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Accounting

Principles
Second Canadian Edition
Weygandt · Kieso · Kimmel ·
Trenholm

Prepared by:
Carole Bowman, Sheridan College
CHAPTER

17

INVESTMENTS
ILLUSTRATION 17-1
TEMPORARY INVESTMENTS
AND THE OPERATING CYCLE
• At the end of their operating cycles, many companies
mayhave temporarily idle cash on hand, pending the
start of the nextoperating cycle.
• Until the cash is needed in operations, these
companies may invest the excess funds to earn
interest and dividends.
Invest
Sell Temporary
Cash
Investments

Accounts
Inventory
Receivable
TEMPORARY VS. LONG-TERM
INVESTMENTS

• Temporary investments are securities, held by a company,


that are
(1) readily marketable, and
(2) intended to be converted into cash in the near future.
– Readily marketable means the investment can be sold easily,
whenever the need for cash arises.
– Intention to convert means that management intends to sell the
investment if and when the need for cash arises.
• Investments that do not meet both criteria are classified as
long-term investments.
DEBT INVESTMENTS
• Investments in government and corporation
bonds.
• In accounting for debt investments, entries are
required to record the:
– acquisition
– interest revenue
– sale
• Are recorded at cost, including brokerage fees.
DEBT INVESTMENTS

• Accounting differs depending on


whether investment is
– Temporary
– Long-term
ACCOUNTING FOR TEMPORARY DEBT
INVESTMENTS
Kuhl Corporation acquires 50 Doan Inc. 8 percent, 10-
year, $1,000 bonds on January 1, 1999, for $54,000,
including brokerage fees of $1,000. The bonds pay
interest semi-annually on July 1 and January 1. The
entry to record the temporary investment at cost is:

54,000

54,000
RECORDING BOND INTEREST

Interest receipts are calculated using the bond’s face or


principal value, which is $50,000 (50 x $1,000). The
interest for July 1 will be $2,000 ($50,000 x 8% x 6/12).
The entry on July 1 is:

2,000

2,000
ACCOUNTING FOR LONG-TERM DEBT
INVESTMENTS
The accounting for temporary and long-term investments is similar. The
major exception is when bonds are purchased at a premium or discount
(above or below its face value). As shown in Chapter 16 with the bond issuer,
the investor would also amortize the premium or discount using either the
straight-line or effective interest methods. Using the previous Kuhl example
and assuming an effective interest rate of 7%, the entries are:
Date Kuhl Corporation (Investor) Doan Inc.
(Investee) 50,000 54,000
Jan 1 Investment in Doan Bonds 4,000 Cash 4,000
Premium on Bonds 54,000 50,000
Premium on Bonds
Cash Bonds
Payable 2,000 1,890
To record purchase of 50 Doan bonds To record issue of 8%, 10 year
bonds 110 110
1,890 2,000
July 1 Cash Interest Expense
= ($50,000 x 8% x 6/12) = ($54,000 x
7% x 6/12)
Premium on Bonds Premium on
ILLUSTRATION 17-4
ACCOUNTING GUIDELINES FOR
EQUITY INVESTMENTS
Equity investments are investments in the share capital of corporations.
Investor’s Ownership Presumed
Interest in Investee’s Influence Accounting
Common Shares on Investee Guidelines

Less than 20% Insignificant Cost method

Between 20% and 50% Significant Equity method

More than 50% Controlling Equity method for


accounting;
Consolidated
financial
statements for
financial reporting
RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%

• In accounting for equity investments of less than


20 percent, the cost method is used.
• Under the cost method, the investment is recorded
at cost and revenue is recognized only when cash
dividends are received.
RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
On July 1, 2003, St. Amand Corporation acquires
1,000 shares (10 percent ownership) of Beal
Corporation at $40 per share plus brokerage fees of
$500. The entry for the purchase is:

40,500

40,500
RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
Entries are required for any cash dividends
received during the time the shares are held.
If a $2 per share dividend is received by St.
Amand Corporation on December 1, 2003,
the entry is:
2,000

