Financial Accounting Chapter 12 Investments

Slide
12-1
Chapter 12
Investments
Financial Accounting, IFRS Edition

Weygandt Kimmel Kieso
Slide
12-2
Study
Study Objectives
Objectives
1. Discuss why corporations invest in debt and share

securities.
2. Explain the accounting for debt investments.
3. Explain the accounting for share investments.
4. Describe the use of consolidated financial statements.
5. Indicate how debt and share investments are reported in
financial statements.
6. Distinguish between short-term and long-term
investments.
Slide
12-3
Investments
Investments
Why Accounting for Accounting for Valuing and

Corporations Debt Share Reporting
Invest Investments Investments Investments
Cash Recording Holdings of less Categories of

management acquisition of than 20% securities
Investment bonds Holdings Statement of
income Recording bond between 20% financial position
Strategic interest and 50% Realized and
reasons Recording sale Holdings of more unrealized gain
of bonds than 50% or loss
Classified
statement of
financial position
Slide
12-4
Why
Why Corporations
Corporations Invest
Invest
Corporations generally invest in debt or share securities

for one of three reasons.
1. Corporation may have excess cash.
2. To generate earnings from investment income.
3. For strategic reasons.
Illustration 12-1
Temporary
investments
and the
operating cycle
Slide
12-5 SO 1 Discuss why corporations invest in debt and share securities.
Why
Why Corporations
Corporations Invest
Invest
Question
Pension funds and banks regularly invest in debt and
share securities to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.
Slide
12-6 SO 1 Discuss why corporations invest in debt and share securities.
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Recording Acquisition of Bonds

Cost includes all expenditures necessary to acquire
these investments, such as the price paid plus
brokerage fees (commissions), if any.
Recording Bond Interest

Calculate and record interest revenue based upon the
carrying value of the bond times the interest rate times the
portion of the year the bond is outstanding.
Slide
12-7 SO 2 Explain the accounting for debt investments.
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Sale of Bonds
Credit the investment account for the cost of the bonds
and record as a gain or loss any difference between the
net proceeds from the sale (sales price less brokerage
fees) and the cost of the bonds.
Slide
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,

10-year, $1,000 bonds on January 1, 2011, for $54,000,
including brokerage fees of $1,000. The entry to record the
investment is:
Jan. 1 Debt investments 54,000

Cash 54,000
Slide
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,

10-year, $1,000 bonds on January 1, 2011, for $54,000,
including brokerage fees of $1,000. The bonds pay interest
semiannually on July 1 and January 1. The entry for the
receipt of interest on July 1 is:
July 1 Cash 2,000 *

Interest revenue 2,000
* ($50,000 x 8% x ½ = $2,000)
Slide
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Illustration: If Kuhl Corporation’s fiscal year ends on

December 31, prepare the entry to accrue interest since
July 1.
Dec. 31 Interest receivable 2,000

Interest revenue 2,000
Kuhl reports receipt of the interest on January 1 as follows.
Jan. 1 Cash 2,000

Interest receivable 2,000
Slide
12-11 SO 2
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Recording Sale of Bonds

Illustration: Assume that Kuhl corporation receives net
proceeds of $58,000 on the sale of the Doan Inc. bonds on
January 1, 2011, after receiving the interest due. Prepare
the entry to record the sale of the bonds.
Jan. 1 Cash 58,000

Debt investments 54,000
Gain on sale of debt investments 4,000
Slide
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Question
An event related to an investment in debt securities that
does not require a journal entry is:
a. acquisition of the debt investment.
b. receipt of interest revenue from the debt
investment.
c. a change in the name of the firm issuing the debt
securities.
d. sale of the debt investment.
Slide
Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Question
When bonds are sold, the gain or loss on sale is the
difference between the:
a. sales price and the cost of the bonds.
b. net proceeds and the cost of the bonds.
c. sales price and the market value of the bonds.
d. net proceeds and the market value of the bonds.
Slide
Accounting
Accounting for
for Share
Share Investments
Investments
Ownership Percentages
0 --------------20% ------------ 50% -------------- 100%

No significant Significant Control usually
influence influence exists
usually exists usually exists
Investment Investment Investment valued on

valued using valued using parent’s books using Cost
Cost Equity Method or Equity Method
Method Method (investment eliminated in
Consolidation)
The accounting depends on the extent of the investor’s influence over

the operating and financial affairs of the issuing corporation.
Slide
12-15 SO 3 Explain the accounting for share investments.
Accounting
Accounting for
for Share
Share Investments
Investments
Holdings of Less than 20% (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).
Slide
Holdings
Holdings of
of Less
Less than
than 20%
20%
Illustration: On July 1, 2011, Sanchez Corporation

acquires 1,000 ordinary shares (10% ownership) of Beal
Corporation. Sanchez pays $40 per share plus brokerage
fees of $500. The entry for the purchase is:
July 1 Share investments 40,500

