Investments

Chapter 12
Investments
Objectives of the Chapter

1.Classification and reporting of Investments:
trading securities, available-for-sale
securities and held-to-maturity securities.
2.Investments recorded and reported using
the equity method.
3. The fair value option reporting for
investments.
Investments
Securities for Investments
Investment in debt securities: include

U.S. treasury securities, municipal
securities, corporate bonds,
commercial papers, pf stock with a
mandatory redemption feature or
redeemable at the option of the holder.
Investment in equity securities: include
common stock, preferred stock, stock
warrants, stock rights, call and put
options.
Investments
Securities for Investments(cont.)
For reporting purposes, all investments

must be classified into one of the
following three categories at the
reporting date:
1. Trading securities;
2. Available-for-sale securities; or
3. Held-to-maturity securities.
Investments
Classification of Investments
1.Trading securities: investments in debt
and equity securities held for the
purpose of selling them in the near
future.
2. Available-for-sale securities: Including
debt and equity securities that are not
classified as trading securities and not
classified as held-to-maturity securities.
Investments
Classification of Investments (cont.)

3.Held-to-maturity securities:
investments in debt securities with
positive intent and ability to hold these
securities to maturity.
Investments
Classification of Investments (cont.)
Classifications of investments in
securities into these three categories
and the subsequent reclassification
are based on managements intent
and judgment.
Investments
Investments - initial recording and

end of period reporting (valuation)
1.Initial Recording of all investments:
at cost.
2. End of Period Reporting (Valuation):
a. Trading securities: reported at their
fair market values on the B/S. The
unrealized gains or losses are included
in income of the current period.
Investments
Investments - initial recording and

valuation (cont.)
b. Available-for-sale securities: reported
at their fair values on the B/S. The
unrealized gains or losses are reported
as a separate component of
stockholders equity until realized.
c. Held-to-maturity securities: reported at
their amortized cost.
Investments
Investments - dividends and Interest

revenue
Dividends, interest revenues of

investments in securities and realized
gains or losses from sale of investments
are reported in the income statement.
Investments
10
Investments - other valuation

methods
Other Valuation Methods:
a. Equity method: Applied when

investments in equity securities with
significant influence over the investee
(usually owing 20% - 50% of the voting
stock). No recognition of unrealized
gains or losses.
Results in a partial consolidation
statements for the investor.
Investments
11

methods (cont.)
b. Consolidated financial statements
Applied when the
investor(the parent) controls the
investee (the subsidiary) through an
investment in equity securities (i.e., the
investor owing over 50% of the voting
common stock).
Investments
12

methods (cont.)
The investor has to issue the

consolidated financial statements.
No recognition of unrealized gains or
losses.
Investments
13
Summary of Accounting for

Investments
A. Invest. In Equity Securities
1. No signoficant influencant
a. Trading
b. Available-for-Sale
2. Significant influence
(20% to 50% ownership)
3. Control
(more than 50% ownership)
B. Invest. In Debt Securities
a. Trading
b. Available-for-Sale
c. Held-to-Maturity
Method
Reporting of Unrealized Holding

Gains and Losses
Fair value
Fair value
Income statement
Stockholders' equity
Equity method Not recognized

Consolidation
Not recognized
Fair value
Income statement
Fair value
Stockholders' equity
Amortized cost Not recognized
Investments
14
Example A:investments classified as

available-for- sale securities (SAS)
The accounting treatment (SFAS 115)
(a) initial recording: at cost;

(b) end of period reported: at fair value;
(c) unrealized holding gains or losses:
reported as a separate component of
stockholders equity on B/S;
(d) interests, dividends, realized gains
or losses reported on the I/S
Investments
15
Example A:(cont.):
Assume that Green Company acquires the

following securities on 5/1/x5:
Shares # per share
A Company common stock 100
$50
B Company common stock 300
$80
C Company preferred stock 200
$120
D Company 10% bonds with a face value of

$15,000 at par plus accrued interest (interests
are paid on 5/31 & 11/30)
Investments
16
Example A:(cont.)
1. Initial recording on 5/1/x5:
Investments in SAS
68,000*
Invest. Rev.
625**
Cash
68,625
Cost = 100 x 50 + 300 x 80 + 200 x 120 +

15,000 = 68,000
** Accrued interests = 15,000 x 10% x 5/12 = $625

Investments
17
Example A: cont.
5/31/x5 Cash 750

Invest. Revenue
750
(the net interest revenue = $750 -625= $125;
the interest revenue for 5/1/95 ~ 5/31/95)
11/30/x5 Cash 750
Invest. Revenue
750
Note: If the bonds were purchased at a discount
or premium, the discount or premium needs to
be amortized when interest revenue is
recongized.
Investments
18
Example A: cont.
12/31/x5 Invest. Receivable

125
Invest. Revenue
125
Assuming Green received $3,000 for
dividends in 20x5
Cash
3,000
Invest. Revenue
3,000
Investments
19
Example A:(contd.)
The following info. is available on 12/31/x5: (Note: for

investment in bonds, the cost is the amortized cost.)
Investments
20
Example A:(contd.):SAS
12/31/x5 Adjusting entry (for valuation):
Fair Value Adjustment
3,000
Unrealized holding Gains**

on investments-OCI
3,000
** Reported in B/S as other comprehensive

income of x5
Investments
21
Balance Sheet Presentation :SAS

Balance Sheet 12/31/x5
Assets
Inv. Sec. (at cost)
Fair Value Adjust.
Liabilities
$68,000
$3,000Stockholders Equity:
Inv. Sec. ( at fair Value) $71,000 Accu. Other Comp. Income

Unrealized holding gains
(losses) on investment 3,000
Investments
22
Example A: SAS(contd.)
The following info. is available on 12/31/x6:
Investments
23
Example A: (cont.):SAS
12/31/x6 Adjusting entry (for valuation):

Unrealized holding Gains
(losses) on investment**-OCI
5,000
5,000
** Other comprehensive income of x6
Investments
24
Balance Sheet Presentation:SAS

Assets
Liabilities
Inv. Sec. (at cost)

Fair Value Adj.
$68,000
(2,000)
Inv. Sec. (at fair value) $66,000 Stockholders Equity:

