Accounting principles chapter 17

Accounting
Principles

Second Canadian Edition
Weygandt · Kieso · Kimmel ·
Trenholm

Prepared by:
Carole Bowman, Sheridan College


CHAPTER

17
INVESTMENTS


ILLUSTRATION 17-1

TEMPORARY INVESTMENTS
AND THE OPERATING CYCLE
• At the end of their operating cycles, many companies
mayhave temporarily idle cash on hand, pending the
start of the nextoperating cycle.
• Until the cash is needed in operations, these
companies may invest the excess funds to earn
interest and dividends.
Invest

Cash

Accounts
Receivable

Sell

Inventory

Temporary
Investments


TEMPORARY VS. LONG-TERM
INVESTMENTS
• Temporary investments are securities, held by a company,
that are
(1) readily marketable, and
(2) intended to be converted into cash in the near future.
– Readily marketable means the investment can be sold easily,
whenever the need for cash arises.
– Intention to convert means that management intends to sell the
investment if and when the need for cash arises.

• Investments that do not meet both criteria are classified as
long-term investments.


DEBT INVESTMENTS
• Investments in government and corporation
bonds.
• In accounting for debt investments, entries are

required to record the:
– acquisition
– interest revenue
– sale
• Are recorded at cost, including brokerage fees.


DEBT INVESTMENTS

• Accounting differs depending on
whether investment is
– Temporary
– Long-term


ACCOUNTING FOR TEMPORARY DEBT
INVESTMENTS
Kuhl Corporation acquires 50 Doan Inc. 8 percent, 10year, $1,000 bonds on January 1, 1999, for $54,000,
including brokerage fees of $1,000. The bonds pay
interest semi-annually on July 1 and January 1. The
entry to record the temporary investment at cost is:

54,000


RECORDING BOND INTEREST
Interest receipts are calculated using the bond’s face or
principal value, which is $50,000 (50 x $1,000). The
interest for July 1 will be $2,000 ($50,000 x 8% x 6/12).
The entry on July 1 is:

2,000

2,000


ACCOUNTING FOR LONG-TERM DEBT
INVESTMENTS
The accounting for temporary and long-term investments is similar. The
major exception is when bonds are purchased at a premium or discount
(above or below its face value). As shown in Chapter 16 with the bond
issuer, the investor would also amortize the premium or discount using
either the straight-line or effective interest methods. Using the previous
Kuhl example and assuming an effective interest rate of 7%, the entries are:
Date
Kuhl Corporation (Investor)
(Investee)
50,000
Jan 1
Investment in Doan Bonds
4,000
Premium on Bonds
54,000
Premium on Bonds
Cash
Payable
2,000
To record purchase of 50 Doan bonds
year bonds
110

1,890
July 1 Cash
= ($50,000 x 8% x 6/12)
7% x 6/12)
Premium on Bonds

Doan Inc.
54,000
Cash
4,000
50,000
Bonds
1,890
To record issue of 8%, 10
110
2,000
Interest Expense
= ($54,000 x
Premium on


ILLUSTRATION 17-4

ACCOUNTING GUIDELINES FOR
EQUITY INVESTMENTS
Equity investments are investments in the share capital of corporations.
Investor’s Ownership
Interest in Investee’s
Common Shares

Presumed
Influence
on Investee

Accounting
Guidelines

Less than 20%

Insignificant

Cost method

Between 20% and 50%

Significant

Equity method

More than 50%

Controlling

Equity method for
accounting;
Consolidated
financial
statements for
financial reporting

RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
• In accounting for equity investments of less than
20 percent, the cost method is used.
• Under the cost method, the investment is
recorded at cost and revenue is recognized only
when cash dividends are received.


RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
On July 1, 2003, St. Amand Corporation acquires
1,000 shares (10 percent ownership) of Beal
Corporation at $40 per share plus brokerage fees of
$500. The entry for the purchase is:

40,500


RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
Entries are required for any cash dividends
received during the time the shares are held.
If a $2 per share dividend is received by St.
Amand Corporation on December 1, 2003,
the entry is:
2,000

2,000

RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
When shares are sold, the difference between the net
proceeds from the sale and the cost of the shares is
recognized as a gain or loss. St. Amand Corporation
receives net proceeds of $39,500 on the sale of its Beal
Corporation common shares on February 10, 2004.
Because the shares cost $40,500, a loss of $1,000 has been
incurred. The entry to record the sale is:
39,500

1,000


ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
•
When an investor owns between 20% and 50% of
the common shares of a corporation, it is usually
presumed that the investor has significant
influence over the financial and operating
activities of the investee.
• Under the equity method, the investment in
common shares is initially recorded at cost, and
the investment account is adjusted annually to
show the investor’s equity in the investee.
• Each year, the investor 1) debits the investment

account and credits revenue for its share of the
investee’s net income and 2) credits dividends
received to the investment account.


ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
• Milar Corporation acquires 30 percent of the
common shares of Beck Company for $120,000 on
January 1, 2003. The entry to record this
transaction is:

120,000
120,000


ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
Beck reports 2003 netAND
income50%
of $100,000 and declares
and pays a $40,000 cash dividend. Milar is required to
record 1) its share of Beck’s net income, $30,000 (30% x
$100,000) and 2) the reduction in the investment
account for the dividends received, $12,000 ($40,000 x
30%). The entries are:
#1
30,000
30,000

#2
12,000
12,000


RECORDING EQUITY
INVESTMENTS
HOLDINGS OF MORE THAN 50%
• A company that controls (e.g., owns more than
50 %) of the common shares of another entity
is known as a parent company.
• The entity whose shares are owned by the
parent company is called the subsidiary
(affiliated) company.
• When one company controls of the common
shares of another company, the equity method
of accounting is used to account for the
investment and consolidated financial
statements are prepared.


RECORDING EQUITY INVESTMENTS
HOLDINGS OF MORE THAN 50%
• Consolidated financial statements present
the assets and liabilities controlled by the
parent company and the combined
profitability of the subsidiary companies.
• They are prepared in addition to the
financial statements for each of the

individual parent and subsidiary
companies.


VALUATION AND REPORTING
OF INVESTMENTS
• The value of debt and equity investments may
fluctuate greatly during the time they are held.
• Conservatism principle requires accountants to
use the lower of cost and market (LCM) rule.
• Application of the LCM rule varies depending
upon whether the investment is temporary or
long-term.


VALUATION AND REPORTING OF
TEMPORARY INVESTMENTS
• The decline in value from cost to market is
reported as a loss.
• An Allowance to Reduce Cost to Market
Value account is used to record the difference
between the cost and market value of the
securities.
• The Allowance account is a contra asset and is
therefore deducted from the cost of the
investments to arrive at the LCM valuation
reported on the balance sheet for temporary
investments.

VALUATION AND REPORTING OF
LONG-TERM INVESTMENTS
• Long-term investments have longer maturities than
temporary investments, therefore, their carrying
values should not be adjusted to reflect temporary
fluctuations in market value.
• When market value falls below cost and the drop is
not due to temporary fluctuations, the investment
must be reduced to its market value.
• Any write-down to market value is accounted for on
the income statement as a permanent loss. No
allowance account is used.
• Long-term investments are reported in a separate
section of the balance sheet, immediately below
current assets.


ILLUSTRATION 17-8

COMPREHENSIVE BALANCE SHEET


ILLUSTRATION 17-8

COMPREHENSIVE BALANCE SHEET
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable
Bond interest payable
Income tax payable

Total current liabilities
Long-term liabilities
Bonds payable, 7%, due 2010
$ 300,000
Less: Discount on bonds
10,000
Total long-term liabilities
Total liabilities
Shareholders’ equity
Common shares, no par value,
200,000 shares
authorized, 80,000 issued
$900,000
Retained earnings (of which
265,000
$100,000 is restricted for
plant expansion)
Total shareholders’ equity
Total liabilities and
shareholders’ equity

$ 185,000
10,000
60,000
255,000

290,000
545,000

1,165,000

$ 1,710,000


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