Cash 40,500
Slide
Holdings
Holdings of
of Less
Less than
than 20%
20%
Illustration: During the time Sanchez owns the shares, it

makes entries for any cash dividends received. If Sanchez
receives a $2 per share dividend on December 31, the
entry is:
Dec. 31 Cash 2,000

Dividend revenue 2,000
Slide
Holdings
Holdings of
of Less
Less than
than 20%
20%
Illustration: Assume that Sanchez Corporation receives

net proceeds of $39,500 on the sale of its Beal shares on
February 10, 2012. Because the shares cost $40,500,
Sanchez incurred a loss of $1,000. The entry to record the
sale is:
Feb. 10 Cash 39,500

Loss on sale of share 1,000
Share investments 40,500
Slide
Accounting
Accounting for
for Share
Share Investments
Investments
Holdings Between 20% and 50% (Equity Method)
Record the investment at cost and subsequently adjust

the amount each period for
 the investor’s proportionate share of the earnings
(losses) and
 dividends received by the investor.
If investor’s share of investee’s losses exceeds the carrying amount of

the investment, the investor ordinarily should discontinue applying the
equity method.
Slide
Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Question
Under the equity method, the investor records dividends
received by crediting:
a. Dividend Revenue.
b. Investment Income.
c. Revenue from Investment.
d. Share Investments.
Slide
Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Illustration: Milar Corporation acquires 30% of the ordinary
shares of Beck Company for $120,000 on January 1, 2011. For
2011, Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.
Jan. 1 Share investments 120,000

Cash
Dec. 31 120,000
Share investments ($100,000 x 30%) 30,000
Revenue from investments
30,000
Dec. 31 Cash ($40,000 x 30%) 12,000
Share investments
Slide
12-22
12,000 SO 3 Explain the accounting for share investments.
Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Illustration: Milar Corporation acquires 30% of the ordinary
shares of Beck Company for $120,000 on January 1, 2011. For
2011, Beck reports net income of $100,000 and paid dividends of
$40,000. Prepare the entries for these transactions.
After Milar posts the transactions for the year, its investment
and revenue accounts will show the following.
Share Investments Revenue from Investments

Debit Credit Debit Credit
120,000 30,000
30,000 12,000
138,000
Slide
Accounting
Accounting for
for Share
Share Investments
Investments
Holdings of More Than 50%

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.
 Parent generally prepares consolidated financial statements.
Slide
12-24 SO 4 Describe the use of consolidated financial statements.
Accounting
Accounting for
for Share
Share Investments
Investments
Holdings of More Than 50%

Consolidated statements indicate the magnitude and scope
of operations of the companies under common control.
Illustration 12-5
Examples of consolidated companies and their subsidiaries
Slide
12-25 SO 4 Describe the use of consolidated financial statements.
Answer
on notes
page
Slide
12-26
Valuing
Valuing and
and Reporting
Reporting Investments
Investments
Categories of Securities
Companies classify debt and share investments into
three categories:
 Fair value through profit or loss (FVPL) securities
 Available-for-sale (AFS) securities
 Held-to-maturity securities
These guidelines apply to all debt securities and all share investments
in which the holdings are less than 20%.
Slide SO 5 Indicate how debt and share investments are

12-27 reported in financial statements.
Valuing
Valuing and
and Reporting
Investments
Fair Value Through Profit or Loss (FVPL)

Companies hold securities with the intention of selling
them in a short period (< month).
Frequent buying and selling.
Companies report securities at fair value, and report

changes from cost as part of net income.
Changes are reported as unrealized gains or losses.

Fair
Fair Value
Value Through
Through Profit
Profit or
or Loss
Loss (FVPL)
(FVPL)
Illustration: Investment of Pace classified as fair value through

profit or loss securities on December 31, 2011.
Illustration 12-7
The adjusting entry for Pace Corporation is:

Dec. 31 Market adjustment—FVPL 7,000
Unrealized gain—income 7,000

Slide
Answer on notes page
12-30
Valuing
Valuing and
and Reporting
Investments
Available-for-Sale (AFS) Securities

Held with the intent of selling these investments
sometime in the future.
Classified as current assets or as non-current assets,
depending on the intent of management.
Report securities at fair value
Report changes from cost as a component of the equity

Valuing
Valuing and
and Reporting
Investments
Question
Marketable securities bought and held primarily for sale
in the near term are classified as:
a. Available-for-sale securities.
b. Held-to-maturity securities.
c. Share securities.
d. Fair value through profit or loss

Available-for-Sale
Available-for-Sale Securities
Securities
Problem: How would the entries for fair value through

profit or loss securities change if the securities were
classified as available-for-sale?
The entries would be the same except that the
Unrealized Gain or Loss—Equity account is used instead of

Unrealized Gain or Loss—Income.
The unrealized loss would be deducted from equity rather

than charged to income.

