Transcript Lecture 18.ppt

PART II: Corporate Accounting Concepts and Issues
Lecture 18
Investments
Instructor
Adnan Shoaib
1
Review: Accounting for Stock
Compensation
2
Accounting for Stock Compensation
Illustration: On November 1, 2011, the shareholders of Chen
Company approve a plan that grants the company’s five
executives options to purchase 2,000 shares each of the
company’s $1 par value common stock. The company grants the
options on January 1, 2012. The executives may exercise the
options at any time within the next 10 years. The option price per
share is $60, and the market price of the shares at the date of
grant is $70 per share. Under the fair value method, the company
computes total compensation expense by applying an acceptable
fair value option-pricing model. The fair value option-pricing model
determines Chen’s total compensation expense to be $220,000.
3
Accounting for Stock Compensation
Illustration: Assume that the expected period of benefit is two
years, starting with the grant date. Chen would record the
transactions related to this option contract as follows.
Dec. 31, 2012
Compensation Expense
110,000 *
Paid-in capital – Stock Options
110,000
Dec. 31, 2013
Compensation Expense
Paid-in capital - Stock Options
* ($220,000 ÷ 2)
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110,000
110,000
Accounting for Stock Compensation
Exercise. If Chen’s executives exercise 2,000 of the 10,000
options (20 percent of the options) on June 1, 2015 (three years
and five months after date of grant), the company records the
following journal entry.
June 1, 2015
Cash (2,000 x $60)
Paid-in Capital - Stock Options
Common Stock (2,000 x $1)
Paid-in Capital in Excess of Par
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120,000
44,000
2,000
162,000
Accounting for Stock Compensation
Expiration. If Chen’s executives fail to exercise the remaining
stock options before their expiration date, the company records
the following at the date of expiration.
Jan. 1, 2022
Paid-in Capital - Stock Options
176,000 *
Paid-in Capital – Expired Stock Options
* ($220,000 x 80%)
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176,000
PART II: Corporate Accounting Concepts and Issues
Lecture 18
Investments
Instructor
Adnan Shoaib
7
Learning Objectives
8
1.
Identify the three categories of debt securities and describe the accounting
and reporting treatment for each category.
2.
Understand the procedures for discount and premium amortization on bond
investments.
3.
Identify the categories of equity securities and describe the accounting and
reporting treatment for each category.
4.
Explain the equity method of accounting and compare it to the fair value
method for equity securities.
Investments
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Investments in
Debt Securities
Investments in
Equity Securities
Held-to-maturity
securities
Holdings of less than
20%
Available-for-sale
securities
Holdings between 20%
and 50%
Trading securities
Holdings of more than
50%
Investment Accounting Approaches
Different motivations for investing:

To earn a high rate of return.

To secure certain operating or financing arrangements
with another company.
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Investment Accounting Approaches
Companies account for investments based on

the type of security (debt or equity) and

their intent with respect to the investment.
Illustration 17-1
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Investments in Debt Securities
Debt securities (creditor relationship):
Type

