Chapter

16
Investments

Chapter
16-1

Accounting Principles, Ninth Edition

Study
Study Objectives
Objectives
1.

Discuss why corporations invest in debt and stock

securities.

2.

Explain the accounting for debt investments.

3.

Explain the accounting for stock investments.

4.

Describe the use of consolidated financial statements.

5.

Indicate how debt and stock investments are reported in

financial statements.

6.

Distinguish between short-term and long-term

investments.

Chapter
16-2

Long-Term
Long-Term Liabilities
Liabilities

Why
Corporations
Invest
Cash
management
Investment
income
Strategic
reasons

Chapter
16-3

Accounting for
Debt Investments
Recording
acquisition of
bonds
Recording bond
interest
Recording sale
of bonds

Accounting for
Stock
Investments
Holdings of less
than 20%
Holdings
between 20%
and 50%
Holdings of more
than 50%

Valuing and
Reporting
Investments
Categories of
securities
Balance sheet
presentation
Realized and
unrealized gain
or loss
Classified
balance sheet

Why
Why Corporations
Corporations Invest
Invest
Corporations generally invest in debt or stock
securities for one of three reasons.
1.

Corporation may have excess cash.

2. To generate earnings from investment income.

3. For strategic reasons.

Illustration 16-1

Temporary
investments
and the
operating cycle

Chapter
16-4

SO 1 Discuss why corporations invest in debt and stock securities.

Why
Why Corporations
Corporations Invest
Invest

Question
Pension funds and banks regularly invest in debt and
stock securities to:
a. house excess cash until needed.
b. generate earnings.
c. meet strategic goals.
d. avoid a takeover by disgruntled investors.

Chapter
16-5

SO 1 Discuss why corporations invest in debt and stock 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.
Chapter
16-6

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.

Chapter
16-7

SO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: Issel Corporation had the following transactions
pertaining to debt investments.
Jan. 1 Purchased 60, 8%, $1,000 Hollis Co. bonds for
$60,000 cash plus brokerage fees of $900.
Interest is
payable semiannually on July 1 and January 1.
July 1

Received semiannual interest on Hollis Co. bonds.

July 1

Sold 30 Hollis Co. bonds for $34,000 less $500

brokerage fees.

Instructions: (a) Journalize the transactions. (b) Prepare

the adjusting entry for the accrual of interest at December
31.
Chapter
16-8

SO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: Jan. 1 Purchased 60, 8%, $1,000 Hollis Co.
bonds for $60,000 cash plus brokerage fees of $900.
Interest is payable semiannually on July 1 and January 1.
Jan 1

Debt investment
Cash

60,900 *

60,900

* ($60,000 + $900 = $60,900)

Chapter
16-9

SO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: July 1 Received semiannual interest on
Hollis Co. bonds. Sold 30 Hollis Co. bonds for $34,000
less $500 brokerage fees.
July 1

Cash
Interest revenue
Cash
Debt investments
Gain on sale

* ($60,000 x 8% x = $2,400)
** ($34,000 - $500 = $33,500)
Chapter
16-10

2,400 *

2,400

33,500 **
30,450 ***
3,050
*** ($60,900 x = $30,450)

SO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Debt
Debt Instruments
Instruments
Exercise: (b) Prepare the adjusting entry for the
accrual of interest at December 31.
Dec 31 Interest receivable
Interest revenue

1,200 *

1,200

* ($30,000 x 8% x = $1,200)
Chapter
16-11

SO 2 Explain the accounting for debt investments.

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.
Chapter
16-12

SO 2 Explain the accounting for debt investments.

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.

Chapter
16-13

SO 2 Explain the accounting for debt investments.

Accounting
Accounting for
for Stock
Stock Investments
Investments
Ownership Percentages

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

No significant
influence
usually exists

Significant
influence
usually exists

Investment
valued using
Cost
Method

Investment
valued using
Equity
Method

Control
usually exists
Investment valued on
parents books using Cost
Method or Equity Method
(investment eliminated in
Consolidation)

The accounting depends on the extent of the investors influence

over the operating and financial affairs of the issuing corporation.
Chapter
16-14

SO 3 Explain the accounting for stock investments.

Holdings
Holdings of
of Less
Less than
than 20%
20%
Companies use the 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).