Accu. Other Comp. Income
(losses) on investment(2,000)
Investments
25
Realized Gains and Losses from Sale

of investments
Realized gains and losses are

calculated as the difference between the
selling price and the cost and is
reported in the income statement.
This is due to the unrealized gain/loss of
SAS is never recognized in the income
statement.
Investments
26
Example B: SAS
In 20x7, Green sold 100 shares of A stock

for $6,000. J.E. to record this transaction
Cash
6,000
Investments in SAS (at cost)
Gain on sale of investments
Investments
5,000
1,000
27
Example B (cont.): SAS
Also in 20x7, Green sold 300 share of B for

$22,000
J.E. to record this transaction
Cash
22,000
Loss on sale of investments 2,000
Investments (at cost)
24,000
Investments
28
Example B:(cont.) (with a fair value

adjustment account) :SAS
Before the adjusting entry on 12/31/x7:

Fair Value adjustment
1/1/x7 3,000
Investment (at cost)
5,000
68,000
5,000a
24,000b
2,000
39,000
a. from sale of Stock A
b. From sale of Stock B
Investments
29
Example B:(contd.):SAS
Investments
30
Example B:SAS
Investments
31
Balance Sheet Presentation:SAS

Assets
Liabilities
Investment Securities
at Cost
$39,000
Fair Value Adjus.
(1,000) Stockholders Equity:
Invest. Sec. (at fair)
$38,000 Accu. Other Comp. Income
(losses) on investment(1,000)
Investments
32
Impairment of Securities Availablefor-Sale
If the decline in the fair value of securities

available-for-sale is NOT temporary (i.e.,
a bankruptcy filing), the value of the
securities should be written down to the
fair value.
The amount of the write-down should be
treated as a realized loss and is included
in the income of the year.
Investments
33
Investments Classified as Trading

Securities
The accounting treatment (SFAS 115)
(a) initial recording: at cost;

(b) end of period reported: at fair value;
(c) unrealized holding gains or losses:
reported in the income statement;
(d) interests, dividends, realized gains or
losses reported in the income statement
Investments
34
Investments Classified as Trading

Securities (contd.)
Trading securities are held primarily by

banks and stock brokers. FASB 115 applies
to all specialized industries.
For trading securities, the realized gains
and losses are computed as the difference
of the selling price and the fair value (NOT
the cost) recorded in the most recent
balance sheet date.
This is due to the unrealized holding
gain/loss for trading sec. is recognized in
the previous income statement.
Investments
35
Example C: same infor. as in Example A on p20 but

for Trading Securities Valuation on 12/31/x5
12/31/x5 Adjusting entry for valuation (a direct

adjustment to the investment account):
Investment Securities*
3,000
Unrealized holding Gains**

on investments-I/S
3,000
*the bal. of the investment securities account

equals $71,000, the fair value, after the
adjustment.
** Reported in the income statement of x5 and will be
closed to income summary at the end of x5.
Investments
36
Example C(contd.): same as in Example A on p23

Except for Trading Securities Valuation on 12/31/x6
12/31/x6 Valuation adjusting entry (a direct

adjustment):
Unrealized holding Gains
on investment * - I/S
5,000
Investment Securities**
5,000
*Reported in the income statement of x6.
**The bal. of investment securities equals

$66,000, the fair value, after the adjustment.
Investments
37
Example D: same as in Example B on p27 Except

for Sale of Trading Securities
In 20x7, Green sold 100 shares of A stock for

$6,000. J.E. to record this transaction
Cash 6,000
Loss on Sale of Investment 100
Investments in Trading Sec. 6,100*
*The investment account is at the fair value. Unlike
the SAS, the unrealized Gains (Losses) of trading
securities have been closed to the Income
Summary at the end of 20x6.
Investments
38
Example D (contd.): same as in Example B on p28

Except for Sale of Trading Securities
Also in 20x7, Green sold 300 share of B for

$22,000
J.E. to record this transaction
Cash
22,000
Loss on sale of investments
700
Investments (at fair value)
22,700
* The investment account is at the fair value.
Investments
39
Example D (contd.): same as in Example B on p30

12/31/x6
cost
12/31/x7
Change
Fair Value Fair Value in F.V
C $24,000 $23,200 $26,000 $2,800

D $15,000 $14,000 $12,000 (2,000)
$39,000 $37,200 $38,000 ($800)
Investments
40
Example D (contd.)
The information on p40 indicates that the

fair value of securities C and D equals
$37,200 and $38,000 on 12/31/x6 and
12/31/x7, respectively.
Since the trading securities account
balance is at the fair value (under the direct
adjustment), the end of period valuation
adjustment is to increase the trading
securities investment account by $800.
Investments
41
Example D (Contd.)
The Adjusting entry on 12/31/x7
Investment in Trading Securities*
800
Unrealized Holding Gain**-I/S
800
*The investment bal. equals $38,000, the fair

value, after the adjustment.
**Reported in the income statement

Investments
42
Investments in Held to Maturity

Securities (debt securities only)
The account treatment (SFAS No. 115):
(a) Initial Recording: at cost*(not using a

discount or a premium account);
(b)End of Period Reporting: at amortized cost;
(c)Unrealized Holding Gains or Losses:not
recognized.
(d)Interests and realized gains (Losses) on
Sale : all included in income.
* the present value
Investments
43
Investments in Held-to-Maturity (HTM)

