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AccountingPrinciples,6eWeygandt,Kieso,&KimmelPreparedbyMarianneBradford,Ph.D.BryantCollegeJohnWiley&Sons,Inc.Afterstudyingthischapter,youshouldbeableto:1Discusswhycorporationsinvestindebtandstocksecurities.2Explaintheaccountingfordebtinvestments.3Explaintheaccountingforstockinvestments.4Describetheuseofconsolidatedfinancialstatements.5Indicatehowdebtandstockinvestmentsarevaluedandreportedonthefinancialstatements.6Distinguishbetweenshort-termandlong-terminvestments.CHAPTER17INVESTMENTSPREVIEWOFCHAPTER17InvestmentsWhyCorporationsInvestAccountingforDebtInvestmentsRecordingacquisitionofbondsRecordingbondinterestRecordingsaleofbondsPREVIEWOFCHAPTER17InvestmentsAccountingforStockInvestmentsHoldingslessthan20%Holdingsbetween20%and50%Holdingsofmorethan50%ValuationandReportingofInvestmentsCategoriesofsecuritiesBalancesheetpresentationRealizedandunrealizedgainorlossComprehensivebalancesheetSTUDYOBJECTIVE1Discusswhycorporationsinvestindebtandstocksecurities.ILLUSTRATION17-1TEMPORARYINVESTMENTSANDTHEOPERATINGCYCLECashTemporaryInvestmentsAccountsReceivableInventoryInvestSellAttheendoftheiroperatingcycles,manycompaniesmayhavetemporarilyidlecashonhanduntilthestartofthenextoperatingcycle.Thesecompaniesmayinvesttheexcessfundstoearnagreaterreturn.Therelationshipoftemporaryinvestmentstotheoperatingcycleisdepictedbelow.ILLUSTRATION17-2WHYCORPORATIONSINVESTReasonTypicalInvestmentTohouseexcesscashuntilneededLow-risk,high-liquidity,short-termsecuritiessuchasgovernment-issuedsecuritiesTogenerateearningsIneed1,000Treasurybillsbytonight!Debtsecurities(banksandotherfinancialinstitutions);andstocksecurities(mutualfundsandpensionfunds)TomeetstrategicgoalsStocksofcompaniesinarelatedindustryorinanunrelatedindustrythatthecompanywishestoenterSTUDYOBJECTIVE2Explaintheaccountingfordebtinvestments.ACCOUNTINGFORDEBTINVESTMENTSRECORDINGAQUISITIONOFBONDSDebtinvestmentsareinvestmentsingovernmentandcorporationbonds.Inaccountingfordebtinvestments,entriesarerequiredtorecordthe1acquisition,2interestrevenue,and3sale.Atacquisition––thecostprincipleapplies.Costincludesallexpendituresnecessarytoacquiretheseinvestments.KuhlCorporationacquires50DoanInc.12%,10-year,$1,000bondsonJanuary1,2002,for$54,000,includingbrokeragefeesof$1,000.Theentrytorecordtheinvestmentis:54,00054,000ACCOUNTINGFORDEBTINVESTMENTSRECORDINGBONDINTERESTThebondspay$3,000interestonJuly1andJanuary1($50,000x12%x½½).TheJuly1entryis:Itisnecessarytoaccrue$3,000interestearnedsinceJuly1atyear-end.TheDecember31entryis:3,0003,000DateAccountTitlesandExplanationDebitCreditDec.31InterestReceivableInterestRevenue(ToaccrueinterestonDoanInc.bonds)3,0003,000ACCOUNTINGFORDEBTINVESTMENTSRECORDINGBONDINTERESTWhentheinterestisreceivedonJanuary1,theentryis:3,0003,000ACCOUNTINGFORDEBTINVESTMENTSRECORDINGSALEOFBONDSAnydifferencebetweenthenetproceedsfromthesale(salespricelessbrokeragefees)andthecostofthebondsisrecordedasagainorloss.KuhlCorporationreceivesnetproceedsof$58,000onthesaleoftheDoanInc.bondsonJanuary1,2003,afterreceivingtheinterestdue.Sincethesecuritiescost$54,000,againof$4,000hasbeenrealized.Theentrytorecordthesaleis:58,00054,0004,000STUDYOBJECTIVE3Explaintheaccountingforstockinvestments.ILLUSTRATION17-3ACCOUNTINGGUIDELINESFORSTOCKINVESTMENTSStockinvestmentsareinvestmentsinthecapitalstockofcorporations.Whenacompanyholdsstockordebtofvariouscorporations,thegroupofsecuritiesisidentifiedasaninvestmentportfolio.RECORDINGSTOCKINVESTMENTSHOLDINGSLESSTHAN20%Inaccountingforstockinvestmentsoflessthan20%,thecostmethodisused.Underthecostmethod,theinvestmentisrecordedatcost,andrevenueisrecognizedonlywhencashdividendsarereceived.OnJuly1,2002,SanchezCorporationacquires1,000shares(10%ownership)ofBealCorporationcommonstock.Sanchezpays$40pershareplusbrokeragefeesof$500.Theentryforthepurchaseis:40,50040,500RECORDINGSTOCKINVESTMENTSHOLDINGSLESSTHAN20%Entriesarerequiredforanycashdividends

