Investments
Chapter15
An electronic presentation by Norman Sunderman Angelo State University
An electronic presentation by Norman Sunderman Angelo State University
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Intermediate AccountingIntermediate Accounting 10th edition 10th edition
Nikolai Bazley JonesNikolai Bazley Jones
2
1. Explain the classification and valuation of investments.
2. Account for investments in debt and equity trading securities.
3. Account for investments in available-for-sale debt and equity securities.
4. Account for investments in held-to-maturity debt securities, including amortization of bond premiums and discounts.
Objectives
3
5. Understand transfers and impairments.
6. Understand disclosures of investments.
7. Explain the conceptual issues regarding investments in marketable securities.
8. Account for investments using the equity method.
9. Describe additional issues for investments.
10. Account for derivatives of financial instruments. (Appendix)
Objectives
4
1. Additional revenues from idle cash.
2. Control over another company.
3. Beneficial relationship with another company.
Why Companies Invest in Other Companies
5
Classification of Investments
1. Trading securities
2. Available-for-sale securities
3. Held-to-maturity debt securities
6
Trading securities are investments in debt and equity securities that are
purchased and held principally for the purpose of selling them in the near
term.
Trading securities are investments in debt and equity securities that are
purchased and held principally for the purpose of selling them in the near
term.
Classification of Investments
7
Trading securities are investments in debt and equity securities that are purchased and held principally for the purpose of
selling them in the near term.
Trading securities are investments in debt and equity securities that are purchased and held principally for the purpose of
selling them in the near term.
These securities are reported at their fair market value on the balance sheet date, and unrealized holding gains and losses are included in net income of the
period.
These securities are reported at their fair market value on the balance sheet date, and unrealized holding gains and losses are included in net income of the
period.
Trading Securities
8
Investments in available-for-sale securities are (a)
debt securities that are not classified as being held to
maturity, and...
Investments in available-for-sale securities are (a)
debt securities that are not classified as being held to
maturity, and...
Available-for-Sale Securities
9
…(b) debt and equity securities that are not
classified as trading securities.
…(b) debt and equity securities that are not
classified as trading securities.
Available-for-Sale Securities
10
Investments in available-for-sale securities are reported at their fair value on the balance sheet date. The unrealized holding gains or losses are included in other comprehensive income.
Investments in available-for-sale securities are reported at their fair value on the balance sheet date. The unrealized holding gains or losses are included in other comprehensive income.
Available-for-Sale Securities
11
Therefore, the unrealized holding gains and losses for
available-for-sale securities are not included in net income.
Therefore, the unrealized holding gains and losses for
available-for-sale securities are not included in net income.
Available-for-Sale Securities
12
Investments in held-to-maturity debt securities are debt securities for which the
company has the positive intent and ability to hold until
they mature.
Investments in held-to-maturity debt securities are debt securities for which the
company has the positive intent and ability to hold until
they mature.
Held-to-Maturity Securities
13
Investments in held-to-maturity debt securities are reported at
their amortized cost on the balance sheet…not their fair
value.
Investments in held-to-maturity debt securities are reported at
their amortized cost on the balance sheet…not their fair
value.
Held to Maturity Securities
14
Accounting for Investments Reporting of
Unrealized Holding Method Gains and Losses
Investment in Equity Securities1. No significant influence
a. Trading Fair value Net Incomeb. Available for sale Fair value Other comprehen-
sive income2. Significant influence Equity method Not recognized3. Control Consolidation Not recognized
15
Accounting for Investments Reporting of
Unrealized Holding Method Gains and Losses
Investment in Debt Securities1. Trading Fair value Net Income2. Available for sale Fair value Other comprehen-
sive income3. Held to maturity Amortized cost Not recognized
16
Investments in Available-for-Sale
Debt and Equity Securities1. The investment is initially recorded at cost.
2. It is subsequently reported at fair value.
3. Unrealized holding gains and losses are reported as a component of other comprehensive income.
4. Interest and dividend revenue, as well as realized gains and losses on sales, are included in net income for the current period.
17
• 100 shares of A Company common stock at $50 per share
• 300 shares of B Company common stock at $80 per share
• 200 shares of Company C preferred stock at $120 per share.