Securities
APB opinion No.21 recommends separate

disclosure of face amount ($100,000) and the
discount ($1,000).
However, most investors do not use separate
accounts for face value and the unamortized
discount (or premium).
The discount ($1,000) will be amortized to
increase the interest revenue using the
effective interest method.
Investments
44
Example E: amortization of discount or
premium of investments in held-to-maturity
Assume that Green acquires an investment in bonds that

will be held to maturity with a face value of $100,000 for
$102,458.71 on 1/1/x5. The stated interest rate is 13%
and interests are paid on 6/30 and 12/31. The bonds
mature on 12/31/x7. The effective interest rate is 12%*
* 102,458.71 = 100,000 x 0.70496 + 6,500 x 4.91732
semiannual effective interest rate = 6%
6 period
Investments
6 period ?%
45
Example E:(contd.)
J.E
1/1/x5
Investment in Bonds held-to-maturity
102,458.71
Cash
102,456.71
6/10/x5
Cash
6,500
Interest Revenue*
6,147.52
Inv. in Bonds
352.48
Investments
46
Example E: record the premium in a

separate account (An alternative)
J.E
1/1/x5
Investment in Bonds
100,000
Prem. on Bond Inv.
2,458.71
Cash
102,456.71
6/10/x5
Cash
6,500
Interest Revenue*
6,147.52
Prem. on Bond Inv.
352.48
Investments
47
Example E:(contd.)
* Interest Rev. = Present Value x Effective Rate
= 102,458.71 x 6% = 6,147.52
Amortization of Premiums(discounts) on
investments decreases (increases) interest
revenue.
Investments
48
Bond Investment Interest revenue and

Premium Amortization Schedule
Effective Interest Method
Cash
Debita
Interest
Revenue
Creditb
Date
1/1/x5
6/30/x5 $ 6,500.00 $ 6,147.52
12/31/x5
6,500.00
6,126.37
6/30/x6
6,500.00
6,103.96
12/31/x6
6,500.00
6,080.19
6/30/x7
6,500.00
6,055.01
12/31/x7
6,500.00
6028.24c
Investment in Carrying Value of

Debt Securities
Investment in
Creditc
Debt Securitiesd
$
102,458.71
$
352.48
102,106.23
373.63
101,732.60
396.04
101,336.56
419.81
100,916.75
444.99
100,471.76
471.76
100,000.00
Investments
49
Bond Investment Interest revenue and

Premium Amortization Schedule:(contd.)
Straight-Line Method
Cash
Debita
Debt Securities
Creditb
Date
1/1/x5
6/30/x5 $ 6,500.00 $
12/31/x6
6,500.00
6/30/x6
6,500.00
12/31/x6
6,500.00
6/30/x7
6,500.00
12/31/x7
6,500.00
409.79
409.79
409.79
409.79
409.79
409.79
revenue Investment in
Creditc Debt Securitiesd
$ 102,458.71
$ 6,090.21
102,106.23
6,090.21
101,732.60
6,090.21
101,336.56
6,090.21
100,916.75
6,090.21
100,471.76
6,090.21
100,000.00
Investments
50
Example F:
Investment in HTM at a Discount
Assume that HTM investments on p45 were

acquired at a discount for $97,616.71. The effective
interest rate is 14%.
1/1/x5 Invest. in Bonds
held to maturity
97,616.71
Cash
97,616.71
6/30 Cash
6,500
Invest. in Bonds
333.17
Interest Revenue*
6833.17
* Interest Revenue = Present value x 14% x 6/12
= 97,616.71 x 14% x 6/12
Investments
51
HTM Example F (contd.): Discount

Recorded in a Separate Account
1/1/x5
Invest. In Bonds
100,000
Cash
97,616.71
Discount on Bond Inv.
2,383.29
6/30 Cash
6,500
Discount on Bond Inv.
333.17
Interest Revenue*
6833.17
Investments
52
Bond Investment Interest Revenue and

Discount Amortization Schedule
Effective Interest Method
Investments
53
Amortization for Bonds Acquired
Example G
Between Interest Dates
13% bonds with a face value of

$200,000 were purchased for
$204,568.5 plus the accrued interest of
$6,500 on 4/3/x5.
Interests were paid on 6/30 and 12/31

and
the bonds mature on
12/31/x7. The effective
rate is 12%
Investments
54

Example
G(cont.)
Bond Investment
Interest Revenue and
Premium Amortization Schedule (Effective

Interest Method)
Date
1/1/x5
6/30/x5
12/31/x5
6/30/x6
12/31/x6
6/30/x7
12/31/x7
Cash
Debita
Interest
Revenue
Creditb
$ 13,000.00
13,000
13,000
13,000
13,000
13,000
$ 12,295.00
12,252.96
12,208.14
12,160.63
12,110.26
12,052.01e
Investment Carrying value

in Debt
of Investment
HTM
in Debt
Creditc
HTMd
$ 204,921.00
$
705.00
204,216.00
747.04
203,468.96
791.86
202,677.10
839.37
201,837.73
889.74
200,947.99
947.99
200,000.00
Investments
55

Example G(cont.)
a. 200,00 x 13% x6/12.
b Previous investment carrying value x 0.12 x 6/12.

c. a - b.
d. Previous investment carrying value - c.
e. Difference $4.87 due to rounding error.
Investments
56

Example G(cont.)
Verifying the purchase price of example G :

Present value of the bond on 1/1/x5
=> 200,000 x 0.705 + 13,000 x 4.917 = $204,921
Interest Revenue for 1/1/95 - 6/30/x5

$204,921 x 12% x 6/12 = 12,295
Cash Received for interest (1/1/x5 - 6/30/x5)

$200,000 x 13% x 6/12 = 13,000
Premium amortized for the period of 1/1/x5 - 6/30/x5

=>13,000 -12,295 = 705 (for 6 months)
Premium amortized for the period of 1/1/x5 - 4/1/x5 =>705 x 3/6 = 352.5 (for 3 months of the first period)
Therefore, the P.V. of the bond on 4/1/x5 =>

$204,921 -352.5 = $204,568.5
Investments
57

Example G(cont.)
4/3/x5
Investment in bonds- HTM
Interest Receivable
Cash
204,568.5
6,500
211,068.5
6/30/x5
Cash
13,000
Interest Receivable
Interest Revenue
Investment in bondds- HTM
Investments
6,500
6,147.5
352.6
58

Example G(cont.)
12/31/x5
Cash
13,000
Interest Revenue*
Inv. In Bonds- HTM**
12,252.96
747.04
* P.V. of bond on 7/1/x5 => P.V. of Bond on 1/1/x5

minus premium amortized for the period of 1/1/x5 6/30/x5 => $204,921 - 352.5 -352.5 = $204,216
Interest revenue of the 2nd. Period (7/1/x5 -12/31/x5)
=>$204,216 x 0.12 x 6/12 = 12,252.96
** Amortization of Premium for 7/1/x5 - 12/31/x5 period.
Investments
59
Sale of Investment in Securities Held

to Maturity Before Maturity
This should not occur unless circumstances
changed.
If it does occur, update the interest revenue

and the amortization of premium or discount
from last interest payment date to the sale date.
To determine the gains or losses, compare

selling price (excluding accrued interests) with
the updated carrying value.
Investments
60
Example H:
Sale of Investment in Securities

