Chapter 13: Investments and Fair Value Accounting
available for sale securities
changes in the fair values of available-for-sale securities are reported as part of stockholders equity and thus, excluded from the income statement valuation allowance for available for sale investments journal entry: valuation allowance for available for sale investments sale investments
between 20-50% of outstanding stock owned by the investor (significant influence)
equity method
Debt Securities -- temporary investment
notes and bonds that pay interest and have a fixed maturity date
long term investments
often involve the purchase of a significant portion of the stock of another company, done for a number of reasons including: 1. reduction of costs 2. replacement of management 3. expansion 4. integration
Example of trading valuation
on Dec. 31,2014 the cost of trading securities portfolio was 79,200 and the fair value was 76,800. prepare the the dec. 31, 2014 adjusting entry to record the unrealized gain or loss on trading investments unrealized loss on trading investments 2400 valuation allowance for trading investments .....2400
receipt of dividends
on july 31st , bart company receives a dividend of .40 per share from lisa company. the entry to record the receipt of the dividend is as follows: cash.........800 dividend revenue.......800 received dividend on lisa company common stock (2000 shares x .40)
Equity securities -- temporary investment
preferred and common stock that represent ownership in a company and do not have a fixed maturity date
Purchase of bonds
purchase of bonds is recorded by debiting an investments account for the purchase of the bonds, including any brokerage commissions. if the bonds are purchased between interest dates, the purchase price includes accrued interest since the last interest payment. this is because the seller has earned the accrued interest rate, but the buyer will receive the accrued interest when it is paid.
Primary objective of investing in temporary investments is to
1. earn interest revenue 2. receive dividends 3. realize gains from increases in the market price of securities
To support its current level of operations, a company also uses cash to pay:
1. expenses 2. suppliers of merchandise and other assets 3. interest to creditors 4. dividends to stockholders
How cash generated from operations are spent by a company:
1. investing in current operations 2. investing in temporary investments to earn additional revenue 3.investing in long term investments in stock of other companies for strategic reasons
accounting for bond investments includes recording the following:
1. purchase of bonds 2. interest revenue 3. sale of bonds
categories of securities
Companies classify debt and stock investments into three categories: 1.Trading securities 2. Available-for-sale securities 3. Held-to-maturity securities
available-for-sale securities
Companies hold available-for-sale securities with the intent of selling these investments sometime in the future. These securities can be classified as current assets or as long-term assets, depending on the intent of management. Companies report securities at fair value, and report changes from cost as a component of the stockholders' equity section.
dividend yield
Dividend Yield measures the rate of return to stockholders based on annual cash dividends distributed. Dividend yield is calculated as follows: Dividend Yield = Dividends per Share of Common Stock/Market Price per Share of Common Stock
equity method
If the investor purchases between 20% and 50% of the outstanding stock of the investee, the investor is considered to have significant influence over the investee, and the investment is accounted for using the equity method. Under the equity method, the investment account is adjusted for the investor's share of the net income and dividends of the investee. These adjustments are as follows: Net income: Recorded as an increase in the investment account. Dividends: Decrease the investment account.
Securities
Instead of letting excess cash remain idle in a checking account, most companies invest their cash in temporary investments.
Extra Cash
Instead of letting excess cash remain idle in a checking account, most companies invest their excess cash in temporary investments.
Interest Revenue journal entry
On july 31st, Homer company receives a semi annual interest payment of 540 (18000x.06x(1/2)) this INCLUDES the 135 accrued interest that Homer company purchased with the bonds on march 17. Thus Homer company has earned 405$ (540-135) of interest revenue since purchasing the bonds. debit cash..................540 interest receivable .....................135 interest revenue..........................405 received semi annual interest Homers companies accounting period ends on Dec. 31, accounting adjusting entry must be made to accrue interest for five months (august 1st- dec 31st) of 450 (18,000x.06x5/12) adjusting entry to record accrued interest as followed: interest receivable: 450 interest revenue.............450 accrued interest for the year ended on dec 31, 2014, homer company would report Interest Revenue of 855 (405+450) as part of other income on its income statement cash............540 interest revenue........90 interest receivable... 450 received interest on treasury bonds
cost method
Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).
Unrealized gain or loss
a change in the fair value value of the portfolio of trading securities is recognized as an unrealized gain or loss for the period.
parent company
a corporation owing all or a majority of the voting stock of another corporation
Purchase of bonds journal entry
assume that Homer company purchases 18,000 of U.S. treaty bonds at their face amount on 3/17/14, plus accrued interests for 45 days. The bonds have an interest rate at 6%, payable on july 31st and January 31st. debit: investments u.s. treasury bonds 18,000 debit: interest receivable..........135 (18000x.06x(45/360)) credit: cash...................................................................18135 purchased 18,000 , 6% treasury bonds *investments debited for the for the purchase price of the bond*
purchase of stock under equity method
assume that simpson inc. purchased its 40% interest in flanders cooperation common stock on january 2, 2014 for 350,000. entry to record the purchase as follows: investment in flanders corporation stock: 350,000 cash: 350,000 (purchased 40% of of flanders corp stock)
investor
company investing in another companies stock
investee
company whose stock is purchased
greater than 50% of outstanding stock owned by the investor (control)
consilidation Controlling Interest - When one corporation acquires a voting interest of more than 50 percent in another corporation Investor is referred to as the parent. Investee is referred to as the subsidiary. Investment in the subsidiary is reported on the parent's books as a long-term investment. At the end of the accounting period, the financial statements of the parent and subsidiary companies are combined, and the parent company prepares and issues consolidated financial statements.
