Is There Anything Else We Can Buy?”
In a rapidly changing world, you must change rapidly or suffer the consequences. In business, change requires investment.
A case in point is found in the entertainment industry. Technology is bringing about innovations so quickly that it is nearly impossible to guess which technologies will last and which will soon fade away. For example, will both satellite TV and cable TV survive? Or, will both be replaced by something else?
Consider the publishing industry as well. Will paper newspapers and magazines be replaced completely by online news? If you are a publisher, you have to make your best guess about what the future holds and invest accordingly.
Time Warner, Inc. lives at the center of this arena. It is not an environment for the timid, and Time Warner's philosophy is anything but that. Instead, it might be characterized as, “If we can't beat you, we will buy you.” Its mantra is “invest, invest, invest.” A list of Time Warner's holdings gives an idea of its reach:
Magazines: People, Time, Life, Sports Illustrated, Fortune.
Book publishers: Time-Life Books, Book-of-the-Month Club, Little, Brown & Co, Sunset Books.
Television and movies: Warner Bros. (“ER,” “Without a Trace,” the WB Network), HBO, and movies like Harry Potter and the Deathly Hollows: Part 2 and the Dark Knight Rises.
Broadcasting: TNT, CNN news, and Turner's library of thousands of classic movies.
Internet: America Online and AOL Anywhere.
Time Warner owns more information and entertainment copyrights and brands than any other company in the world.
The merger of America Online (AOL) with Time Warner, one of the biggest mergers ever, was originally perceived by many as the gateway to the future. In actuality, it was a financial disaster. It is largely responsible for much of the decline in Time Warner's stock price, from a high of $95.80 to a recent level of $32. Ted Turner, who was at one time Time Warner's largest shareholder, lost billions of dollars on the deal and eventually sold most of his shares. In 2009, Time Warner completed a spin-off of AOL after years of trying to integrate the two companies. One analyst called the failed deal “a nine-year adventure akin to a marathon through mud.”
Scan Learning Objectives
Read Feature Story
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Read text and answer DO IT! p. 742
p. 747 p. 751 p. 754
Work Comprehensive DO IT! p. 756
Review Summary of Learning Objectives
Answer Self-Test Questions
Complete Assignments
Go to WileyPLUS for practice and tutorials
Read A Look at IFRS p. 773
After studying this chapter, you should be able to:
[1] Discuss why corporations invest in debt and stock securities.
[2] Explain the accounting for debt investments.
[3] Explain the accounting for stock investments.
[4] Describe the use of consolidated financial statements.
[5] Indicate how debt and stock investments are reported in financial statements.
[6] Distinguish between short-term and long-term investments.
Preview of Chapter 16
Time Warner's management believes in aggressive growth through investing in the stock of existing companies. Besides purchasing stock, companies also purchase other securities such as bonds issued by corporations or by governments. Companies can make investments for a short or long period of time, as a passive investment, or with the intent to control another company. As you will see in this chapter, the way in which a company accounts for its investments is determined by a number of factors.
The content and organization of Chapter 16 are as follows.
Why Corporations Invest
Corporations purchase investments in debt or stock securities generally for one of three reasons. First, a corporation may have excess cash that it does not need for the immediate purchase of operating assets. For example, many companies experience seasonal fluctuations in sales. A Cape Cod marina has more sales in the spring and summer than in the fall and winter. The reverse is true for an Aspen ski shop. Thus, at the end of an operating cycle, many companies may have cash on hand that is temporarily idle until the start of another operating cycle. These companies may invest the excess funds to earn—through interest and dividends—a greater return than they would get by just holding the funds in the bank. The role that such temporary investments play in the operating cycle is shown in Illustration 16-1.
Illustration 16-1
Temporary investments and the operating cycle
Excess cash may also result from economic cycles. For example, when the economy is booming, General Electric generates considerable excess cash. It uses some of this cash to purchase new plant and equipment, and pays out some of the cash in dividends. But, it may also invest excess cash in liquid assets in anticipation of a future downturn in the economy. It can then liquidate these investments during a recession, when sales slow and cash is scarce.
When investing excess cash for short periods of time, corporations invest in low-risk, highly liquid securities—most often short-term government securities. It is generally not wise to invest short-term excess cash in shares of common stock because stock investments can experience rapid price changes. If you did invest your short-term excess cash in stock and the price of the stock declined significantly just before you needed cash again, you would be forced to sell your stock investment at a loss.
A second reason some companies purchase investments is to generate earnings from investment income. For example, banks make most of their earnings by lending money, but they also generate earnings by investing in debt. Conversely, mutual stock funds invest primarily in equity securities in order to benefit from stock-price appreciation and dividend revenue.
Third, companies also invest for strategic reasons. A company can exercise some influence over a customer or supplier by purchasing a significant, but not controlling, interest in that company. Or, a company may purchase a noncontrolling interest in another company in a related industry in which it wishes to establish a presence. For example, Time Warner initially purchased an interest of less than 20% in Turner Broadcasting to have a stake in Turner's expanding business opportunities. At a later date, Time Warner acquired the remaining 80%. Subsequently, Time Warner merged with AOL and became AOL Time Warner, Inc. Now, it is again just Time Warner, Inc., as indicated in the Feature Story.
A corporation may also choose to purchase a controlling interest in another company. For example, as the Accounting Across the Organization box on page 746 shows, Procter & Gamble purchased Gillette. Such purchases might be done to enter a new industry without incurring the tremendous costs and risks associated with starting from scratch. Or, a company might purchase another company in its same industry.
In summary, businesses invest in other companies for the reasons shown in Illustration 16-2.
Illustration 16-2
Why corporations invest
Accounting for Debt Investments
Debt investments are investments in government and corporation bonds. In accounting for debt investments, companies make entries to record (1) the acquisition, (2) the interest revenue, and (3) the sale.
Recording Acquisition of Bonds
At acquisition, debt investments are recorded at cost. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any.
For example, assume that Kuhl Corporation acquires 50 Doan Inc. 8%, 10-year, $1,000 bonds on January 1, 2014, for $50,000. Kuhl records the investment as:
Recording Bond Interest
The Doan Inc. bonds pay interest of $2,000 semiannually on July 1 and January 1 ($50,000 × 8% × ½). The entry for the receipt of interest on July 1 is:
If Kuhl Corporation's fiscal year ends on December 31, it accrues the interest of $2,000 earned since July 1. The adjusting entry is:
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.
A credit to Interest Revenue at this time is incorrect because the company earned and accrued interest revenue in the preceding accounting period.
Recording Sale of Bonds
When Kuhl sells the bonds, it credits the investment account for the cost of the bonds. Kuhl records as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds.
Assume, for example, that Kuhl Corporation receives net proceeds of $54,000 on the sale of the Doan Inc. bonds on January 1, 2015, after receiving the interest due. Since the securities cost $50,000, the company realizes a gain of $4,000. It records the sale as:
Kuhl reports the gain on sale of debt investments under “Other revenues and gains” in the income statement and reports losses under “Other expenses and losses.”
Debt Investments
Waldo Corporation had the following transactions pertaining to debt investments.
Jan. 1 Purchased 30, $1,000 Hillary Co. 10% bonds for $30,000. Interest is payable semiannually on July 1 and January 1.
July 1 Received semiannual interest on Hillary Co. bonds.
July 1 Sold 15 Hillary Co. bonds for $14,600.
(a) Journalize the transactions, and (b) prepare the adjusting entry for the accrual of interest on December 31.
Record bond investments at cost.
Record interest when received and/or accrued.
When bonds are sold, credit the investment account for the cost of the bonds.
Record any difference between the cost and the net proceeds as a gain or loss.
Solution
Related exercise material: BE16-1, E16-2, E16-3, and DO IT! 16-1.
Accounting for Stock Investments
Stock investments are investments in the capital stock of other corporations. When a company holds stock (and/or debt) of several different corporations, the group of securities is identified as an investment portfolio.
The accounting for investments in common stock depends on the extent of the investor's influence over the operating and financial affairs of the issuing corporation (the investee). Illustration 16-3 shows the general guidelines.
Illustration 16-3
Accounting guidelines for stock investments
Companies are required to use judgment instead of blindly following the guidelines.1 We explain the application of each guideline next.
Holdings of Less than 20%
In accounting for stock investments of less than 20%, companies use the cost method. Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received.
Helpful Hint The entries for investments in common stock also apply to investments in preferred stock.
RECORDING ACQUISITION OF STOCK INVESTMENTS
At acquisition, stock investments are recorded at cost. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions), if any.
For example, assume that on July 1, 2014, 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
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:
Sanchez reports Dividend Revenue under “Other revenues and gains” in the income statement. Unlike interest on notes and bonds, dividends do not accrue. Therefore, companies do not make adjusting entries to accrue dividends.
RECORDING SALE OF STOCK
When a company sells a stock investment, it recognizes as a gain or a loss the difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the stock.
Assume that Sanchez Corporation receives net proceeds of $39,000 on the sale of its Beal stock on February 10, 2015. Because the stock cost $40,000, Sanchez incurred a loss of $1,000. The entry to record the sale is:
Sanchez reports the loss under “Other expenses and losses” in the income statement. It would show a gain on sale under “Other revenues and gains.”
Holdings Between 20% and 50%
When an investor company owns only a small portion of the shares of stock of another company, the investor cannot exercise control over the investee. But, when an investor owns between 20% and 50% of the common stock of a corporation, it is presumed that the investor has significant influence over the financial and operating activities of the investee. The investor probably has a representative on the investee's board of directors. Through that representative, the investor may exercise some control over the investee. The investee company in some sense becomes part of the investor company.
For example, even prior to purchasing all of Turner Broadcasting, Time Warner owned 20% of Turner. Because it exercised significant control over major decisions made by Turner, Time Warner used an approach called the equity method. Under the equity method, the investor records its share of the net income of the investee in the year when it is earned. An alternative might be to delay recognizing the investor's share of net income until the investee declares a cash dividend. But, that approach would ignore the fact that the investor and investee are, in some sense, one company, making the investor better off by the investee's earned income.
Under the equity method, the investor company initially records the investment in common stock at cost. After that, it adjusts the investment account annually to show the investor's equity in the investee. Each year, the investor does the following. (1) It increases (debits) the investment account and increases (credits) revenue for its share of the investee's net income.2 (2) The investor also decreases (credits) the investment account for the amount of dividends received. The investment account is reduced for dividends received because payment of a dividend decreases the net assets of the investee.