Available-for-Sale
Securities
Illustration: Assume that Ingrao Corporation has two securities

that it classifies as available-for-sale.
Illustration 12-8
The adjusting entry for Ingrao Corporation is:

Dec. 31 Unrealized gain or loss—equity 9,537
Market adjustment—AFS 9,537
Available-for-Sale
Securities
Question
An unrealized loss on available-for-sale securities is:
a. reported under other revenue and expenses in the

income statement.
b. closed-out at the end of the accounting period.
c. reported as a separate component of equity.
d. deducted from the cost of the investment.

Valuing
Valuing and
and Reporting
Investments
Statement of Financial Position Presentation

Short-Term Investments
Securities held by a company that are

(1) readily marketable and
(2) intended to be converted into cash within the next year
or operating cycle, whichever is longer.
Investments that do not meet both criteria are classified as

long-term investments.
Slide
12-36 SO 6 Distinguish between short-term and long-term investments.
Statement
Statement of
of Financial
Financial Position
Position Presentation
Presentation
Presentation of Realized and Unrealized Gain

or Loss
Nonoperating items related to investments
Illustration 12-10
Slide
Statement
Statement of
of Financial
Financial Position
Presentation
Realized and Unrealized Gain or Loss

Unrealized gain or loss on available-for-sale securities is
reported as a separate component of equity.
Illustration 12-11
Slide
Classified
Statement of
Financial
Position
(partial)
Illustration 12-12
Slide
Classified
Statement of
Financial
Position
(partial)
Illustration 12-12
Slide
Statement
Statement of
of Financial
Financial Position
Presentation
Identify where each of the following items would be
reported in the financial statements.
Use the following possible categories:

Intangible assets Equity
Property, plant, and equipment Non-current liabilities
Investments Current liabilities
Current assets
Other income and expenses
Answers on
Slide
notes page SO 6 Distinguish between short-term and long-term investments.
12-41
Understanding
Understanding U.S.
U.S. GAAP
GAAP
Key Differences Investments
Both IFRS and GAAP use the same criteria to determine

whether the equity method of accounting should be used—that
is, significant influence with a general guide of over 20%
ownership. GAAP uses the term equity investment whereas
IFRS uses the term associate investment to describe
investments under the equity method.
Under IFRS, both the investor and an associate company

should follow the same accounting policies. As a result, in
order to prepare financial information, adjustments are made to
the associate’s policies to conform to the investor’s books.
GAAP does not have that requirement.
Slide
12-42
Understanding
Understanding U.S.
U.S. GAAP
GAAP
The basis for consolidation under IFRS is control. Under GAAP,

a bipolar approach is used, which is a risk-and reward model
(often referred to as a variable-entity approach) and a voting
interest approach. However, under both systems, for
consolidation to occur, the investor company must generally
own 50% of another company.
IFRS specifies the following four types of financial assets:

1. Financial assets at fair value through profit or loss.
2. Held-to-maturity investments.
3. Loans and receivables.
4. Available-for-sale financial assets.
Slide
12-43
The loans and receivables category does not exist under GAAP.
Understanding
Understanding U.S.
U.S. GAAP
GAAP
The category of financial asset at fair value through profit or

loss is similar to the trading securities discussed in GAAP. As
noted in the chapter, this category also includes investments
that the company has decided to report at fair value. GAAP also
gives the company the option to report investments at fair value.
Unrealized gains and losses related to available-for-sale

securities are reported in other comprehensive income under
GAAP and IFRS. These gains and losses that accumulate are
then reported in the equity section. Under IFRS, they are
frequently reported in a line item labeled “Reserves” whereas
under GAAP, they are reported in accumulated other
Slide comprehensive income.
12-44
Understanding
Understanding U.S.
U.S. GAAP
GAAP
Looking to the Future Investments
As indicated earlier, both the FASB and IASB have indicated that
they believe that all financial instruments should be reported at fair
value and that changes in fair value should be reported as part of
net income. It seems likely, as more companies choose the fair
value option for financial instruments, that we will eventually arrive
at fair value measurement for all financial instruments.
Slide
12-45
Preparing
Preparing Consolidated
Consolidated Financial
Financial Statements
Statements
Consolidated Statement of Appendix

Financial Position
 Companies prepare consolidated statements of
financial position from the individual statements of their
affiliated companies.
 Transactions between the affiliated companies are
eliminated.
Slide
12-46
Preparing
Statements
Consolidated Statement of Financial Position