• $15,000 Company D 10% bonds
• 100 shares of A Company common stock at $50 per share
• 300 shares of B Company common stock at $80 per share
• 200 shares of Company C preferred stock at $120 per share.
• $15,000 Company D 10% bonds
$ 5,000
24,000
24,00015,000
$ 5,000
24,000
24,00015,000
Kent Company purchases the following securities on May 1, 2006, as an investment in
available-for-sale securities:
Total $68,000
Investments in Available-for-Sale
Debt and Equity Securities
18
Investment in Available-for-Sale Securities 68,000Interest Revenue 625 Cash 68,625
See Page 709
Investments in Available-for-Sale
Debt and Equity Securities
19
Accrued interest on the D Company bond from November 30, 2005, to May 31, 2006
Accrued interest on the D Company bond from November 30, 2005, to May 31, 2006
May 31, 2006
Interest Revenue 750
$15,000 x 0.10 x 6/12$15,000 x 0.10 x 6/12
Investments in Available-for-Sale
Debt and Equity Securities
Cash 750
20
December 31, 2006Interest Receivable 125 Interest Revenue 125
Cash 3,000 Dividend Revenue 3,000
$15,000 x 0.10 x 1/12$15,000 x 0.10 x 1/12$15,000 x 0.10 x 1/12$15,000 x 0.10 x 1/12
During 2006 Kent Company receives dividends of $3,000 from its investment in
the stocks of A, B, and C Companies.
During 2006 Kent Company receives dividends of $3,000 from its investment in
the stocks of A, B, and C Companies.
Investments in Available-for-Sale
Debt and Equity Securities
21
The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:
The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:
CumulativeChange
Fair in FairSecurity Cost Value Value
100 shares of A Co. common stock $ 5,000 $ 6,000 $1,000 300 shares of B Co. common stock 24,000 23,500 (500)200 shares of C Co. preferred stock 24,000 26,000 2,000 D Company 10% bonds 15,000 15,500 500 Totals $68,000 $71,000 $3,000
Investments in Available-for-Sale
Debt and Equity Securities
12/31/06
22
The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:
The cost and fair value of the available-for-sale securities held by the Kent Company is as follows:
CumulativeChange
Fair in FairSecurity Cost Value Value
100 shares of A Co. common stock $ 5,000 $ 6,000 $1,000 300 shares of B Co. common stock 24,000 23,500 (500)200 shares of C Co. preferred stock 24,000 26,000 2,000 D Company 10% bonds 15,000 15,500 500 Totals $68,000 $71,000 $3,000
Investments in Available-for-Sale
Debt and Equity Securities
12/31/06Allowance for Change in ValueAllowance for Change in Value of Investmentof Investment 3,0003,000 Unrealized Increase/DecreaseUnrealized Increase/Decrease in Value of Available-for-in Value of Available-for- Sale SecuritiesSale Securities 3,0003,000
Allowance for Change in ValueAllowance for Change in Value of Investmentof Investment 3,0003,000 Unrealized Increase/DecreaseUnrealized Increase/Decrease in Value of Available-for-in Value of Available-for- Sale SecuritiesSale Securities 3,0003,000
23
The same securities are held on December 31, 2007.The same securities are held on December 31, 2007.
Cumulative Change Fair in FairSecurity Cost Value Value
100 shares of A Co. common stock $ 5,000 $ 6,100 $1,100 300 shares of B Co. common stock 24,000 22,700 (1,300)200 shares of C Co. preferred stock 24,000 23,200 (800)D Company 10% bonds 15,000 14,000 (1,000) Totals $68,000 $66,000 $(2,000)
Investments in Available-for-Sale
Debt and Equity Securities
12/31/07
24
12/31/06 3,000 5,000 adjusting entry
2,000 12/31/07
Allowance for Change in Value of Investment
Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 5,0005,000 Allowance for Change in Value ofAllowance for Change in Value of InvestmentInvestment 5,0005,000
Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 5,0005,000 Allowance for Change in Value ofAllowance for Change in Value of InvestmentInvestment 5,0005,000
25
Sale of Available-for-Sale Securities
On March 1, 2008, the Kent Company sold 100 shares of A Company stock for $6,000. The stock
had a fair value on Dec. 31, 2007, of $6,100.