Held to Maturity Before Maturity
13% bonds with a face value of $100,000 were

purchased on
1/1/x5 for $97,616.71 as in example
F. The bonds were sold on
3/31/x6 for $102,000 plus accrued interest effective interest rate is
14%.
(1)
Interest
Date
Revenue
1/1/x5
6/30/x5
6833.17
12/31/x5 6856.49
6/30/x6
6881.45
(2)
Sated
Interest
6,500.00
6,500.00
6,500.00
(3)
Dis.
Amortized
333.17
356.49
381.45
Investments
(4)
P.V.
of Invest
97,616.71
97,949.88
98,306.37
98,687.82
61

Example H:(contd.)
(1) = (4) * 0.07
(2) = face amount * 0.065
(3) = (1) - (2)
(4) = P.V. at beginning + (3)
* Interest Revenue for 1/1/96 - 3/31/96
=> 6881.45 * 3/6 = 3440.72
Dis. Amortized for 1/1/96 - 3/31/96
=> 381.45 * 3/6 = 190.73
Investments
62

Example H:(contd.)
Investment in Debt Securities Held to Maturity
6/30/x5
12/31/x5
3/31/x6
97,616.71
333.17
356.49
190.17*
97616.71 + 333.17 +
356.49 = 98,306.37
*Interest Revenue
= (P.V. on 1/1/x6) x 14% x 3/12
= (98,306.39) x 14% x 3/12
= 3,440.72
98,496.54
Investments
63

Example H:(contd.)
J.E
3/31/x6
Interest Receivable 3,250
Investment in Debt Sector
190.73
Interest Revenue 3440.72
Cash (102,000 + 3,250)

105,250
Investment in Debt
98,496.54
Interest receivable
3,250
Gain on Sale of Invest. in Debt
3,503.46
Investments
64

Example H:(contd.)
Gains= Selling pirce (excluding accrued
=102,000-98,496.54 =3,503.46
interest)- Carrying value
(updated with amort. of pemium)
Investments
65
The Fair Value Option for Financial

Assets (SFAS 159)
SFAS159 allows companies to choose
reporting most financial assets at fair value
including security investments classified as
available-for-sale (SAS) and held-to-maturity
(HTM).
This decision of reporting these investments
at fair value is irrevocable.
Once the decision is made for a SAS or a
HTM security, the company would report that
security as a trading security.
Investments
66
The Fair Value Option (contd.)

When electing the fair value option to
account for SAS or HTM, the fair value
adjustment for these securities should be
made indirectly using a valuation account
(i.e., the fair value adjustment account).
The fair value adjustment should not be
made directly to the trading security account.
The unrealized gain or loss would be
Investments
67
Example I: Same infor. as in Example A on p20,

Investment in SAS-Fair Value Option Reporting
The fair value option reporting was elected for all investments
in SASa. The following entry would be recorded on 12/31/x5:
Fair Value Adjustmentb
3,000
Unrealized Holding Gain/Lossc
3,000
The fair value option can be applied on an instrument-byinstrument basis.

bThe adjustment to fair value is made indirectly and the SAS
investment is reported as trading securities on the B/S at the fair
value. C Reported in the income statement
Investments
68
Example I: Same infor. as in Example A on p23,

The following entry would be recorded on

12/31/x6:
Unrealized holding Gain/Loss a

5,000
5,000
Reported in the income statement
An indirect adjustment; the SAS is reported

as trading securities on the B/S at fair value.
Investments
69
Example J: Same infor. as in Example B on p27,

In 20x7, Green sold 100 shares of A stock

for $6,000. J.E. to record this transaction
Cash
6,000
Loss on sale of invest.
100
Investments (at cost)
5,000
Fair Value Adjustment *
1,100
*For stock A, the cost is $5000 while the
fair value on 12/31/x6 is $6,100 (see
P23).
Investments
70
Transfers Between Reporting Categories

Investment classification is
reassessed at each reporting date.
Securities investments can be
reclassified* at the reporting date if a
different reporting category is more
appropriate.
*an unusual event, disclosures of
reasons are required
Investments
71
Transfers (contd.)
At reclassification:
1) The security is updated to its fair
value.
2) The security is transferred at its
fair value.
3) Any unrealized holding gain or loss
should be accounted for in a
manner consistent with the new
reporting category.
Investments
72
Transfers :(contd.)
The accounting Treatments for Transfers:
From
SAS,HTM
To
Trading
Treatment
The unrealized gain
or loss included in
current earnings.
Investments
73
Transfers :(contd.)
From
To
Trading
Available
Treatment
Held to Maturity
No accounting for
the unrealized gain
or loss (it has been
recognized in
income)
Investments
74
Transfers :(contd.)
From
To
Held to
SAS
Maturity
Treatment
The unrealized gain or
loss reported in the
balance sheet as a
separate component of
stockholders equity
Investments
75
Transfers :(contd.)
From
To
SAS
HTM
Treatment
Fair value of SAS
became the
amortized cost of
HTM. (amortized the
unrealized gain or loss to
earnings over the remaining
life of the securities.)
Investments
76
Transfers :(contd.)
Example 1: Transfer from SAS to Trading:
Using the example of Green Company and
instead of selling security A (cost is $5,000)
in 20x7, Green decided to transfer security
A from SAS security category to trading
security category when security As fair
value is $6,300 on 12/31/20x7. The
transfer is recorded as follows:
Investments
77
Transfers :from SAS to Trading

* (Fair value of security A on 12/31/x6 is $6,100)
1. Fair Value Adjustment
200
Unrealized gain or loss
200
2. Investment in Trading
6,300
Unrealized gain/ loss
1,300
Investment in SAS (at cost)
5,000
Fair Value Adjustment (for A)
1,300
Gain on Transfer of Securities
1,300
Investments
78
Transfers : from Trading to SAS