Chapter
16-15

SO 3 Explain the accounting for stock investments.

Holdings
Holdings of
of Less
Less than
than 20%
20%
Exercise: Dossett Company had the following transactions
pertaining to stock investments.
Feb. 1

Purchased 800 shares of Hippo common stock (2%)

for $8,000 cash, plus brokerage fees of $200.

July 1

Received cash dividends of $1 per share on Hippo

common stock.

Sept. 1 Sold 300 shares of Hippo common stock for

$4,400, less brokerage fees of $100.
Instructions:
Journalize the transactions.
Chapter
16-16

SO 3 Explain the accounting for stock investments.

Holdings
Holdings of
of Less
Less than
than 20%
20%
Exercise: Feb. 1 Purchased 800 shares of Hippo
common stock (2%) for $8,000 cash, plus brokerage
fees of $200. July 1 Received cash dividends of $1
per share on Hippo common stock.
Feb. 1
July 1

Stock investments
Cash
Cash
Dividend revenue

8,200 *
800 **

8,200
800

* ($8,000 + $200 = $8,200)

** (800 x $1 = $800)
Chapter
16-17

SO 3 Explain the accounting for stock investments.

Holdings
Holdings of
of Less
Less than
than 20%
20%
Exercise: Sept. 1 Sold 300 shares of Hippo common
stock for $4,400, less brokerage fees of $100.
Sept. 1

Stock investments
Cash
Gain on sale

4,300 *

3,075 **
1,225

* ($4,400 - $100 = $4,300)

** ($8,200 x 3/8 = $3,075)
Chapter
16-18

SO 3 Explain the accounting for stock investments.

Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Equity Method
Record the investment at cost and subsequently
adjust the amount each period for
the investors proportionate share of the

earnings (losses) and

dividends received by the investor.

If investors share of investees losses exceeds the carrying
amount of the investment, the investor ordinarily should
discontinue applying the equity method.
Chapter
16-19

SO 3 Explain the accounting for stock investments.

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. Stock Investments.

Chapter
16-20

SO 3 Explain the accounting for stock investments.

Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Exercise: (Equity Method) On January 1, 2010,
Pennington Corporation purchased 30% of the common
shares of Edwards Company for $180,000. During the
year, Edwards earned net income of $80,000 and paid
dividends of $20,000.
Instructions:
Prepare the entries for Pennington to record the
purchase and any additional entries related to this
investment in Edwards Company in 2008.

Chapter
16-21

SO 3 Explain the accounting for stock investments.

Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Exercise: Pennington purchased 30% of the common
shares of Edwards for $180,000. Edwards earned net
income of $80,000 and paid dividends of $20,000.
Stock investments

180,000

Cash

180,000

Stock investments

24,000

Investment revenue
Cash

6,000

Stock investments
Chapter
16-22

24,000

($80,000 x 30%)

($20,000 x 30%)

6,000

SO 3 Explain the accounting for stock investments.

Holdings
Holdings Between
Between 20%
20% and
and 50%
50%
Exercise: Pennington purchased 30% of the common
shares of Edwards for $180,000. Edwards earned net
income of $80,000 and paid dividends of $20,000.
After Pennington posts the transactions for the year, its
investment and revenue accounts will show the following.
Stock Investments
Debit
Credit
180,000
24,000

Investment Revenue
Debit
Credit
24,000

6,000

198,000
Chapter
16-23

SO 3 Explain the accounting for stock investments.

Holdings
Holdings of
of More
More Than
Than 50%
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

parents books as a long-term investment.

Parent generally prepares consolidated financial

statements.

Chapter
16-24

SO 4 Describe the use of consolidated financial statements.

Chapter
16-25

Valuing
Valuing and
and Reporting
Reporting Investments
Investments
Categories of Securities
Companies classify debt and stock investments
into three categories:
Trading securities
Available-for-sale securities
Held-to-maturity securities
These guidelines apply to all debt securities and all stock
investments in which the holdings are less than 20%.
Chapter
16-26

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Valuing
Valuing and
and Reporting
Reporting Investments
Investments
Trading Securities
Companies hold trading securities with the
intention of selling them in a short period.

Trading means frequent buying and selling.

Companies report trading securities at fair
value, and report changes from cost as part of
net income.