On March 1, 2008, the Kent Company sold 100 shares of A Company stock for $6,000. The stock
had a fair value on Dec. 31, 2007, of $6,100.
Cash 6,000 Investment in Available-for- Sale Securities 5,000 Gain on Sale of Available-for- Sale Securities 1,000
The Unrealized Increase/Decrease in Value (DR) and the allowance (CR) account are reduced by $1,100.
The Unrealized Increase/Decrease in Value (DR) and the allowance (CR) account are reduced by $1,100.
26
Cumulative 12/31/08 Change Fair in FairSecurity Cost Value Value
300 shares of B Co. common stock $24,000 $23,500 $(500)200 shares of C Co. preferred stock 24,000 24,100 100 D Company 10 bonds 15,000 14,700 (300) Totals $63,000 $62,300 $(700)
Available-for-Sale SecuritiesDecember 2008
27
700 12/31/08
2,400 adjusting entry2,000 12/31/07 1,100 3/1/08
Allowance for Change in Value of Investments
Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 2,4002,400 Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 2,4002,400
Allowance for Change in Value of InvestmentAllowance for Change in Value of Investment 2,4002,400 Unrealized Increase/Decrease in Unrealized Increase/Decrease in Value of Available-for-Sale SecuritiesValue of Available-for-Sale Securities 2,4002,400
28
Classify Recognize Recognize Compute According to Interest and Realized Realized Management Dividend Gain or Gain or Intent as: Revenue in: Loss in: Loss as:
Trading Net Income Net Income Selling Price minus
Fair Value at Most
Recent BalanceSheet Date
Available- Net Income Net Income Selling price minus
for-Sale (Amortized) Cost Held-to- Net Income Net Income Selling Price minus
Maturity (Amortized) Cost
Accounting for Investments
29
Investments in Held-to-Maturity Debt Securities
1. The investment is initially recorded at cost.
2. It is subsequently reported at amortized cost.
3. Unrealized holding gains and losses are not recorded.
4. Interest revenue and realized gains and losses on sales (if any) are all included in net income.
30
A company purchases 9% bonds with a face value of $100,000 on August 1, 2006, at 99 plus
accrued interest, which is payable semiannually.
A company purchases 9% bonds with a face value of $100,000 on August 1, 2006, at 99 plus
accrued interest, which is payable semiannually.
Investment in Held-to-Maturity Debt Securities 99,000Interest Revenue 1,500 Cash 100,500
$100,000 x 0.99$100,000 x 0.99
$100,000 x 0.09 x 2/12$100,000 x 0.09 x 2/12
Investments in Held-to-Maturity Debt Securities
31
Accounting for Bond Premiums
On January 1, 2006, Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000, paying $102,458.71. The stated rate is
13% and the effective interest rate is 12%.
On January 1, 2006, Colburn Company invests in bonds that will be held to maturity, with a face value of $100,000, paying $102,458.71. The stated rate is
13% and the effective interest rate is 12%.
Investment in Held-to- Maturity Debt Securities 102,458.71 Cash 102,458.71
32
Colburn Company records the first interest receipt on June 30, 2006, using the effective interest method.
Colburn Company records the first interest receipt on June 30, 2006, using the effective interest method.
Cash 6,500.00 Investment in Held-to- Maturity Debt Securities 352.48 Interest Revenue 6,147.52
$100,000 x 0.13 x 1/2$100,000 x 0.13 x 1/2
$102,458.71 x .12 x 1/2$102,458.71 x .12 x 1/2$102,458.71 x .12 x 1/2$102,458.71 x .12 x 1/2
Accounting for Bond Premiums
33
Accounting for Bond Discounts
On January 1, 2006, Colburn Company invests in bonds that will be held to maturity, with a
face value of $100,000, paying $97,616.71. The stated rate is 13% and the effective interest rate
is 14%.
On January 1, 2006, Colburn Company invests in bonds that will be held to maturity, with a
face value of $100,000, paying $97,616.71. The stated rate is 13% and the effective interest rate
is 14%.
