Accounting for Investments

1. Cash investment
2. Debt investment
3. Equity investment
4. Valuing and reporting investment
Cash Investments
 Cash Investments

Investing cash in current operation

In this context, the cash investment is used to:

1. Expenses
2. Suppliers of merchandise and other assets
3. Interest to creditors
4. Dividends to stockholders
 Cash Investments

Investing cash in temporary investment

If the excess cash exists, the company will invest in securities such as:

• Preferred and
• Notes and bonds
common stock
• Interest
• Ownership to the
• Fixed maturity date
company
 Cash Investments

Investing cash in temporary investment

The primary objective of investing in this type of investment:

1. Earn interest revenue
2. Receive dividends
3. Realize gains from increases in the market price of the securities
 Cash Investments

Investing cash in long-term investment

such as:
1. Reduction of costs
2. Replacement of management
3. Expansion
4. Integration
 Debt Investments

Why Bonds??
 Debt Investments

Purchase of bonds

Assume that XXX Company purchases $18,000 of U.S. Treasury bonds at their par
value on March 17, 2012, plus accrued interest for 45 days. The bonds have an
interest rate of 6% payable on July 31 and January 31.

Mar 17| Investments 18,000

Interest Receivable 135
Cash 18,135

Accrued interest = $18,000 X 6% X (45/360)

= $135
 Debt Investments

Interest revenue

Jul 31| Cash 540

Interest Receivable 135
Interest Revenue 405

Semi-annual interest = ($18,000 X 6% X 1.5)

= $540 (It includes the $135 accrued interest that the
company purchased with the bonds on March 17.
(the company has earned $405 ($540-$135) of interest revenue since purchasing the
bonds).
 Debt Investments

$135 $405 Interest timeline $450 $90

Interest receivable Interest earned Interest earned Interest earned

Mar 17 Jul 31 Dec 31

Jan 31 2012 2012 2012
Jan 31
2012 2013

Interest Purchase Interest Interest Interest

date bonds received accrued received
receipt $540 $450 $540
 Debt Investments

Semi-annual interest

2013
Jan 31|Cash 540
Interest revenue 90
Interest receivable 450
 Debt Investments

Sale of bonds

2013
Jan 31|Cash 17,640
Loss on Sale of Investment 360
Investments – Treasury Bonds 18,000

The loss/gain on sale of investments is reported as part of other income or losses on

the income statement.
 Debt Investments

Sale of bonds

2013
Jan 31|Cash 17,640
Loss on Sale of Investment 360
Investments – Treasury Bonds 18,000

The loss/gain on sale of investments is reported as part of other income or losses on

the income statement.
 Equity Investments

3 Conditions of ownership in equity investments :

Percent of Outstanding Degree of Control of Accounting Method

Stock Owned by Investor Investor over Investee
Less than 20% No control Cost method
Between 20% and 50% Significant influence Equity method
Greater than 50% Control Consolidation
 Equity Investments

Less than 20% ownership

No control over the investee:

It is assumed that the investor the stock primarily to earn dividends or realize gains
on price increases of the stock.

Cost method:
- Purchase of stock
- Receipt of dividends
- Sale of stock
 Equity Investments

Less than 20% ownership

Purchase of stock
Assume that on May 1, ABC Company purchases 2,000 shares of XYZ Company
common stock at $49,90 per share plus a brokerage fee of $200.
May 1| Investments – XYZ Company 100,000
Cash 100,000

Receipt of Dividends
Assume that on July 31, ABC Company receives a dividends $0.40/share from XYZ
Company.
Jul 31| Cash 800
Dividends Revenue 800
 Equity Investments

Less than 20% ownership

Sale of stock
To illustrate, Sept 1, ABC Company sells 1,500 shares of XYZ Company stock for
$54.5/share, less a $160 commission. The sale results in $6,590
Jul 31| Cash 81,590
Gain on Sale of Investments 6,590
Investments – XYZ Company 75,000

Proceeds from sale ($54.50 X 1,500) $81,590

Book value of stock ($100,000/2,000 shares) X 1,500 shares $75,000
Gain on sale $ 6,590
 Equity Investments

Between 20%-50% ownership

Significant influence over the investee:

It is assumed that the investor purchased the stock primarily for strategic reasons
such as developing a supplier relationship.