2,000
RECORDING EQUITY INVESTMENTS
HOLDINGS LESS THAN 20%
When shares are sold, the difference between the net
proceeds from the sale and the cost of the shares is
recognized as a gain or loss. St. Amand Corporation
receives net proceeds of $39,500 on the sale of its Beal
Corporation common shares on February 10, 2004.
Because the shares cost $40,500, a loss of $1,000 has been
incurred. The entry to record the sale is:
39,500

1,000

40,500
ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
• When an investor owns between 20% and 50% of the
common shares of a corporation, it is usually presumed
that the investor has significant influence over the
financial and operating activities of the investee.
• Under the equity method, the investment in common
shares is initially recorded at cost, and the investment
account is adjusted annually to show the investor’s
equity in the investee.
• Each year, the investor 1) debits the investment account
and credits revenue for its share of the investee’s net
income and 2) credits dividends received to the
investment account.
ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
AND 50%
• Milar Corporation acquires 30 percent of the
common shares of Beck Company for $120,000 on
January 1, 2003. The entry to record this
transaction is:

120,000
ACCOUNTING FOR EQUITY INVESTMENTS
HOLDINGS BETWEEN 20%
Beck reports 2003 netAND
income50%
of $100,000 and declares
and pays a $40,000 cash dividend. Milar is required to
record 1) its share of Beck’s net income, $30,000 (30% x
$100,000) and 2) the reduction in the investment
account for the dividends received, $12,000 ($40,000 x
30%). The entries are:
#1
30,000

#2
12,000
30,000
RECORDING EQUITY
INVESTMENTS
HOLDINGS OF MORE THAN 50%
• A company that controls (e.g., owns more than 50
%) of the common shares of another entity is
known as a parent company.
• The entity whose shares are owned by the parent
company is called the subsidiary (affiliated)
company.
• When one company controls of the common shares
of another company, the equity method of
accounting is used to account for the investment
and consolidated financial statements are prepared.
RECORDING EQUITY INVESTMENTS
HOLDINGS OF MORE THAN 50%

• Consolidated financial statements present


the assets and liabilities controlled by the
parent company and the combined
profitability of the subsidiary companies.
• They are prepared in addition to the
financial statements for each of the
individual parent and subsidiary
companies.
VALUATION AND REPORTING
OF INVESTMENTS

• The value of debt and equity investments may


fluctuate greatly during the time they are held.
• Conservatism principle requires accountants to
use the lower of cost and market (LCM) rule.
• Application of the LCM rule varies depending
upon whether the investment is temporary or
long-term.
VALUATION AND REPORTING OF
TEMPORARY INVESTMENTS
• The decline in value from cost to market is
reported as a loss.
• An Allowance to Reduce Cost to Market Value
account is used to record the difference between
the cost and market value of the securities.
• The Allowance account is a contra asset and is
therefore deducted from the cost of the
investments to arrive at the LCM valuation
reported on the balance sheet for temporary
investments.
VALUATION AND REPORTING OF
LONG-TERM INVESTMENTS
• Long-term investments have longer maturities than
temporary investments, therefore, their carrying values
should not be adjusted to reflect temporary fluctuations
in market value.
• When market value falls below cost and the drop is not
due to temporary fluctuations, the investment must be
reduced to its market value.
• Any write-down to market value is accounted for on
the income statement as a permanent loss. No allowance
account is used.
• Long-term investments are reported in a separate
section of the balance sheet, immediately below current
assets.
ILLUSTRATION 17-8
COMPREHENSIVE BALANCE SHEET
ILLUSTRATION 17-8
COMPREHENSIVE BALANCE SHEET
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable $ 185,000
Bond interest payable 10,000
Income tax payable 60,000
Total current liabilities 255,000
Long-term liabilities
Bonds payable, 7%, due 2010 $ 300,000
Less: Discount on bonds 10,000
Total long-term liabilities 290,000
Total liabilities 545,000
Shareholders’ equity
Common shares, no par value,
200,000 shares
authorized, 80,000 issued $900,000
Retained earnings (of which 265,000
$100,000 is restricted for
plant expansion)
Total shareholders’ equity 1,165,000
Total liabilities and $ 1,710,000
shareholders’ equity
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