Helpful Hint Under the equity method, the investor recognizes revenue on the accrual basis—i.e., when it is earned by the investee.
RECORDING ACQUISITION OF STOCK INVESTMENTS
Assume that Milar Corporation acquires 30% of the common stock of Beck Company for $120,000 on January 1, 2014. The entry to record this transaction is:
RECORDING REVENUE AND DIVIDENDS
For 2014, Beck reports net income of $100,000. It declares and pays a $40,000 cash dividend. Milar records (1) its share of Beck's income, $30,000 (30% × $100,000) and (2) the reduction in the investment account for the dividends received, $12,000 ($40,000 × 30%). The entries are:
After Milar posts the transactions for the year, its investment and revenue accounts will show the following.
Illustration 16-4
Investment and revenue accounts after posting
During the year, the net increase in the investment account was $18,000. As indicated above, the investment account increased by $30,000 due to Milar's share of Beck's income, and it decreased by $12,000 due to dividends received from Beck. In addition, Milar reports $30,000 of revenue from its investment, which is 30% of Beck's net income of $100,000.
Note that the difference between reported revenue under the cost method and reported revenue under the equity method can be significant. For example, Milar would report only $12,000 of dividend revenue (30% × $40,000) if it used the cost method.
Holdings of More than 50%
A company that owns more than 50% of the common stock of another entity is known as the parent company. The entity whose stock the parent company owns is called the subsidiary (affiliated) company. Because of its stock ownership, the parent company has a controlling interest in the subsidiary.
When a company owns more than 50% of the common stock of another company, it usually prepares consolidated financial statements. These statements present the total assets and liabilities controlled by the parent company. They also present the total revenues and expenses of the subsidiary companies. Companies prepare consolidated statements in addition to the financial statements for the parent and individual subsidiary companies.
Helpful Hint If parent (A) has three wholly owned subsidiaries (B, C, & D), there are four separate legal entities. From the viewpoint of the shareholders of the parent company, there is only one economic entity.
As noted earlier, when Time Warner had a 20% investment in Turner, it reported this investment in a single line item—Other Investments. After the merger, Time Warner instead consolidated Turner's results with its own. Under this approach, Time Warner included Turner's individual assets and liabilities with its own. Its plant and equipment were added to Time Warner's plant and equipment, its receivables were added to Time Warner's receivables, and so on.
ACCOUNTING ACROSS THE ORGANIZATION 
How Procter & Gamble Accounts for Gillette
Several years ago, Procter & Gamble Company acquired Gillette Company for $53.4 billion. The common stockholders of Procter & Gamble elect the board of directors of the company, who, in turn, select the officers and managers of the company. Procter & Gamble's board of directors controls the property owned by the corporation, which includes the common stock of Gillette. Thus, they are in a position to elect the board of directors of Gillette and, in effect, control its operations. These relationships are graphically illustrated here.
Where on Procter & Gamble's balance sheet will you find its investment in Gillette Company? (See page 773.)
Consolidated statements are useful to the stockholders, board of directors, and management of the parent company. These statements indicate the magnitude and scope of operations of the companies under common control. For example, regulators and the courts undoubtedly used the consolidated statements of AT&T to determine whether a breakup of the company was in the public interest. Illustration 16-5 lists three companies that prepare consolidated statements and some of the companies they have owned.
Illustration 16-5
Examples of consolidated companies and their subsidiaries
Stock Investments
Presented below are two independent situations.
1. Rho Jean Inc. acquired 5% of the 400,000 shares of common stock of Stillwater Corp. at a total cost of $6 per share on May 18, 2014. On August 30, Stillwater declared and paid a $75,000 dividend. On December 31, Stillwater reported net income of $244,000 for the year.
2. Debbie, Inc. obtained significant influence over North Sails by buying 40% of North Sails’ 60,000 outstanding shares of common stock at a cost of $12 per share on January 1, 2014. On April 15, North Sails declared and paid a cash dividend of $45,000. On December 31, North Sails reported net income of $120,000 for the year.
Prepare all necessary journal entries for 2014 for (1) Rho Jean Inc. and (2) Debbie, Inc.
Action Plan
Presume that the investor has relatively little influence over the investee when an investor owns less than 20% of the common stock of another corporation. In this case, net income earned by the investee is not considered a proper basis for recognizing income from the investment by the investor.
Presume significant influence for investments of 20%–50%. Therefore, record the investor's share of the net income of the investee.
Solution
Related exercise material: BE16-2, BE16-3, E16-4, E16-5, E16-6, E16-7, E16-8, and DO IT! 16-2.
Valuing and Reporting Investments
The value of debt and stock investments may fluctuate greatly during the time they are held. For example, in one 12-month period, the stock price of Time Warner hit a high of $58.50 and a low of $9. In light of such price fluctuations, how should companies value investments at the balance sheet date? Valuation could be at cost, at fair value, or at the lower-of-cost-or-market value.
Many people argue that fair value offers the best approach because it represents the expected cash realizable value of securities. Fair value is the amount for which a security could be sold in a normal market. Others counter that unless a security is going to be sold soon, the fair value is not relevant because the price of the security will likely change again.
Categories of Securities
For purposes of valuation and reporting at a financial statement date, companies classify debt investments into three categories:
1. Trading securities are bought and held primarily for sale in the near term to generate income on short-term price differences.
2. Available-for-sale securities are held with the intent of selling them sometime in the future.
3. Held-to-maturity securities are debt securities that the investor has the intent and ability to hold to maturity.3
Stock investments are classified into two categories:
1. Trading securities (as defined above).
2. Available-for-sale securities (as defined above).
Stock investments have no maturity date. Therefore, they are never classified as held-to-maturity securities.
Illustration 16-6 shows the valuation guidelines for these securities. These guidelines apply to all debt securities and all stock investments in which the holdings are less than 20%.
Illustration 16-6
Valuation guidelines
TRADING SECURITIES
Companies hold trading securities with the intention of selling them in a short period (generally less than a month). Trading means frequent buying and selling. As indicated in Illustration 16-7, companies adjust trading securities to fair value at the end of each period. They report changes from cost as part of net income. The changes are reported as unrealized gains or losses because the securities have not been sold. The unrealized gain or loss is the difference between the total cost of trading securities and their total fair value. Companies classify trading securities as current assets.
Illustration 16-7 shows the cost and fair values for investments Pace Corporation classified as trading securities on December 31, 2014. Pace has an unrealized gain of $7,000 because total fair value of $147,000 is $7,000 greater than total cost of $140,000.
Illustration 16-7
Valuation of trading securities
Pace records fair value and unrealized gain or loss through an adjusting entry at the time it prepares financial statements. In this entry, the company uses a valuation allowance account, Fair Value Adjustment—Trading, to record the difference between the total cost and the total fair value of the securities. The adjusting entry for Pace Corporation is:
The use of a Fair Value Adjustment—Trading account enables Pace to maintain a record of the investment cost. It needs actual cost to determine the gain or loss realized when it sells the securities. Pace adds the debit balance (or subtracts a credit balance) of the Fair Value Adjustment—Trading balance to the cost of the investments to arrive at a fair value for the trading securities.
The fair value of the securities is the amount Pace reports on its balance sheet. It reports the unrealized gain in the income statement in the “Other revenues and gains” section. The term “Income” in the account title indicates that the gain affects net income.
If the total cost of the trading securities is greater than total fair value, an unrealized loss has occurred. In such a case, the adjusting entry is a debit to Unrealized Loss—Income and a credit to Fair Value Adjustment—Trading. Companies report the unrealized loss under “Other expenses and losses” in the income statement.
The Fair Value Adjustment—Trading account is carried forward into future accounting periods. The company does not make any entry to the account until the end of each reporting period. At that time, the company adjusts the balance in the account to the difference between cost and fair value. For trading securities, it closes the Unrealized Gain (Loss)—Income account at the end of the reporting period.
ACCOUNTING ACROSS THE ORGANIZATION
And the Correct Way to Report Investments Is...?
The accompanying graph presents an estimate of the percentage of companies on the major exchanges that have investments in the equity of other entities.
As the graph indicates, many companies have equity investments of some type. These investments can be substantial. For example, the total amount of equity-method investments appearing on company balance sheets is approximately $403 billion, and the amount shown in the income statements in any one year for all companies is approximately $38 billion.
Source: “Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 on Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers,” United States Securities and Exchange Commission—Office of Chief Accountant, Office of Economic Analyses, Division of Corporation Finance (June 2005), p. 36–39.
Why might the use of the equity method not lead to full disclosure in the financial statements? (See page 773.)
AVAILABLE-FOR-SALE SECURITIES
As indicated earlier, companies hold available-for-sale securities with the intent of selling these investments sometime in the future. If the intent is to sell the securities within the next year or operating cycle, the investor classifies the securities as current assets in the balance sheet. Otherwise, it classifies them as long-term assets in the investments section of the balance sheet.
Companies report available-for-sale securities at fair value. The procedure for determining fair value and the unrealized gain or loss for these securities is the same as for trading securities. To illustrate, assume that Ingrao Corporation has two securities that it classifies as available-for-sale. Illustration 16-8 provides information on the cost, fair value, and amount of the unrealized gain or loss on December 31, 2014. There is an unrealized loss of $9,537 because total cost of $293,537 is $9,537 more than total fair value of $284,000.
Ethics Note
Some managers seem to hold their available-for-sale securities that have experienced losses, while selling those that have gains, thus increasing income. Do you think this is ethical?
Illustration 16-8
Valuation of available-for-sale securities
Both the adjusting entry and the reporting of the unrealized gain or loss for Ingrao's available-for-sale securities differ from those illustrated for trading securities. The differences result because Ingrao does not expect to sell these securities in the near term. Thus, prior to actual sale it is more likely that changes in fair value may change either unrealized gains or losses. Therefore, Ingrao does not report an unrealized gain or loss in the income statement. Instead, it reports it as a separate component of stockholders’ equity.
In the adjusting entry, Ingrao identifies the fair value adjustment account with available-for-sale securities, and it identifies the unrealized gain or loss account with stockholders’ equity. Ingrao records the unrealized loss of $9,537 as follows.
If total fair value exceeds total cost, Ingrao debits Fair Value Adjustment— Available-for-Sale and credits Unrealized Gain or Loss—Equity.
For available-for-sale securities, the company carries forward the Unrealized Gain or Loss—Equity account to future periods. At each future balance sheet date, Ingrao adjusts the Fair Value Adjustment— Available-for-Sale account and the Unrealized Gain or Loss—Equity account to show the difference between cost and fair value at that time.
