chap012-updated-vucolfr4.ppt
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
PowerPoint Authors:
Susan Coomer Gal
eath, Ph.D., CPA
Charles W. Caldwell, D.B.A., CMA
Jon A. Booker, Ph.D., CPA, CIA
Cynthia J. Rooney, Ph.D., CPA
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Investments
Chapter 12
Chapter 12: Investments
In this chapter you will learn about various approaches used to account for investments that companies make in the debt and equity of other companies. An investing company always has the option to account for these investments at fair value, with changes in fair values reported on the income statement.
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Nature of Investments
Investments can be accounted for in a variety of ways, depending on the nature of the investment relationship.
Bonds and notes
(Debt securities)
Common and prefe
ed stock
(Equity securities)
To finance its operations, and often the expansion of those operations, a corporation raises funds by selling equity securities (common and prefe
ed stock) and debt securities (bonds and notes). These securities, also called financial instruments, are purchased as investments by individual investors, mutual funds, and also by other corporations. Our focus in this chapter is on the corporations that invest in securities issued by other corporations as well as those issued by governmental units (bonds, Treasury bills, and Treasury bonds).
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Reporting Categories for Investments
To finance its operations, and often the expansion of those operations, a corporation raises funds by selling equity securities (common and prefe
ed stock) and debt securities (bonds and notes). These securities are purchased as investments by individual investors, mutual funds, and also by other corporations. In later chapters we discuss equity and debt securities from the perspective of the issuing company. Our focus in this chapter is on the corporations that invest in debt and equity securities issued by other corporations as well as debt securities issued by governmental units (bonds, Treasury bills, and Treasury bonds).
Most companies invest in financial instruments issued by other companies. For some investors, these investments represent ongoing affiliations with the companies whose securities are acquired.
Sheet1
Reporting Categories for Investments
Control Characteristics of the Investment Reporting Method Used by the Investo
The investor lacks significant influence over the operating and financial policies of the investee:
Investment in debt securities for which the investor has the "positive intent and ability" to hold to maturity. Held-to-maturity (HTM) - investment reported at amortized cost.*
Investment held in an active trading account. Trading securities (TS) - investment reported at fair value with unrealized holding gains and losses included in net income.
Other. Securities available-for-sale (AFS) - investment reported at fair value with unrealized holding gains and losses excluded from net income and reported in other comprehensive income.*
The investor has significant influence over the operating and financial policies of the investee:
Typically the investor owns between 20% and 50% of the voting stock of the investee. Equity method - investment cost adjusted for subsequent earnings and dividends of the investee.*
The investor controls the investee:
The investor owns more than 50% of the voting stock of the investee. Consolidation - the financial statements of the investor and investee are combined as if they are a single company.
* If the investor elects the fair value option, this type of investment also can be accounted for using the same approach that's used for trading securities, with the investment reported at fair value and unrealized holding gains and losses included in earnings.
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Investor Lacks Significant Influence
When the investor lacks significant influence over the investee, the investment is classified in one of three categories: held-to-maturity securities (HTM), trading securities (TS), and available-for-sale securities (AFS). Each type of investment has its own reporting method. However, regardless of the investment type, investors can elect the “fair value option” that we discuss later in the chapter and classify HTM and AFS securities as TS. The key difference among the reporting approaches is how we account for unrealized holding gains and losses.
Sheet1
Reporting Approach Treatment of Unrealized Holding Gains and Losses Investment Reported in the Balance Sheet at
Held-to-maturity (HTM): used for debt Not recognized Amortized Cost
that is planned to be held for its entire
life
Trading (TS): used for debt or equity Recognized in net income Fair Value
that is held in an active trading and therefore in retained
account for immediate resale, or for earnings as part of
which the fair value option had been stockholders' equity
elected.
Available-for-sale (AFS): used for debt Recognized in other Fair Value
that does not qualify as comprehensive income,
held-to-maturity or trading. and therefore in
accumulated othe
comprehensive income
in shareholders' equity
Sheet2
Sheet3
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Securities to Be Held to Maturity
Securities are investments in bonds or other debt security that have a specified maturity date. The bonds or other debt are initially recorded at cost. The investor may have the “positive intent and ability” to hold the securities to maturity and can therefore be classified as held-to-maturity (HTM).
They are reported on the balance sheet at “amortized cost.”
Amortized cost (Face amount less unamortized discount, or plus unamortized premium).
Balance
Sheet
Securities are investments in bonds or other debt security that have a specified maturity date. The bonds or other debt are initially recorded at cost. The investor may have the “positive intent and ability” to hold the securities to maturity and can therefore be classified as held-to-maturity (HTM).
They are reported on the balance sheet at “amortized cost.” Amortized cost is equal to the face amount of the debt less any unamortized discount, or plus any unamortized premium. If management decides to sell the securities prior to maturity, they will be reclassified to trading securities. We will discuss trading securities later in the presentation.
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Securities to Be Held to Maturity
On January 1, 2013, Matrix Inc. purchased as an investment $1,000,000, of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%. Let’s look at the calculation of the present value of the bond issue.
