Revenue

Loss on Sale of Debt Investments

Dividend Revenue

Loss on Sale of Stock Investments

Gain on Sale of Debt Investments

Unrealized Loss - Income

Gain on Sale of Stock Investments

Unrealized Gain - Income

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12-50

Balance Sheet Presentation Avail. For Sale

Realized and Unrealized Gain or Loss
Unrealized gain or loss on available-for-sale securities are
reported as a separate component of stockholders
equity.
Illustration 12-11

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12-51

Classified
Balance
Sheet
(partial)

Illustration 12-12
Slide
12-52

End of Chapter 12
Good Bye and Good Luck.

Solutions to Coursepack problems to

follow

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12-53

SOLUTION TO JUBILEE FARMS:

a) 2011
Jan. 1 Debt Investments
Cash

200,000
200,000

To record purchase

July 1

Cash ($200,000 X .07 X 1/2)

Interest Revenue

7,000
7,000

To record dividends

Dec. 31

Interest Receivable
Interest Revenue

7,000

7,000

To record dividends accrual

2014
Jan. 1

Cash
Interest Receivable

7,000
7,000

To record dividends payment

Cash [($70,000 X 1.12) $1,500]

Debt Investments
Gain on Sale of Debt
Investments

76,900

70,000
6,900

To record sales of bonds.

July 1

Cash ($130,000 X .07 X 1/2)

Interest Revenue

4,550
4,550

To record dividends

Dec. 31

Interest Receivable
Interest Revenue

4,550
4,550

To record dividends accrual

(b) 2011
Dec. 31
Slide
12-54

Unrealized Gain or LossEquity

Market Adjustment
Available-for-Sale

To record market adjustment of bonds

8,000
8,000

SOLUTION TO FRANKS PRODUCE CONGLOMERATE:

(a) Feb. 1

Stock Investments
Cash ($5,000 + $250)

5,250
5,250

To record purchase

July 1

Cash (500 X $1)

Dividend Revenue

500
500

To record dividend payment

Sept. 1

Cash ($3,000 $75)

Stock Investments
($5,250 X 1/2)
Gain on Sale of Stock Investments
($2,925-2,625)

2,925
2,625
300

To record sale of stock

Dec. 1

Cash (250 X $1)

Dividend Revenue

To record dividend payment

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12-55

250
250