Chapter
16-27

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Valuing
Valuing and
and Reporting
Reporting Investments
Investments
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.
Chapter
16-28

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Valuing
Valuing and
and Reporting
Reporting Investments
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. stock securities.
d. trading securities

Chapter
16-29

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Trading
Trading Securities
Securities
Problem: Loxley Company has the following portfolio of
securities at September 30, 2010, its last reporting date.
Trading Securities
Dan Fogelberg, Inc. common (5,000 shares)
Petra, Inc. preferred (3,500 shares)
Tim Weisberg Corp. common (1,000 shares)

Cost
$ 225,000
133,000
180,000

Fair Value
$ 200,000
140,000
179,000

On Oct. 10, 2010, the Fogelberg shares were sold at a price

of $54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2,
2008. The Dec. 31, 2010, fair values were: Petra $96,000, Los
Tigres $132,000, and the Weisberg common $193,000.
Chapter
16-30

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Trading
Trading Securities
Securities
Problem: Prepare the journal entries to record the sale,
purchase, and adjusting entries related to the trading
securities in the last quarter of 2010.
Portfolio at September 30, 2010
Trading Securities
Dan Fogelberg, Inc. common (5,000 shares)
Petra, Inc. preferred (3,500 shares)
Tim Weisberg Corp. common (1,000 shares)

Cost
$ 225,000
133,000
180,000
$ 538,000

Market Adjustment Trading (account balance)

Chapter
16-31

Fair Value
$ 200,000
140,000
179,000
$ 519,000

($19,000)

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Trading
Trading Securities
Securities
Problem: On Oct. 10, the Fogelberg shares were sold at a
$54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2.
October 10, 2010 (Fogelberg):
Cash (5,000 x $54)

270,000

Trading securities

225,000

Gain on sale

45,000

November 2, 2010 (Los Tigres):

Trading securities (3,000 x $59.50)
Cash
Chapter
16-32

178,500
178,500

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Trading
Trading Securities
Securities
Problem: Portfolio at December 31, 2010
Trading Securities
Petra, Inc. preferred
Tim Weisberg Corp. common
Los Tigres common

Cost
133,000
180,000
178,500
491,500

Prior market adjustment balance

Market fair value adjustment

Fair Value
$ 96,000
193,000
132,000
$ 421,000

Unrealized
Gain (Loss)
$ (37,000)
13,000
(46,500)
(70,500)
$

(19,000)
(51,500)

December 31, 2010:

Unrealized loss - Income
Market adjustment - Trading
Chapter
16-33

51,500
51,500

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Available-for-Sale
Available-for-Sale Securities
Securities
Problem: How would the entries change if the securities
were classified as available-for-sale?

The entries would be the same except that the

Unrealized Gain or LossEquity account is used
instead of Unrealized Gain or LossIncome.
The unrealized loss would be deducted from the
stockholders equity section rather than charged to
the income statement.

Chapter
16-34

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Available-for-Sale
Available-for-Sale Securities
Securities

Question
An unrealized loss on available-for-sale securities is:
a. reported under Other Expenses and Losses in
the income statement.
b. closed-out at the end of the accounting period.
c. reported as a separate component of
stockholders' equity.
d. deducted from the cost of the investment.
Chapter
16-35

SO 5 Indicate how debt and stock investments

are reported in financial statements.

Chapter
16-36

Balance
Balance Sheet
Sheet Presentation
Presentation
Short-Term Investments
Also called marketable securities, are 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.
Chapter
16-37

SO 6 Distinguish between short-term and long-term investments.

Balance
Balance Sheet
Sheet Presentation
Presentation
Presentation of Realized and Unrealized Gain
or Loss
Nonoperating items related to investments

Chapter
16-38

Illustration 16-10

SO 6 Distinguish between short-term and long-term investments.

Balance
Balance Sheet
Sheet Presentation
Presentation
Realized and Unrealized Gain or Loss
Unrealized gain or loss on available-for-sale
securities are reported as a separate component of
Illustration 16-11
stockholders equity.

Chapter
16-39

SO 6 Distinguish between short-term and long-term investments.

Balance
Balance Sheet
Sheet Presentation
Presentation
Classified Balance Sheet (partial)
Illustration 16-12

Chapter
16-40

SO 6 Distinguish between short-term and long-term investments.

Copyright
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Chapter
16-41