Investment in Held-to- Maturity Debt Securities 97,616.71 Cash 97,616.71
34
Colburn Company records the first interest receipt on June 30, 2006,
using the effective interest method.
Colburn Company records the first interest receipt on June 30, 2006,
using the effective interest method.
Cash 6,500.00Investment in Held-to- Maturity Debt Securities 333.17 Interest Revenue 6,833.17
$97,616.71 x .14 x 1/2$97,616.71 x .14 x 1/2$97,616.71 x .14 x 1/2$97,616.71 x .14 x 1/2
Accounting for Bond Discounts
35
Trading Cost Fair Value Net Income
Available- Cost Fair Value Other Compre-for-Sale hensive Income
Held-to- Cost Amortized ---Maturity Cost
Classify Subsequently Recognize According to Report on the Unrealized Management Initially Balance Holding Gains Intent as: Record as: Sheet at: and Losses in:
Investment in Securities
36
Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2006.
Interest on these bonds is payable June 30 and December 31, and the bonds mature on December 31,
2008.
Tallen Company purchased 13% bonds with a face value of $200,000 for $204,575.07 on April 3, 2006.
Interest on these bonds is payable June 30 and December 31, and the bonds mature on December 31,
2008.
Investment in Held-to-MaturityDebt Securities 204,575.07
Interest Revenue 6,500.00Cash 211,075.07
ContinuedContinuedContinuedContinued
Amortization of Bonds Acquired Between Interest Dates
$200,000 x $200,000 x 0.13 x 3/120.13 x 3/12$200,000 x $200,000 x 0.13 x 3/120.13 x 3/12
37
June 30, 2006
Cash 13,000.00Interest Revenue 12,637.25Investment in Held-to-Maturity Debt Securities 362.75
$13,000 $13,000 –– $12,637.25$12,637.25$13,000 $13,000 ––
$12,637.25$12,637.25ContinuedContinued
Amortization of Bonds Acquired Between Interest Dates
($204,575.07 ($204,575.07 x 0.12 x ¼) x 0.12 x ¼)
+ $6,500+ $6,500
($204,575.07 ($204,575.07 x 0.12 x ¼) x 0.12 x ¼)
+ $6,500+ $6,500
38
December 31, 2006
Cash 13,000.00Interest Revenue 12,252.74Investment in Held-to-Maturity Debt Securities 747.26
$13,000 – $12,252.74$13,000 –
$12,252.74
Amortization of Bonds Acquired Between Interest Dates
($204,575.07 ($204,575.07 - $362.75) X - $362.75) X 0.12 X 1/20.12 X 1/2
($204,575.07 ($204,575.07 - $362.75) X - $362.75) X 0.12 X 1/20.12 X 1/2
39
The $100,000 of 13% bonds purchased by the Colburn Company for $97,616.71 were sold on
March 31, 2007, for $102,000 plus accrued interest.
The $100,000 of 13% bonds purchased by the Colburn Company for $97,616.71 were sold on
March 31, 2007, for $102,000 plus accrued interest.
Investment in Held-to-MaturityDebt Securities 198.61
Interest Revenue 198.61
($2,383.29 ($2,383.29 ÷ ÷ 6) x ½6) x ½
($2,383.29 ($2,383.29 ÷ ÷ 6) x ½6) x ½
ContinuedContinued
Sale of Investment in Bonds Before Maturity
40
Sale of Investment in Bonds Before Maturity
41
Cash 105,250.00Interest Revenue 3,250.00Gain on Sale of Debt Securities 3,390.24Investment in Held-to-Maturity
Debt Securities 98,609.76
$98,411.15 + $98,411.15 + $198.61$198.61
$98,411.15 + $98,411.15 + $198.61$198.61
Sale of Investment in Bonds Before Maturity
$100,000$100,000 x 0.13 x ¼x 0.13 x ¼$100,000$100,000
x 0.13 x ¼x 0.13 x ¼
$102,000 $102,000 + $3,250+ $3,250
$102,000 $102,000 + $3,250+ $3,250
42
1. A transfer from the trading category.
2. A transfer into the trading category.
3. A transfer into the available for sale category.
4. A transfer of a debt security into the held to maturity category from the available for sale category.
Transfers of Investments Between Categories
43
In 2007, Kent transfers the Company A securities into the trading category when the fair value is $6,300.
