Investments Chapter 15 2015 Pearson Education Limited 15

Investments Chapter 15 © 2015 Pearson Education, Limited. 15 -1

Learning Objectives 1. Identify why companies invest in debt and equity securities, and classify investments 2. Account for investments in debt securities 3. Account for investments in equity securities © 2015 Pearson Education, Limited. 15 -2

Learning Objectives 4. Describe and illustrate how debt and equity securities are reported 5. Use the rate of return on total assets to evaluate business performance © 2015 Pearson Education, Limited. 15 -3

Learning Objective 1 Identify why companies invest in debt and equity securities, and classify investments © 2015 Pearson Education, Limited. 15 -4

Reasons to Invest in Other Companies • Opportunities to invest excess cash. • Opportunities to achieve strategic objectives by establishing relationships through investment of capital. Strategic Investments can be used to: Acquire control of another company. Establish a relationship that allows the investor to have significant influence over the investee company. © 2015 Pearson Education, Limited. 15 -5

Classification of Investments • Short-term Investments – Marketable securities – Current Assets – Intended to be sold for profit in 1 year • Long-term Investments – Can be investments in stocks or bonds Debt and equity securities can be subdivided into 5 types: • Trading Investments • Held-to-Maturity Investments • Available-for-Sale Investments • Significant Interest Investments • Controlling Interest Investments © 2015 Pearson Education, Limited. 15 -6

© 2015 Pearson Education, Limited. 15 -7

>TRY IT! © 2015 Pearson Education, Limited. 15 -8

>TRY IT! © 2015 Pearson Education, Limited. 15 -9

>TRY IT! © 2015 Pearson Education, Limited. 15 -10

>TRY IT! © 2015 Pearson Education, Limited. 15 -11

>TRY IT! © 2015 Pearson Education, Limited. 15 -12

>TRY IT! © 2015 Pearson Education, Limited. 15 -13

Learning Objective 2 Account for investments in debt securities © 2015 Pearson Education, Limited. 15 -14

Purchasing Debt Securities On July 1, 2014, Smart Touch Learning invests $100, 000 in excess cash to buy bonds from Neon Company that have $100, 000 face value and pay 9% interest over their 5 -year life. Smart Touch plans to hold bonds until maturity. Record the investment in bonds on July 1, 2014. © 2015 Pearson Education, Limited. 15 -15

Purchasing Debt Securities On July 1, 2014, Smart Touch Learning invests $100, 000 in excess cash to buy bonds from Neon Company that have $100, 000 face value and pay 9% interest over their 5 -year life. Smart Touch plans to hold bonds until maturity. © 2015 Pearson Education, Limited. 15 -16

Interest Revenue On December 31, 2014, Smart Touch Learning will receive their first interest payment from Neon Company for the bonds purchased on July 1, 2014. Record the interest revenue on December 31, 2014. © 2015 Pearson Education, Limited. 15 -17

Interest Revenue On December 31, 2014, Smart Touch Learning will receive their first interest payment from Neon Company for the bonds purchased on July 1, 2014. © 2015 Pearson Education, Limited. 15 -18

Disposal at Maturity On June 30, 2019, the Neon Company bonds will mature and Smart Touch Learning will receive a final payment. Record the maturity of the bonds. © 2015 Pearson Education, Limited. 15 -19

Disposal at Maturity On June 30, 2019, the Neon Company bonds will mature and Smart Touch Learning will receive a final payment. © 2015 Pearson Education, Limited. 15 -20

Learning Objective 3 Account for investments in equity securities © 2015 Pearson Education, Limited. 15 -21

Equity Investments < 20% • Accounted for as either – Trading Securities – Available-for-Sale Securities • Must recognize dividend revenue • Will be adjusted for changes in market value (see Learning Objective 4) 1. Record at cost when acquired. 2. Recognize dividend revenues. 3. Record a gain or loss on disposal when the investment is sold. © 2015 Pearson Education, Limited. 15 -22

Equity Investments < 20% On March 1, 2014, Smart Touch Learning acquires 1, 000 shares of stock in Yellow Corporation for $26. 16 per share. This will be treated as an available-for-sale investment. Record the stock acquisition on March 1, 2014. © 2015 Pearson Education, Limited. 15 -23

Equity Investments < 20% On March 1, 2014, Smart Touch Learning acquires 1, 000 shares of stock in Yellow Corporation for $26. 16 per share. This will be treated as an available-for-sale investment. © 2015 Pearson Education, Limited. 15 -24

Equity Investments < 20% On May 17, 2014, Yellow Corporation declares a cash dividend of $0. 16 per share to stockholders of record on March 17, 2014. The dividend will be paid on June 9, 2014. Record the dividend when it is received on June 9, 2014. © 2015 Pearson Education, Limited. 15 -25

Equity Investments < 20% On May 17, 2014, Yellow Corporation declares a cash dividend of $0. 16 per share to stockholders of record on March 17, 2014. The dividend will be paid on June 9, 2014. © 2015 Pearson Education, Limited. 15 -26

Equity Investments < 20% On July 15, 2014, Smart Touch Learning sells 800 shares of its Yellow Corporation stock for $25, 000. Record the sale of Yellow Corporation stock on July 15, 2014. © 2015 Pearson Education, Limited. 15 -27

Equity Investments < 20% On July 15, 2014, Smart Touch Learning sells 800 shares of its Yellow Corporation stock for $25, 000. The cost of the shares sold is: 800 shares x $26. 16 per share = $20, 928. The journal entry does not yet balance. The difference will be either a gain since proceeds > cost. © 2015 Pearson Education, Limited. 15 -28

