15–1 Chapter 15 Investments. 15–2 Copyright © Cengage Learning. All rights reserved. eBay, Inc. Approximately 90% of the company’s 90 investments are

15–1

Chapter 15

Investments

15–2Copyright © Cengage Learning. All rights reserved.

eBay, Inc.

Approximately 90% of the company’s 90 investments are debt securities, yielding significant income in interest

In 2007, eBay purchased about $271 million of investments and sold about $889 million of investments

Click here to read about recent acquisitions by eBay

© Royalty Free/ Corbis


LO1 Recognition of Investments

When are purchases of investments recorded?

When are sales of investments recorded?

On which statement are income and gains or losses from investments recorded?

The date of purchase

The date of sale

The income statement © Royalty Free C Squared Studios/ Getty Images


Valuation of Investments

At the time of purchase, investments are valued at cost (cost principle)

Includes commissions and fees

After the purchase: Value is adjusted to reflect subsequent

conditions

Changes in market value

© Royalty Free PhotoDisc/ Getty Images


How Are Investments Classified?

Short-Term Investments Long-Term Investments

Maturity of more than 90 days but are intended to be held only until cash is needed for current operations

Intended to be held for more than one year

Trading securities Available-for-sale securities

Held-to-maturity securities

held principally for the purpose of being sold in the near term

securities that do not meet the criteria for either trading or held-to-maturity securities

Debt securities that management intends to hold until their maturity date


Ownership Interests

Noninfluential and noncontrolling

investment

Owns less than 20 percent of the stock of another company and has no influence on the other company’s operations

Influential but noncontrolling

investment

Owns 20 to 50 percent of another company’s stock; can exercise significant influence over that company’s operating and financial policies

Controlling investment

Owns more than 50 percent of another company’s stock and can exercise control over that company’s operating and financial policies


Ethics of Investing

Insider TradingMaking use of inside information for personal gain is unethical and illegal

Officers and employees of a company are not allowed to buy or sell stock in the company or in the firm whose shares the company is buying until the company releases investment information to the public



Discussion: Ethics on the Job

The sales director of a leading pharmaceutical company discloses information about a breakthrough drug that will likely be approved by the FDA for distribution in the U.S. to one of the company’s vendors. The vendor subsequently purchases a large block of stock in the pharmaceutical company.

Q. Do you think the vendor qualifies as an “insider” and has engaged in “insider trading”? Why or why not?

The vendor qualifies as a “temporary” insider, with respect to the information.


Stop & Review

Q. What is insider trading?

A. The illegal and unethical use of inside corporate information for personal gain


Stop & Review

Q. What is the difference between a trading security and a held-to-maturity security?

A. The difference is management’s intent to hold the security. For a trading security, the intent is to hold the security for a short period of time to yield a short-term profit. For a held-to-maturity security, the security is held to its maturity date.


Stop & Review

Q. What conditions, subsequent to purchase, are adjusted in the accounting records for the value of investments?

A. Changes in market value; changes caused by passage of time; changes in the operations of the investee company


LO2 Trading Securities

short-term investments, bought and sold to generate profits on the short-term changes in their prices

Classified as current assets, valued at fair value, which is usually the same as market value

Any change in the fair value of a company’s total trading portfolio (the group of securities it holds for trading purposes) is included in net income


Trading Securities Illustrated

Norman Company purchases 5,000 shares of stock in IBM Corporation for $450,000 ($90 per share) and 5,000 shares of stock in Microsoft for $150,000 ($30 per share) on October 25, 2010.

Record the investment in trading securities:

2010 Oct. 25 Short-Term Investments 600,000 Cash 600,000 Investment in stocks for trading

($450,000 + $150,000)



Trading Securities Illustrated (cont’d)

At year end, IBM’s stock price has decreased to $80 per share and Microsoft’s stock price has risen to $32 per share. The trading portfolio is now valued at $560,000. It has lost $40,000 in value.

Record the adjustment in value at year end: 2010 Dec. 31 Unrealized Loss on Investments 40,000 Allowance to Adjust Short-Term

Investments to Market 40,000

Recognition of unrealized loss on trading portfolio

Security Market Value

Cost Gain (Loss)

IBM (10,000 shares) $ 400,000 $ 450,000

Microsoft (10,000 shares) 160,000 150,000

Totals $ 560,000 $ 600,000 $(40,000)

The unrealized loss appears on the income statement as a reduction in income. It is unrealized because the securities have not been sold.