In 2007, Kent transfers the Company A securities into the trading category when the fair value is $6,300.
Investment in Trading Securities 6,300 Investment in Available-for- Sale Securities 5,000 Gain on Transfer of Securities 1,300
Unrealized Increase/Decrease in Value of Available-for-Sale Securities1,100 Allowance for Change in Value of Investment 1,100
Transfer from Available-for-Sale to Trading Securities
44
Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500,
Devon transfers them to the available-for-sale category.
Devon Company has $10,000 in bonds that were purchased at par. When the fair value is $9,500,
Devon transfers them to the available-for-sale category.
Investment in Available-for-Sale Securities 10,000 Investment in Held-to- Maturity Debt Securities 10,000Unrealized Increase/Decrease in Value of Available-for-Sale Securities 500 Allowance for Change in Value of Investment 500
Transfers from Held-to-Maturity to Available-for-Sale
45
Disclosures1. Trading Securities--A company must disclose the
change in the net unrealized holding gain or loss that is included in each income statement.
2. Available-for-Sale Securities--For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains and gross unrealized holding losses and (amortized cost) by major types.
3. Held-to-Maturity Debt Securities--For each balance sheet date, a company must disclose the aggregate fair value, gross unrealized holding gains, gross unrealized holding losses, and amortized cost by major security types.
46
Devon Company classifies its bond investment as available for sale with a previous fair vale of $9,700,
and transfers them into the held-to-maturity category when the current market value of the debt securities
is $9,500.
Devon Company classifies its bond investment as available for sale with a previous fair vale of $9,700,
and transfers them into the held-to-maturity category when the current market value of the debt securities
is $9,500.
Investment in Held-to-Maturity Debt Securities 9,500Unrealized Increase/Decrease from Transfer of Securities 500 Investment in Available-for- Sale Securities 10,000
ContinuedContinuedContinuedContinued
Transfer from Available-for-Sale to Held to Maturity
47
An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amount in the allowance and
unrealized increase/decrease accounts.
An entry is needed to eliminate the previous $300 ($9,700 – $10,000) amount in the allowance and
unrealized increase/decrease accounts.
Allowance for Change in Value of Investment 300 Unrealized Increase/Decrease in Value of Available-for-Sale Securities 300
Transfer from Available-for-Sale to Held to Maturity
48
Impairments may be an “other than temporary” decline below the
amortized cost of an investment in a debt security classified as available
for sale or held to maturity.
Impairments may be an “other than temporary” decline below the
amortized cost of an investment in a debt security classified as available
for sale or held to maturity.
Impairments
49
Tracy Company has a bond investment categorized as held to maturity, which has an unamortized carrying amount of $21,500 and a fair value of
$6,500. The investment is considered to be “impaired.”
Tracy Company has a bond investment categorized as held to maturity, which has an unamortized carrying amount of $21,500 and a fair value of
$6,500. The investment is considered to be “impaired.”
Realized Loss on Decline in Value 15,000 Investment in Held-to-Maturity Debt Securities 15,000
Impairments
50
Current AssetsTemporary investment in available-for-sale securities (at cost)
$29,000Plus: Allowance for change in value of investment
500Temporary investment in available-for-sale securities (at fair value)
$29,500
Noncurrent AssetsInvestment in available-for-sale securities (at cost) $39,000Plus: Allowance for change in value of investment 2,500Investment in available-for-sale securities (at fair value) $41,500
Financial Statement Classification
51
1. Fair value is required in the balance sheet for trading securities and available-for-sale securities, whereas amortized cost is required for held-to-maturity securities.
2. Fair value is not required for certain liabilities.
3. Unrealized holding gains and losses are reported in net income for trading securities, but in other comprehensive income for available-for-sale securities.
4. The classification of securities is based on management intent.
FASB 115: A Conceptual Evaluation
52
Equity Method
When an investor corporation owns a significantly large
percentage of common stock, it is able to exert
significant influence over the policies of the investee corporation. The equity
method is used to account for this investment.
When an investor corporation owns a significantly large
percentage of common stock, it is able to exert
significant influence over the policies of the investee corporation. The equity
method is used to account for this investment.
