Chapter 16 Investments

ACC440
Professor Mindy Wolfe

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Investments in Debt and Equity Securities
 Investments in Debt Securities(Creditor relationship)-Accounting is determined by how
long you plan on keeping the investment:
 Held to Maturity (intent and ability to hold to maturity) Amortized Cost Method
 Trading (short-term) Fair Value through Income Method
 Available for Sale (all others) Fair Value through OCI Method
 Investments in Equity Securities-Accounting is determined by the influence the
purchasing company has over the company they’re investing in. We try to measure the
influence by % ownership but this is not a bright line rule.
 0-<20% - Fair Value Method
 20- 50% - Equity Method
 50-100% - Consolidation (Not covered in this class)
 Fair Value and Cost options


 Debt Securities
Held to Maturity Securities
Available for Sale Securities
Trading Securities
Debt – Held to Maturity Securities
 Plan is to hold the investment until the bond matures. Intent and ability to do so.
 Same accounting for a bond payable (from the issuer’s perspective), but now from the
investor’s perspective.
 No write ups/downs to Fair Value.
 Each year record Interest Revenue and amortize the Premium/Discount if there is one.
 Purchase: DR Debt Investments $XX; CR Cash $XX
 Record Interest Revenue:
DR Cash/Interest Receivable $XX(=Face Value * stated rate);
DR/CR Debt Investments $XX (Depending on whether Discount/Premium);
CR Interest Rev. $XX (Book Value of Debt Investment * market rate)
Debt – Held to Maturity Example
 On January 1, 2020 Anderson Corp. 1. Prepare an amortization schedule for the
purchases 5% bonds, with a face first 3 years
value of $500,000 for $429,764. The 2. What are the journal entries needed on:
A. January 1, 2020
bonds provide the bondholders with
B. December 31, 2020
a 7% yield. They are dated January C. December 31, 2021
1, 2020, and mature December 31,
2029 with interest paid December 31
of each year. Anderson Corp. uses
the effective-interest method to
allocate unamortized discount or
premium. The bonds are classified
as held-to-maturity.
Debt – Held to Maturity Example Yearly

Cash Received /
Bond Discount Debt Investment
Interest Interest Revenue
Amortization (Carrying Amount)
Receivable

Face value * Debt Investment *

Stated rate * time yield * time

Jan 1, 2020

Dec 31, 2020

Dec 31, 2021

Dec 31, 2022

 Debt Securities
Held to Maturity Securities
Available for Sale Securities
Trading Securities
Debt - Available for Sale Securities
(Fair Value through OCI)
 Not sure how long you’ll hold the securities? If doesn’t meet definition of Trading
Security or Held to Maturity then default is Available For Sale.
 Purchase: DR Debt Investment $XX; CR Cash $XX
 At end of year
1. Record Interest Revenue and amortize the Premium/Discount if there is one.
DR Cash/Interest Receivable $XX;
DR/CR Debt Investments $XX (Depending on whether Discount/Premium);
CR Interest Rev. $XX
2. Adjustment - Mark to Fair Value (assuming increase)
 DR Fair Value Adjustment $XX; CR Unrealized Holding Gain/Loss – Equity $XX
 What financial statements are affected by the adjustment entry?
Debt – Available for Sale Example
 Morris Corp. acquires $2,960,000 1. What are the journal entries needed on:
A. January 1, 2021
face value, 5%, 6 year bonds as
B. December 31, 2021
a held-to-maturity investment on 2. If fair value at the end of 2022 is
January 1, 2021 when the market $2,470,000 what is the journal entry needed
rate of interest is 10%. Interest is to record the FV adjustment on December
31, 2022?
paid annually each December 31.
3. If fair value at the end of 2023 is
Purchase price of the bonds, is $2,600,000 what is the fair value
$2,315,421. Morris Corp. uses adjustment needed on December 31,
the effective interest method to 2023?
account for the bonds and the fair 4. On January 1, 2024 you sell the Available
for sale bonds for $2,605,000 what is the
value at the end of 2021 is journal entry needed on January 1, 2024?
$2,350,000.
Debt – Held to Maturity Example Yearly
Cash Debt
Bond
Received / Interest Investment Fair Value
Discount
Interest Revenue (Carrying
Amortization
Receivable Amount)
Face value * Debt
Stated rate * Investment *
time yield * time

Jan 1, 2021

Dec 31, 2021

Dec 31, 2022

Dec 31, 2023

Sale of AFS Debt Securities
 Similar to Held to Maturity Investments:
1. Amortize Debt Security/Record Interest Revenue up to date of sale
2. Record Cash Received, Zero out Debt Investment Acct, for that investment Zero out
Interest Receivable (if any), Record Gain/Loss (Plug).
 At end of fiscal period clear out or true up Fair Value Adjustment account.
 Debt Securities
Held to Maturity Securities
Available for Sale Securities
Trading Securities
Debt - Trading Securities
 Held to bring in a return in the short term; actively and frequently traded
 Accounting is the same as Available for Sale but Unrealized Holding Gain/Loss goes through
the income statement.
 Adjustment to fair value at period end (assuming increase in value):
 DR Fair Value Adjustment $XX; CR Unrealized Holding Gain/Loss-Income $XX
 While you still amortize discounts/premiums the text and the CPA exam focus on the fair value
adjustment using a portfolio approach; meaning the company has multiple trading security
investments
 Using the portfolio approach just means the company makes one journal entry to record the net
increase/decrease in fair value of all investments recorded as trading securities.