receivedduringthetimethestockisheld.Ifa$2pershare

dividendisreceivedbySanchezCorporationonDecember31,theentryis:DividendRevenueisreportedunderOtherRevenueandGainsintheincomestatement.Sincedividendsdonotaccrue,adjustingentriesarenotmadetoaccruedividends.2,0002,000RECORDINGSTOCKINVESTMENTSHOLDINGSLESSTHAN20%Whenstockissold,thedifferencebetweenthenetproceedsfromthesaleandthecostofthestockisrecognizedasagainorloss.SanchezCorporationreceivesnetproceedsof$39,500onthesaleofitsBealCorporationcommonstockonFebruary10,2003.Becausethestockcost$40,500,alossof$1,000hasbeenincurred.Theentrytorecordthesaleis:DateAccountTitlesandExplanationDebitCreditFeb.10CashLossonSaleofStockInvestmentsStockInvestments(TorecordsaleofBealcommonstock)39,5001,00040,500ACCOUNTINGFORSTOCKINVESTMENTSHOLDINGSBETWEEN20%AND50%Whenaninvestorownsbetween20%and50%ofthecommonstockofacorporation,theinvestorhassignificantinfluenceoverthefinancialandoperatingactivitiesoftheinvestee.Undertheequitymethod,theinvestmentincommonstockisinitiallyrecordedatcost,andtheinvestmentaccountisadjustedannuallytoshowtheinvestor’’sequityintheinvestee.Eachyear,theinvestor1)debitstheinvestmentaccountandcreditsrevenueforitsshareoftheinvestee’snetincomeand2)creditsdividendsreceivedtotheinvestmentaccount.ACCOUNTINGFORSTOCKINVESTMENTSHOLDINGSBETWEEN20%AND50%MilarCorporationacquires30%ofthecommonstockofBeckCompanyfor$120,000onJanuary1,2002.Theentrytorecordthistransactionis:120,000120,000ACCOUNTINGFORSTOCKINVESTMENTSHOLDINGSBETWEEN20%AND50%Beckreports2002netincomeof$100,000anddeclaresandpaysa$40,000cashdividend.Milarisrequiredtorecord1)itsshareofBeck’snetincome,$30,000(30%X$100,000)and2)thereductionintheinvestmentaccountforthedividendsreceived,$12,000($40,000X30%).Theentriesare:30,00030,00012,00012,000ILLUSTRATION17-4INVESTMENTANDREVENUEACCOUNTSAFTERPOSTINGAfterpostingthetransactionsfortheyear,theinvestmentandrevenueaccountswillshowtheaboveresults.Duringtheyear,theinvestmentaccounthasincreasedby$18,000whichrepresentsMilar’s30%equityinthe$60,000increaseinBeck’’sretainedearnings($100,000-$40,000).Milarwillalsoreport$30,000ofrevenuefromitsinvestment,whichis30%ofBeck’snetincomeof$100,000.Milarwouldreportonly$12,000(30%X$40,000)ofdividendrevenueifthecostmethodwereused.RECORDINGSTOCKINVESTMENTSHOLDINGSOFMORETHAN50%Acompanythatownsmorethan50%ofthecommonstockofanotherentityisknownasaparentcompany.Theentitywhosestockisownedbytheparentcompanyiscalledthesubsidiary(affiliated)company.Theparentcompanyisperceivedtohaveacontrollinginterestinthesubsidiaryduetoitsstockownership.Whenonecompanyownsmorethan50%ofthecommonstockofanothercompany,consolidatedfinancialstatementsareusuallyprepared.RECORDINGSTOCKINVESTMENTSMANAGEMENTPERSPECTIVEControllingGroupHomeBoxOfficeBoardofDirectorsTimeWarner,Inc.BoardofDirectorsHomeBoxOfficeCorporationTimeWarner,Inc.TimeWarner,Inc.ControlControlSeparateLegalEntitiesSingleEconomicEntityTimeWarner,Inc.own100%ofthecommonstockofHomeBoxOffice(HBO).ThecommonstockholdersofTimeWarnerelecttheboardofdirectorsofthecompany,who,inturn,selecttheofficersandmanagersofthecompany.TheBoardofDirectorscontrolsthepropertyownedbythecorporation,whichincludesthecommonstockofHBO.STUDYOBJECTIVE4Indicatehowdebtandstockinvestmentsarevaluedandreportedonthefinancialstatements.ILLUSTRATION17-5VALUATIONGUIDELINESTradingWe’llsellwithintendays.Available-for-SaleWe’llholdthestockforawhiletoseehowitperforms.Held-to-MaturityWeintendtoholdthesebondsuntilmaturity.AtfairvaluewithchangesreportedinnetincomeAtfairvaluewithchangesreportedinthestockholders’equitysectionAtamortizedcostFairvalueistheamountforwhichasecuritycouldbesoldinanormalmarketandoffersthebestapproachatinvestmentvaluationsinceitrepresentstheexpectedcashrealizablevalueofthesecurities.CATEGORIESOFSECURITIESForpurposesofvaluationandreportingatafinancialstatementdate,debtandstockinvestmentsareclassifiedintothefollowingTHREEcategoriesofsecurities:1)Tradingsecuritiesaresecuritiesboughtandheldprimarilyforsaleintheneartermtogenerateincomeonshort-termpricedifferences.2)Available-for-salesecuritiesaresecuritiesthatmaybesoldinthefuture.3)Held-to-maturitysecuritiesaredebtsecuritiesthattheinvestorhastheintentandabilitytoholdtomaturity.ILLUSTRATION17-6VALUATIONOFTRADINGSECURITIESTradingsecuritiesare1)heldwiththeintentionofsellingtheminashortperiod(generallylessthanamonth),and2)arereportedatfairvalue,andchangesfromcostarereportedaspartofnetincome.Thechangesarereportedasunrealizedgainsorlossessincethesecuritieshavenotbeensold.Theunrealizedgainorlossisthedifferencebetweenthetotalcostoftradingsecuritiesandtheirtotalfairvalue.PaceCorporationhasthefollowingcostsandfairvaluesforitsinvestmentsclassifiedastradingsecurities:VALUATIONANDREPORTINGOFINVESTMENTS——TRADINGSECURITIESPaceCorporationhasanunrealizedgainof$7,000becausetotalfairvalue($147,000)is$7,000greaterthantotalcost($140,000).Fairvalueandtheunrealizedgainorlossarerecordedthroughanadjustingentryatthetimefinancialstatementsareprepared.Avaluationallowanceaccount,MarketAdjustment-Trading,isusedtorecordthedifferencebetweenthetotalcostandthetotalfairvalueofthesecurities.TheadjustingentryforPaceCorporationis:7,0007,0001Thefairvalueofthesecuritiesistheamountreportedonthebalancesheet.2TheunrealizedgainisreportedontheincomestatementintheOtherRevenuesandGainssection.3TheunrealizedlossisreportedontheincomestatementintheOtherExpensesandLossessection.VALUATIONANDREPORTINGOFINVESTMENTS——TRADINGSECURITIESILLUSTRATION17-7VALUATIONOFAVAILABLE-FOR-SALESECURITIESAvailable-for-salesecuritiesare1)heldwiththeintentionofsellingtheminthenearfuture,and2)arereportedatfairvalue,andchangesfromcostarereportedasacomponentofstockholdersequity.Thechangesarereportedasunrealizedgainsorlossessincethesecuritieshavenotbeensold.Theunrealizedgainorlossisthedifferencebetweenthetotalcostofthesecuritiesinthecategoryandtheirtotalfairvalue.ElbertCorporationhasthefollowingcostsandfairvaluesforitsinvestmentsclassifiedasavailable-for-salesecurities:VALUATIONANDREPORTINGOFINVESTMENTSAVAILABLE-FOR-SALESECURITIESElbertCorporationhasanunrealizedlossof$9,537becausetotalfairvalue($284,000)is$9,537lessthantotalcost($293,537).Fairvalueandtheunrealizedgainorlossarerecordedthroughanadjustingentryatthetimefinancialstatementsareprepared.Avaluationallowanceaccount,MarketAdjustment-Available-for-Sale,isusedtorecordthedifferencebetweenthetotalcostandthetotalfairvalueofthesecurities.TheadjustingentryforElbertCorporationis:9,5379,537VALUATIONANDREPORTINGOFINVESTMENTSAVAILABLE-FOR-SALESECURITIES1Thefairvalueofthesecuritiesistheamountreportedonthebalancesheet.2Theunrealizedgainorlossisreportedasaseparatecomponentofstockholders’’equity.STUDYOBJECTIVE5Distinguishbetweenshort-termandlong-terminvestments.SHORT-TERMINVESTMENTSShort-terminvestmentsaresecuritiesheldbyacompanythatare(1)readilymarketableand(2)intendedtobeconvertedintocashwithinthenextyearoroperatingcycle,whicheverislonger.Aninvestmentisreadilymarketablewhenitcanbesoldeasilywhenevertheneedforcasharises.Intenttoconvertmeansthatmanagementintendstoselltheinvestmentwithinthenextyearoroperatingcycle,whicheverislonger.ILLUSTRATION17-8PRESENTATIONOFSHORT-TERMINVESTMENTSShortTerminvestmentsarelistedimmediatelybelowcashinthecurrentassetsectionofthebalancesheetduetotheirliquidity.Theyarereportedatfairvalue.ILLUSTRATION17-9NONOPERATINGITEMSRELATEDTOINVESTMENTSLong-terminvestmentsaretypicallyreportedinaseparatesectionofthebalancesheetimmediatelybelowcurrentassets.Intheincomestatement,theitemsbelowarereportedinthenonoperatingsection:ILLUSTRATION17-10UNREALIZEDLOSSINSTOCKHOLDERS’EQUITYSECTIONAnunrealizedgainorlossonavailable-for-salesecuritiesisreportedasaseparatecomponentofstockholders’equity.DawsonInc.hascommonstockof$3,000,000,retainedearningsof$1,500,000,andanunrealizedlossonavailable-for-salesecuritiesof$100,000.Thestatementpresentationoftheunrealizedlossisshownbelow.ILLUSTRATION17-11COMPREHENSIVEBALANCESHEETThecomprehensivebalancesheetforPaceCorporationincludesthefollowingassets:1Short-termInvestments,2Investmentsoflessthan20%,and3Investmentsof20%-50%.

PACECORPORATION

BalanceSheet

December31,2002

Assets

Currentassets

Cash

$21,000

Short-term

investments,atfairvalue

147,000

Accountsreceivable

$84,000

Less:Allowancefordoubfulaccounts

4,000

80,000

Merchandiseinventory,atFIFOcost

43,000

Prepaidinsurance

23,000

Totalcurrentassets

314,000

Investments

Bondsinkingfund

100,000

Investmentsinstockoflessthan20%o