Illustration: Assume that on January 1, 2011, Powers
Construction Company pays $150,000 in cash for 100% of
Serto Brick Company’s ordinary shares. Powers Company
records the investment at cost, as required by the cost
principle.
The combined totals do not represent a consolidated
statement of financial position, because there has been a
double counting of assets and equity in the amount of
$150,000.
Slide
12-47
Preparing
Statements
Illustration 12A-1
Slide
12-48
Preparing
Statements
Use of a Worksheet—Cost Equal to Book Value
Illustration 12A-2
Slide
12-49 SO 7
Preparing
Statements
Use of a Worksheet—Cost Above Book Value
Illustration: Assume the same data used above, except

that Powers Company pays $165,000 in cash for 100% of
Serto’s ordinary shares. The excess of cost over book
value is $15,000 ($165,000 - $150,000).
Slide SO 7 Describe the content of a worksheet for a

12-50 consolidated statement of financial position.
Preparing
Statements
Use of a Worksheet—Cost Above Book Value
Illustration 12A-3
Slide
12-51 SO 7
Preparing
Statements
Illustration: The prior worksheet shows an excess of cost
over book value of $15,000. In the consolidated statement
of financial position, Powers first allocates this amount to
specific assets, such as inventory and plant equipment, if
their fair market values on the acquisition date exceed their
book values. Any remainder is considered to be goodwill.
For Serto Company, assume that the fair market value of
property and equipment is $155,000.Thus, Powers
allocates $10,000 of the excess of cost over book value to
property and equipment, and the remainder, $5,000, to
goodwill.
Slide
12-52 SO 8 Explain the form and content of consolidated financial statements.
Preparing
Statements
Consolidated Statement of Financial Position Illustration 12A-4
Slide
Preparing
Statements
Consolidated Income Statement Appendix
 Statement shows the results of operations of affiliated

companies as though they are one economic unit.
 All intercompany revenue and expense transactions
must be eliminated.
 A worksheet facilitates the preparation of consolidated
income statements in the same manner as it does for
the statement of financial position.
Slide
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Slide
12-55

Financial Accounting Chapter 12 Investments

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Slide

Financial Accounting, IFRS Edition

1. Discuss why corporations invest in debt and share

Why Accounting for Accounting for Valuing and

Cash Recording Holdings of less Categories of

Corporations generally invest in debt or share securities

Recording Acquisition of Bonds

Recording Bond Interest

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,

Jan. 1 Debt investments 54,000

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%,

July 1 Cash 2,000 *

Illustration: If Kuhl Corporation’s fiscal year ends on

Dec. 31 Interest receivable 2,000

Kuhl reports receipt of the interest on January 1 as follows.

Jan. 1 Cash 2,000

Recording Sale of Bonds

Jan. 1 Cash 58,000

0 --------------20% ------------ 50% -------------- 100%

Investment Investment Investment valued on

The accounting depends on the extent of the investor’s influence over

Holdings of Less than 20% (Cost Method)

Cost includes all expenditures necessary to acquire these investments,

Illustration: On July 1, 2011, Sanchez Corporation

July 1 Share investments 40,500

Illustration: During the time Sanchez owns the shares, it

Dec. 31 Cash 2,000

Illustration: Assume that Sanchez Corporation receives

Feb. 10 Cash 39,500

Holdings Between 20% and 50% (Equity Method)

Record the investment at cost and subsequently adjust

If investor’s share of investee’s losses exceeds the carrying amount of

Jan. 1 Share investments 120,000

Share Investments Revenue from Investments

Holdings of More Than 50%

 Investee is referred to as the subsidiary.

 Investment in the subsidiary is reported on the parent’s books

Holdings of More Than 50%

 Available-for-sale (AFS) securities

Slide SO 5 Indicate how debt and share investments are

Fair Value Through Profit or Loss (FVPL)

Frequent buying and selling.

Companies report securities at fair value, and report

Changes are reported as unrealized gains or losses.

Slide SO 5 Indicate how debt and share investments are

Illustration: Investment of Pace classified as fair value through

The adjusting entry for Pace Corporation is:

Slide SO 5 Indicate how debt and share investments are

Available-for-Sale (AFS) Securities

Slide SO 5 Indicate how debt and share investments are

Slide SO 5 Indicate how debt and share investments are

Problem: How would the entries for fair value through

The entries would be the same except that the

Unrealized Gain or Loss—Equity account is used instead of

The unrealized loss would be deducted from equity rather

Slide SO 5 Indicate how debt and share investments are

Illustration: Assume that Ingrao Corporation has two securities

The adjusting entry for Ingrao Corporation is:

a. reported under other revenue and expenses in the

b. closed-out at the end of the accounting period.

c. reported as a separate component of equity.

d. deducted from the cost of the investment.

Slide SO 5 Indicate how debt and share investments are

Statement of Financial Position Presentation