53
Acknowledges the existence of a material economic relationship between the investor and the investee.
Is based upon the requirements of accrual accounting.
Reflects the change in stockholders’ equity of the investee company.
Equity Method
54
According to FASB Interpretation No. 35, what are the facts and
circumstances that indicate that investors
with 20% or more in the investee’s stock should not
use the equity method?
According to FASB Interpretation No. 35, what are the facts and
circumstances that indicate that investors
with 20% or more in the investee’s stock should not
use the equity method?
Equity Method
In the absence of evidence to the contrary, an
investment of 20% or more in the outstanding
common stock of the investee leads to the
presumption of significant influence.
In the absence of evidence to the contrary, an
investment of 20% or more in the outstanding
common stock of the investee leads to the
presumption of significant influence.
55
Opposition by the investee which challenges the investor’s ability to exercise significant influence.
The investor and investee sign an agreement under which the investor surrenders significant stockholder’s rights.
Majority ownership of the investee is concentrated among a small group of shareholders who operate the investee without regard to views of the investor.
Inability to gather information not available to other shareholders.
Failure to obtain representation on investee’s board of directors.
Equity Method Not Used
56
Cliborn Company purchases 4,200 shares of the S company’s outstanding stock (25%) on January 1,
2007, for $125,000 (significant influence).
Cliborn Company purchases 4,200 shares of the S company’s outstanding stock (25%) on January 1,
2007, for $125,000 (significant influence).
Investment in Stock: S Company 125,000 Cash 125,000
S Company pays a $20,000 dividend.S Company pays a $20,000 dividend.
Cash 5,000 Investment in Stock: S Company 5,000
See Page 731
Equity Method
57
S Company reported net income for 2007 of $81,000, consisting of ordinary income of $73,000
and an extraordinary gain of $8,000.
S Company reported net income for 2007 of $81,000, consisting of ordinary income of $73,000
and an extraordinary gain of $8,000.
Investment in Stock: S Company 20,250 Investment Income: Ordinary 18,250 Investment Income: Extraordinary 2,000
25% of $81,00025% of $81,00025% of $73,00025% of $73,000
25% of 8,00025% of 8,00025% of 8,00025% of 8,000
Equity Method
58
Balance Sheet Book Value Fair Value
Depreciable assets $400,000 $450,000 (remaining life, 10 yrs)Other nondepreciable assets 190,000 246,000 (e.g., land) Total $590,000$696,000
Liabilities $200,000 $220,000Common Stock 250,000 Retained earnings 140,000Total $590,000
Equity MethodInvestment Book Value Difference X
% of Investment
50,000 X 25% = 12,500
59
When acquired by S Company, the investee’s depreciable assets had a fair market value that exceeded book value by $50,000 (10-year life). Cliborn’s share of the depreciable asset value is $12,500 (25%). Additional depreciation is
needed on December 31.
When acquired by S Company, the investee’s depreciable assets had a fair market value that exceeded book value by $50,000 (10-year life). Cliborn’s share of the depreciable asset value is $12,500 (25%). Additional depreciation is
needed on December 31.
Investment Income: Ordinary 1,250 Investment in Stock: S Company 1,250
Note that this entry results in a deduction from ordinary income.
Note that this entry results in a deduction from ordinary income.
Equity Method
$12,500 / $12,500 / 10 years10 years
60
Investment 125,000Ordinary income 18,250 Extraordinary income 2,000
5,000 Dividends received
1,250 Excess depreciation
Ending balance 139,000
Disclosure-Carrying Value
61
Disclosure-Equity Income
Share of 2007 ordinary income $18,250
Less: excess depreciation 1,250
Ordinary investment income $17,000
Plus: investee extraordinary income 2,000
Net investment income $19,000
62
Stock Dividends
Smith Corporation purchased 2,000 shares of Kell Company common stock for $30 per share. Two months later, Kell issued a 50% stock dividend.
Smith Corporation purchased 2,000 shares of Kell Company common stock for $30 per share. Two months later, Kell issued a 50% stock dividend.