Ethics Note
At one time, the SEC accused investment bank Morgan Stanley of overstating the value of certain bond investments by $75 million. The SEC stated that, in applying market value accounting, Morgan Stanley used its own more-optimistic assumptions rather than relying on external pricing sources.
> DO IT!
Trading and Available-for-Sale Securities
Some of Powderhorn Corporation's investment securities are classified as trading securities and some are classified as available-for-sale. The cost and fair value of each category at December 31, 2014, are shown below.
At December 31, 2013, the Fair Value Adjustment—Trading account had a debit balance of $9,200, and the Fair Value Adjustment—Available-for-Sale account had a credit balance of $5,750. Prepare the required journal entries for each group of securities for December 31, 2014.
Action Plan
Mark trading securities to fair value and report the adjustment in current-period income.
Mark available-for-sale securities to fair value and report the adjustment as a separate component of stockholders’ equity.
Solution
Related exercise material: BE16-4, BE16-5, BE16-6, BE16-7, E16-10, E16-11, E16-12, and DO IT! 16-3.
Balance Sheet Presentation
In the balance sheet, companies classify investments as either short-term or long-term.
SHORT-TERM INVESTMENTS
Short-term investments (also called marketable securities) are securities held by a company that are (1) readily marketable and (2) intended to be converted into cash within the next year or operating cycle, whichever is longer. Investments that do not meet both criteria are classified as long-term investments.
Helpful Hint Trading securities are always classified as short-term. Available-for-sale securities can be either short-term or long-term.
READILY MARKETABLE An investment is readily marketable when it can be sold easily whenever the need for cash arises. Short-term paper4 meets this criterion. It can be readily sold to other investors. Stocks and bonds traded on organized securities exchanges, such as the New York Stock Exchange, are readily marketable. They can be bought and sold daily. In contrast, there may be only a limited market for the securities issued by small corporations, and no market for the securities of a privately held company.
INTENT TO CONVERT Intent to convert means that management intends to sell the investment within the next year or operating cycle, whichever is longer. Generally, this criterion is satisfied when the investment is considered a resource that the investor will use whenever the need for cash arises. For example, a ski resort may invest idle cash during the summer months with the intent to sell the securities to buy supplies and equipment shortly before the winter season. This investment is considered short-term even if lack of snow cancels the next ski season and eliminates the need to convert the securities into cash as intended.
Because of their high liquidity, short-term investments appear immediately below Cash in the “Current assets” section of the balance sheet. They are reported at fair value. For example, Pace Corporation would report its trading securities as shown in Illustration 16-9.
Illustration 16-9
Presentation of short-term investments
LONG-TERM INVESTMENTS
Companies generally report long-term investments in a separate section of the balance sheet immediately below “Current assets,” as shown later in Illustration 16-12 (page 755). Long-term investments in available-for-sale securities are reported at fair value. Investments in common stock accounted for under the equity method are reported at equity.
Presentation of Realized and Unrealized Gain or Loss
Companies must present in the financial statements gains and losses on investments, whether realized or unrealized. In the income statement, companies report gains and losses in the nonoperating activities section under the categories listed in Illustration 16-10. Interest and dividend revenue are also reported in that section.
Illustration 16-10
Nonoperating items related to investments
As indicated earlier, companies report an unrealized gain or loss on available-for-sale securities as a separate component of stockholders’ equity. To illustrate, assume that Dawson Inc. has common stock of $3,000,000, retained earnings of $1,500,000, and an unrealized loss on available-for-sale securities of $100,000. Illustration 16-11 shows the balance sheet presentation of the unrealized loss.
Illustration 16-11
Unrealized loss in stockholders’ equity section
Note that the loss decreases stockholders’ equity. An unrealized gain is added to stockholders’ equity. Reporting the unrealized gain or loss in the stockholders’ equity section serves two purposes. (1) It reduces the volatility of net income due to fluctuations in fair value. (2) It informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value.
Companies must report items such as this, which affect stockholders’ equity but are not included in the calculation of net income, as part of a more inclusive measure called comprehensive income. We discuss comprehensive income more fully in Chapter 18.
Classified Balance Sheet
We have presented many sections of classified balance sheets in this and preceding chapters. The classified balance sheet in Illustration 16-12 includes, in one place, key topics from previous chapters: the issuance of par value common stock, restrictions of retained earnings, and issuance of long-term bonds. From this chapter, the statement includes (highlighted in red) short-term and long-term investments. The investments in short-term securities are considered trading securities. The long-term investments in stock of less than 20% owned companies are considered available-for-sale securities. Illustration 16-12 also includes a long-term investment reported at equity and descriptive notations within the statement, such as the basis for valuing inventory and one note to the statement.
Financial Statement Presentation of Investments
Identify where each of the following items would be reported in the financial statements.
1. Interest earned on investments in bonds.
2. Fair value adjustment—available-for-sale.
3. Unrealized loss on available-for-sale securities.
4. Gain on sale of investments in stock.
5. Unrealized gain on trading securities.
Use the following possible categories:
Balance sheet: |
|
Current assets |
Current liabilities |
Investments |
Long-term liabilities |
Property, plant, and equipment |
Stockholders’ equity |
Intangible assets |
|
Income statement: |
|
Other revenues and gains |
Other expenses and losses |
Action Plan
Classify investments as current assets if they will be held for less than one year.
Report unrealized gains or losses on trading securities in income.
Report unrealized gains or losses on available-for-sale securities in equity.
Report realized earnings on investments in the income statement as “Other revenues and gains” or as “Other expenses and losses.”
Solution
Related exercise material: BE16-5, BE16-7, BE16-8, E16-10, E16-11, E16-12, and DO IT! 16-4.
Illustration 16-12
Classified balance sheet
In its first year of operations, DeMarco Company had the following selected transactions in stock investments that are considered trading securities.
June 1 Purchased for cash 600 shares of Sanburg common stock at $24 per share.
July 1 Purchased for cash 800 shares of Cey Corporation common stock at $33 per share.
Sept. 1 Received a $1 per share cash dividend from Cey Corporation.
Nov. 1 Sold 200 shares of Sanburg common stock for cash at $27 per share.
Dec. 15 Received a $0.50 per share cash dividend on Sanburg common stock.
At December 31, the fair values per share were Sanburg $25 and Cey $30.
Instructions
(a) Journalize the transactions.
(b) Prepare the adjusting entry at December 31 to report the securities at fair value.
Action Plan
Record the price paid as the cost of the investment.
Compute the gain or loss on sales as the difference between selling price and the cost of the securities.
Base the adjustment to fair value on the total difference between the cost and the fair value of the securities.
Solution to Comprehensive DO IT!
SUMMARY OF LEARNING OBJECTIVES
1 Discuss why corporations invest in debt and stock securities. Corporations invest for three primary reasons. (a) They have excess cash. (b) They view investments as a significant revenue source. (c) They have strategic goals such as gaining control of a competitor or moving into a new line of business.
2 Explain the accounting for debt investments. Companies record investments in debt securities when they purchase bonds, receive or accrue interest, and sell the bonds. They report gains or losses on the sale of bonds in the “Other revenues and gains” or “Other expenses and losses” sections of the income statement.
3 Explain the accounting for stock investments. Companies record investments in common stock when they purchase the stock, receive dividends, and sell the stock. When ownership is less than 20%, the cost method is used. When ownership is between 20% and 50%, the equity method should be used. When ownership is more than 50%, companies prepare consolidated financial statements.
4 Describe the use of consolidated financial statements. When a company owns more than 50% of the common stock of another company, it usually prepares consolidated financial statements. These statements indicate the magnitude and scope of operations of the companies under common control.
5 Indicate how debt and stock investments are reported in financial statements. Investments in debt securities are classified as trading, available-for-sale, or held-to-maturity securities for valuation and reporting purposes. Stock investments are classified either as trading or available-for-sale securities. Stock investments have no maturity date and therefore are never classified as held-to-maturity securities. Trading securities are reported as current assets at fair value, with changes from cost reported in net income. Available-for-sale securities are also reported at fair value, with the changes from cost reported in stockholders’ equity. Available-for-sale securities are classified as short-term or long-term, depending on their expected future sale date.
6 Distinguish between short-term and long-term investments. Short-term investments are securities that are (a) readily marketable and (b) intended to be converted to cash within the next year or operating cycle, whichever is longer. Investments that do not meet both criteria are classified as long-term investments.
GLOSSARY
Available-for-sale securities Securities that are held with the intent of selling them sometime in the future. (p. 748).
Consolidated financial statements Financial statements that present the assets and liabilities controlled by the parent company and the total revenues and expenses of the subsidiary companies. (p. 746).
Controlling interest Ownership of more than 50% of the common stock of another entity. (p. 746).
Cost method An accounting method in which the investment in common stock is recorded at cost, and revenue is recognized only when cash dividends are received. (p. 743).
Debt investments Investments in government and corporation bonds. (p. 741).
Equity method An accounting method in which the investment in common stock is initially recorded at cost, and the investment account is then adjusted annually to show the investor's equity in the investee. (p. 745).
Fair value Amount for which a security could be sold in a normal market. (p. 748).
Held-to-maturity securities Debt securities that the investor has the intent and ability to hold to their maturity date. (p. 748).
Investment portfolio A group of stocks and/or debt securities in different corporations held for investment purposes. (p. 743).
Long-term investments Investments that are not readily marketable or that management does not intend to convert into cash within the next year or operating cycle, whichever is longer. (p. 752).
Parent company A company that owns more than 50% of the common stock of another entity. (p. 746).
Short-term investments Investments that are readily marketable and intended to be converted into cash within the next year or operating cycle, whichever is longer. (p. 752).
Stock investments Investments in the capital stock of other corporations. (p. 743).
Subsidiary (affiliated) company A company in which more than 50% of its stock is owned by another company. (p. 746).
Trading securities Securities bought and held primarily for sale in the near term to generate income on short-term price differences. (p. 748).
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more components are available for practice in WileyPLUS.
SELF-TEST QUESTIONS
Answers are on page 773.
(LO 1)
1. Which of the following is not a primary reason why corporations invest in debt and equity securities?
(a) They wish to gain control of a competitor.
(b) They have excess cash.
(c) They wish to move into a new line of business.
(d) They are required to by law.
(LO 2)
2. Debt investments are initially recorded at:
(a) cost.
(b) cost plus accrued interest.
(d) face value.
(LO 2)
3. Hanes Company sells debt investments costing $26,000 for $28,000. In journalizing the sale, credits are to:
(a) Debt Investments and Loss on Sale of Debt Investments.