Trading Securities Illustrated (cont’d)

Assume Jackson sells its 5,000 shares of stock in Microsoft for $35 per share on March 2, 2011. A realized gain is recorded.

2011 Mar. 2 Cash 175,000 Short-Term Investments 150,000 Realized Gain on Investments 25,000 Sale of 5,000 shares of stock in

Microsoft for $35 per share; cost was $30 per share

The realized gain is unaffected by the adjustment for the unrealized loss at the end of 2010. The two transactions are independent of each other.


Year-End Adjustment for Trading Securities

Security Market Value Cost Gain (Loss)

IBM $ 475,000 $ 450,000

Apple 58,000 64,000

Totals 533,000 $514,000 $19,000

This amount represents the target amount for the ending balance of the Allowance to Adjust Short-Term Investments to Market account. Since

the account had a credit balance of $40,000 at the end of 2010, the journal entry to adjust should debit the account for 59,000.

2011 Dec. 31 Allowance to Adjust Short-Term Inv. To Market 59,000 Unrealized Gain on Investments 59,000

Assume that Norman’s portfolio of trading securities appears as follows at the end of 2011:

15–17

59,000 adjust

Allowance for unrealized gains/losses

40,000 Bal

Bal 19,000


Stop & Review

Q. If a company holds an available-for-sale security and it’s market value increases, how is the unrealized gain handled?

A. Reported as a special item in the stockholders’ equity section of the balance sheet.


Stop & Apply

Q. Assume Alpine Company holds trading securities worth $100,000. At year-end the market value of the securities is $90,000. Would this change in value be reflected on the financial statements? If so, on which statement?

A. The unrealized loss appears on the income statement as a reduction in income. It is unrealized because the securities have not been sold.


LO3 Noninfluential and Noncontrolling Investment

Debt or equity securities not classified as trading or held-to-maturity securities

If equity securities, must be less than 20 percent of ownership of voting stock

Account for using cost-adjusted-to-market method• Record at cost

• Adjust periodically through an allowance account for changes in market value

Available-for-sale securities:


Short-Term Available-for-Sale Securities

Accounted for in the same way as trading securities except:

An unrealized gain or loss is reported as a special item in the stockholders’ equity section of the balance sheet, not as a gain or loss on the income statement.

15–22

Long-term Available for Sale Securities if held for more than one year Unrealized gain or loss from adjustment reported in

stockholders’ equity section of balance sheet Determine portfolio cost and market at end of each

accounting period

Total market value < total cost

The dollar amount of the difference should be equal to the credit balance in the Allowance to Adjust Long-Term Investments to Market account

Total market value > total cost

The dollar amount of the difference should be equal to the debit balance in the Allowance to Adjust Long-Term Investments to Market Account


June 1, 2010: Paid cash for the following long-term investments: 5,000 shares of Murcia Corporation common stock (representing 2 percent of outstanding stock) at $25 per share; 2,500 shares of Rava Corporation common stock (representing 3 percent of outstanding stock) at $15 per share.

2010 June 1 Long-Term Investments 162,500 Cash 162,500 Investments in Murcia common stock (5,000

shares x $25 = $125,000) and Rava common stock (2,500 shares x $15 = $37,500)

Investment:

Available-for-Sale Securities Illustrated


Dec. 31, 2010: The market price of Murcia and Rava stock at year end is $21 and $17 respectively.

2010 Dec. 31 Unrealized Loss on Long-Term Investments 15,000 Allowance to Adjust Long-Term

Investments to Market

15,000 To record reduction of long-term

investment to market

Year-End Adjustment:

Company Shares Market Price Total Market Total Cost Murcia 5,000 $21 $105,000 $125,000 Rava 2,500 17 42,500 37,500

$147,500 $162,500

Total Cost – Total Market Value = $162,500 – $147,500 = $15,000

Available-for-Sale Securities Illustrated (cont’d)


April 1, 2011: Change in policy required sale of 1,000 shares of Murcia Corporation common stock at $23.