Present
Amount PV Factor Value
Interest $ 50,000 × XXXXXXXXXX = $573,496
Principal 1,000,000 × XXXXXXXXXX = 311,805
Present value of bonds $885,301
PV of ordinary annuity of $1, n = 20, i = 6%
PV of $1, n = 20, i = 6%
On January 1, 2013, Matrix Inc. purchased as an investment $1,000,000 of 10%, 10-year bonds, interest paid semi-annually. The market rate for similar bonds is 12%. Let’s look at the calculation of the present value of the bond issue. The interest annuity is $50,000 ($1,000,000 times 10% equals $100,000, divide $100,000 by 2 for $50,000 cash interest). Look at the present value of an ordinary annuity of $1 table. Find the 20 periods row and move across to the 6% column to find the factor of XXXXXXXXXXGo to the present value of $1 table and follow the same procedures to a
ive at the present value factor of XXXXXXXXXXThe present value of the bonds at 12% return is $885,301.
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Securities to Be Held to Maturity
Partial Bond Amortization Table
January 1, 2013
Investment in bonds 1,000,000
Discount on bond investment XXXXXXXXXX,699
Cash XXXXXXXXXX,301
June 30, 2013
Cash (stated rate × face amount) 50,000
Discount on bond investment XXXXXXXXXX,118
Investment revenue XXXXXXXXXX,118
Here is a partial amortization table for the bonds purchased on January 1, 2013, with the intent of holding them to maturity. The bonds were priced as $885,301, to yield Matrix a 12% return with interest compounded semi-annually on June 30 and December 31. Let’s look at the journal entry to record the initial purchase of the bonds and the subsequent receipt of the first interest amount.
On January 1, Matrix will debit investment in bonds for the face amount of $1 million, credit discount on bond investment for $114,699, and credit cash for $885,301. On June 30, the first payment is due to Matrix. The journal entry is to debit cash for $50,000, debit discount on bonds payable for $3,118, and credit interest revenue for $53,118. The interest revenue is determined by taking 6% of the ca
ying value of the bonds, which is $885,301. The $50,000 cash received is determined by multiplying the face amount of the bonds, $1 million, by 5%, the stated rate. The difference between the calculated interest revenue and the cash interest received represents the amortization of the bond discount.
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Interest Interest Discount Unamortized Ca
ying
Date Payment Revenue Amortization Discount Value
Fair value of net assets $ 600,000 1/1/13 $ 114,699 $ 885,301
Book value of net assets 400,000 6/30/13 $ 50,000 $ 53,118 $ 3,118 111,581 888,419
Difference 200,000 12/31/13 50,000 53,305 3,305 108,276 891,724
Percentage of net assets acquired × 25% 6/30/14 50,000 53,503 3,503 104,772 895,228
Excess 50,000 12/31/14 50,000 53,714 3,714 101,059 898,941
Amount attributable to land 12,500
Amount attributable to depreciable assets 37,500
Remaining life of depreciable assets 20 years
Additional depreciation expense per year $ 1,875
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Securities to Be Held to Maturity
This investment would appear on the June 30, 2013, balance sheet as follows:
Unrealized holding gains and losses are not recognized for HTM investments.
$114,699 - $3,118 = $111,581 unamortized discount
As of June 30, discount on the bond investment account has been reduced to $111,581. The amortized amount of the investment is $888,419. If a balance sheet were prepared as of June 30, the investment in bonds would be shown at $888,419. We do not recognize unrealized holding gains and losses for HTM investments.
Sheet1
1000000
0.1 114699
100000
10
($885,300.79) XXXXXXXXXX
June 30, 2013
1 50000 XXXXXXXXXX XXXXXXXXXX 888,418.84 Investment in bonds $ 1,000,000
2 50000 XXXXXXXXXX XXXXXXXXXX 891,723.97 Less: Discount on bond investment 111,581
3 50000 XXXXXXXXXX XXXXXXXXXX 895,227.41 Book value (amortized cost) $ 888,419
4 50000 XXXXXXXXXX XXXXXXXXXX 898,941.05
5 50000 XXXXXXXXXX XXXXXXXXXX 902,877.51
6 50000 XXXXXXXXXX XXXXXXXXXX 907,050.16
7 50000 XXXXXXXXXX XXXXXXXXXX 911,473.17
8 50000 XXXXXXXXXX XXXXXXXXXX 916,161.56
9 50000 XXXXXXXXXX XXXXXXXXXX 921,131.26
10 50000 XXXXXXXXXX XXXXXXXXXX 926,399.13
11 50000 XXXXXXXXXX XXXXXXXXXX 931,983.08
12 50000 XXXXXXXXXX XXXXXXXXXX 937,902.07
13 50000 XXXXXXXXXX XXXXXXXXXX 944,176.19 114,699
14 50000 XXXXXXXXXX XXXXXXXXXX 950,826.76 3,118
15 50000 XXXXXXXXXX XXXXXXXXXX 957,876.37 111,581
16 50000 XXXXXXXXXX XXXXXXXXXX 965,348.95
17 50000 XXXXXXXXXX XXXXXXXXXX 973,269.89
18 50000 XXXXXXXXXX XXXXXXXXXX 981,666.08
19 50000 XXXXXXXXXX XXXXXXXXXX 990,566.04
20 50000 XXXXXXXXXX XXXXXXXXXX 1,000,000.01
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Sheet3
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Securities to Be Held to Maturity
On December 31, 2013, after interest is received by Matrix, all the bonds are sold for $900,000 cash.
December 31, 2013
Cash 50,000
Discount on bond investment 3,305
Investment