Equity Investments < 20% On July 15, 2014, Smart Touch Learning sells 800 shares of its Yellow Corporation stock for $25, 000. The gain on disposal is: $25, 000 proceeds - $20, 928 cost = $4, 072 gain © 2015 Pearson Education, Limited. 15 -29

Equity Investments > 20%, but < 50% • Significant influence is assumed. • Accounted for using the Equity method of accounting for investments. EQUITY METHOD 1. Record investment at cost when acquired. 2. Dividends reduce the investment balance. 3. Investor’s share of investee’s income increases the investment balance. © 2015 Pearson Education, Limited. 15 -30

Equity Investments > 20%, but < 50% On January 6, 2014, Smart Touch Learning paid $400, 000 to acquire 40% of the common stock of Kline, Inc. Record the acquisition of the Kline, Inc. stock on January 6, 2014. © 2015 Pearson Education, Limited. 15 -31

Equity Investments > 20%, but < 50% On January 6, 2014, Smart Touch Learning paid $400, 000 to acquire 40% of the common stock of Kline, Inc. © 2015 Pearson Education, Limited. 15 -32

Equity Investments > 20%, but < 50% On June 30, 2014, Smart Touch Learning receives a dividend of $20, 000 from Kline, Inc. (Remember: in the equity method, dividends reduce the investment account). Record the receipt of dividends from Kline, Inc. on June 30, 2014. © 2015 Pearson Education, Limited. 15 -33

Equity Investments > 20%, but < 50% On June 30, 2014, Smart Touch Learning receives a dividend of $20, 000 from Kline, Inc. (Remember: in the equity method, dividends reduce the investment account). © 2015 Pearson Education, Limited. 15 -34

Equity Investments > 20%, but < 50% At December 31, Kline, Inc. reports net income of $125, 000 for 2014. Smart Touch Learning must account for 40% of Kline’s net income. (In the equity method, investee net income increases the investment account). Record the Smart Touch Learning’s share of Kline, Inc. ’s net income at December 31, 2014. © 2015 Pearson Education, Limited. 15 -35

Equity Investments > 20%, but < 50% At December 31, Kline, Inc. reports net income of $125, 000 for 2014. Smart Touch Learning must account for 40% of Kline’s net income. (In the equity method, investee net income increases the investment account). © 2015 Pearson Education, Limited. 15 -36

Equity Investments > 20%, but < 50% On January 1, 2015, Smart Touch Learning sells 10% of the Kline, Inc. stock for $40, 000. The Long-term Investment account for Kline, Inc. has a balance of $430, 000. Record the disposal of 10% of Smart Touch Learning’s investment in Kline, Inc. on January 1, 2015. © 2015 Pearson Education, Limited. 15 -37

Equity Investments > 20%, but < 50% On January 1, 2015, Smart Touch Learning sells 10% of the Kline, Inc. stock for $40, 000. The Long-term Investment account for Kline, Inc. has a balance of $430, 000. © 2015 Pearson Education, Limited. 15 -38

Equity Investments > 20%, but < 50% On January 1, 2015, Smart Touch Learning sells 10% of the Kline, Inc. stock for $40, 000. The Long-term Investment account for Kline, Inc. has a balance of $430, 000. © 2015 Pearson Education, Limited. 15 -39

Equity Investments > 50% • Control is established. • Parent company must Effectively, the financial report the subsidiary company as if they were information for the two one company. companies is • Combined statements combined, and are called “Consolidated adjusted for intracompany effects. Statements” © 2015 Pearson Education, Limited. 15 -40

Learning Objective 4 Describe and illustrate how debt and equity securities are reported © 2015 Pearson Education, Limited. 15 -41

Trading Investments • Recorded initially at cost. • Adjusted for changes in fair value. • The adjustment is called “Unrealized Holding Gain/Loss” – Shown on the Income Statement Fair Value is the price that would be used if the company were to sell the investments on the market. © 2015 Pearson Education, Limited. 15 -42

Trading Investments On December 31, 2014, Smart Touch Learning reported trading investments of $26, 160. The market value of the investments is $24, 000. The adjustment is recorded as: © 2015 Pearson Education, Limited. 15 -43

Available-for-Sale Investments • Recorded initially at cost • Adjusted for changes in fair value • The adjustment is called “Unrealized Holding Gain/Loss” – Shown in Stockholders’ Equity The adjustment is recorded and shown in the stockholders’ equity section of the balance sheet as part of Accumulated Other Comprehensive Income. © 2015 Pearson Education, Limited. 15 -44

Available-for-Sale Investments On December 31, 2014, Smart Touch Learning reported AFS investments of $60, 000. The market value of the investments is $64, 000. The adjustment is recorded as: © 2015 Pearson Education, Limited. 15 -45

Summary of Accounting for Debt & Equity Securities © 2015 Pearson Education, Limited. 15 -46

Learning Objective 5 Use the rate of return on total assets to evaluate business performance © 2015 Pearson Education, Limited. 15 -47

Rate of Return on Total Assets © 2015 Pearson Education, Limited. 15 -48

Practice Questions © 2015 Pearson Education, Limited. 15 -49

© 2015 Pearson Education, Limited. 15 -50

© 2015 Pearson Education, Limited. 15 -51

© 2015 Pearson Education, Limited. 15 -52

End of Chapter 15 © 2015 Pearson Education, Limited. 15 -53