c h a p t e r 17

Chapter 17-1

Chapter 17-2

C H A P T E R C H A P T E R 1717

INVESTMENTSINVESTMENTS

Intermediate Accounting13th Edition

Kieso, Weygandt, and Warfield

Chapter 17-3

1. Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

2. Understand the procedures for discount and premium amortization on bond investments.

3. Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

4. Explain the equity method of accounting and compare it to the fair value method for equity securities.

Learning ObjectivesLearning ObjectivesLearning ObjectivesLearning Objectives

Chapter 17-4

Investments in Investments in Debt SecuritiesDebt Securities

Investments in Investments in Equity SecuritiesEquity Securities

Held-to-maturity Held-to-maturity securitiessecurities

Available-for-sale Available-for-sale securitiessecurities

Trading securitiesTrading securities

Holdings of less than Holdings of less than 20%20%

Holdings between 20% Holdings between 20% and 50%and 50%

Holdings of more than Holdings of more than 50%50%

Fair value optionFair value option

InvestmentsInvestmentsInvestmentsInvestments

Chapter 17-5

Different motivations for investing:

To earn a high rate of return e.g. interest

revenue from a debt investment or dividend

revenue from an equity investment.

To secure certain operating or financing

arrangements with another company.

Investment Accounting ApproachesInvestment Accounting ApproachesInvestment Accounting ApproachesInvestment Accounting Approaches

Chapter 17-6

Companies account for investments based on

the type of security (debt or equity) and

their intent with respect to the investment.

Investment Accounting ApproachesInvestment Accounting ApproachesInvestment Accounting ApproachesInvestment Accounting Approaches

Illustration 17-1

Chapter 17-7

LO 1 Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

Debt securities (creditor relationship with anther entity):

Investments in Debt SecuritiesInvestments in Debt SecuritiesInvestments in Debt SecuritiesInvestments in Debt Securities

government securities

Municipal securities

Corporate bonds

Convertible debt

Commercial paper

Type

Held-to-maturity

Trading

Available-for-sale

Accounting Category

Chapter 17-8

LO 1 Identify the three categories of debt securities and describe the accounting and reporting treatment for each category.

Investments in Debt SecuritiesInvestments in Debt SecuritiesInvestments in Debt SecuritiesInvestments in Debt Securities

Accounting for Debt Securities by Category

Illustration 17-2

Chapter 17-9

Held-to-Maturity SecuritiesHeld-to-Maturity SecuritiesHeld-to-Maturity SecuritiesHeld-to-Maturity Securities

Classify a debt security as held-to-maturity only if it has both

(1) the positive intent and

(2) the ability to hold securities to maturity.

Accounted for at amortized cost, not fair value.

Amortize premium or discount using the effective-interest method unless the straight-line method yields a similar result.

LO 2 Understand the procedures for discount and premium amortization on bond investments.

Chapter 17-10


Illustration: KC Company purchased $100,000 of 8

percent bonds of Evermaster Corporation on January 1,

2009, at a discount, paying $92,278. The bonds mature

January 1, 2014 and yield 10%; interest is payable each

July 1 and January 1. KC records the investment as

follows:

January 1, 2009Held-to-Maturity Securities 92,278

Cash 92,278


Chapter 17-11

LO 2

Illustration 17-3

Schedule of InterestRevenue and BondDiscount Amortization—Effective-Interest Method


Chapter 17-12


Illustration: KC Company records the receipt of the

first semiannual interest payment on July 1, 2009, as

follows:

July 1, 2009

Cash 4,000

Held-to-Maturity Securities 614

Interest Revenue 4,614


Chapter 17-13


Illustration: KC is on a calendar-year basis, it accrues

interest and amortizes the discount at December 31,

2009, as follows:

December 31, 2009

Interest Receivable 4,000


Interest Revenue 4,645


Chapter 17-14



Reporting of Held-to-Maturity Securities

Illustration 17-4

Chapter 17-15



Illustration: Assume that KC Company sells its

investment in Evermaster bonds on November 1, 2013,

at 99,750 plus accrued interest. KC records this

discount amortization as follows:

November 1, 2013


Interest Revenue 635

$952 x 4/6 = $952 x 4/6 = $635$635

Chapter 17-16


LO 2

Computation of the realized gain on sale.

Cash 102,417

Interest Revenue (4/6 x $4,000) 2,667

Held-to-Maturity Securities 99,683

Gain on Sale of Securities 67

Illustration 17-5

Chapter 17-17

Companies report available-for-sale securities at

fair value, with

unrealized holding gains and losses reported as part of comprehensive income (equity).

Any discount or premium is amortized.


Available-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale SecuritiesAvailable-for-Sale Securities Debt Debt SecuritieSecuritie

ss

Chapter 17-18


Illustration (Single Security): Graff Corporation

purchases $100,000, 10 percent, five-year bonds on

January 1, 2009, with interest payable on July 1 and

January 1. The bonds sell for $108,111, which results in

a bond premium of $8,111 and an effective interest rate

of 8 percent. Graff records the purchase of the bonds

on January 1, 2009, as follows.