(b) Debt Investments and Gain on Sale of Debt Investments.
(c) Stock Investments and Gain on Sale of Stock Investments.
(d) No correct answer is given.
(LO 3)
4. Pryor Company receives net proceeds of $42,000 on the sale of stock investments that cost $39,500. This transaction will result in reporting in the income statement a:
(a) loss of $2,500 under “Other expenses and losses.”
(b) loss of $2,500 under “Operating expenses.”
(c) gain of $2,500 under “Other revenues and gains.”
(d) gain of $2,500 under “Operating revenues.”
(LO 3)
5. The equity method of accounting for long-term investments in stock should be used when the investor has significant influence over an investee and owns:
(a) between 20% and 50% of the investee's common stock.
(b) 20% or more of the investee's common stock.
(c) more than 50% of the investee's common stock.
(d) less than 20% of the investee's common stock.
(LO 3)
6. Assume that Horicon Corp acquired 25% of the common stock of Sheboygan Corp. on January 1, 2014, for $300,000. During 2014, Sheboygan Corp. reported net income of $160,000 and paid total dividends of $60,000. If Horicon uses the equity method to account for its investment, the balance in the investment account on December 31, 2014, will be:
(a) $300,000.
(b) $325,000.
(c) $400,000.
(d) $340,000.
(LO 3)
7. Using the information in Self-Test Question 6, what entry would Horicon make to record the receipt of the dividend from Sheboygan?
(a) Debit Cash and credit Revenue from Stock Investments.
(b) Debit Cash Dividends and credit Revenue from Stock Investments.
(c) Debit Cash and credit Stock Investments.
(d) Debit Cash and credit Dividend Revenue.
(LO 3)
8. You have a controlling interest if:
(a) you own more than 20% of a company's stock.
(b) you are the president of the company.
(c) you use the equity method.
(d) you own more than 50% of a company's stock.
(LO 4)
9. Which of the following statements is false? Consolidated financial statements are useful to:
(a) determine the profitability of specific subsidiaries.
(b) determine the total profitability of companies under common control.
(c) determine the breadth of a parent company's operations.
(d) determine the full extent of total obligations of companies under common control.
(LO 5)
10. At the end of the first year of operations, the total cost of the trading securities portfolio is $120,000. Total fair value is $115,000. The financial statements should show:
(a) a reduction of an asset of $5,000 and a realized loss of $5,000.
(b) a reduction of an asset of $5,000 and an unrealized loss of $5,000 in the stockholders’ equity section.
(c) a reduction of an asset of $5,000 in the current assets section and an unrealized loss of $5,000 in “Other expenses and losses.”
(d) a reduction of an asset of $5,000 in the current assets section and a realized loss of $5,000 in “Other expenses and losses.”
(LO 5)
11. At December 31, 2014, the fair value of available-for-sale securities is $41,300 and the cost is $39,800. At January 1, 2014, there was a credit balance of $900 in the Fair Value Adjustment—Available-for-Sale account. The required adjusting entry would be:
(a) Debit Fair Value Adjustment—Available-for-Sale for $1,500 and credit Unrealized Gain or Loss— Equity for $1,500.
(b) Debit Fair Value Adjustment—Available-for-Sale for $600 and credit Unrealized Gain or Loss— Equity for $600.
(c) Debit Fair Value Adjustment—Available-for-Sale for $2,400 and credit Unrealized Gain or Loss— Equity for $2,400.
(d) Debit Unrealized Gain or Loss—Equity for $2,400 and credit Fair Value Adjustment—Available-for-Sale for $2,400.
(LO 5)
12. In the balance sheet, a debit balance in Unrealized Gain or Loss—Equity is reported as a(n):
(a) increase to stockholders’ equity.
(b) decrease to stockholders’ equity.
(c) loss in the income statement.
(d) loss in the retained earnings statement.
(LO 6)
13. Short-term debt investments must be readily marketable and expected to be sold within:
(a) 3 months from the date of purchase.
(b) the next year or operating cycle, whichever is shorter.
(c) the next year or operating cycle, whichever is longer.
(d) the operating cycle.
Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.
QUESTIONS
1. What are the reasons that corporations invest in securities?
2. (a) What is the cost of an investment in bonds?
(b) When is interest on bonds recorded?
3. Alex Ramirez is confused about losses and gains on the sale of debt investments. Explain to Alex (a) how the gain or loss is computed, and (b) the statement presentation of the gains and losses.
4. Seibel Company sells Mayo's bonds costing $40,000 for $45,000, including $500 of accrued interest. Seibel records a $5,000 gain on this sale. Is this correct? Explain.
5. What is the cost of an investment in stock?
6. To acquire Peoples Corporation stock, J. Rich pays $62,000 in cash. What entry should be made for this investment?
7. (a) When should a long-term investment in common stock be accounted for by the equity method? (b) When is revenue recognized under this method?
8. Ling Corporation uses the equity method to account for its ownership of 35% of the common stock of Gorman Packing. During 2014, Gorman reported a net income of $80,000 and declares and pays cash dividends of $10,000. What recognition should Ling Corporation give to these events?
9. What constitutes “significant influence” when an investor's financial interest is below the 50% level?
10. Distinguish between the cost and equity methods of accounting for investments in stocks.
11. What are consolidated financial statements?
12. What are the classification guidelines for investments at a balance sheet date?
13. Jill Hollern is the controller of Chavez Inc. At December 31, the company's investments in trading securities cost $74,000. They have a fair value of $72,000. Indicate how Jill would report these data in the financial statements prepared on December 31.
14. Using the data in Question 13, how would Jill report the data if the investment were long-term and the securities were classified as available-for-sale?
15. Culver Company's investments in available-for-sale securities at December 31 show total cost of $195,000 and total fair value of $205,000. Prepare the adjusting entry.
16. Using the data in Question 15, prepare the adjusting entry assuming the securities are classified as trading securities.
17. What is the proper statement presentation of the account Unrealized Loss—Equity?
18. What purposes are served by reporting Unrealized Gain or Loss—Equity in the stockholders’ equity section?
19. Deering Wholesale Supply owns stock in Orr Corporation. Deering intends to hold the stock indefinitely because of some negative tax consequences if sold. Should the investment in Orr be classified as a short-term investment? Why or why not?
20. What does Apple state regarding its accounting policy involving consolidated financial statements?
BRIEF EXERCISES
BE16-1 Ownbey Corporation purchased debt investments for $52,000 on January 1, 2014. On July 1, 2014, Ownbey received cash interest of $2,340. Journalize the purchase and the receipt of interest. Assume that no interest has been accrued.
Journalize entries for debt investments. (LO 2)
BE16-2 On August 1, Shaw Company buys 1,000 shares of Estrada common stock for $37,000 cash. On December 1, Shaw sells the stock investments for $40,000 in cash. Journalize the purchase and sale of the common stock.
Journalize entries for debt investments.
(LO 3)
BE16-3 Noler Company owns 25% of Lauer Company. For the current year, Lauer reports net income of $180,000 and declares and pays a $50,000 cash dividend. Record Noler's equity in Lauer's net income and the receipt of dividends from Lauer.
Record transactions under the equity method of accounting.
(LO 3)
BE16-4 The cost of the trading securities of Munoz Company at December 31, 2014, is $64,000. At December 31, 2014, the fair value of the securities is $59,000. Prepare the adjusting entry to record the securities at fair value.
Prepare adjusting entry using fair value.
(LO 5)
BE16-5 For the data presented in BE16-4, show the financial statement presentation of the trading securities and related accounts.
Indicate statement presentation using fair value.
(LO 5, 6)
BE16-6 Godfrey Corporation holds, as a long-term investment, available-for-sale securities costing $72,000. At December 31, 2014, the fair value of the securities is $68,000. Prepare the adjusting entry to record the securities at fair value.
Prepare adjusting entry using fair value.
(LO 5)
BE16-7 For the data presented in BE16-6, show the financial statement presentation of the available-for-sale securities and related accounts. Assume the available-for-sale securities are noncurrent.
Indicate statements presentation using fair value.
(LO 5, 6)
BE16-8 Kruger Corporation has the following long-term investments. (1) Common stock of Eidman Co. (10% ownership) held as available-for-sale securities, cost $108,000, fair value $115,000. (2) Common stock of Pickerill Inc. (30% ownership), cost $210,000, equity $260,000. Prepare the investments section of the balance sheet.
Prepare investments section of balance sheet.
(LO 5, 6)
Make journal entry for bond purchase and adjusting entry for interest accrual.
(LO 2)
DO IT! 16-1 Kurtyka Corporation had the following transactions relating to debt investments:
| Jan. 1 | Purchased 50, $1,000, 10% Spiller Company bonds for $50,000. Interest is payable semiannually on January 1 and July 1. |
| July 1 | Received semiannual interest from Spiller Company bonds. |
| July 1 | Sold 30 Spiller Company bonds for $29,000. |
(a) Journalize the transactions, and (b) prepare the adjusting entry for the accrual of interest on December 31.
Make journal entries for stock investments. (LO 3)
DO IT! 16-2 Presented below are two independent situations:
1. Edelman Inc. acquired 10% of the 500,000 shares of common stock of Schuberger Corporation at a total cost of $11 per share on June 17, 2014. On September 3, Schuberger declared and paid a $160,000 dividend. On December 31, Schuberger reported net income of $550,000 for the year.
2. Wen Corporation obtained significant influence over Hunsaker Company by buying 30% of Hunsaker's 100,000 outstanding shares of common stock at a cost of $18 per share on January 1, 2014. On May 15, Hunsaker declared and paid a cash dividend of $150,000. On December 31, Hunsaker reported net income of $270,000 for the year.
Prepare all necessary journal entries for 2014 for (a) Edelman and (b) Wen.
Make journal entries for trading and available-for-sale securities.
(LO 5)
DO IT! 16-3 Some of Tollakson Corporation's investment securities are classified as trading securities and some are classified as available-for-sale. The cost and fair value of each category at December 31, 2014, were as follows.
At December 31, 2013, the Fair Value Adjustment—Trading account had a debit balance of $3,200, and the Fair Value Adjustment—Available-for-Sale account had a credit balance of $5,750. Prepare the required journal entries for each group of securities for December 31, 2014.
Indicate financial statement presentation of investments.
(LO 6)
DO IT! 16-4 Identify where each of the following items would be reported in the financial statements.