20% of outstanding stock owned by the investor (no control)
cost method
trading securities
debt and equity securities that are purchased to earn short term profits from changes in their market prices. often held by banks, mutual funds, insurance companies, Trading securities are debt and equity securities that are purchased and sold to earn short-term profits from changes in their market prices. They are reported as current assets on the balance sheet. Trading means frequent buying and selling. (actively managed) Trading securities are valued as a portfolio (group) of securities using their fair market values. Changes in fair value of the portfolio are recognized as an unrealized gain or loss for the period, and reported as part of net income.
held to maturity securities
debt investments, such as notes or bonds, that a company intends to hold until their maturity date. held to maturity securities are primarily purchased to earn interest revenue. if held to maturity securities will mature within a year, they will be reported as a current asset on the balance sheet Held-to-maturity securities are debt investments, such as notes or bonds, that a company intends to hold until their maturity date. They are recorded at their cost, including any brokerage fees or commissions Any premium or discount on these bonds/notes are amortized over the life of the bonds The investing company plans to hold these securities until they mature, so do NOT record fluctuations in year-to-year market values of these assets in their balance sheet. They are reported on the balance sheet at their amortized costs.
fair value
fair value is the market price that the company would receive for a security if it were sold.
fair value accounting
fair value is the price that would be received to sell an asset or pay off a liability
recording invested net income
for the year ended on dec 31, 2014, flanders corporation reported net income of 105,000. under the equity method, simpson inc records its share of flanders net income, as shown on the next page: dec. 31, 2015 investment in flanders corporation stock...42,000 income of flanders corporation.....................42,000 recorded 40% share of flanders corporation net income, 105,000 x 40% income of flanders corporation is reported on Simpsons inc's income statement
trading securities continued
held as a short term investment, reported as a current asset on the balance sheet. trading securities are valued as a group (portfolio) of securities using the securities' fair values. fair value is the market security if the security were sold. a change in the fair value of the group of trading securities is recognized as an unrealized gain or loss for the period
more than 50% ownership
if the investor purchases more than 50% of the outstanding stock of this invested, the investor is considered to have control of the investee
journal entry to record fair value
in order to maintain a record for the original cost of the securities, a valuation account, called Valuation Allowance for trading securities
journal entry for valuation
in order to maintain a record of the original cost of the securities, a valuation account called valuation allowance for trading investments debited, unrealized gain on investments credited. unrealized gain on trading investments is reported on the income statements unrealized loss on trading investments debited if there is a loss, credit valuation allowance to make up the difference
What most companies do with excess cash
invest excess cash in investments to earn interest revenue
investment and dividends
investment in flanders corp stock + 40% flanders corps net income- 40% of flanders corps cash dividends = investment in flanders corp stock.
Investments
investments in debt and equity securities (investments ot temporary investments) are reported in the current assets section of the balance sheet.
case of 20% or less
investor is assumed to have purchased the stock primarily to earn dividends or to realize gains on price increases of the stock
Net income adjustment for equity method
net income: the investor records its share of the net income of the invested as an increase in the investment account. its share of ay net loss is recorded as a decrease in the investment account
changes in fair values for available for sale securities
reported as part of stockholders equity and excluded from the income statement
sale of bonds
sale of a bond normally results in a gain or loss. if the proceeds from the sale exceed the book value (cost) of the bonds, then a gain is recorded. if the proceeds are less, loss recorded debit cash credit loss on sale of investment
sale of stock
sale of stock investment normally results in a gain or loss. a gain is recorded if the proceeds from the sale exceed the book value (cost) of the stock. a loss is recorded if there's less than book value. to illustrate, on september 1st bart company sells 1500 shares of lisa company stock for 54.50 per share, less a 160$ commission. the sale results in a gain of 6590 cash......81,590 [(54.20x1500 shares)-160] gain on sale of investments....6590 investments- lisa company stock..75000 (100,000$/2000 shares) x 1500 shares sold 1500 shares of lisa company common stock
subsidiary company
the corporation that is controlled is classed the subsidiary company
dividends for equity method
the investors share of cash dividends received from the invested decreases the investment account
business combination
the purchase of more than 50% ownership of the investee's stock is known as a business combination
purchase of stock journal entry for cost method
the purchase of stock is recorded at its cost. any brokerage commissions are included as part of the cost assume that on may 1 bart company purchases 2,000 shares of lisa company common stock at 49.99 per share plus a brokerage fee of $200. the entry to record the purchase of the stock is as follows: investments .....100,000 cash...........................100,000 purchased 2,000 shares of Lisa company common stock [(49.90x2,000 shares)+200]
cost method
under the cost method, entries are recorded for the following transactions: 1. purchase of stock 2. receipt of dividends 3. sale of stock
FAIR VALUE OF THE PORTFOLIO OF TRADING SECURITIES LESS THAN THE COST (for trading securities)
unrealized loss on trading investments 2400 valuation allowance for trading investments .....2400
FAIR VALUE OF THE PORTFOLIO OF TRADING SECURITIES MORE THAN THE COST (for trading securities)
valuation allowance... unrealized gain on trading investments..........
journal entry for available for sale secuities
when theres an increase of 1300 from the cost to the fair value, a valuation account called valuation account for available-for-sale securities is debited, the 1300 increase in fair value is credited to the unrealized gain(loss) on available for sale investments. a credit balance in unrealized gain (loss) on available for sale securities is added to stockholders equity, while a debit balance is subtracted from stockholders equity.
