Accounting Principles : Investment

 Corporation Investment 

Corporations purchase investments in debt or stock securities generally for one of three reasons.

1. The corporation may have excess cash
2. Generate earnings from investment income
3. For strategic reasons
4. 

Accounting for Debt Investments :

Investments in government and corporation bonds.

Entries are made to record

1. the acquisition.
2. the interest revenue.
3. the sale.

Recording Acquisition of Bonds

Cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any.

Illustration: Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2020, for $50,000. The entry to record the investment is:

Recording Bond Interest

Calculate and record interest revenue based upon the

• carrying value of the bond.
• times interest rate.
• times portion of year bond is outstanding.

Recording Bond Interest

Illustration: The Doan Inc. bonds pay interest of $4,000 annually on January 1 ($50,000 × 8%). If Kuhl Corporation’s fiscal year ends on December 31, it accrues the interest earned since January 1. Calculate the accrued interest.

Recording Bond Interest

Kuhl reports Interest Receivable as a current asset in the balance sheet. It reports Interest Revenue under “Other revenues and gains” in the income statement.

Kuhl reports receipt of the interest on January 1 as follows.

Recording Bond Interest

Assume that Kuhl Corporation receives net proceeds of $54,000 on the sale of the Doan Inc. bonds on January 1, 2021, after receiving the interest due. Prepare the entry to record the sale of the bonds.

Explain how to account for stock investments.

The accounting depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation (investee).

Holding of Less than 20%

• Companies use the cost method.
• Investment is recorded at cost and revenue is recognized only when cash dividends are received.
• Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).

Recording Acquisition of Stock Investments

Illustration: Assume that on July 1, 2020, Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock. Sanchez pays $40 per share. The entry for the purchase is:

Recording Dividends

Illustration: During the time Sanchez owns the stock, it makes entries for any cash dividends received. If Sanchez receives a $2 per share dividend on December 31, the entry is:

Recording Sale of Stock

Illustration: Assume that Sanchez Corporation receives net proceeds of $39,000 on the sale of its Beal stock on February 10, 2021. Because the stock cost $40,000, Sanchez incurred a loss of $1,000. The entry to record the sale is:

Holding Between 20% and 50%

Equity Method: The investor records the investment at cost and subsequently adjusts the amount each period for the

• proportionate share of earnings (losses).
• dividends received.

If the investor’s share of the investee’s losses exceeds the carrying amount of the investment, the investor ordinarily should discontinue applying the equity method.

Illustration: Milar Corporation acquired 30% of the common shares of Beck Company for $120,000 on January 1, 2020. For 2020, Beck reports net income of $100,000 and paid dividends of $40,000. Prepare the entries for these transactions.

Illustration: Milar Corporation acquires 30% of the common shares of Beck Company for $120,000 on January 1, 2020. For 2020, Beck reports net income of $100,000 and paid dividends of $40,000.

After Milar posts the transactions for the year, its investment and revenue accounts will show the following.

Holdings of More than 50%

Controlling Interest - When one corporation acquires a voting interest of more than 50 percent in another corporation,

• Investor is referred to as parent.
• Investee is referred to as subsidiary.
  
• Investment in subsidiary is reported on parent’s books as a long-term investment.
• Parent generally prepares consolidated financial statements.

Consolidated statements indicate the magnitude and scope of operations of the companies under common control.

Debt Securities

For purposes of valuation and reporting, debt investments are classified into three categories:

1. Trading.
2. Available for sale.
3. Held-to-maturity.

Trading Securities

• Companies hold with the intention of selling in a short period.
• Trading means frequent buying and selling.
• Reported at fair value.
• Changes from cost are reported in the income statement as unrealized gains or losses.

Illustration: Cost and fair values for investments of Pace Corporation classified as trading securities on December 31, 2020.

DEBT SECURITIES :

Available-for-Sale Securities

• Held with the intent of selling sometime in the future.
• Classified as current assets or as long-term assets, depending on intent of management.
• Reported at fair value.
• Changes from cost are reported in stockholders’ equity as unrealized gains or losses.

Illustration: Assume that Shelton Corporation has two securities that are classified as available-for-sale.