Example 2: From Trading to SAS
Assume the same facts as example 1 expect
security A is being transferred from Trading to
SAS. The transfer is recorded as:
Investment in Trading
200
Unrealized Gain / Loss
200
Investment in SAS
6,300
nvestment in Trading
6,300
Investments
79
Transfers:(contd.)
3.From held-to-maturity to Available (or
Trading):
Bonds with a face amount of $10,000 was
purchased at par and was included in the
held-to-maturity category. When the fair
value is $9,500, the company transfers the
bonds into the available-for- sale category.
Investments
80
Transfers:(contd.)
The transfer is recorded as follows:
Investment in SAS
9,500*
Unrealized Gain or Loss in Value
of Investment in SAS
500
Investment in HTM
10,000*
Note: the new carry value is $9,500. The unrealized gain
or loss is reported in the stockholders equity section of
the Balance Sheet.
Investments
81
Transfers :(contd.)
* or any amortized cost if the bonds were
purchased at discount or premium. The

unrealized account will be adjusted accordingly.
** If the transfer is to Trading category, the gain
or loss will be included in income.
Alternative J.E. for the transfer:
Investment in T. S.
9,500
Loss
500
Investment in HTM
10,000
Investments
82
Financial Statement Classification

a.Trading securities: current assets.
b.Securities-available-for-sale (SAS):
Current or noncurrent depends on
whether the securities will be sold in
one year or one operating cycle,
whichever is longer.
c.Securities-held-to-maturity:current or
noncurrent assets.
Investments
83
Financial Statement Classification
Trading securities related cash flows are
classified as cash flows of operating

activities while cash flows from all other
types of securities are reported as cash
flows of investing activities.
Investments
84
Financial Statement Disclosure

Disclosure notes for investments should
include:
a. Amortized cost (cost basis).
b.Gross unrealized gains.
c. Gross unrealized losses.
d. Estimated fair value.
Investments
85
Impairment of Value
If the decline in the fair value of

investment is NOT temporary (I.e., a
bankruptcy filing), the value of the
securities should be written down to the
fair value.
The amount of the write-down should be
treated as a realized loss and is included
in the income of the year.
Investments
86
Impairment of Value (in Debt Investment)
Impairment occurs for debt

securities when company cannot
collect all the amount due from
debt securities investments.
Investments
87
Impairment of Value (in Debt Investment)
(cont.)
The amount of write down is

included in the Income statement
as a realized loss.
The fair value becomes the New
cost and is not changed for the
subsequent recovery in the fair
value.
Investments
88
Example a:
Impairment:(contd.)
Tracy company had an investment
categorized as held to maturity with an

amortized cost of $21,500 and a fair value
of $6,500. If the decline is Not temporary,
the accounting treatment is:
Loss on Impairment
15,000
Investment in Debt Securities Held

to Maturity
15,000
Investments
89
Example a(contd.):
Impairment:(contd.)
The $6,500 became the new cost.

Interest revenue is computed using the
effective interest needed based on the
new effective rate.
Investments
90
Impairment of Value (contd.):

For investment in debt securities classified as
SAS experienced a decline in value other than
temporary, the accounting treatments are:
1.Eliminate the unrealized gain or loss

related to the securities.
2.Write down to the fair value and
recognize the write down as a realized
Loss.
Therefore, the fair value becomes the new cost
basis.
Investments
91
(contd.)
Impairments:
Example
(debt investment
classified
In 20x7,b:
Hinges'
investment
in Das SAS)
company had a fair value of $5,000.

The cost of this investment is $15,000
and the fair value of D company
investment is 13,000 on 12/31/x6. This
investment was classified as SAS. The
J.E. to record the impairment are :
Investments
92
Impairments:(contd.)
Example b: (debt investment classified as SAS)

2,000
Unrealized Holding Gain/Loss
2,000
Eliminate the unrealized gain/loss
Loss on Impairment
Investment in SAS
10,000
10,000
Write down to the fair value

Investments
93
(contd.)
Impairments:
Example c:
If the debt investment is classified as

trading securities, the following entry will be
recorded for the write-down:
Loss on Impairment
8,000
Investment in Trading
8,000
Securities
Investments
94
Impairment of Value ( in equity securities)
SFAS No. 115 does not provide precise

guideline to determine the impairment
for equity securities.
Whenever the realizable value is lower
than the carrying amount of the
investment, an impairment should be
considered.
Accounting treatment for the write
down is similar to that of the debt
securities as in examples b and c.
Investments
95
Equity Method
APB Opinion No.18 requires the use of
equity method by an investor who is
able to exercise significant influence
over the operating and financial policies
of an investee.
In the absence to the contrary, an
investment of 20% or more in the
outstanding common stock of the
investee leads to the presumption of
significant influence.
Investments
96
Equity Method
Exceptions: there are cases that
investors hold 20% or more of the
outstanding common stock of an
investee but do not have significant
influence. In these cases, the equity
method should not be used.
FASB Interpretation No. 35 provides

examples of these cases:
Investments
97
Equity Method:(contd.)
1.The investee challenges the investor's
ability to exercise significant influence

(through litigation or complaints to
regulators).
2.Majority of investees ownership is
concentrated among a small group of
shareholders who operate the investee
without regards the views of the
investor;
Investments
98
3.The investor tries and fails to obtain
representation on the investees board of
directors;
4.The investor signs an agreement to give
up significant shareholder rights.
5.The investor could not acquire financial
information needed to apply the equity
method (i.e., fair market value of
depreciable assets).
Investments
99
On the other hand, the investor may
own less than 20% of the voting shares
but is able to exercise significant
influence over the investee.
The equity method should be applied
in this case.
Investments
100
Consolidated Financial Statements

and the Equity Method
When a company acquires 51% or more of

the voting stock of another company, the
acquiring firm has the controlling interest
and is called the parent while the investee
company is called the subsidiary.
Both companies continue to operate as
separate legal entities and report separate
financial statements .
The parent company also reports
consolidated financial statements (F/S).
Investments
101

and the Equity Method (contd.)
Consolidated F/S combine the parent and

subsidiary F/S into a single aggregate set
of F/S.
When a purchase method is used to
account for the acquisition, the acquired
company's assets are reported on the
consolidated F/S at their fair values, not
their book values.
Investments
102

