Download Chapter 12

Financial Accounting:
Tools for Business Decision Making
Kimmel, Weygandt, Kieso, Trenholm
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Chapter 12
Reporting and Analysing
Investments
1.
2.
3.
4.
5.
6.
After studying Chapter 12, you should be able
to:
Identify the reasons corporations invest in debt and
equity securities.
Explain the accounting for debt investments.
Explain the accounting for equity investments.
Describe the purpose and usefulness of
consolidated financial statements.
Distinguish between short-term and long-term
investments.
Indicate how debt and equity investments are valued
and reported in the financial statements.
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Illustration 12-1
Short-Term
Investments and the
Operating Cycle
Illustration 12-2
Reasons Companies Invest
Debt Investments
 Investments in money market
instruments (short-term) and bonds
(long-term)
 In accounting for debt investments,
entries are required to record:
 Acquisition
 Interest revenue
 Sale
 Are recorded at cost including
brokerage fees
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Acquisition of Bonds
Kuhl Corporation acquires 50 Doan, Inc. 12%,
10-year, $1,000 on Jan. 1 for $54,000.
1/1 Debt investments 54,000
Cash
54,000
(To record purchase of 50 Doan, Inc. bonds)
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Bond Interest
The bonds pay interest of $3,000
semiannually on July 1 and January 1.
The entry to record the receipt of interest
on July 1 is:
7/1 Cash
3,000
Interest Revenue
3,000
(To record receipt of interest on Doan Inc.
bonds)
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Accrued Bond Interest
If the buyer’s (Kuhl) fiscal year ends on
December 31, the following adjusting
entry is needed to accrue interest of
$3,000 earned since July 1:
12/31 Interest Receivable 3,000
Interest Revenue
3,000
(To accrue interest on Doan Inc. bonds)
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Sale of Bonds
Kuhl sells the bonds for $58,000 on January
1, 2002, after receiving the interest due.
*The bonds were purchased for $54,000.
Kuhl must record a gain of $4,000. The entry
to record the sale of the bonds is as follows:
1/1 Cash
58,000
Debt Investments
54,000
Gain on sale of Debt Investments 4,000
(To record sale of Doan Inc. bonds)
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Equity Investments
 Investments in the share capital
(preferred or common) of
corporations
 Accounting for investments in
common shares is based on the
extent of the investor's degree of
influence over the operating and
financial affairs of the issuing
corporation (the investee)
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Equity Investments
 Factors to consider in determining
degree of influence are whether:
 Investor has representation on the
investee's board of directors
 Investor participates in the investee's
policy-making process
 Material transactions between the investor
and the investee
 Common shares held by other shareholders
are concentrated or dispersed
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Illustration 12-3
Accounting Guidelines Equity Investments
Cost Method
(less than 20%)
 Record investment at cost
 Cost includes all expenditures
necessary to acquire these
investments, such as the price paid
plus brokerage fees (commissions),
if any
 Recognize revenue when cash
dividends are declared
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Acquisition of Shares
On July 1, 2001, Passera Corporation
acquires 1,000 shares (10% ownership)
of Beal Corporation common shares at
$40 per share plus brokerage fees of
$500
7/1 Equity Investments
40,500
Cash
40,500
(To record purchase of 1,000 Beal common
shares)
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Dividends
$2.00 per share dividend is received by
Passera Corporation on December 31:
12/31
Cash (1,000 x $2)
2,000
Dividend Revenue
2,000
(To record receipt of cash dividend)
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Sale of Shares
 Net proceeds from the
sale (sales price less
brokerage fees) - Cost
of the shares =Gain
(Loss)
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Sale of Shares
Passera Corporation receives net
proceeds of $39,500 on the sale of its
Beal Corporation shares on February 10,
2002
1/1
Cash
39,500
Loss on Sale of Equity
Investments
1,000
Equity Investments
40,500
(To record sale of Beal common shares)
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Equity Method
(more than 20%)
 Investment in common shares
initially recorded at cost
 Investment account adjusted
annually to show the investor’s
equity in the investee
 Investor has significant influence
over investee
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Acquisition of Shares
Milar Corporation acquires 30% of the
common shares of Beck Company for
$120,000 on January 1, 2001
1/1 Equity Investments
120,000
Cash
120,000
(To record purchase of Beck common shares)
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Net Earnings (Loss) and
Dividends
 For 2001, Beck reports net earnings of
$100,000 and declares and pays a
$40,000 cash dividend
 Milar is required to record
 It’s share of Beck's earnings, $30,000
(100,000 x 30%)
 The reduction in the investment account
for the dividends received, $12,000
($40,000 x 30%)
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Revenue and Dividends
12/31 Equity Investments
30,000
Revenue from Investment
in Beck Company
30,000
(To record 30% equity in Beck's 2001 net earnings)
12/31 Cash
Equity Investments
(To record dividends received)
12,000
12,000
During the year the investment account has increased
by $18,000 ($30,000 - $12,000)
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Controlling Interest
 Controlling interest
 Usually more than 50% of
the common shares of
another entity
 Investor – parent company
 Investee – subsidiary
company
 Investor and investee are,
in some sense, one
company
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Consolidated Financial
Statements
 Inform creditors, investors, and
others of magnitude and scope of
operations of companies under
common control
 Present assets and liabilities
controlled by parent and aggregate
profitability of subsidiary companies
 Prepared in addition to financial
statements for individual parent and
subsidiary companies
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Short- and Long-Term
Investments
 Investments include short-term
paper (certificates of deposit,
treasury bills, commercial paper),
debt securities (government and
corporate bonds) and equity
securities (preferred and common
shares)
 These can be classified as either
short-term or long-term
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Short- and Long-Term
Investments
 Short-term investments are debt or
equity securities, held by a company,
that are
 Readily marketable
 Intended to be converted into cash in
the near future
 Investments that do not meet both
criteria (readily marketable; intent to
convert) are classified as long-term
investments
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Valuation of Investments
 Value of debt and equity investments
may fluctuate greatly during the time
they are held
 Conservatism requires accountants
to use the lower of cost and market
(LCM) rule
 Application of the LCM rule varies
depending upon whether the
investment is short- or long-term
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Valuation of Short-Term
Investments
 LCM normally applied to total
portfolio
 Allowance to Reduce Cost to Market
Value used to record the difference
between cost and market value
 Allowance account is a contra asset
account deducted from the cost of
the investments to arrive at the LCM
valuation
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Reporting of Short-Term
Investments
Current Assets
Cash
xxx
Short-term investments, at cost
$140,000
Less: Allowance to reduce cost to market value
2,000
Short-term investments, at market
138,000
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Valuation of Long-Term
Investments
 LCM applied to individual investments
 Carrying values not adjusted to reflect
temporary fluctuations in market
value
 When market falls below cost and the
decline is not temporary, reduce
investment to market value
 Investment is credited directly; no
Allowance account is used
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Evaluating Investment
Portfolio Performance
 Time sale of investments before
year-end
 Misclassification of investments as
short- and long-term
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Balance Sheet
Presentation
 Short-term investments
 Report at LCM in current asset section of
balance sheet
 Disclose market value
 Present after Cash or combined with
Cash as a cash equivalent
 Long-term investments
 Separate section of the balance sheet
immediately below Current Assets
 Report at cost or at equity (if significant
influence)
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Decision Checkpoints
 Is the company window-dressing its
results by manipulating its
investment portfolio?
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Copyright
Copyright © 2001 John Wiley & Sons Canada, Ltd. All
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these programs or from the use of the information
contained herein.
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