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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.