2011 Apr. 1 Cash 23,000 Loss on Sale of Investments 2,000 Long-Term Investments 25,000 Sale of 1,000 shares of Herald common

stock

1,000 x $23 = $23,000 1,000 x $25 = 25,000 Loss $ 2,000


© Royalty Free C Squared Studios/ Getty Images


July 1, 20x8: Received cash dividend from Rava Corporation equal to $0.20 per share.

2011 July 1 Cash 500 Dividend Income 500 Receipt of cash dividend from Rava stock

2,500 x $0.20 = $500


© Royalty Free C Squared Studios/ Getty Images


Dec. 31, 2011: The market price at year end for Murcia and Rava stock is $24 and $13, respectively.

Company Shares Market Price Total Market Total Cost Murcia 4,000 $24 $96,000 $100,000 Rava 2,500 13 32,500 37,500

$128,500 $137,500

Total Cost – Total Market Value = $137,500 – $128,500 = $9,000

The Allowance to Adjust Long-Term Investments to Market account and the Unrealized Loss on Long-Term Investments account must both be adjusted to carry a balance of $9,000. Since the accounts already contain $15,000, they must be adjusted by $6,000.


2011 Dec. 31 Allowance to Adjust Long-Term Investments to Market 6,000 Unrealized Loss on Long-Term Investments 6,000 To record adjustment in long-term investment

so it is reported at market

15–28

Allow unrealized

15,000 Bal

Unrealized gain/loss

15,000 BalAdjust 6,000 6,000 adjust

9,000 Bal 9,000 Bal


Influential but Noncontrolling Investment - Equity Method

to account for a stock investment when ownership is 20-50 percent and influential in nature

Equity Method1. Record the original purchase of the stock at cost

2. records its share of the company’s income as an increase in the Investment account and a credit to investment Income (income statement.)

3. When investor receives a cash dividend, Cash is increased and the Investment account is decreased.


On January 1, Shafer Corporation acquired 40 percent of the voting stock of Nica Corporation for $90,000. Jan. 1 Investments in Nica Corporation 90,000 Cash 90,000 Investment in Quay Corporation

common stock

Equity Method Illustrated

During the year, Nica Corporation reported net income of $40,000 and paid cash dividends of $10,000.

Investment in Nica Corporation 16,000 Income, Nica Corporation Investment 16,000 Recognition of 40% of income reported

by Nica Corporation 40% x $40,000 = $16,000

Cash 4,000 Investment in Nica Corporation 4,000 Cash dividend from Quay Corporation

40% x 10,000 = $4,000

15–31

Controlling Investment Consolidated Method

Ownership of more than 50 percent of a company’s voting stock

Forms a parent-subsidiary relationship

Parent

Investing company

Subsidiary

More than 50 percent of voting stock owned by another

company

Both are separate legal entities and prepare separate financial statements. Combine into consolidated statements.


Stop & Review

Q. If a company owns 35 percent of another company’s stock and its ownership is influential in nature, what method should be used to account for the stock investment?

A. Considered an influential but noncontrolling investment; use the equity method to account for the stock investment


Stop & Review

Q. If the market value of available-for-sale securities changes from the cost of those securities, what accounts are used to record this changes at year end?

A. Unrealized Gain (Loss) on Long-Term Investments and Allowance to Adjust Long-Term Investments to Market


Stop & Review

Q. If a company owns more than 50 percent of the voting stock in another company how are the financial statements handled?

A. Consolidated financial statements are prepared for this parent-subsidiary relationship


LO4 Consolidated Balance Sheet

Acquisition Accounting

A way to prepare consolidated financial statements in which similar accounts from separate statements of the parent and subsidiaries are combined

SubsidiaryParent

Transactions between the entities should not be included in

the consolidated financial statements. Eliminations appear

only on the work sheets when preparing consolidated financial

statements.