Memo: Received 1,000 shares of Kell Company common stock as a stock dividend. The cost of the shares is now $20 per share, computed as follows:
$60,000 ÷ 3,000 (2,000 + 1,000) shares.
63
Subsequently, Smith Corporation sold 500 of the shares for $25 per share, and the fair value at the most recent balance sheet date was $23 per share.
Subsequently, Smith Corporation sold 500 of the shares for $25 per share, and the fair value at the most recent balance sheet date was $23 per share.
Cash 12,500 Investment in Available-for-Sale Securities 10,000 Gain on Sale of Investment 2,500Unrealized Increase/Decrease in Value of Available-for Sale Securities 1,500 Allowance for Change in Value of Investment 1,500
Stock Dividends
64
Merle Corporation paid an annual insurance premium of $5,500 at the
beginning of the year to cover the lives of its officers.
Merle Corporation paid an annual insurance premium of $5,500 at the
beginning of the year to cover the lives of its officers.
Prepaid Insurance 5,500 Cash 5,500
ContinuedContinuedContinuedContinued
Cash Surrender Value of Life Insurance
65
Insurance Expense 4,400Cash Surrender Value of Life Insurance 1,100 Prepaid Insurance 5,500
$8,300 $8,300 –– $7,200 $7,200$8,300 $8,300 –– $7,200 $7,200
Cash Surrender Value of Life Insurance
According to the terms of the insurance contract, the cash surrender value
increases from $7,200 to $8,300 during the year.
According to the terms of the insurance contract, the cash surrender value
increases from $7,200 to $8,300 during the year.
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Appendix-DerivativesDerivatives are financial instruments, such as forwards and options whose value depends upon the value of an underlying instrument such as a security, commodity, currency or interest rate. Hence, they are "derived" from these underlying instruments. Derivatives are used to transfer risk, and companies often use them to reduce the risk of adverse changes in interest rates, commodity prices, and foreign currency exchange rates.The fair value of a derivative fluctuates with movements in the underlying instrument (for example, if interest rates increase, the value of a swap to pay a fixed interest rate increases).
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Derivatives
The two basic types of derivatives are:–Forward contracts
•Forwards
•Futures
•Swaps
–Option contracts•Puts
•Calls
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Forward or Future ContractsContracts to purchase or sell a commodity or
stock, such as grain, oil, or livestock, at a given price in the future. The purpose is to lock in a price. A seller wants to guarantee a current price for future delivery and a buyer wants to assure a steady supply of raw materials at a given price.– A forward is a privately-negotiated contract to be satisfied in the
future.– A future is a standardized forward contract, that can be traded on
an exchange, like the Chicago Board of Trade.– A swap is a bundle of forward contracts, often used by companies
to switch floating-rate debt to fixed-rate debt.• Each interest payment would, in effect, be covered by an
individual forward contract.• A swap combines all these small forward contracts into one
instrument.
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HedgesFair value hedge – protects against the
risk from changes in value caused by fixed terms, rates or prices.– For example, a company with debt that has a
fixed interest rate that enters into an interest rate swap to pay a variable rate of interest and receive a fixed rate.
– This protects the company against paying more interest than necessary if interest rates decline.
– Gains or losses on the market value of these hedges flow through net income.
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HedgesCash flow hedge – protects against the
risk caused by variable prices, costs, rates, or terms that cause future cash flows to be uncertain– For example, a company with variable rate debt that
enters into a swap to pay a fixed rate of interest and receive a variable rate.
– This guarantees that the company will pay a fixed rate, no matter what happens to interest rates in the market.
– Gains or losses of “effective” cash flow hedges flow through other comprehensive income.
– “Effectiveness” is determined by how well the terms of the hedge, such as time period and notional value, match the terms of the underlying debt.
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Hedges
Foreign currency hedge -to reduce the risk of currency fluctuation for transactions and investments in foreign currencies. –Foreign currency hedges can be structured so that they behave like fair value hedges OR cash flow hedges.
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Options
A call enables the owner to purchase a commodity, security, or currency at a set price in the future, but is under no obligation to do so. Any gain or loss is included in net income.
A put enables the owner to sell a commodity, security, or currency at a set price in the future, but again is under no obligation to do so. Any gain or loss is included in net income.
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Chapter15
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