1. Loss on sale of investments in stock.
2. Unrealized gain on available-for-sale securities.
3. Fair value adjustment—trading.
4. Interest earned on investments in bonds.
5. Unrealized loss on trading securities.
Use the following possible categories:
Balance sheet:
| Current assets | Current liabilities |
| Investments | Long-term liabilities |
| Property, plant, and equipment | Stockholders’ equity |
| Intangible assets |
Income statement:
| Other revenues and gains | Other expenses and losses |
EXERCISES
E16-1 Mr. Taliaferro is studying for an accounting test and has developed the following questions about investments.
1. What are three reasons why companies purchase investments in debt or stock securities?
2. Why would a corporation have excess cash that it does not need for operations?
3. What is the typical investment when investing cash for short periods of time?
4. What are the typical investments when investing cash to generate earnings?
5. Why would a company invest in securities that provide no current cash flows?
6. What is the typical stock investment when investing cash for strategic reasons?
Understand debt and stock investments.
(LO 1)
Instructions
Provide answers for Mr. Taliaferro.
E16-2 Jenek Corporation had the following transactions pertaining to debt investments.
| Jan. 1 | Purchased 50 9%, $1,000 Leeds Co. bonds for $50,000 cash. Interest is payable semiannually on July 1 and January 1. |
| July 1 | Received semiannual interest on Leeds Co. bonds. |
| July 1 | Sold 30 Leeds Co. bonds for $33,000. |
Journalize debt investment transactions and accrue interest.
(LO 2)
Instructions
(a) Journalize the transactions.
(b) Prepare the adjusting entry for the accrual of interest at December 31.
E16-3 Flynn Company purchased 70 Rinehart Company 12%, 10-year, $1,000 bonds on January 1, 2014, for $70,000. The bonds pay interest semiannually on July 1 and January 1. On January 1, 2015, after receipt of interest, Flynn Company sold 40 of the bonds for $38,500.
Journalize debt investment transactions, accrue interest, and record sale.
(LO 2)
Instructions
Prepare the journal entries to record the transactions described above.
E16-4 Hulse Company had the following transactions pertaining to stock investments.
Feb. 1 Purchased 600 shares of Wade common stock (2%) for $7,200 cash.
July 1 Received cash dividends of $1 per share on Wade common stock.
Sept.1 Sold 300 shares of Wade common stock for $4,300.
Dec. 1 Received cash dividends of $1 per share on Wade common stock.
Journalize stock investment transactions.
(LO 3)
Instructions
(a) Journalize the transactions.
(b) Explain how dividend revenue and the gain (loss) on sale should be reported in the income statement.
E16-5 Nosker Inc. had the following transactions pertaining to investments in common stock.
Jan. 1 Purchased 2,500 shares of Escalante Corporation common stock (5%) for $152,000 cash.
July 1 Received a cash dividend of $3 per share.
Dec. 1 Sold 500 shares of Escalante Corporation common stock for $32,000 cash.
Dec. 31 Received a cash dividend of $3 per share.
Journalize transactions for investments in stocks
(LO 3).
Instructions
Journalize the transactions.
E16-6 On February 1, Rinehart Company purchased 500 shares (2% ownership) of Givens Company common stock for $32 per share. On March 20, Rinehart Company sold 100 shares of Givens stock for $2,900. Rinehart received a dividend of $1.00 per share on April 25. On June 15, Rinehart sold 200 shares of Givens stock for $7,600. On July 28, Rinehart received a dividend of $1.25 per share.
Instructions
Prepare the journal entries to record the transactions described above.
Journalize transactions for investments in stocks.
(LO 3)
E16-7 On January 1, Zabel Corporation purchased a 25% equity in Helbert Corporation for $180,000. At December 31, Helbert declared and paid a $60,000 cash dividend and reported net income of $200,000.
Instructions
(a) Journalize the transactions.
(b) Determine the amount to be reported as an investment in Helbert stock at December 31.
Journalize and post transactions, under the equity method.
(LO 3)
E16-8 Presented below are two independent situations.
1. Gambino Cosmetics acquired 10% of the 200,000 shares of common stock of Nevins Fashion at a total cost of $13 per share on March 18, 2014. On June 30, Nevins declared and paid a $60,000 dividend. On December 31, Nevins reported net income of $122,000 for the year. At December 31, the market price of Nevins Fashion was $15 per share. The stock is classified as available-for-sale.
2. Kanza, Inc., obtained significant influence over Rogan Corporation by buying 40% of Rogan's 30,000 outstanding shares of common stock at a total cost of $9 per share on January 1, 2014. On June 15, Rogan declared and paid a cash dividend of $30,000. On December 31, Rogan reported a net income of $80,000 for the year.
Instructions
Prepare all the necessary journal entries for 2014 for (a) Gambino Cosmetics and (b) Kanza, Inc.
Journalize entries under cost and equity methods.
(LO 3, 5)
E16-9 Agee Company purchased 70% of the outstanding common stock of Himes Corporation.
Instructions
(a) Explain the relationship between Agee Company and Himes Corporation.
(b) How should Agee account for its investment in Himes?
(c) Why is the accounting treatment described in (b) useful?
Understand the usefulness of consolidated statements.
(LO 4)
E16-10 At December 31, 2014, the trading securities for Storrer, Inc. are as follows.
Instructions
(a) Prepare the adjusting entry at December 31, 2014, to report the securities at fair value.
(b) Show the balance sheet and income statement presentation at December 31, 2014, after adjustment to fair value.
Prepare adjusting entry to record fair value, and indicate statement presentation.
(LO 5, 6) 
E16-11 Data for investments in stock classified as trading securities are presented in E16-10. Assume instead that the investments are classified as available-for-sale securities. They have the same cost and fair value. The securities are considered to be a long-term investment.
Instructions
(a) Prepare the adjusting entry at December 31, 2014, to report the securities at fair value.
(b) Show the statement presentation at December 31, 2014, after adjustment to fair value.
(c) 
E. Kretsinger, a member of the board of directors, does not understand the reporting of the unrealized gains or losses. Write a letter to Ms. Kretsinger explaining the reporting and the purposes that it serves.
Prepare adjusting entry to record fair value, and indicate statement presentation.
(LO 5, 6)
E16-12 Uttinger Company has the following data at December 31, 2014.
The available-for-sale securities are held as a long-term investment.
Instructions
(a) Prepare the adjusting entries to report each class of securities at fair value.
(b) Indicate the statement presentation of each class of securities and the related unrealized gain (loss) accounts.
Prepare adjusting entries for fair value, and indicate statement presentation for two classes of securities.
(LO 5, 6)
EXERCISES: SET B AND CHALLENGE EXERCISES
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Exercise Set B and Challenge Exercises.
PROBLEMS: SET A
P16-1A Vilander Carecenters Inc. provides financing and capital to the health-care industry, with a particular focus on nursing homes for the elderly. The following selected transactions relate to bonds acquired as an investment by Vilander, whose fiscal year ends on December 31.
Journalize debt investment transactions and show financial statement presentation. (LO 2, 5, 6)
2014
Jan. 1 Purchased at face value $2,000,000 of Javier Nursing Centers, Inc., 10-year, 8% bonds dated January 1, 2014, directly from Javier.
July 1 Received the semiannual interest on the Javier bonds.
Dec. 31 Accrual of interest at year-end on the Javier bonds.
(Assume that all intervening transactions and adjustments have been properly recorded and that the number of bonds owned has not changed from December 31, 2014, to December 31, 2016.)
2017
Jan. 1 Received the semiannual interest on the Javier bonds.
Jan. 1 Sold $1,000,000 Javier bonds at 106.
July 1 Received the semiannual interest on the Javier bonds.
Dec. 31 Accrual of interest at year-end on the Javier bonds.
Instructions
(a) Journalize the listed transactions for the years 2014 and 2017.
(b) Assume that the fair value of the bonds at December 31, 2014, was $2,200,000. These bonds are classified as available-for-sale securities. Prepare the adjusting entry to record these bonds at fair value.
(c) Based on your analysis in part (b), show the balance sheet presentation of the bonds and interest receivable at December 31, 2014. Assume the investments are considered long-term. Indicate where any unrealized gain or loss is reported in the financial statements.
(a) Gain on sale of debt investment $60,000
P16-2A In January 2014, the management of Kinzie Company concludes that it has sufficient cash to permit some short-term investments in debt and stock securities. During the year, the following transactions occurred.
Feb. 1 Purchased 600 shares of Muninger common stock for $32,400.
Mar. 1 Purchased 800 shares of Tatman common stock for $20,000.
Apr. 1 Purchased 50 $1,000, 7% Yoakem bonds for $50,000. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the Muninger common stock.
Aug. 1 Sold 200 shares of Muninger common stock at $58 per share.
Sept. 1 Received a $1 per share cash dividend on the Tatman common stock.
Oct. 1 Received the semiannual interest on the Yoakem bonds.
Oct. 1 Sold the Yoakem bonds for $49,000.
Journalize investment transactions, prepare adjusting entry, and show statement presentation.
(LO 2, 3, 5, 6) 
At December 31, the fair value of the Muninger common stock was $55 per share. The fair value of the Tatman common stock was $24 per share.
Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock Investments. (Use the T-account form.)
(b) Prepare the adjusting entry at December 31, 2014, to report the investment securities at fair value. All securities are considered to be trading securities.
(a) Gain on sale of stock investment $800
(c) Show the balance sheet presentation of investment securities at December 31, 2014.
(d) Identify the income statement accounts and give the statement classification of each account.
P16-3A On December 31, 2014, Turnball Associates owned the following securities, held as a long-term investment. The securities are not held for influence or control of the investee.
On December 31, 2014, the total fair value of the securities was equal to its cost. In 2015, the following transactions occurred.
July 1 Received $1 per share semiannual cash dividend on Wooderson Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Gehring Co. common stock.
Sept. 1 Sold 1,500 shares of Wooderson Co. common stock for cash at $8 per share.
Oct. 1 Sold 800 shares of Gehring Co. common stock for cash at $33 per share.
Nov. 1 Received $1 per share cash dividend on Kitselton Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Gehring Co. common stock.
31 Received $1 per share semiannual cash dividend on Wooderson Co. common stock.
Journalize transactions and adjusting entry for stock investments.
(LO 3, 5, 6)
At December 31, the fair values per share of the common stocks were: Gehring Co. $32, Wooderson Co. $8, and Kitselton Co. $18.
Instructions
(a) Journalize the 2015 transactions and post to the account Stock Investments. (Use the T-account form.)
(b) Prepare the adjusting entry at December 31, 2015, to show the securities at fair value. The stock should be classified as available-for-sale securities.
