REVIEW OF CHAPTER
17
Temporary and Long-Term Investments
Accounting
for Short-Term Debt Investments
2.
(S.O. 2) Debt
investments are investments in government and corporation bonds.
At acquisition, the cost principle is applied and all expenditures
necessary to acquire these investments are included in the cost (e.g., brokerage
fees). At acquisition, Debt
Investments is debited and Cash is credited for the cost of the investment.
3.
Interest revenue must also be recorded on debt investments. Assume Buboo Company (fiscal year ends December 31) receives
$2,000 interest every six months on a debt investment purchased April 1, 2001.
The following entries are required:
Oct. 1
Cash..........................................................................................
2,000
Interest Revenue.........................................................................
2,000
Dec. 31
Interest Receivable.....................................................................
1,000
Interest Revenue.........................................................................
1,000
Apr. 1
Cash..........................................................................................
2,000
Interest Receivable......................................................................
1,000
Interest Revenue.........................................................................
1,000
4. When
bonds are sold, it is necessary to credit the investment account for the cost of
the bonds, debit Cash, and any difference between the sale price and cost of
bonds is recorded as a gain or loss. The
gain or loss on the sale of debt investments is reported under Other Revenues
and Gains or Other Expenses and Losses, respectively, in the income statement.
Accounting
for Long-Term Debt Investments
5. The
accounting for temporary debt investments and for long-term debt investments is
similar except for when bonds are purchased at a premium or a discount.
For temporary investments, the bond premium or discount is
not amortized, and for long-term investments, the bond premium or discount
is amortized. The investor can use
either the straight-line or the effective-interest method of amortization.
Accounting
for Stock Investments
6. (S.O. 3)
Stock investments are
investments in the capital stock of corporations.
The accounting for stock investments differs depending on the degree of
influence the investor has over the issuing corporation.
The presumed influences based on the investor's ownership interest and
the accounting guidelines that are to be used are as follows:
Investor's
Ownership Interest
Presumed Influence
in Investee's Common Stock
on
Investee
Accounting Guidelines
Less than 20%
Insignificant
Cost Method
Between 20% and 50%
Significant
Equity Method
More than 50%
Controlling
Consolidated financial
statements
Holdings
Less than 20%
7.
In accounting for stock investments of less than 20%, 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.
a.
At acquisition, the cost principle applies and Stock Investments is
debited and Cash is credited.
b.
When dividends are received, Cash is debited and Dividend Revenue is
credited.
c.
When stock is sold, Cash is debited, Stock Investments is credited, and
any difference between the two is debited or credited to Loss or Gain on Sale of
Stock Investments, respectively. The
loss or gain is reported under Other Expenses and Losses or Other Revenues and
Gains in the income statement.
Holdings Between 20% and 50%
8.
When an investor owns between 20% and 50% of the common stock of a
corporation, it is generally presumed that the investor has a significant
influence over the financial and operating activities of the investee; and
therefore the equity method is used.
Under the equity method, the investor does not record its share of the
investee until the investee has earned income.
a.
At acquisition, the cost principle applies and Stock Investments is
debited and Cash is credited.
b.
Each year, the investor records its share of the investee's income
(investee's income X % of ownership in investee) with a debit to Stock
Investments and a credit to Revenue from Investee Company (if the investee
incurred a loss, then the opposite entry is made).
c.
Upon receiving dividends from the investee, the investor makes a debit to
Cash and a credit to Stock Investments.
Holdings of More Than 50%
9.
(S.O. 4) A company that owns
more than 50% of the common stock of another entity is known as the parent company. The
entity whose stock is owned by the parent company is called the Subisidiary (affiliated) company.
Because of its stock ownership, the parent company has a controlling
interest in the subsidiary company.
10.
When a company owns more than 50% of the common stock of another company,
consolidated financial statements are
usually prepared. Consolidated
financial statements present the assets and liabilities controlled by the parent
company and the aggregate profitability of the subsidiary companies.
Valuation and Reporting of Investments
11.
(S.O. 5) For purposes of
valuation and reporting at a financial statement date, debt and stock
investments are classified into the following three categories.
a.
Trading securities are
securities bought and held primarily for sale in the near term to generate
income on short-term price differences.
b.
Available-for-sale securities
are securities that may be sold in the future.
c.
Held-to-maturity securities are
debt securities that the investor has the intent and ability to hold to
maturity.
12. The valuation guidelines for the above
securities are as follows:
Trading
Available-for-sale
Held-to-maturity
At fair value with
At fair value with changes
At amortized cost
changes reported in
reported in the stock-
net income
holders' equity section
Trading Securities
13.
When the trading securities are not sold, the difference between the
total cost of the securities and their total fair value is reported as
unrealized gains or losses in the income statement.
The adjusting entry to record an unrealized gain would include a debit to
Market Adjustment
Trading and a credit to Unrealized Gain
Income. The adjusting entry
to record an unrealized loss would include a debit to Unrealized Loss
Income and a credit to Market Adjustment
Trading. The unrealized
gains or losses are reported in the income statement under Other Revenues and
Gains or Other Expenses and Losses, respectively.
Available-for-Sale
14.
If available-for-sale securities are held with the intent to sell them
within the next year or operating cycle, the securities are classified as
current assets in the balance sheet. Otherwise,
they are classified as long-term assets in the investments section of the
balance sheet.
15.
The available-for-sale securities adjusting entry is made in the same way
as the trading securities adjusting entry except that the unrealized gain or
loss is reported in the stockholders' equity section of the balance sheet.
This balance is then adjusted with the market adjustment account to show
the difference between the cost and fair value at that time.
16. (S.O.
6) Temporary investments are securities held by a company
that are (a) readily marketable and (b) 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.
17. An
investment is readily marketable when
it can be sold easily whenever the need for cash arises.
Intent to convert means that
management intends to sell the investment within the next year or the operating
cycle, whichever is longer.
Balance Sheet Presentation
18.
Temporary investments are listed immediately below cash in the current
asset section of the balance sheet. Temporary
investments are reported at fair value. Long-term
investments are generally reported in a separate section of the balance sheet
immediately below current assets; and available-for-sale securities are reported
at fair value, and investments in common stock accounted for under the equity
method are reported at equity.
19. In the income statement, the following items
are reported in the nonoperating section:
Other Revenue and Gains
Other Expenses and Losses
Interest Revenue
Loss on Sale of Investments
Dividend Revenue
Unrealized Loss
Income
Gain on Sale of Investments
Unrealized Gain
Income
The unrealized gain
or loss on available-for-sale securities is reported as a separate component of
stockholders' equity.