If the purchase price is greater than the fair

value of the acquired net assets (fair value
of assets - fair value of liabilities), the excess
amount is recorded as goodwill.
The depreciation of the acquired company's
assets is based on the fair value on the
consolidated F/S.
This depreciation expense is greater than
that of using the book value as the
deprecation base.
Investments
103

The goodwill is NOT subject to amortization

on the consolidated F/S (SFAS No.142).a
The incremental depreciation expense will
reduce the net income reported on the
consolidated F/S.
The investment account of the equity method
is to approximate the net outcome of the
consolidated F/S for the investor.
a. Effective date for SFAS 142 is for fiscal years beginning after
12/15/2001. SFAS 142 is to apply to all goodwill. Goodwill acquired after
6/30/2001 is subject immediately to nonamortization of SFAS 142.
Investments
104
The Accounting Procedures of the

Equity Method
The investment is originally recorded at
cost but is subsequently adjusted each
period for the changes in the net assets
of the investee.
The investment is increased (decreased)
by the investor's proportionate shares of
investees net income (loss) and
decreased by the dividends received.
Investments
105

Equity Method
The Investees net income is further
adjusted by the following:
1. Elimination of intercompany
transaction impact;
2. the depreciation of investees
assets step-upa (if there is any)
a. fair value of investees depreciable

assets - book value of these assets
Investments
106

Treat the proportionate share of investee

extraordinary items as investor's
extraordinary items.
Similar principle applies to investees
discontinued operation results and
cumulative effect from accounting method
change).
Investments
107
Summary of the Equity Method

Procedures:
Investment = Acquisition Cost + Investors
Share of Investee's Net Income (N/I) Dividends Received
Where:
Investors Share of Investee's Income =

(Investees N/I x owner. %) - Adjustments
Dividends Received =
Total Div. Paid by Investee x ownership %
Investments
108

Procedures (contd.):
Adjustments include:
a.
b.
elimination of intercompany
transaction impact
the depreciation of investees
depreciable assets step-up
Investments
109

Investment
Cost
Share of Income
Share of dividends
Share of depre. on
assets step-up
Investments
110
Example: Equity Method

Investments
On 1/1/x5, Clibron Company purchases
4,200 shares of common stock of the Sam
Corporation which has 16,800 shares of
common stock outstanding on 1/1/x5.
Thus, Cliborn has 25% of the ownership

and significant influence is presumed to
exist. The acquisition cost for the 4,200
shares is $125,000.
The following information concerning Sam

Corporation is also available on 1/1/x5:
Investments
111
Example:(contd.)
B/S Book Value Fair Market Value
Depreciable assets
(remaining
life, 10 year)
$400,000
$ 450,000
Other nondepreciatble assets
(e.g.,
land)
$190,000
$ 226,000
Total
$ 590,000
$ 676,000
Liabilities
$ 200,000
$ 200,000
Common Stock
$ 250,000
Retained Earnings
$ 140,000
$ 590,000
Investments
112
Example:(contd.)
Also, no intercompany transactions occur
during the year.
Sam Corp. paid $20,000 dividends on
8/28/x5, and reported net income for 20x5
of $81,000 consisting of ordinary income
of $75,000 and an extraordinary gain of
$6,000.
These events are recorded on Cliborn
Companys book as follows:
Investments
113
Example:(contd.)
1.To record the investment on 1/1/x5:
Investment in Stock 125,000

Cash
125,000
2.To record the receipt of dividends on
8/28/x5:
Cash (20,000 x 25%)

Investment in Stock
Investments
5,000
5,000
114
Example:(contd.)
3.To record Cliborn Companys 25% share in
the years net income:
12/31/x5
Investment in Stock 20,250a

Investment Income: ordinary
Investment Income: extra
18,750b
1,500c
a. $81,000 x 25% b. $75,000 x 25% c. 6,000 x 25%

Investments
115
Example:(contd.)
4. Adjustments:
To reduce the investment by the
proportionate depreciation of invstees
depreciable assets step-up:
Investment Income: ordinary
1,250a
Investment in Stock
1,250
a.[(450,000 - 4000,000) x 25%] / 10
Investments
116
Example:(contd.)
Goodwill:
Purchase price - fair value of net assets acquired
Fair value of net assets (assets liabilities)
=$676,000 - $200,000= $476,000
Investor's share of the fair value of net assets

= $476,000*25% = $119,000
Goodwill = $125,000 - 119,000

= $6,000
Investments
117

Investment (12/31/x5)
Cost
125,000
Share of Income 20,250 5,000 Dividends
1,250
Incremental Depr.
Balance
139,000
Investments
118
Financial Statement Disclosures

The Investment in stock account is disclosed in the long-term
investment section of the 12/31/x5 Balance Sheet of Cliborn
Company as follows:
Investment in Sam Corp.

Acquisition Price (1/1/x5) $125,000
Add: Shares of 20x5 reported
ordinary Income
$18,750
Shares of 20x5
reported
extraordinary Income
1,500
20,250
145,000 Less:
Dividends Paid (8/28/x5) $5,000
Depreciation on Excess Market Value
of Acquired Assets
1,250
($6,250)
Carrying Value
$139,000
Investments
119
Financial Statement Disclosures :

(contd.)
The total amount of Investee income disclosed on Cliborn
income statement for 20x5 is $18,700, which consists of
$17,200 income from continuing operations and $1,500 of an
extraordinary income. The supporting schedule is as follows:
Shares of 20x5 Ordinary Income
$18,750
Less: Depreciation on Excess M.V. of
Acquired Assets
($1,250)
Ordinary Investment Income

Plus: Share of extraordinary Income
Net Investment Income
$17,500
$1,500
$19,000
Investments
120
Fair Value Option for Investments

Accounted for Under the Equity Method
When the fair value option is elected to

report investments accounted for under
the equity method, the investments are
reported at the fair value.
The investments are not reclassified as
trading securities as in the case of fair
value option reporting for SAS or HTM.
Investments
121
Fair Value Option for Equity Method

