Lecture Accounting principles (8th edition) – Chapter 16: Investments
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Chapter
16-1
CHAPTER
CHAPTER 16
16
INVESTMENTS
Accounting Principles, Eighth Edition
Chapter
16-2
Study Objectives
Study 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 shortterm and longterm investments.
Chapter
16-3
LongTerm Liabilities
LongTerm 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 Corporations Invest
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 161
Temporary
investments and the
operating cycle
Chapter
16-5
LO 1 Discuss why corporations invest in debt and stock securities.
Why Corporations Invest
Why Corporations Invest
Question
Pension funds and banks regularly invest in debt and stock securities
to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.
Chapter
16-6
LO 1 Discuss why corporations invest in debt and stock securities.
Accounting for Debt Instruments
Accounting for Debt 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 for Debt Instruments
Accounting for Debt 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 for Debt Instruments
Accounting for Debt 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 for Debt Instruments
Accounting for Debt 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
Cash
60,900 *
60,900
* ($60,000 + $900 = $60,900)
Chapter
16-10
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Accounting for Debt 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
Gain on sale
33,500 **
* ($60,000 x 8% x ½ = $2,400)
** ($34,000 $500 = $33,500)
Chapter
16-11
2,400
30,450 ***
3,050
*** ($60,900 x ½ = $30,450)
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Accounting for Debt 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 for Debt Instruments
Accounting for Debt Instruments
Question
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.
Chapter
16-13
LO 2 Explain the accounting for debt investments.
Accounting for Debt Instruments
Accounting for Debt Instruments
Question
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.
Chapter
16-14
LO 2 Explain the accounting for debt investments.
Accounting for Stock Investments
Accounting for Stock 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 of Less than 20%
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.
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 of Less than 20%
Holdings of Less than 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 of Less than 20%
Holdings of Less than 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
July 1
Stock investments
Cash
Cash
Dividend revenue
8,200 *
8,200
800 **
800
* ($8,000 + $200 = $8,200)
** (800 x $1 = $800)
Chapter
16-18
LO 3 Explain the accounting for stock investments.
Holdings of Less than 20%
Holdings of Less than 20%
Exercise: Sept. 1 Sold 300 shares of Hippo common stock for $4,400,
less brokerage fees of $100.
Sept. 1
Stock investments
Cash
Gain on sale
4,300 *
3,075 **
1,225
* ($4,400 $100 = $4,300)
** ($8,200 x 3/8 = $3,075)
Chapter
16-19
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
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.
Chapter
16-20
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
Holdings Between 20% and 50%
Question
Under the equity method, the investor records dividends received by
crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Stock Investments.
Chapter
16-21
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
Holdings Between 20% and 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 Between 20% and 50%
Holdings Between 20% and 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
180,000
Cash
180,000
Stock investments
Investment revenue
24,000
Cash
Stock investments
Chapter
16-23
24,000
($80,000 x 30%)
6,000
($20,000 x 30%)
6,000
LO 3 Explain the accounting for stock investments.
Holdings Between 20% and 50%
Holdings Between 20% and 50%
Exercise: Pennington purchased 30% of the common shares of Edwards for
Exercise:
$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
Debit
180,000
24,000
Investment Revenue
Credit
Debit
Credit
24,000
6,000
198,000
Chapter
16-24
LO 3 Explain the accounting for stock investments.
Holdings of More Than 50%
Holdings of More Than 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
longterm investment.
Parent generally prepares consolidated financial statements.
Chapter
16-25
LO 4 Describe the use of consolidated financial statements.
