Accounting principles 8th weygars kieso kimmel chapter 16

Chapter
16-1


CHAPTER
CHAPTER 16
16

INVESTMENTS

Accounting Principles, Eighth Edition
Chapter
16-2


Study
Study Objectives
Objectives
1.

Discuss why corporations invest in debt and stock
securities.

2.

Explain the accounting for debt investments.

3.

Explain the accounting for stock investments.

4.

Describe the use of consolidated financial
statements.

5.

Indicate how debt and stock investments are
reported in financial statements.

6.

Distinguish between short-term and long-term
investments.

Chapter
16-3


Long-Term
Long-Term Liabilities
Liabilities
Why
Why
Corporations
Corporations
Invest
Invest
Cash
management

Investment
income
Strategic
reasons

Accounting
Accountingfor
for
Debt
Debt
Investments
Investments
Recording
acquisition of
bonds

Accounting
Accountingfor
for
Stock
Stock
Investments
Investments

Valuing
Valuingand
and
Reporting
Reporting
Investments

Investments

Holdings of less
than 20%

Categories of
securities

Recording bond
interest

Holdings
between 20%
and 50%

Balance sheet
presentation

Recording sale
of bonds

Holdings of
more than 50%

Realized and
unrealized gain
or loss
Classified
balance sheet

Chapter
16-4


Why
Why Corporations
Corporations Invest
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 16-1

Temporary
investments
and the
operating cycle

Chapter
16-5

LO 1 Discuss why corporations invest in debt and stock securities.

Why
Why Corporations
Corporations Invest
Invest
Question
Pension funds and banks regularly invest in debt and
stock securities to:

Chapter
16-6

a.

house excess cash until needed.

b.

generate earnings.

c.

meet strategic goals.

d.

avoid a takeover by disgruntled investors.

LO 1 Discuss why corporations invest in debt and stock securities.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
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.
Chapter
16-7

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Debt
Debt Instruments
Instruments
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.

Chapter
16-8

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Debt
Debt Instruments
Instruments
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.
Chapter
16-9

LO 2 Explain the accounting for debt investments.


Accounting

Accounting for
for Debt
Debt Instruments
Instruments
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.
Jan 1

Debt investment

*
60,900

Cash
60,900

* ($60,000 + $900 = $60,900)
Chapter
16-10

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: July 1 Received semiannual interest on

Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000
less $500 brokerage fees.
July 1

Cash
Interest revenue
2,400
Cash
Debt investments
30,450
Gain on sale
3,050

* ($60,000 x 8% x ½ = $2,400)
** ($34,000 - $500 = $33,500)
Chapter
16-11

*
2,400
**
33,500

***

*** ($60,900 x ½ = $30,450)

LO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: (b) Prepare the adjusting entry for the
accrual of interest at December 31.
Dec 31 Interest receivable
Interest revenue
1,200

*
1,200

* ($30,000 x 8% x ½ = $1,200)
Chapter
16-12

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Question
An event related to an investment in debt securities
that does not require a journal entry is:

Chapter
16-13

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.

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Question

When bonds are sold, the gain or loss on sale is the
difference between the:

Chapter
16-14

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.

LO 2 Explain the accounting for debt investments.


Accounting
Accounting for
for Stock
Stock Investments

Investments
Ownership Percentages

0 --------------20% ------------ 50% -------------- 100%
No significant
influence
usually exists

Significant
influence
usually exists

Investment
valued using
Cost
Method

Investment
valued using
Equity
Method

Control
usually exists
Investment valued on
parent’s books using Cost
Method or Equity Method
(investment eliminated in
Consolidation)

The accounting depends on the extent of the investor’s influence
over the operating and financial affairs of the issuing corporation.
Chapter
16-15

LO 3 Explain the accounting for stock investments.


Holdings
Holdings of
of Less
Less than
than 20%
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.
Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus any
brokerage fees (commissions).

Chapter
16-16

LO 3 Explain the accounting for stock investments.


Holdings
Holdings of

of Less
Less than
than 20%
20%
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.
Chapter
16-17

LO 3 Explain the accounting for stock investments.


Holdings
Holdings of
of Less
Less than
than 20%
20%
Exercise: 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.

Feb. 1

Stock investments
Cash
8,200
July 1 Cash
Dividend revenue
800
* ($8,000 + $200 = $8,200)
** (800 x $1 = $800)
Chapter
16-18

*
8,200
**
800

LO 3 Explain the accounting for stock investments.


Holdings
Holdings of
of Less
Less than
than 20%
20%
Exercise: Sept. 1 Sold 300 shares of Hippo common
stock for $4,400, less brokerage fees of $100.
Sept. 1

Stock investments
Cash
3,075Gain on sale
1,225

*
4,300

**

* ($4,400 - $100 = $4,300)
** ($8,200 x 3/8 = $3,075)
Chapter
16-19

LO 3 Explain the accounting for stock investments.


Holdings
Holdings Between
Between 20%
20% and
and 50%
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.
Chapter
16-20

LO 3 Explain the accounting for stock investments.


Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Question
Under the equity method, the investor records
dividends received by crediting:

Chapter
16-21

a.

Dividend Revenue.

b.

Investment Income.

c.

Revenue from Investment.

d.

Stock Investments.

LO 3 Explain the accounting for stock investments.


Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Exercise: (Equity Method) On January 1, 2008,
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 2008.

Chapter
16-22

LO 3 Explain the accounting for stock investments.


Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
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
Cash

180,000
180,000

Stock investments
Investment revenue

24,000
24,000

($80,000 x 30%)

Cash

Stock investments

Chapter
16-23

6,000
6,000

($20,000 x 30%)
LO 3 Explain the accounting for stock investments.


Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
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.
After Pennington posts the transactions for the year, its
investment and revenue accounts will show the following.
Stock Investments

Investment Revenue

Debit

Debit

180,000
24,000

Credit

Credit
24,000

6,000

198,000
Chapter
16-24

LO 3 Explain the accounting for stock investments.


Holdings
Holdings of
of More
More Than
Than 50%
50%
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.

Chapter
16-25

LO 4 Describe the use of consolidated financial statements.