Investments (Contd.)
The investments are reported on a
separate line in the balance sheet or
with other equity method investments
with the fair value in a parenthesis.
The unrealized holding gain/loss is
Investments
122
Example: Fair Value Option for

Equity Method Investments
Using the example on p111-120, Clibron

Corporation has been applying the equity
method to account for its investment in Sam
Corporation, the investment account balance
under the equity method is $139,000 on
12/31/20x5(see the t-account on p118).
Assuming the fair value of Sam Corporation
on 20x5 is $700,000, the fair value of
Clibrones 25% share of Sam Corp. would be
$175,000.
Investments
123

Equity Method Investments (Contd.)
If Clibron had been using the equity method

to account for its investments in Sam Corp.
but elected the fair value option reporting for
this investment on 12/31/x5, the following
adjustment would be made by Clibron Corp.
on 12/31/x5:
Fair Value Adjustment*
36,000
Unrealized Holding Gain**
36,000
*to adjust the investment account to fair value of
$175,000 ** reported in the income statement
Investments
124

Equity Method Investments (Contd.)
The contribution to the earnings from
investment in Sam Corp equals:
$19,000 (net investment income
recognized under the equity method,
see p 120) +$36,000 (fair value adjust.)
= $55,000
Investments
125
Example: Fair Value Option for Equity Method

Investments (Contd): An Alternative
If Clibron has been using the fair value

reporting for its investment in Sam and
made its fair value adjusting on 12/31/x5,
the following entries would have been
recorded in 20x5 for this invement:
1/1 Investment
125,000
Cash
125,000
8/28 Cash 5,000
Investment Revenue
5,000
Investments
126
Example: Fair Value Option for Equity Method

Investments (Contd): An Alternative
12/31/x5
Fair Value Adjustment *
50,000
Unrealized Holding Gain**
50,000
* to adjust the investment to the fair value of
$175,000
** reported in the income statement
The contribution to the earnings from
investment in Sam equals: $55,000 (i.e.,
$5,000+50,000).
Investments
127
Change from Equity method:

When the ownership falls below 20%,
the investor may lose significant influence
over the investee and the use of the
equity method is no longerappropriate.
The investment should be accounted for

under the fair value method.
Investments
128
Change from Equity method

(contd.):
No adjustment is made to the carrying
amount of the investment account.
The carrying amount of the investment

on the date of change becomes the new
cost basis.
The equity method is simply discontinued

and the appropriate new method is
applied from then on.
Investments
129
Change to Equity method:

The investment account is retroactively
adjusted to the balance as if the equity
method always had been used.
An example of changing from
accounting the investment as SAS to
the equity method:
Procedures:
Investments
130

1. Eliminate the unrealized gain or loss
(i.e., adjust the investment account to
the cost)
2. Adjust the investment account
retroactively:
Investment in Stock
$$
Retained Earnings
$$
$$ = its previous percentage of( investee's
adjusted income - Dividends) prior to the change.
Investments
131
Change to Equity method (contd.):

Prior financial statements should be
restated using the equity method for
comparative purposes.
The income effect for years prior to those
shown in the comparative statements is
reported as an adjustment to the
beginning retained earnings of the earliest
year reported on the R/E statement.
Investments
132
Sale of Equity Method Investment
A gain or loss is recognized as the

difference between the selling price and
the carrying amount of the investment
account.
Investments
133
Conclusion
Different methods in accounting for

investments will not affect the cash
flows, but only the income number.
Equity method is to prevent income
manipulation by investees who have
significant influence on dividend policy.
Investments
134
Additional Issues
A. Reporting for non marketable securities:
non marketable securities are stock or

bonds issued by a privately-held company
whose securities are not traded in a
qualifying market.
Reporting for these securities does not
follow the guidance of SFAS 115. These
securities are typically reported at their
historical cost and the unrealized gains and
losses are ignored.
Investments
135
Additional Issues (contd.)

B.Stock Dividends and Splits
No journal entry is needed to account
for either the stock dividends or the
splits. However, a memo is required to
indicate that the cost of shares is
reduced.
Investments
136
Additional Issues:(contd.)
Example of stock dividends:
2,000 shares of Kell Co. common

stock were originally purchased for $30
per share by the Smith Co.
Two months later, Kell issued a 50%
stock dividend. Therefore, Smith
received another 1,000 shares. The
following memo is to reflect the stock
dividend received by Smith:
Investments
137
Example of stock dividends:
memo: Received 1,000 shares of Kell

Company common stock as a stock
dividend. The cost of the shares is now $20
per share, computed as follows: $60,000 /
(2,000 + 1,000) = $20.
Subsequently, 500 shares of investment
were sold for $25 per share. The fair value
at the most recent B/S data was $23 per
share. The journal entry to record this
transaction is:
Investments
138
Example:(contd.)
Cash
12,500
Unrealized Gain and Loss
in Value of SAS
1,500
Investment in SAS
Gain on Sale of Investments **
11,500
2,500
* Cost per share has been reduced from $30 to $20 per share
due to stock dividends.
** ($25 - 20) * 500 = 2,500
Investments
139
C.Stock Warrants
Stock warrants are certificates that enable

their holders to purchase a specific
number of shares at a predetermined
price.
No additional cost is incurred when the
warrants are received by the corporation
holding the investment in common stock.
It is necessary to assign a portion of the
cost of the stock (investment) to the
warrants upon their receipt of warrants.
Investments
140
C.Stock Warrants (contd.)
The amount is determined by use of a
weighted average based on the market
value of the stock ex right and the market
value of the warrants.
The accounting for any subsequent
purchases of shares (or any sale of
warrants) would use the amount assigned
to the warrants.
Investments
141
D.Convertible Bonds
Investments in convertible bonds
would be included in the available for
sale (or trading) category and valued at
fair value.
When these convertible bonds are
converted into stocks,memo is required
to specify the number of shares that are
now owned instead of bonds.
Investments
142
E.Cash Surrender Value of Life Insurance
Portion of insurance premiums paid for
executives may be returned to the company
upon the cancellation of the policy.
This guaranteed cash returned upon the