(c) Show the balance sheet presentation of the investments at December 31, 2015. At this date, Turnball Associates has common stock $1,500,000 and retained earnings $1,000,000.
(b) Unrealized loss $4,100
P16-4A Heidebrecht Design acquired 20% of the outstanding common stock of Quayle Company on January 1, 2014, by paying $800,000 for the 30,000 shares. Quayle declared and paid $0.30 per share cash dividends on March 15, June 15, September 15, and December 15, 2014. Quayle reported net income of $320,000 for the year. At December 31, 2014, the market price of Quayle common stock was $34 per share.
Prepare entries under the cost and equity methods, and tabulate differences.
(LO 3)
Instructions
(a) Prepare the journal entries for Heidebrecht Design for 2014 assuming Heidebrecht Design cannot exercise significant influence over Quayle. (Use the cost method and assume that Quayle common stock should be classified as a trading security.)
(b) Prepare the journal entries for Heidebrecht Design for 2014, assuming Heidebrecht Design can exercise significant influence over Quayle. Use the equity method.
(c) Indicate the balance sheet and income statement account balances at December 31, 2014, under each method of accounting.
(a) Total dividend revenue $36,000
(b)Revenue from stock investments $64,000
P16-5A The following securities are in Frederick Company's portfolio of long-term available-for-sale securities at December 31, 2014.
Journalize stock investment transactions and show statement presention.
(LO 3,5,6)
On December 31, 2014, the total cost of the portfolio equaled total fair value. Frederick had the following transactions related to the securities during 2015.
At December 31, 2015, the fair values of the securities were:
| Hutcherson Corporation common stock | $64 per share |
| Liggett Corporation common stock | $72 per share |
Instructions
(a) Prepare journal entries to record the transactions.
(b) Post to the investment accounts. (Use T-accounts.)
(c) Prepare the adjusting entry at December 31, 2015 to report the portfolio at fair value.
(d) Show the balance sheet presentation at December 31, 2015, for the investment-related accounts.
(a) Loss on sale of stock investment $1,200
(c) Unrealized loss $5,800d
P16-6A The following data, presented in alphabetical order, are taken from the records of Nieto Corporation.
Prepare a balance sheet.
(LO 5, 6)
| Accounts payable | $ 260,000 |
| Accounts receivable | 140,000 |
| Accumulated depreciation—buildings | 180,000 |
| Accumulated depreciation—equipment | 52,000 |
| Allowance for doubtful accounts | 6,000 |
| Bonds payable (10%, due 2022) | 500,000 |
| Buildings | 950,000 |
| Cash | 62,000 |
| Common stock ($10 par value; 500,000 shares authorized, 150,000 shares issued) | 1,500,000 |
| Dividends payable | 80,000 |
| Equipment | 275,000 |
| Fair value adjustment—available-for-sale securities (Dr) | 8,000 |
| Goodwill | 200,000 |
| Income taxes payable | 120,000 |
| Inventory | 170,000 |
| Investment in Mara common stock (30% ownership), at equity | 380,000 |
| Investment in Sasse common stock (10% ownership), at cost | 278,000 |
| Land | 390,000 |
| Notes payable (due 2015) | 70,000 |
| Paid-in capital in excess of par—common stock | 130,000 |
| Premium on bonds payable | 40,000 |
| Prepaid insurance | 16,000 |
| Retained earnings | 103,000 |
| Short-term investments, at fair value (and cost) | 180,000 |
| Unrealized gain—available-for-sale securities | 8,000 |
The investment in Sasse common stock is considered to be a long-term available-for-sale security.
Instructions
Prepare a classified balance sheet at December 31, 2014.
Total assets $2,811,000
PROBLEMS: SET B
P16-1B Cheese Farms is a grower of hybrid seed corn for Mukenthaler Genetics Corporation. It has had two exceptionally good years and has elected to invest its excess funds in bonds. The selected transactions, shown on the next page, relate to bonds acquired as an investment by Cheese Farms, whose fiscal year ends on December 31.
Journalize debt investment transactions and show financial statement presentation.
(LO 2, 5, 6)
Jan. 1 Purchased at face value $400,000 of Wilkerson Corporation 10-year, 9% bonds dated January 1, 2014, directly from the issuing corporation.
July 1 Received the semiannual interest on the Wilkerson bonds.
Dec. 31 Accrual of interest at year-end on the Wilkerson bonds.
(Assume that all intervening transactions and adjustments have been properly recorded and the number of bonds owned has not changed from December 31, 2014, to December 31, 2016.)
2017
Jan. 1 Received the semiannual interest on the Wilkerson bonds.
Jan. 1 Sold $200,000 of Wilkerson bonds at 114.
July 1 Received the semiannual interest on the Wilkerson bonds.
Dec. 31 Accrual of interest at year-end on the Wilkerson bonds.
(a) Gain on sale of debt investments $28,000
Instructions
(a) Journalize the listed transactions for the years 2014 and 2017.
(b) Assume that the fair value of the bonds at December 31, 2014, was $385,000. These bonds are classified as available-for-sale securities. Prepare the adjusting entry to record these bonds at fair value.
(c) Based on your analysis in part (b), show the balance sheet presentation of the bonds and interest receivable at December 31, 2014. Assume the investments are considered long-term. Indicate where any unrealized gain or loss is reported in the financial statements.
P16-2B In January 2014, the management of Kord Company concludes that it has sufficient cash to purchase some short-term investments in debt and stock securities. During the year, the following transactions occurred.
Journalize investment transactions, prepare adjusting entry, and show statement presentation.
(LO 2,3,5,6)
Feb. 1 Purchased 500 shares of Day common stock for $30,800.
Mar. 1 Purchased 600 shares of Eldridge common stock for $20,300.
Apr. 1 Purchased 40 $1,000, 9% Lorenz bonds for $40,000. Interest is payable semiannually on April 1 and October 1.
July 1 Received a cash dividend of $0.60 per share on the Day common stock.
Aug. 1 Sold 300 shares of Day common stock at $69 per share.
Sept. 1 Received a $1 per share cash dividend on the Eldridge common stock.
Oct. 1 Received the semiannual interest on the Lorenz bonds.
Oct. 1 Sold the Lorenz bonds for $44,000.
At December 31, the fair value of the Day common stock was $66 per share. The fair value of the Eldridge common stock was $29 per share.
Instructions
(a) Journalize the transactions and post to the accounts Debt Investments and Stock Investments. (Use the T-account form.)
(b) Prepare the adjusting entry at December 31, 2014, to report the investments at fair value. All securities are considered to be trading securities.
(b) Unrealized loss $2,020
(c) Show the balance sheet presentation of investment securities at December 31, 2014.
(d) Identify the income statement accounts and give the statement classification of each account.
P16-3B On December 31, 2014, Bly Associates owned the following securities, held as long-term investments.
Journalize transactions and adjusting entry for stock investments.
(LO 3, 5, 6)
On this date, the total fair value of the securities was equal to its cost. The securities are not held for influence or control over the investees. In 2015, the following transactions occurred.
July 1 Received $1 per share semiannual cash dividend on Coria Co. common stock.
Aug. 1 Received $0.50 per share cash dividend on Woolridge Co. common stock.
Sept. 1 Sold 1,500 shares of Coria Co. common stock for cash at $7 per share.
Oct. 1 Sold 600 shares of Woolridge Co. common stock for cash at $30 per share.
Nov. 1 Received $1 per share cash dividend on Sterling Motor Co. common stock.
Dec. 15 Received $0.50 per share cash dividend on Woolridge Co. common stock.
31 Received $1 per share semiannual cash dividend on Coria Co. common stock.
At December 31, the fair values per share of the common stocks were Woolridge Co. $23, Coria Co. $7, and Sterling Motors Co. $19.
Instructions
(a) Journalize the 2015 transactions and post to the account Stock Investments. (Use the T-account form.)
(a) Gain on sale, $1,500 and $3,000
(b) Prepare the adjusting entry at December 31, 2015, to show the securities at fair value. The stock should be classified as available-for-sale securities.
(c) Show the balance sheet presentation of the investment-related accounts at December 31, 2015. At this date, Bly Associates has common stock $2,000,000 and retained earnings $1,200,000.
P16-4B Wooden's Concrete acquired 20% of the outstanding common stock of Hoag, Inc. on January 1, 2014, by paying $1,100,000 for 40,000 shares. Hoag declared and paid a $0.50 per share cash dividend on June 30 and again on December 31, 2014. Hoag reported net income of $600,000 for the year. At December 31, 2014, the market price of Hoag's common stock was $30 per share.
Prepare entries under the cost and equity methods, and tabulate differences.
(LO 3)
Instructions
(a) Prepare the journal entries for Wooden's Concrete for 2014, assuming Wooden's cannot exercise significant influence over Hoag. Use the cost method and assume Hoag common stock should be classified as available-for-sale.
(a) Total dividend revenue $40,000
(b) Prepare the journal entries for Wooden's Concrete for 2014, assuming Wooden's can exercise significant influence over Hoag. Use the equity method.
(b) Revenue from investment $120,000
(c) Indicate the balance sheet and income statement account balances at December 31, 2014, under each method of accounting.
P16-5B The following are in Rodriguez's Company's portfolio of long-term available-for-sale securities at December 31, 2014.
Journalize stock investment transactions and show statement presentation.
(LO 3, 5, 6)
On December 31, the total cost of the portfolio equaled total fair value. Rodriguez's Company had the following transactions related to the securities during 2015.
| Jan. | 7 | Sold 700 shares of Parra Corporation common stock at $55 per share. |
| 10 | Purchased 300 shares, $70 par value common stock of Younker Corporation at $78 per share. | |
| 26 | Received a cash dividend of $1.15 per share on Robison Corporation common stock. | |
| Feb. | 2 | Received cash dividends of $0.40 per share on Vega Corporation preferred stock. |
| 10 | Sold all 800 shares of Vega Corporation preferred stock at $26 per share. | |
| July | 1 | Received a cash dividend of $1.00 per share on Robison Corporation common stock. |
| Sept. | 1 | Purchased an additional 800 shares of the $70 par value common stock of Younker Corporation at $75 per share. |
| Dec. | 15 | Received a cash dividend of $1.50 per share on Younker Corporation common stock. |
At December 31, 2015, the fair values of the securities were:
| Robison Corporation common stock | $48 per share |
| Younker Corporation common stock | $72 per share |
Instructions
(a) Prepare journal entries to record the transactions.
(a) Loss on sale $1,600
(b) Post to the investment accounts. (Use T-accounts.)