Consolidated Balance Sheet (cont’d)

What kind of transactions might occur between a parent company and a subsidiary? Purchases and sales between parent and subsidiary

• Are only transfers between different parts of the business Receivables and payables between parent and subsidiary

• Do not represent amounts due or receivable from outside parties Investment in subsidiary account

• On parent company’s balance sheet• In stockholders’ equity section of subsidiary

These accounts should be eliminated for the purpose of consolidated financial statements


Accounts Parent

Company Subsidiary

Company

Cash $50,000 $12,500 Other assets 380,000 30,000 Total assets $430,000 $42,500 Liabilities $ 30,000 $5,000 Common stock 300,000 27,500 Retained earnings 100,000 10,000 Total liabilities and stockholders’ equity $430,000 $42,500

Suppose Parent Company purchases 100 percent of the stock of Subsidiary Company for an amount exactly equal to Subsidiary’s book value, which is $37,500 ($42,500 – $5,000).

Investment in Subsidiary Company 37,500 Cash 37,500 Purchase of 100 percent of Subsidiary

Company at book value

100 Percent Purchase at Book Value

We will use this balance sheet information to prepare a consolidated balance sheet under the purchase method.

Gail Mestas

Insert MNS. 16-10, chapter 16, FA (found on page 16-132 of Galley. Place below slide title, above blue text box. Animate to be first object to appear


Work Sheet for Preparing a Consolidated Balance Sheet

Gail Mestas

Insert Exhibit 1, work sheet for preparing a consolidated baalnce sheet, chapter 16, FA (MNS 16-11 in Galley)


Less Than 100 Percent Purchase at Book Value

Must also account for minority interest: Interest of stockholders of the subsidiary owning less than

50 percent of the voting stock Equal to the percentage of ownership times the net assets

of the subsidiary Two ways to classify on consolidated balance sheet

1. Place between long-term liabilities and stockholders’ equity

2. Include in stockholders’ equity section before common stock

Financial statements are consolidated when more than 50 percent of the voting stock of a subsidiary is

purchased by the parent company.


Suppose Parent Company purchases 90 percent of the stock of Subsidiary Company for an amount less than Subsidiary’s book value, which is is $37,500 ($42,500 – $5,000).

Subsidiary Company’s stockholders’ equity $37,500 Investment in Subsidiary Company 33,750 (90% x $37,500) Minority interest $ 3,750 (10% x $37,500)

Less Than 100 Percent Purchase at Book Value

eBay, for instance, has $4 million of minority interest on the liability side of its balance sheet, which stems mainly from its

less than 100 percent ownership of Internet Auction.


Worksheet Showing Elimination When Purchase is for Less Than 100 Percent

Ownership

Gail Mestas

Insert Exhibit 2, work sheet showing elimination when purchase is for less than 100 percent ownership, chapter 16, FA (MNS 16-13 in Galley)


Purchase at More or Less Than Book Value

Reasons to pay more than book valueParent wants to purchase a controlling interest in

subsidiarySubsidiary has something parent wants

• Such as a new process, market, different product, etc.

Reasons to pay less than book valueSubsidiary’s assets are not worth their

depreciated costSubsidiary may have suffered heavy losses

• Causing its stock to sell at low prices


Intercompany Receivables and Payables

Eliminate receivables and payables where either the parent or subsidiary company owes money to the other It does not make sense for

a company to owe itselfDebit the payable and

credit the receivable for the amount of the intercompany loan

On the worksheet:



Consolidated Income Statement

Prepared by combining revenues and expenses of the parent and subsidiary companies

Intercompany transactions are eliminated to prevent double counting of revenues and expenses.• (Similar to eliminations for

preparing a consolidated balance sheet)


Consolidated Income Statement (cont’d)

Sales and purchases between parent and subsidiary Income and expenses related to loans, receivables,

or bond indebtedness between parent and subsidiaryOther income and expense from intercompany

transactions

What kinds of intercompany transactions affect the consolidated income statement?


Parent Company made sales of $60,000 in goods to Subsidiary Company, which in turn sold all the goods to others. Subsidiary Company paid Parent Company $1,000 interest on a loan from the parent.

1. To eliminate $60,000 of intercompany sales:• Debit Sales and credit Cost of Goods Sold, $60,000

2. To eliminate $1,000 interest from an intercompany loan:• Debit Other Revenues and credit Other Expenses,

$1,000

Consolidated Income Statement (cont’d)


Worksheet for Preparing a Consolidated Income Statement

Gail Mestas

Insert Exhibit 4, work sheet for preparing a consolidated income statement, chapter 16, FA (MNS 16-16 in Galley)


International Accounting

Multinational or transnational companies are those who operate in more than one country

Consolidation procedure

• Restate foreign subsidiary statements in the reporting currency before the consolidation takes place.