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U.S. government
securities

Municipal securities

Corporate bonds

Convertible debt

Commercial paper
Accounting Category

Held-to-maturity

Trading

Available-for-sale
LO 1 Identify the three categories of debt securities and describe the
accounting and reporting treatment for each category.
Investments in Debt Securities
Accounting for Debt Securities by Category
Illustration 17-2
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LO 1 Identify the three categories of debt securities and describe the
accounting and reporting treatment for each category.
Held-to-Maturity Securities
Classify a debt security as held-to-maturity only if it has
both
(1) the positive intent and
(2) the ability to hold securities to maturity.
Accounted for at amortized cost, not fair value.
Amortize premium or discount using the effective-interest
method unless the straight-line method yields a similar
result.
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Illustration: Robinson Company purchased $100,000 of 8
percent bonds of Evermaster Corporation on January 1, 2011,
at a discount, paying $92,278. The bonds mature January 1,
2016 and yield 10%; interest is payable each July 1 and
January 1. Robinson records the investment as follows:
January 1, 2011
Debt investments
Cash
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92,278
92,278
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Schedule of
Interest
Revenue and
Bond
Discount
Amortization—
Effective-Interest
Method
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Illustration 17-3
LO 2
Held-to-Maturity Securities
Illustration: Robinson Company records the receipt of the
first semiannual interest payment on July 1, 2011, as follows:
July 1, 2011
Cash
Debt Investments
Interest Revenue
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4,000
614
4,614
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Illustration: Robinson is on a calendar-year basis, it accrues
interest and amortizes the discount at December 31, 2011, as
follows:
December 31, 2011
Interest Receivable
Debt Investments
Interest Revenue
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4,000
645
4,645
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Reporting of Held-to-Maturity Securities
Illustration 17-4
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Illustration: Assume that Robinson Company sells its
investment in Evermaster bonds on November 1, 2015, at 99¾
plus accrued interest. Robinson records this discount
amortization as follows:
November 1, 2015
Debt Investments
Interest Revenue
635
635
$952 x 4/6 = $635
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Held-to-Maturity Securities
Computation of gain on sale of bonds
Illustration 17-5
Cash
Interest Revenue (4/6 x $4,000)
Debt Investments
Gain on Sale of Securities
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102,417
2,667
99,683
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LO 2
Available-for-Sale Securities
Debt
Securities
Companies report available-for-sale securities at

fair value, with

unrealized holding gains and losses reported as part
of comprehensive income (equity).
Any discount or premium is amortized.
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Single Security): Graff Corporation purchases
$100,000, 10 percent, five-year bonds on January 1, 2011, with
interest payable on July 1 and January 1. The bonds sell for
$108,111, which results in a bond premium of $8,111 and an
effective interest rate of 8 percent. Graff records the purchase
of the bonds on January 1, 2011, as follows.
Debt Investments
Cash
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108,111
108,111
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration 17-6
Schedule of
Interest
Revenue and
Bond
Premium
Amortization—
Effective-Interest
Method
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LO 2
Debt
Securities
Available-for-Sale Securities
Illustration (Single Security): The entry to record interest
revenue on July 1, 2011, is as follows.
Cash
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5,000
Debt Investments
676
Interest Revenue
4,324
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Debt
Securities
Available-for-Sale Securities
Illustration (Single Security): At December 31, 2011, Graff
makes the following entry to recognize interest revenue.
Interest Receivable
5,000
Debt Investments
703
Interest Revenue
4,297
Graff reports revenue for 2009 of $8,621 ($4,324 + $4,297).
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Single Security): To apply the fair value method to
these debt securities, assume that at year-end the fair value of
the bonds is $105,000 and that the carrying amount of the
investments is $106,732. Graff makes the following entry.
Unrealized Holding Gain or Loss—Equity
Fair Value Adjustment (AFS)
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1,732
1,732
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Portfolio of Securities): Webb Corporation has
two debt securities classified as available-for-sale. The following
illustration identifies the amortized cost, fair value, and the
amount of the unrealized gain or loss.
Illustration 17-7
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Portfolio of Securities): Webb makes an
adjusting entry to a valuation allowance on December 31, 2012
to record the decrease in value and to record the loss as
follows.
Unrealized Holding Gain or Loss—Equity
9,537
Fair Value Adjustment (AFS)
9,537
Webb reports the unrealized holding loss of $9,537 as other
comprehensive income and a reduction of stockholders’ equity.
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Sale of Available-for-Sale Securities
If company sells bonds before maturity date:


Must make entry to remove the,
►
Cost in Available-for-Sale Securities and
►
Securities Fair Value Adjustment accounts.
Any realized gain or loss on sale is reported in the
“Other expenses and losses” section of the income
statement.
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Debt
Securities
Available-for-Sale Securities
Illustration (Sale of Available-for-Sale Securities): Webb
Corporation sold the Watson bonds (from Illustration 17-7) on
July 1, 2013, for $90,000, at which time it had an amortized cost
of $94,214.
Illustration 17-8
Cash
90,000
Loss on Sale of Investments
Debt Investments
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4,214
94,214
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Sale of Available-for-Sale Securities): Webb
reports this realized loss in the “Other expenses and losses”
section of the income statement. Assuming no other purchases
and sales of bonds in 2013, Webb on December 31, 2013,
prepares the information:
Illustration 17-9
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Illustration (Sale of Available-for-Sale Securities): Webb
records the following at December 31, 2013.
Illustration 17-9
Fair Value Adjustment (AFS)
Unrealized Holding Gain or Loss—Equity
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4,537
4,537
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Available-for-Sale Securities
Debt
Securities
Financial Statement Presentation
Illustration 17-10
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Trading Securities
Debt
Securities
Companies report trading securities at

fair value, with

unrealized holding gains and losses reported as part
of net income.
Any discount or premium is amortized.
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Trading Securities
Debt
Securities
Illustration: On December 31, 2012, Western Publishing
Corporation determined its trading securities portfolio to be as
follows:
Illustration 17-11
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LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Trading Securities
Debt
Securities
Illustration: At December 31, Western Publishing makes an
adjusting entry:
Illustration 17-11
Fair Value Adjustment (Trading)
Unrealized Holding Gain or Loss—Income
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3,750
3,750
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Trading Securities
Debt
Securities
Hendricks Corporation purchased trading investment bonds for
$50,000 at par. At December 31, Hendricks received annual
interest of $2,000, and the fair value of the bonds was $47,400.
Instructions:
(a) Prepare the journal entry for the purchase of the
investment.
(b) Prepare the journal entry for the interest received.
(c)
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Prepare the journal entry for the fair value adjustment.
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Trading Securities
Debt
Securities
Prepare the journal entries for (a) the purchase of the investment,
(b) the interest received, and (c) the fair value adjustment.
(a)
Debt investments
50,000
Cash
(b)
50,000
Cash
2,000
Interest revenue
(c)
2,000
Unrealized Holding Loss - Income
Fair Value Adjustment (Trading)
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2,600
2,600
LO 2 Understand the procedures for discount and
premium amortization on bond investments.
Investments in Equity Securities
Represent ownership of capital stock.
Cost includes:

price of the security, plus

broker’s commissions and fees related to purchase.
The degree to which one corporation (investor) acquires an
interest in the common stock of another corporation (investee)
generally determines the accounting treatment for the investment
subsequent to acquisition.
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LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Investments in Equity Securities
Ownership Percentages
0 ------------------20% ---------------- 50% ---------------- 100%
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No significant
influence
usually exists
Significant
influence
usually exists
Investment
valued using
Fair Value
Method
Investment
valued using
Equity
Method
Control usually
exists
Investment valued on
parent’s books using Cost
Method or Equity Method
(investment eliminated in
Consolidation)
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Investments in Equity Securities
Accounting and Reporting for Equity Securities by Category
Illustration 17-13
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LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Accounting Subsequent to Acquisition
Market Price Available
Market Price
Unavailable
Value and report the
investment using the
fair value method.
Value and report the
investment using the
cost method.*
* Securities are reported at cost. Dividends are recognized when
received and gains or losses only recognized on sale of securities.
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LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Upon acquisition, companies record available-for-sale securities
at cost.
Illustration: On November 3, 2012 Republic Corporation
purchased common stock of three companies, each investment
representing less than a 20 percent interest.
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LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration: Republic records these investments on November
3, 2012, as follows.
Equity Investments
718,550
Cash
718,550
On December 6, 2012, Republic receives a cash dividend of
$4,200 from Campbell Soup Co.
Cash
4,200
Dividend revenue
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4,200
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration: Republic’s available-for-sale equity security portfolio
on December 31, 2012:
Illustration 17-14
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LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration: On December 31, 2012, Republic records the net
unrealized gains and losses related to changes in the fair value of
available-for-sale equity securities in an Unrealized Holding Gain
or Loss—Equity account.
Unrealized Holding Gain or Loss—Equity
Fair Value Adjustment (AFS)
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35,550
35,550
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration: On January 23, 2013, Republic sold all of its
Northwest Industries, Inc. common stock receiving net proceeds
of $287,220.
Illustration 17-15
Cash
287,220
Equity Investments
Gain on Sale of Investments
48
259,700
27,520
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration: On February 10, 2013, Republic purchased 20,000
shares of Continental Trucking at a price of $12.75 per share plus
brokerage commissions of $1,850 (total cost, $256,850).
Illustration 17-16
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LO 3
Holdings of Less Than 20%
Available-for-Sale Securities
Illustration 17-16
Illustration:
Fair Value Adjustment (AFS)
Unrealized Holding Gain or Loss—Equity
50
99,800
99,800
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
McElroy Company has the following portfolio of securities at
September 30, 2012, its last reporting date.
Trading Securities
Horton, Inc. common (5,000 shares)
Cost
$ 215,000
Fair Value
$ 200,000
Monty, Inc. preferred (3,500 shares)
133,000
140,000
Oakwood Corp. common (1,000 shares)
180,000
179,000
On Oct. 10, 2012, the Horton shares were sold at a price of $54
per share. In addition, 3,000 shares of Patriot common stock
were acquired at $54.50 per share on Nov. 2, 2012. The Dec. 31,
2012, fair values were: Monty $106,000, Patriot $132,000, and
the Oakwood common $193,000.
51
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Prepare the journal entries to record the sale, purchase, and
adjusting entries related to the trading securities in the last
quarter of 2012.
Portfolio at September 30, 2012
52
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Prepare the journal entries to record the sale, purchase, and
adjusting entries related to the trading securities in the last
quarter of 2012.
October 10, 2012 (Horton):
Cash (5,000 x $54)
270,000
Equity investments
215,000
Gain on sale of investments
55,000
November 2, 2012 (Patriot):
Equity investments (3,000 x $54.50)
Cash
53
163,500
163,500
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
Portfolio at December 31, 2012
December 31, 2012:
Unrealized holding loss - Income
Fair value adjustment (Trading)
54
36,500
36,500
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings of Less Than 20%
How would the entries change if the securities were classified as
available-for-sale?
The entries would be the same except that the

Unrealized Holding Gain or Loss—Equity account is used
instead of Unrealized Holding Gain or Loss—Income.

The unrealized holding loss would be deducted from the
stockholders’ equity section rather than charged to the
income statement.
55
LO 3 Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
Holdings Between 20% and 50%
An investment (direct or indirect) of 20 percent or more of the
voting stock of an investee should lead to a presumption that
in the absence of evidence to the contrary, an investor has the
ability to exercise significant influence over an investee.
In instances of “significant influence,” the investor must
account for the investment using the equity method.
56
LO 4 Explain the equity method of accounting and compare
it to the fair value method for equity securities.
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.
57
LO 4 Explain the equity method of accounting and compare
it to the fair value method for equity securities.
Holdings Between 20% and 50%
(Equity Method) On January 1, 2012, Meredith Corporation
purchased 25% of the common shares of Pirates Company for
$200,000. During the year, Pirates earned net income of $80,000
and paid dividends of $20,000.
Instructions: Prepare the entries for Meredith to record the
purchase and any additional entries related to this investment in
Pirates Company in 2012.
58
LO 4 Explain the equity method of accounting and compare
it to the fair value method for equity securities.
Holdings Between 20% and 50%
Prepare the entries for Meredith to record the purchase and any
additional entries related to this investment in Pirates Company in
2012.
Equity Investments
200,000
Cash
200,000
Equity Investments
Investment Revenue
20,000
Cash
5,000
Equity Investments
59
20,000
($80,000 x 25%)
($20,000 x 25%)
5,000
LO 4 Explain the equity method of accounting and compare
it to the fair value method for equity securities.
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.
60
LO 4 Explain the equity method of accounting and compare
it to the fair value method for equity securities.
End of Lecture 18
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