ACCOUNTING PRINCIPAL Ppt 17

Accounting Accounting PrinciplesPrinciplesSecond Canadian EditionSecond Canadian Edition

Prepared by: Carole Bowman, Sheridan College

Weygandt · Kieso · Kimmel · Trenholm

INVESTMENTSINVESTMENTS

CHAPTERCHAPTER

1717

ILLUSTRATION ILLUSTRATION 17-117-1 TEMPORARY INVESTMENTS TEMPORARY INVESTMENTS

AND THE OPERATING CYCLE 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.

Cash Temporary Investments

Accounts Receivable Inventory

InvestSell

TEMPORARY VS. LONG-TERM TEMPORARY VS. LONG-TERM INVESTMENTSINVESTMENTS

• 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 INVESTMENTSDEBT 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 INVESTMENTSDEBT INVESTMENTS

• Accounting differs depending on whether investment is – Temporary– Long-term

ACCOUNTING FOR TEMPORARY DEBT ACCOUNTING FOR TEMPORARY DEBT INVESTMENTSINVESTMENTS

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 INTERESTRECORDING 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 ACCOUNTING FOR LONG-TERM DEBT INVESTMENTSINVESTMENTS

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)Jan 1 Investment in Doan Bonds Cash

Premium on BondsPremium on Bonds

Cash Bonds Payable

To record purchase of 50 Doan bonds To record issue of 8%, 10 year bonds

July 1 Cash Interest Expense = ($50,000 x 8% x 6/12) = ($54,000 x

7% x 6/12)Premium on Bonds Premium on

BondsInterest Revenue Cash

To record receipt of interest and To record payment of interest and

amortization of bond premium amortization of bond premium

50,000 4,000

54,000

2,000

110 1,890

54,000 4,00050,000

1,890

110 2,000

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

ILLUSTRATION ILLUSTRATION 17-417-4 ACCOUNTING GUIDELINES FOR ACCOUNTING GUIDELINES FOR

EQUITY INVESTMENTSEQUITY INVESTMENTSEquity investments are investments in the share capital of corporations.

RECORDING EQUITY INVESTMENTS RECORDING EQUITY INVESTMENTS HOLDINGS LESS THAN 20% 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.


40,500 40,500

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:


2,000 2,000

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:


39,500 1,000 40,500

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:

ACCOUNTING FOR EQUITY INVESTMENTS ACCOUNTING FOR EQUITY INVESTMENTS HOLDINGS BETWEEN 20% HOLDINGS BETWEEN 20%

AND 50%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.


AND 50%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:

120,000 120,000


AND 50%AND 50%Beck reports 2003 net income 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 30,000

12,000 12,000

#2

RECORDING EQUITY RECORDING EQUITY INVESTMENTS INVESTMENTS

HOLDINGS OF MORE THAN 50%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 RECORDING EQUITY INVESTMENTS HOLDINGS OF MORE THAN 50% 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 VALUATION AND REPORTING OF INVESTMENTS 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 VALUATION AND REPORTING OF TEMPORARY INVESTMENTSTEMPORARY 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 VALUATION AND REPORTING OF LONG-TERM INVESTMENTS 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 ILLUSTRATION 17-817-8 COMPREHENSIVE BALANCE SHEETCOMPREHENSIVE 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

$100,000 is restricted for plant expansion)

265,000

Total shareholders’ equity 1,165,000 Total liabilities and shareholders’ equity

$ 1,710,000

ILLUSTRATION ILLUSTRATION 17-817-8 COMPREHENSIVE BALANCE SHEETCOMPREHENSIVE BALANCE SHEET

COPYRIGHTCOPYRIGHT

Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Economy & Finance

ACCOUNTING PRINCIPAL Ppt 17