Available-for-Sale Securities 108,111

Cash

108,111


ss

Chapter 17-19

LO 2

Illustration 17-6

Schedule of InterestRevenue and BondPremium Amortization—Effective-Interest Method


ss

Chapter 17-20


Illustration (Single Security): The entry to record

interest revenue on July 1, 2009, is as follows.

Cash 5,000

Available-for-Sale Securities

676

Interest Revenue

4,324


ss

Chapter 17-21


Illustration (Single Security): At December 31, 2009,

Graff makes the following entry to recognize interest

revenue.Interest Receivable 5,000


703

Interest Revenue

4,297Graff reports revenue for 2009 of $8,621 ($4,324 + $4,297).


ss

Chapter 17-22


Illustration (Single Security): To apply the fair value

method to these debt securities, assume that at year-

end the fair value of the bonds is $105,000 and that the

carrying amount of the investments is $106,732. Graff

makes the following entry.

Unrealized Holding Gain or Loss—Equity 1,732

Securities Fair Value Adjustment (AFS)

1,732


ss

Chapter 17-23


Illustration (Portfolio of Securities): Webb

Corporation has two debt securities classified as

available-for-sale. The following illustration identifies the

amortized cost, fair value, and the amount of the

unrealized gain or loss. Illustration 17-7


ss

Chapter 17-24


Illustration (Portfolio of Securities): Webb makes

an adjusting entry to a valuation allowance on

December 31, 2010 to record the decrease in value and

to record the loss as follows.



9,537

Webb reports the unrealized holding loss of $9,537 as other

comprehensive income and a reduction of stockholders’

equity.


ss

Chapter 17-25

Sale of Available-for-Sale Securities


If company sells bonds before maturity date:

Must make entry to remove the,

Cost in Available-for-Sale Securities and

Securities Fair Value Adjustment accounts.

Any realized gain or loss on sale is reported in the “Other expenses and losses” section of the income statement.


ss

Chapter 17-26


Illustration (Sale of Available-for-Sale Securities):

Webb Corporation sold the Watson bonds (from

Illustration 17-7) on July 1, 2011, for $90,000, at which

time it had an amortized cost of $94,214.

Cash 90,000

Loss on Sale of Securities 4,214


Illustration 17-8


ss

Chapter 17-27



Webb reports this realized loss in the “Other expenses

and losses” section of the income statement. Assuming

no other purchases and sales of bonds in 2011, Webb on

December 31, 2011, prepares the information:Illustration 17-9


ss

Chapter 17-28



Webb records the following at December 31, 2011.

Securities Fair Value Adjustment (AFS) 4,537


Illustration 17-9


ss

Chapter 17-29


Financial Statement PresentationIllustration 17-10


ss

Chapter 17-30

Trading SecuritiesTrading SecuritiesTrading SecuritiesTrading Securities

Companies report trading securities at

fair value, with

unrealized holding gains and losses reported as part of net income.

Any discount or premium is amortized.


Debt Debt SecuritieSecuritie

ss

Chapter 17-31

Illustration: Illustration: On December 31, 2010, Western Publishing Corporation determined its trading securities portfolio to be as follows:


Illustration 17-11

Trading SecuritiesTrading SecuritiesTrading SecuritiesTrading Securities Debt Debt SecuritieSecuritie

ss

Chapter 17-32

Illustration: Illustration: At December 31, Western Publishing makes an adjusting entry:


Illustration 17-11

Securities Fair Value Adjustment (Trading) 3,750

Unrealized Holding Gain or Loss—Income3,750


ss

Chapter 17-33

BE17-4:BE17-4: (Trading Securities) Hendricks Corporation purchased trading investment bonds for $50,000 at par. At December 31, Hendricks received annual interest of $2,000, and the fair value of the bonds was $47,400.

Instructions:

(a) Prepare the journal entry for the purchase of the investment.

(b) Prepare the journal entry for the interest received.

(c) Prepare the journal entry for the fair value adjustment.



ss

Chapter 17-34

BE17-4: BE17-4: Prepare the journal entries for (a) the purchase of the investment, (b) the interest received, and (c) the fair value adjustment.


(a) Trading securities 50,000

Cash

50,000(b) Cash 2,000

Interest revenue

2,000(c) Unrealized Holding Loss - Income 2,600

Securities Fair Value Adj.- Trading

2,600


ss

Chapter 17-35

Investments in Equity SecuritiesInvestments in Equity SecuritiesInvestments in Equity SecuritiesInvestments in Equity Securities

Represent ownership of capital stock.

Cost includes: price of the security, plus

broker’s commissions and fees related to purchase.

The degree to which one corporation (investor) acquires an interest in the common stock of another corporation (investee) generally determines the accounting treatment for the investment subsequent to acquisition.

LO 3 Identify the categories of equity securities and describe the accounting and reporting treatment for each category.