(c) Prepare the adjusting entry at December 31, 2015, to report the portfolio at fair value.
(c) Unrealized loss $3,000
(d) Show the balance sheet presentation at December 31, 2015, for the investment-related accounts.
P16-6B The following data, presented in alphabetical order, are taken from the records of Mussatto Corporation.
Prepare a balance sheet.
(LO 5, 6)
| Accounts payable | $ 375,000 |
| Accounts receivable | 135,000 |
| Accumulated depreciation—buildings | 270,000 |
| Accumulated depreciation—equipment | 80,000 |
| Allowance for doubtful accounts | 10,000 |
| Bonds payable (10%, due 2024) | 600,000 |
| Buildings | 1,350,000 |
| Cash | 210,000 |
| Common stock ($5 par value; 500,000 shares authorized, 440,000 shares issued) | 2,200,000 |
| Discount on bonds payable | 30,000 |
| Dividends payable | 75,000 |
| Equipment | 415,000 |
| Goodwill | 300,000 |
| Income taxes payable | 180,000 |
| Inventory | 255,000 |
| Investment in Sanchez Inc. stock (30% ownership), at equity | 900,000 |
| Land | 780,000 |
| Notes payable (due 2015) | 110,000 |
| Paid-in capital in excess of par—common stock | 300,000 |
| Prepaid insurance | 25,000 |
| Retained earnings | 480,000 |
| Short-term investments, at fair value (and cost) | 280,000 |
Instructions
Prepare a classified balance sheet at December 31, 2014.
Total assets $4,290,000
PROBLEMS: SET C
Visit the book's companion website, at www.wiley.com/college/weygandt, and choose the Student Companion site to access Problem Set C.
COMPREHENSIVE PROBLEM: Chapter 12 TO Chapter 16
CP16 Part I Debby Kauffman and her two colleagues, Jamie Hiatt and Ella Rincon, are personal trainers at an upscale health spa/resort in Tampa, Florida. They want to start a health club that specializes in health plans for people in the 50+ age range. The growing population in this age range and strong consumer interest in the health benefits of physical activity have convinced them they can profitably operate their own club. In addition to many other decisions, they need to determine what type of business organization they want. Jamie believes there are more advantages to the corporate form than a partnership, but he hasn't yet convinced Debby and Ella. They have come to you, a small-business consulting specialist, seeking information and advice regarding the choice of starting a partnership versus a corporation.
Instructions
(a) Prepare a memo (dated May 26, 2013) that describes the advantages and disadvantages of both partnerships and corporations. Advise Debby, Jamie, and Ella regarding which organizational form you believe would better serve their purposes. Make sure to include reasons supporting your advice.
Part II After deciding to incorporate, each of the three investors receives 20,000 shares of $2 par common stock on June 12, 2013, in exchange for their co-owned building ($200,000 fair value) and $100,000 total cash they contributed to the business. The next decision that Debby, Jamie, and Ella need to make is how to obtain financing for renovation and equipment. They understand the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business.
Instructions
(b) Prepare notes for a discussion with the three entrepreneurs in which you will compare the consequences of using equity versus debt financing. As part of your notes, show the differences in interest and tax expense assuming $1,400,000 is financed with common stock, and then alternatively with debt. Assume that when common stock is used, 140,000 shares will be issued. When debt is used, assume the interest rate on debt is 9%, the tax rate is 32%, and income before interest and taxes is $300,000. (You may want to use an electronic spreadsheet.)
Part III During the discussion about financing, Ella mentions that one of her clients, Timothy Hansen, has approached her about buying a significant interest in the new club. Having an interested investor sways the three to issue equity securities to provide the financing they need. On July 21, 2013, Mr. Hansen buys 90,000 shares at a price of $10 per share.
The club, LifePath Fitness, opens on January 12, 2014, and after a slow start begins to produce the revenue desired by the owners. The owners decide to pay themselves a stock dividend since cash has been less than abundant since they opened their doors. The 10% stock dividend is declared by the owners on July 27, 2014. The market price of the stock is $3 on the declaration date. The date of record is July 31, 2014 (there have been no changes in stock ownership since the initial issuance), and the issue date is August 15, 2014. By the middle of the fourth quarter of 2014, the cash flow of LifePath Fitness has improved to the point that the owners feel ready to pay themselves a cash dividend. They declare a $0.05 cash dividend on December 4, 2014. The record date is December 14, 2014, and the payment date is December 24, 2014.
Instructions
(c) (1) Record all of the transactions related to the common stock of LifePath Fitness during the years 2013 and 2014. (2) Indicate how many shares are issued and outstanding after the stock dividend is issued.
Part IV Since the club opened, a major concern has been the pool facilities. Although the existing pool is adequate, Debby, Jamie, and Ella all desire to make LifePath a cutting-edge facility. Until the end of 2014, financing concerns prevented this improvement. However, because there has been steady growth in clientele, revenue, and income since the fourth quarter of 2014, the owners have explored possible financing options. They are hesitant to issue stock and change the ownership mix because they have been able to work together as a team with great effectiveness. They have formulated a plan to issue secured term bonds to raise the needed $600,000 for the pool facilities. By the end of April 2015, everything was in place for the bond issue to go ahead. On June 1, 2015, the bonds were issued for $548,000. The bonds pay semiannual interest of 3% (6% annual) on December 1 and June 1 of each year. The bonds mature in 10 years, and amortization is computed using the straight-line method.
Instructions
(d) Record (1) the issuance of the secured bonds, (2) the interest payment made on December 1, 2015, (3) the adjusting entry required at December 31, 2015, and (4) the interest payment made on June 1, 2016.
Part V Mr. Hansen's purchase of the stock of LifePath Fitness was done through his business. The stock investment has always been accounted for using the cost method on his firm's books. However, early in 2016 he decided to take his company public. He is preparing an IPO (initial public offering), and he needs to have the firm's financial statements audited. One of the issues to be resolved is to restate the stock investment in LifePath Fitness using the equity method since Mr. Hansen's ownership percentage is greater than 20%.
(e) (1) Give the entries that would have been made on Hansen's books if the equity method of accounting for investments had been used from the initial investment through 2015. Assume the following data for LifePath.
(2) Compute the balance in the Stock Investment account (as it relates to LifePath Fitness) at the end of 2015.
CONTINUING COOKIE CHRONICLE
(Note: This is a continuation of the Cookie Chronicle from Chapter 1 through Chapter 15.)
CCC16 Natalie has been approached by Ken Thornton, a shareholder of The Beanery Coffee Inc. Ken wants to retire and would like to sell his 1,000 shares in The Beanery Coffee, which represents 30% of all shares issued. The Beanery is currently operated by Ken's twin daughters, who each own 35% of the common shares. The Beanery not only operates a coffee shop but also roasts and sells beans to retailers, under the name “Rocky Mountain Beanery.”
Ken has met with Curtis and Natalie to discuss the business operation. All have concluded that there would be many advantages for Cookie & Coffee Creations Inc. to acquire an interest in The Beanery Coffee. Despite the apparent advantages, however, Natalie and Curtis are still not convinced that they should participate in this business venture.
Go to the book's companion website, www.wiley.com/college/weygandt, to see the completion of this problem.
Broadening Your Perspective
Financial Reporting and Analysis
Financial Reporting Problem: Apple Inc.
BYP16-1 The annual report of Apple Inc. is presented in Appendix A. Instructions for accessing and using the company's complete annual report, including the notes to the financial statements, are also provided in Appendix A.
Instructions
(a) Determine the percentage increase for (1) short-term marketable securities from 2010 to 2011, and (2) long-term marketable securities from 2010 to 2011.
(b) Using Apple's consolidated statement of cash flows, determine:
(1) Purchases of marketable securities during the current year.
(2) How much was spent for business acquisitions, net of cash acquired during the current year.
Comparative Analysis Problem: PepsiCo, Inc. vs. The Coca-Cola Company
BYP16-2 PepsiCo's financial statements are presented in Appendix B. Financial statements of The Coca-Cola Company are presented in Appendix C. Instructions for accessing and using the complete annual reports of PepsiCo and Coca-Cola, including the notes to the financial statements, are also provided in Appendices B and C, respectively.
(a) Based on the information contained in these financial statements, determine the following for each company.
(1) Net cash used in investing (investment) activities for the current year (from the statement of cash flows).
(2) Cash used for capital expenditures during the current year.
(b) Each of PepsiCo's financial statements is labeled “consolidated.” What has been consolidated? That is, from the contents of PepsiCo's annual report, identify by name the corporations that have been consolidated (parent and subsidiaries).
Comparative Analysis Problem:
Amazon.com, Inc. vs. Wal-Mart Stores, Inc.
BYP16-3 Amazon.com, Inc.'s financial statements are presented in Appendix D. Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E. Instructions for accessing and using the complete annual reports of Amazon and Wal-Mart, including the notes to the financial statements, are also provided in Appendices D and E, respectively.
Instructions
(a) Based on the information contained in these financial statements, determine the following for each company.
(1) Net cash used for investing (investment) activities for the current year (from the statement of cash flows).
(2) Cash used for business acquisitions, net of cash acquired during the current year.
(b) Each of Amazon's financial statements is labeled “consolidated.” What has been consolidated? That is, from the contents of Amazon's annual report, identify by name the corporations that have been consolidated (parent and subsidiaries).
Real-World Focus
BYP16-4 Most publicly traded companies are examined by numerous analysts. These analysts often don't agree about a company's future prospects. In this exercise, you will find analysts’ ratings about companies and make comparisons over time and across companies in the same industry. You will also see to what extent the analysts experienced “earnings surprises.” Earnings surprises can cause changes in stock prices.
Address: biz.yahoo.com/i, or go to www.wiley.com/college/weygandt
Steps
1. Choose a company.
2. Use the index to find the company's name.
3. Choose Research.
Instructions
(a) How many analysts rated the company?
(b) What percentage rated it a strong buy?
(c) What was the average rating for the week?
(d) Did the average rating improve or decline relative to the previous week?
(e) What was the amount of the earnings surprise percentage during the last quarter?
Critical Thinking
Decision-Making Across the Organization 
BYP16-5 At the beginning of the question-and-answer portion of the annual stockholders’ meeting of Neosho Corporation, stockholder John Linton asks, “Why did management sell the holdings in JMB Company at a loss when this company has been very profitable during the period Neosho held its stock?”
Since president Tony Cedeno has just concluded his speech on the recent success and bright future of Neosho, he is taken aback by this question and responds, “I remember we paid $1,300,000 for that stock some years ago. I am sure we sold that stock at a much higher price. You must be mistaken.”