cancellation of an insurance is called
Cash Surrender Value of an insurance
plan.
Investments
143
E. (contd.)
This portion of the insurance premiums
(equal to the cash surrender value) should
be reported as a long- term investment on
the balance sheet, rather than an
insurance expense.
Example: At the beginning of the year, the
Mele Co. pays an annual insurance
premium of $5,500 to cover the lives of its
officers. The following entry is recorded:
Investments
144
Example:
Prepaid Insurance
Cash
5,500
5,500
According to the terms of the insurance

contract the cash surrender value of the policy
increases from $7,200 to 8,300 during that
year.
The adjusting entry at the end of year to
record the insurance expense and the
increase in cash surrender value is as follows:
Investments
145
Example:(contd.)
Insurance Expense
4,400
Cash Surr. Value of Life Ins. 1,100
Prepaid Insurance 5,500
Upon the death of any of insurance officer, Mele
would debit cash for the proceeds received from the
insurance company, credit cash surrender value and
any difference will be reported as an ordinary gain.
For tax purchases, the premiums are Not tax

deductible and the gain is not taxable.
Investments
146
F.Investments in Funds
Assets (i.e., securities, cash,..) could be placed
in special funds for specific purposes (i.e. for the
retirement of long-term liabilities (bond sinking
fund), etc).
Assets placed in the funds are not available for

normal operations because of the contractual
arrangement. Therefore, long-term funds are
reported as investments on the balance sheet.
Investments
147
F.Investments in Funds (contd.)
The accounts used in connection with a bond
sinking fund are:
Sinking Fund Cash, Sinking Fund Securities,

Sinking Fund Revenues, Sinking Fund
Expenses, Allowance for Change in Value of
Sinking Fund Securities, Unrealized Gain/Loss in
Value of Sinking Fund Securities, and loss on
Sale of Sinking Fund Securities and Loss on
Sale of Sinking Fund Securities.
Investments
148
Impairment of Receivable due to

Troubled Debt Restructuring
The receivable is settled outright

(example is from p589 of Spiceland, etc.
textbook)
First Prudent is owed $30 million by Brillard
Properties under a 10% note with two years
remaining.
The previous years interest was not
received due to financial difficulties of
Brillard.
First Prudent agrees to settle the receivable
and the accrued interest in exchange for
property with a fair value of $20 million on
1/1/x3.
Investments
149

Troubled Debt Restructuring (contd.)
J.E. ($ in millions)
Land
20
Loss on T/D
restructuring 13
Interest receivable
3
Note receivable
30
Investments
150

The receivable is continued but with
modified terms: (p589 of Spiceland, etc.)
Same information as on p148, except
First Prudent agrees to forgive the
interest accrued, reduce the remaining
two interest payments to $2 million each
and reduce the principal to $25 million.
Investments
151

Carrying value of the loan: $33 million

Present value of future
cash flows of receivable
(24,132,330)
Loss from the settlement
$8,867,670
PV=$2 millionx1.73554+$25
millionx0.82645
Investments
152

J.E.(1/1/x3)
Loss on T/B restructuring 8,867,670
Interest receivable
3,000,000
Note receivable
5,867,670*
* $30 million-24,132,330 (PV of future cash
flows from the settlement)
1/1/x4
Cash
2,000,000
Note Receivable
413,233
Interest Revenue*
2,413,233
*10% interest on the balance of N/R on
1/1/x3
Investments
153
Impairment of Receivable due to Troubled

Debt Restructuring (contd.)
The balance of Note Receivable on
1/1/x4 = 24,132,330 +413,233 =
24,545,563 = present value of Note
receivable on 1/1/x4 =
$2 million x0.9091+25,000,000x0.9091
Investments
154
Impairment of Receivable due to Troubled

Debt Restructuring (contd.)
1/1/x5 (receipt of $2 million interest and $25

million of principal)
Cash
2,000,000
Note Receivable
454,570
Interest Revenue
2,454,570*
*10% interest on the bal. of N/R on 1/1/x4
Cash
25,000,000
Note Receivable
25,000,000
Investments
155

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Chapter 12

Objectives of the Chapter

Securities for Investments

Investment in debt securities: include

Securities for Investments(cont.)

For reporting purposes, all investments

Classification of Investments (cont.)

Classification of Investments (cont.)

Investments - initial recording and

Investments - initial recording and

Investments - dividends and Interest

Dividends, interest revenues of

Investments - other valuation

Other Valuation Methods:

a. Equity method: Applied when

Investments - other valuation

Investments - other valuation

The investor has to issue the

Summary of Accounting for

Reporting of Unrealized Holding

Equity method Not recognized

Example A:investments classified as

The accounting treatment (SFAS 115)

(a) initial recording: at cost;

Assume that Green Company acquires the

A Company common stock 100

B Company common stock 300

C Company preferred stock 200

D Company 10% bonds with a face value of

Cost = 100 x 50 + 300 x 80 + 200 x 120 +

** Accrued interests = 15,000 x 10% x 5/12 = $625

5/31/x5 Cash 750

12/31/x5 Invest. Receivable

The following info. is available on 12/31/x5: (Note: for

12/31/x5 Adjusting entry (for valuation):

Fair Value Adjustment

Unrealized holding Gains**

** Reported in B/S as other comprehensive

Balance Sheet Presentation :SAS

Inv. Sec. ( at fair Value) $71,000 Accu. Other Comp. Income

The following info. is available on 12/31/x6:

12/31/x6 Adjusting entry (for valuation):

** Other comprehensive income of x6

Balance Sheet Presentation:SAS

Inv. Sec. (at cost)

Inv. Sec. (at fair value) $66,000 Stockholders Equity:

Unrealized holding gains

Realized Gains and Losses from Sale

Realized gains and losses are

In 20x7, Green sold 100 shares of A stock

Example B (cont.): SAS

Also in 20x7, Green sold 300 share of B for

Example B:(cont.) (with a fair value

Before the adjusting entry on 12/31/x7:

Investment (at cost)

The following info. is available on 12/31/x7:

Balance Sheet Presentation:SAS

Fair Value Adjus.

(1,000) Stockholders Equity:

Invest. Sec. (at fair)

$38,000 Accu. Other Comp. Income

Unrealized holding gains

Impairment of Securities Availablefor-Sale

If the decline in the fair value of securities