Chapter 17-36

0 --------------20% ------------ 50% -------------- 100%0 --------------20% ------------ 50% -------------- 100%

SFAS 115 APBO 18, SFAS 142

SFAS 141, SFAS 142

No significant influence usually exists

Significant influence usually exists

Control usually exists

Investment valued using Fair Value

Method

Investment valued using

Equity Method

Investment valued on parent’s books using

Cost Method or Equity Method (investment

eliminated in Consolidation)

Ownership PercentagesOwnership Percentages



Chapter 17-37



Illustration 17-13Accounting and Reporting for Equity Securities by Category

Chapter 17-38

Holdings of Less Than 20%Holdings of Less Than 20%Holdings of Less Than 20%Holdings of Less Than 20%

Accounting Subsequent to Acquisition


Market Price Available

Value and report the investment using

the fair value method.

Market Price Unavailable

Value and report the investment using

the cost method.*

* Securities are reported at cost. Dividends are recognized when received and gains or losses only recognized on sale of securities.

Chapter 17-39




Upon acquisition, companies record available-for-sale securities at cost.

Illustration: On November 3, 2010 Republic Corporation purchased common stock of three companies, each investment representing less than a 20 percent interest.

Chapter 17-40




Illustration: Republic records these investments on November 3, 2010, as follows.


Cash 718,550

On December 6, 2010, Republic receives a cash dividend of $4,200 from Campbell Soup Co.

Cash 4,200

Dividend revenue 4,200

Chapter 17-41




Illustration: Republic’s available-for-sale equity security portfolio on December 31, 2010:

Illustration 17-14

Chapter 17-42




Illustration: On December 31, 2010, Republic records the net unrealized gains and losses related to changes in the fair value of available-for-Sale equity securities in an Unrealized Holding Gain or Loss—Equity account.



35,550

Chapter 17-43




Illustration: On January 23, 2011, Republic sold all of its Northwest Industries, Inc. common stock receiving net proceeds of $287,220.

Cash 287,220


Gain on Sale of Stock 27,520

Illustration 17-15

Chapter 17-44




Illustration: On February 10, 2011, Republic purchased 20,000 shares of Continental Trucking at a price of $12.75 per share plus brokerage commissions of $1,850 (total cost, $256,850).

Illustration 17-16

Chapter 17-45




Illustration:Illustration 17-16

Securities Fair Value Adjustment (AFS) 99,800

Unrealized Holding Gain or Loss—Equity99,800

Chapter 17-46

P17-6:P17-6: McElroy Company has the following portfolio of securities at September 30, 2010, its last reporting date.



Trading Securities Cost Fair Value

Horton, I nc. common (5,000 shares) 215,000$ 200,000$

Monty, I nc. pref erred (3,500 shares) 133,000 140,000

Oakwood Corp. common (1,000 shares) 180,000 179,000

On Oct. 10, 2010, the Horton shares were sold at a price of $54 per share. In addition, 3,000 shares of Patriot common stock were acquired at $54.50 per share on Nov. 2, 2010. The Dec. 31, 2010, fair values were: Monty $106,000, Patriot $132,000, and the Oakwood common $193,000.

Chapter 17-47

P17-6:P17-6: Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2010.



Portfolio at September 30, 2010

Chapter 17-48

P17-6:P17-6: Prepare the journal entries to record the sale, purchase, and adjusting entries related to the trading securities in the last quarter of 2010.



Cash (5,000 x $54) 270,000

Trading securities

215,000

October 10, 2010 (Horton):

Gain on sale

55,000

Trading securities (3,000 x $54.50) 163,500

Cash

163,500

November 2, 2010 (Monty):

Chapter 17-49

P17-6: P17-6: Portfolio at December 31, 2010



Unrealized holding loss - Income 36,500

Securities fair value adj. - Trading

36,500

December 31, 2010:

Chapter 17-50

P17-6:P17-6: How would the entries change if the securities were classified as available-for-sale?



The entries would be the same except that the

Unrealized Holding Gain or Loss—Equity account is

used instead of Unrealized Holding Gain or Loss—

Income.

The unrealized holding loss would be deducted from

the stockholders’ equity section rather than charged

to the income statement.

Chapter 17-51

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

An investment (direct or indirect) of 20 percent or

more of the voting stock of an investee should lead

to a presumption that in the absence of evidence to

the contrary, an investor has the ability to exercise

significant influence over an investee.

In instances of “significant influence,” the investor

must account for the investment using the equity

method.

LO 4 Explain the equity method of accounting and compare it to the fair value method for equity securities.

Chapter 17-52


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 17-53

E17-17: E17-17: (Equity Method) On January 1, 2010,

Meredith Corporation purchased 25% of the common

shares of Pirates Company for $200,000. During the

year, Pirates earned net income of $80,000 and paid

dividends of $20,000.

Instructions: Prepare the entries for Meredith to record

the purchase and any additional entries related to this

investment in Pirates Company in 2010.



Chapter 17-54

E17-17: E17-17: Prepare the entries for Meredith to record the purchase and any additional entries related to this investment in Pirates Company in 2010.

Investment in Stock 200,000

Cash

200,000

Cash 5,000

Investment in Stock

5,000

Investment in Stock 20,000

Investment Revenue

20,000



($20,000 x 25%)

($80,000 x 25%)

c h a p t e r 17

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