• For U.S. companies, the reporting currency is the U.S. dollar.



Stop & Review

Q. What are eliminating entries and where do they appear?

A. Eliminating entries remove transactions between the parent and subsidiary company that should not be included in the consolidated financial statements. They appear only on the worksheets.


Stop & Apply

Q. A Company sold its subsidiary company, B Company $500,000 in merchandise. B Company sold the merchandise to its customers. What eliminating entry should be made on the worksheet for the consolidated financial statements?

A. Debit Sales and credit Cost of Goods Sold, $500,000


LO5 Held-to-Maturity Securities

Debt securities that management intends to hold to their maturity date

On December 1, 2010, Espinosa Company pays $48,500 for U.S. Treasury bills, which are short-term debts of the federal government. The bills will mature in 120 days at $50,000.

2010 Dec. 1 Short-Term Investments 48,500 Cash 48,500 Purchase of U.S. Treasury bills

that mature in 120 days

On Dec. 31, accrue the interest earned as follows:

2010 Dec. 31 Short-Term Investments 375 Interest Income 375 Accrual of interest on U.S. Treasury bills

$1,500 x 30/120 = $375


Held-to-Maturity Securities (cont’d)

On December 31, 2010, the U.S. Treasury bills would be shown on the balance sheet as short-term investments at their amortized cost of $48,875 ($48,500 + $375). When Espinosa Company receives the maturity value on March 31, 2010, the following entry is recorded:

2011 Mar. 31 Cash 50,000 Short-Term Investments 48,875 Interest Income 1,125 Receipt of cash at maturity of U.S.

Treasury bills and recognition of related income


Long-Term Investment in Bonds

At what value is the initial investment in bonds recorded?

At cost (often the price of the bonds plus the broker’s commission)

Available-for-Sale Bonds

Company plans to sell them at some point before their

maturity date

Accounted for at fair value

Held-to-Maturity Bonds

Company intends to hold the bonds until they are paid off

on their maturity date

Accounted for at cost, adjusted for amortization of

discount or premium


Internet Research: Debt Securities

On the Web

Examples: State bond issuance & Microfinance bond issuance

City, state, and local governments issue bonds to fund expansions, renovations, and growth. Corporations and banks also use debt securities to raise money.

Use resources on the Web to locate articles and press releases about bond issuances. Select one issuance to discuss. What is the total amount of bonds issued and when will the bonds mature?


Stop & Review

Q. At what value are held-to-maturity investments shown on the balance sheet?

A. Valued on the balance sheet at cost adjusted for the effects of interest


Stop & Review

Q. Bonds that are intended to be sold at some point prior to maturity are considered to be what type of security?

A. Available-for-sale securities


Chapter Review Problem

Required: 1. At Dec. 31, 20x7, Apple shares are selling at $53.50 and GE

shares are selling at $32.50. Record the adjustment in value for these securities.

2. The market price of Hope Corporation common stock is $25.00 per share on Dec. 31, 20x7. Record the year-end adjustment.

Signway Co. holds the following portfolio of trading securities: 10,000 shares of stock in Apple, Inc. (cost $51.80 per share) and 20,000 shares of stock in GE (cost $33.50 per share). It also purchased 15,000 shares of Hope Corporation common stock (representing 4 percent of outstanding stock) at $19 per share on July 15, 20x7.


Chapter Review Problem (Solution)

Security Market Value Cost Gain (Loss)

Apple $ 535,000 $ 518,000

GE 650,000 670,000

Totals $1,185,000 $1,188,000 $(3,000)

1.

20x7 Dec. 31 Unrealized Loss on Investments 3,000 Allowance to Adjust Short-Term

Investments to Market 3,000

Recognition of unrealized loss on trading portfolio

$375,000 (market) - $285,000 (cost) = $90,000 gain2.

20x7 Dec. 31 Allowance to Adjust Long-Term Investments to Market 90,000 Unrealized Gain on Long-Term Investments 90,000 To record increase of long-term

investment to market

Documents

15–1 Chapter 15 Investments. 15–2 Copyright © Cengage Learning. All rights reserved. eBay, Inc. Approximately 90% of the company’s 90 investments are