Download Investments in Stocks and Bonds of Other Companies

Investments in Stocks
and Bonds of Other
Companies
Chapter 23
Classifications of
Investments
• Less than 20% ownership
– investor company has no influence over the
investee
• 20% to 50% ownership
– investor company has significant influence over
the investee
• More than 50% ownership
– investor company has control over the investee
Accounting for Investments
Exhibit 23-1
Type of Investment
Method
Investments in Common Stock
No influence
Market value method
Significant influence
Equity method
Control
Consolidation method
Investments in Bonds
Available-for-sale
Market value method
Held-to-maturity
Amortized cost method
Market Prices of
Stocks and Bonds
•
•
•
•
Publicly traded companies
Stockbroker
Stock exchange
Over-the-counter market
Market Value Method
• Used for available-for-sale securities
(marketable securities)
• Stock - less than 20% ownership
• Bonds - when investor does not expect to
hold the bonds until their maturity date
Purchase of
Marketable Securities
Investment in Availablefor-Sale Securities
Cash
12,000
12,000
Recording Dividends
and Interest
Cash
200
Dividend (Interest) Revenue
200
•Recorded when the cash dividend or bond interest is
received
•Reported in the “other items” section on the income
statement
Reporting Ending
Market Value
• Marketable securities are reported on the
balance sheet at the market value of the
portfolio
• Investment account is
increased or decreased
for the change in
market value
?
Recording Increase in
Market Value of
Investments
Investment in Availablefor-Sale Securities
Bal. 12,000
500
Bal. 12,500
Unrealized Increase in Market
Value of Investments
500
Sale of Investments
When a company sells an investment, it must
record:
• Cash received
• Reduction in the Investments account
• Adjustment to the Unrealized Increase (or
Decrease) account
• Gain or loss on the sale
Recording Sale of
Investments
Unrealized Increase in Market
Value of Investments
Bal. 500
600
Cash
4,800
Bal. 100
Investment in Available-forSale Securities
Bal. 12,500
4,600
Bal. 7,900
Gain on Sale of Investments
800
Affect on the Cash
Flow Statement
• Cash paid for investment - outflow for an
investing activity
• Cash received from the sale of investment inflow from an investing activity
• Dividends and interest received - inflows
from operating activities
Equity Method
• Used when there is
significant influence
over the operations
• Stock - between 20%
and 50% ownership
Reasons for Using
the Equity Method
• The market value of the common stock of the
investee is not a good indicator of the total value
of the investment
• The dividends received are not a good indicator
of the increase in the investor company’s wealth
• The investor may be able to influence the
dividend policy and thereby affect the cash
payments it receives
Recording Investments
Using the Equity Method
Investment = Cost + Income Earned - Dividends Received
where:
Income Earned = Investee’s Net Income
X Investor’s Ownership %
and:
Dividends Received = Total Dividends Paid by Investee
X Investor’s Ownership %
Affect on the Cash
Flow Statement
• Cash paid for investment - outflow for an
investing activity
• Cash received from the sale of investment inflow from an investing activity
• Dividends and interest received - inflows
from operating activities
Consolidated
Financial Statements
• Control over the investee - more
than 50% ownership
• Parent company - investor
• Subsidiary company - investee
• Includes the sum of the
information in the accounting
records of the separate companies
Accounting for a
Controlling Interest
• Purchase is recorded at cost in an
Investment account
• Equity method is used for accounting
during the year
• Eliminations are made at the end of the year
to produce consolidated statements
Segment Reports
An operating segment is a component of a
company:
• that earns revenues and incurs expenses
• whose performance is reviewed regularly by
the company’s top executive
• for which financial information is available
Information Included
in a Segment Report
• Operating profit or loss
• Assets
• General information (e.g., types of products,
geographical areas)
Investments in
Held-to-Maturity Bonds
• Investor has the intent and the ability to
hold the bonds until maturity
• Bonds may be purchased at face value, a
premium or a discount
• Purchase of bonds are recorded at cost in an
Investment in Held-to-Maturity Bonds
account
Amortized Cost
Method
• Used when bonds are purchased at a
premium or discount
• Same as the effective interest method used
in Chapter 22
Interest Revenue for Period =
Book Value of Investment at Beginning of Period
X Yield
Affect on the Cash
Flow Statement
• Cash paid for investment - outflow for an
investing activity
• Cash received from the sale of investment inflow from an investing activity equal to
amount of original investment
• Interest received - inflows from operating
activities
Conclusion
An investor accounts for its investments in
stock depending on the amount of
“influence” over the investee.
An investor accounts for its investments in
bonds depending on how long it expects to
hold the bonds.