 Any brokerage fees or other costs incidental to the purchase are capitalized as part of the asset.
Debt - Trading Securities Portfolio Example
 You purchase Bonds A and B on 10/1/2020
 You then sell Bonds A and B on 3/31/2021.
 On 12/1/2021 you purchase Bonds C and D.
 What are journal entries needed on 10/1/2020, 12/31/2020, 3/31/2021, 12/1/2021,
and 12/31/2021? Ignore interest payments.
10/1/2020 Cost 12/31/2020 Fair 3/31/2021 Sale
Value Price
Bond A $500,000 (par) $501,500 $502,000
Bond B $300,000 (par) $299,750 $301,000

12/1/2021 Cost 12/31/2021 Fair

Value
Bond C $200,000 (par) $200,350
Bond D $100,000 (par) $100,250
Equity Securities
Fair Value Method
Equity Method
Equity Investments
 An Equity investment represents ownership
 Investor has passive interest generally 0-20% ownership - Fair Value method
 Investor has significant influence generally 20% > Investment <50% - Equity Method
 Investor has a controlling interest generally >50% - Consolidate Statements (not
covered in this class)
Equity Investments
 Even though may own 20%-50% may lack significant influence:
 Another block owns a larger share
 No representation on board of directors
 Investee opposes investor
 Investee in bankruptcy
 Even though may own less than 20% may have significant influence:
 No other investor has a material voting ownership
 Representation on board of directors
 Participates in investee policy making
 intercompany transactions/Investee is technologically dependent on investor
Equity - Fair Value Method (Passive Investment)
 Purchase: DR Equity Investments $XX; CR Cash $XX
 Receive Dividends: DR Cash $XX; CR Dividend Revenue $XX
 End of period adjustment:
DR Unrealized Holding Gain/Loss-Income $XX
CR Fair Value Adjustment $XX
 Sale:
DR Cash $XX;
DR/CR Loss/Gain on Sale of Investment $XX
CR Equity Investment $XX
**Loss/Gain on Sale if Investment (realized gain) is difference between purchase price and
sale price less any brokerage fees.

 End of period clear out or true up the Fair Value adjustment account.
Equity – Fair Value (Passive Investment) Example
 Below is the cost of a portfolio of Equity  Record the purchase of the stock,
investments purchased in 2020 and their assuming all three securities were
Fair Values at 12/31/2020. On January 20, purchased on the same day.
2021 Your Company sold Apple for  Record the adjusting entry at December 31,
$31,200. The sale proceeds are net of 2020, to report the portfolio at fair value.
brokerage fees.  Show the balance sheet presentation of the
investment related account at December
31, 2020.
Security Cost Fair Value  Prepare the journal entry for the 2021 sale
12/31/2020 of Apple
 At the end of 2021 Banana has a fair value
Apple $ 33,600 $31,000 of $170,000 and Crisp has a fair value of
Banana 175,000 174,000 $65,000 what is the adjusting journal entry
needed?
Crisp 59,400 68,500
$ 268,000 $273,500
Equity - Equity Method (Significant Influence)
 How do we account for Equity investments when the investor has significant influence?
 Think about what is happening to the investee’s retained earnings. When Investee’s R/E goes
up Investor’s investment goes up. When investee’s R/E goes down, Investor’s investment goes
down.
 Purchase: DR Equity Investments $XX; CR Cash $XX
 Receive Dividends: DR Cash $XX; CR Equity Investment $XX
 $XX = Total Dividends paid to all shareholders * % ownership
 Net Income reported (what if the company had a net loss?):
 $XX = Total Net Income reported * % ownerships
DR Equity Investment $XX;
CR Investment Income $XX
 How would the dollar amounts of the above journal entries change if the company purchases
common stock in the middle of the year? Equity method is applied prospectively.
 No Fair Value adjustment under the Equity Method
Equity - Equity Method (Significant Influence) Example
 On January 1, 2021 Barker  Record the purchase of shares on January
Company purchases 40% of Kimbel 1, 2021
 Record the receipt of dividends on October
Company’s 500,000 outstanding
25th.
shares of common stock at a cost of  What are the journal entries needed on
$13/share. On October 25th Kimbel December 31, 2021?
Company declared and paid a cash
dividend of $0.40 per share. On
December 31, Kimbel reported net  Assume instead the purchase of Kimbel
income of $860,000 for the year and Company’s shares was made on July 1,
the market price of its common 2021.
stock was $14/share.  Record dividends on October 25th.
 Record Kimbel’s net income on December
31, 2021.
Investments – Miscellaneous Items
Cost and Fair Value Option
Fair Value Option
 Fair Value Option – Companies have the option to record most financial instruments at
fair value (including HTM debt securities and Equity Investments that would otherwise
use the Equity Method).
 The Fair Value Option must be chosen when the asset is purchased and may not be
changed (irrevocable).
 Also is an individual investment decision
 DR (Debt or Equity) Investment $XX; CR Unrealized Holding Gain/Loss-Income $XX
Cost Option
 Cost Option – recorded at purchase price and not revalued (unless shares purchased
or sold) mainly because there is no readily available fair value. Dividends are recorded
as Dividend Income.
 If there are transactions from which to determine fair value can use to measure investment.
 DR Equity Investment $XX; CR Cash $XX
Disclosure
 If valuing Financial Instrument at Fair Value must disclose Fair Value and cost.
 Reliability of Fair Value:
 Level 1 Quoted Prices in Active markets
 Level 2 Significant Other Observable inputs
 Level 3 Significant Unobservable Inputs
 Reconciliation of changes in Level 3 Financial Instruments