Cost method:
- Net income (The investor records its share of the net income of the investee as an
increase in the investment account).
- Dividends (The investor’s share of cash dividends received from the investee
decreases the investment account).
 Equity Investments

Between 20%-50% ownership

Purchase of stock
Assume that XXX Company purchased its 40% interest in YYY Company’s common
stock on Jan 2, 2012, for $350,000.
2012
Jan 2| Investment in YYY Company 350,000
Cash 350,000
 Equity Investments

Between 20%-50% ownership

Recording investee Net income

For the year ended Dec 31, 2012, YYY Company reported net income $105,000.
(Under the equity method, XXX Company records its share of YYY Company)
2012
Dec 31| Investment in YYY Company Stock 42,000
Income of YYY Company 42,000
 Equity Investments

Between 20%-50% ownership

Recording investee dividends

YYY Company reported the payment and declaration of cash dividends of $45,000.
(Under the equity method, XXX Company records its share of YYY Company
dividends)
2012
Dec 31| Cash 18,000
Investment in YYY Company Stock 18,000
 Equity Investments

Between 20%-50% ownership

The effect of recording 40% of YYY Company’s net income and dividends.

Dec 31
374,000
40% YYY
Cash
Jan 2
dividend
350,000
40% YYY 18,000
Net
income
42,000
 Equity Investments

Between 20%-50% ownership

Sale of stock
XXX Company sold YYY Company’s stock on Jan 1, 2013, for $400,000, a gain of
$26,000 would be reported
2013
Jan 1| Cash 400,000
Investment in YYY Company Stock 374,000
Gain on Sale of Flanders Company stock 26,000
 Equity Investments

More than 50% ownership

Full control over investee:

Company has rights such as engaging in business combination (diversify product
lines, expand geographically, or acquire other business)

There will be parent and subsidiary company that produce:

consolidated financial statement
Valuing and Reporting Investment
 Valuing and Reporting Investment

The classification of valuation and report for debt and equity securities:
1. Trading securities
2. Available-for-sale securities
3. Held-to-maturity securities
 Valuing and Reporting Investment

Trading securities

Debt and equity securities that are purchased and sold to earn short-term profits
from changes in their market prices.
These are held by banks, mutual funds, insurance companies, and other financial
institutions and are valued at the fair value in the income statement as “unrealized
gain or loss”.

Market price that the company would

receive for a security if it were sold
 Valuing and Reporting Investment

Trading securities

Name Number of Shares Total Cost Total Fair Value

A Company 400 5,000 7,250
B Company 500 11,000 7,500
C Company 200 8,000 10,600

24,000 25,300

Gain =
25,300 – 24,000
1,300
 Valuing and Reporting Investment

Trading securities

Adjusting entries at Dec 31,2012 is counted for $1,300.

2012
Dec 31| Valuation Allowance for Trading Investments 1,300
Unrealized Gain on Trading Investments 1,300
 Valuing and Reporting Investment

Trading securities

XXX Company
Balance Sheet (selected section)
December 31, 2012
Current Assets
Cash 120,000
Trading investment 24,000
Plus Valuation allowances for trading investments 1,300
Trading investments (at fair value) 25,300
 Valuing and Reporting Investment

Available-for-sale securities

Debt and equity securities that are held for trading, held to maturity, or held for
strategic reasons.
The only difference from trading securities is:
the report at fair value will be stated in the stockholders’ equity section.
 Valuing and Reporting Investment

Available-for-sale securities

Name Number of Shares Total Cost Total Fair Value

A Company 400 5,000 7,250
B Company 500 11,000 7,500
C Company 200 8,000 10,600

24,000 25,300

Gain =
25,300 – 24,000
1,300
 Valuing and Reporting Investment

Available-for-sale securities

Adjusting entries at Dec 31,2012 is counted for $1,300.

2012
Dec 31| Valuation Allowance for Available-for-Sale Investments 1,300
Unrealized Gain on Available-for-Sale Investments 1,300
 Valuing and Reporting Investment

Available-for-sale securities
XXX Company
Balance Sheet (selected section)
December 31, 2012
Current Assets
Cash 120,000
Trading investment 24,000
Plus Valuation allowances for trading investments 1,300
Trading investments (at fair value) 25,300
Stockholders' Equity
Common stock 10,000
Paid-in capital in excess of par value 150,000
Retained earnings 250,000
Unrealized gain (loss) on available-for-sale investments 1,300
Total stockholders' equity 411,000
 Valuing and Reporting Investment

Held-to-maturity securities

Debt investments, such as notes and bonds, that a company intends to hold until
their maturity date (purchased to gain the interest).