Linton retorts, “Well, right here in footnote number 7 to the annual report it shows that 240,000 shares, a 30% interest in JMB, were sold on the last day of the year. Also, it states that JMB earned $520,000 this year and paid out $160,000 in cash dividends. Further, a summary statement indicates that in past years, while Neosho held JMB stock, JMB earned $1,240,000 and paid out $440,000 in dividends. Finally, the income statement for this year shows a loss on the sale of JMB stock of $180,000. So, I doubt that I am mistaken.”
Red-faced, president Cedeno turns to you.
Instructions
With the class divided into groups, answer the following.
(a) What dollar amount did Neosho receive upon the sale of the JMB stock?
(b) Explain why both stockholder Linton and president Cedeno are correct.
Communication Activity
BYP16-6 Fegan Corporation has purchased two securities for its portfolio. The first is a stock investment in Plummer Corporation, one of its suppliers. Fegan purchased 10% of Plummer with the intention of holding it for a number of years, but has no intention of purchasing more shares. The second investment was a purchase of debt securities. Fegan purchased the debt securities because its analysts believe that changes in market interest rates will cause these securities to increase in value in a short period of time. Fegan intends to sell the securities as soon as they have increased in value.
Instructions
Write a memo to Sam Nichols, the chief financial officer, explaining how to account for each of these investments. Explain what the implications for reported income are from this accounting treatment.
Ethics Case
BYP16-7 Harding Financial Services Company holds a large portfolio of debt and stock securities as an investment. The total fair value of the portfolio at December 31, 2014, is greater than total cost. Some securities have increased in value and others have decreased. Ann Bales, the financial vice president, and Kim Reeble, the controller, are in the process of classifying for the first time the securities in the portfolio.
Bales suggests classifying the securities that have increased in value as trading securities in order to increase net income for the year. She wants to classify the securities that have decreased in value as long-term available-for-sale securities, so that the decreases in value will not affect 2014 net income.
Reeble disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long-term available-for-sale securities. Reeble argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profitable, the company will have built-in gains.
Instructions
(a) Will classifying the securities as Bales and Reeble suggest actually affect earnings as each says it will?
(b) Is there anything unethical in what Bales and Reeble propose? Who are the stakeholders affected by their proposals?
(c) Assume that Bales and Reeble properly classify the portfolio. At year-end, Bales proposes to sell the securities that will increase 2014 net income, and that Reeble proposes to sell the securities that will decrease 2014 net income. Is this unethical?
All About You
BYP16-8 The Securities and Exchange Commission (SEC) is the primary regulatory agency of U.S. financial markets. Its job is to ensure that the markets remain fair for all investors. The following SEC sites provide useful information for investors.
Address: www.sec.gov/answers.shtml and http://www.sec.gov/investor/tools/quiz.htm, or go to www.wiley.com/college/weygandt.
Instructions
(a) Go to the first SEC site and find the definition of the following terms.
(i) Ask price.
(ii) Margin.
(iii) Prospectus.
(iv) Index fund.
(b) Go to the second SEC site and take the short quiz.
FASB Codification Activity
BYP16-9 If your school has a subscription to the FASB Codification, go to http://aaahq.org/ascLogin.cfm to log in and prepare responses to the following.
(a) What is the definition of a trading security?
(b) What is the definition of an available-for-sale security?
(c) What is definition of a holding gain or loss?
Answers to Chapter Questions
Answers to Insight and Accounting Across the Organization Questions
p. 746 How Procter & Gamble Accounts for Gillette Q: Where on Procter & Gamble's balance sheet will you find its investment in Gillette Company? A: Because Procter & Gamble owns 90% of Gillette, Procter & Gamble does not report Gillette in the investment section of its balance sheet. Instead, Gillette's assets and liabilities are included and commingled with the assets and liabilities of Procter & Gamble.
p. 750 And the Correct Way to Report Investments Is... ? Q: Why might the use of the equity method not lead to full disclosure in the financial statements? A: Under the equity method, the investment in common stock of another company is initially recorded at cost. After that, the investment account is adjusted at each reporting date to show the investor's equity in the investee. However, on the investor's balance sheet, only the investment account is shown. The pro rata share of the investee's assets and liabilities are not reported. Because the pro rata share of the investee's assets and liabilities are not shown, some argue that the full disclosure principle is violated.
Answers to Self-Test Questions
1. d 2. a 3. b 4. c 5. a 6. b $300,000 + [25% × ($160,000 − $60,000)] 7. c 8. d 9. a 10. c 11. c ($41,300 − $39,800) + $900) 12. b 13. c
A Look at IFRS
Until recently, when the IASB issued IFRS 9, the accounting and reporting for investments under IFRS and GAAP were for the most part very similar. However, IFRS 9 introduces new investment classifications and increases the situations when investments are accounted for at fair value, with gains and losses recorded in income.
LEARNING OBJECTIVE 7
Compare the accounting for investments under GAAP and IFRS.
Key Points
- The basic accounting entries to record the acquisition of debt securities, the receipt of interest, and the sale of debt securities are the same under IFRS and GAAP.
- The basic accounting entries to record the acquisition of stock investments, the receipt of dividends, and the sale of stock securities are the same under IFRS and GAAP.
- Both IFRS and GAAP use the same criteria to determine whether the equity method of accounting should be used—that is, significant influence with a general guide of over 20% ownership, IFRS uses the term associate investment rather than equity investment to describe its investment under the equity method.
- Under IFRS, both the investor and an associate company should follow the same accounting policies. As a result, in order to prepare financial information, adjustments are made to the associate's policies to conform to the investor's books. GAAP does not have that requirement.
- The basis for consolidation under IFRS is control. Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a voting-interest approach. However, under both systems, for consolidation to occur, the investor company must generally own 50% of another company.
- In general, IFRS requires that companies determine how to measure their financial assets based on two criteria:
The company's business model for managing their financial assets; and The contractual cash flow characteristics of the financial asset.
If a company has (1) a business model whose objective is to hold assets in order to collect contractual cash flows and (2) the contractual terms of the financial asset gives specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding, then the company should use cost (often referred to as amortized cost).For example, assume that Mitsubishi purchases a bond investment that it intends to hold to maturity (held-for-collection). Its business model for this type of investment is to collect interest and then principal at maturity. The payment dates for the interest rate and principal are stated on the bond. In this case, Mitsubishi accounts for the investment at cost. If, on the other hand, Mitsubishi purchased the bonds as part of a trading strategy to speculate on interest rate changes (a trading investment), then the debt investment is reported at fair value. As a result, only debt investments such as receivables, loans, and bond investments that meet the two criteria above are recorded at amortized cost. All other debt investments are recorded and reported at fair value.
- Equity investments are generally recorded and reported at fair value under IFRS. Equity investments do not have a fixed interest or principal payment schedule and therefore cannot be accounted for at amortized cost. In general, equity investments are valued at fair value, with all gains and losses reported in income.
- GAAP classifies investments as trading, available-for-sale (both debt and equity investments), and held-to-maturity (only for debt investments). IFRS uses held-for-collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifications. GAAP classifications are based on management's intent with respect to the investment. IFRS classifications are based on the business model used to manage the investments and the type of security.
- The accounting for trading investments is the same between GAAP and IFRS. Held-to-maturity (GAAP) and held-for-collection (IFRS) investments are accounted for at amortized cost. Gains and losses related to available-for-sale securities (GAAP) and non-trading equity investments (IFRS) are reported in other comprehensive income.
- Unrealized gains and losses related to available-for-sale securities are reported in other comprehensive income under GAAP and IFRS. These gains and losses that accumulate are then reported in the balance sheet.
- IFRS does not use “Other revenues and gains” or “Other expenses and losses” in its income statement presentation. It will generally classify these items as unusual items or financial items.
Looking to the Future
As indicated earlier, both the FASB and IASB have indicated that they believe that all financial instruments should be reported at fair value and that changes in fair value should be reported as part of net income. It seems likely, as more companies choose the fair value option for financial instruments, that we will eventually arrive at fair value measurement for all financial instruments.
IFRS Self-Test Questions
1. The following asset is not considered a financial asset under IFRS:
(a) trading securities.
(b) equity securities.
(c) held-for-collection securities.
(d) inventories.
2. Under IFRS, the equity method of accounting for long-term investments in common stock should be used when the investor has significant influence over an investee and owns:
(a) between 20% and 50% of the investee's common stock.
(b) 30% or more of the investee's common stock.
(c) more than 50% of the investee's common stock.
(d) less than 20% of the investee's common stock.
3. Under IFRS, at the end of the first year of operations, the total cost of the trading investments portfolio is $120,000. Total fair value is $115,000. The financial statement should show:
(a) a reduction in the carrying value of the asset of $5,000 and an unrealized loss of $5,000 in other expenses and losses.
(b) a reduction in the carrying value of the asset of $5,000 and an unrealized loss of $5,000 in the stockholders’ equity section.
(c) a reduction in the carrying value of the asset of $5,000 in current assets and an unrealized loss of $5,000 in other comprehensive income.
(d) a reduction in the carrying value of the asset of $5,000 in current assets and a realized loss of $5,000 in other expenses and losses.
4. Under IFRS, unrealized gains on non-trading stock investments should:
(a) be reported in the income statement as part of net income.
(b) be reported as other gains on the income statement as part of net income.
(c) not be reported on the income statement or balance sheet.
(d) be reported as other comprehensive income.
5. Under IFRS, the unrealized loss on trading investments should be reported:
(a) as part of other comprehensive loss reducing net income.
(b) on the income statement reducing net income.
(c) as part of other comprehensive loss not affecting net income.
(d) directly to stockholders’ equity bypassing the income statement.
Answers to IFRS Self-Test Questions
1. d 2. a 3. a 4. d 5. b
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1Among the questions that are considered in determining an investor's influence are these: (1) Does the investor have representation on the investee's board? (2) Does the investor participate in the investee's policy-making process? (3) Are there material transactions between the investor and investee? (4) Is the common stock held by other stockholders concentrated or dispersed?
2Or, the investor increases (debits) a loss account and decreases (credits) the investment account for its share of the investee's net loss.
3This category is provided for completeness. The accounting and valuation issues related to held-to-maturity securities are discussed in more advanced accounting courses.
4Short-term paper includes (1) certificates of deposit (CDs) issued by banks, (2) money market certificates issued by banks and savings and loan associations, (3) Treasury bills issued by the U.S. government, and (4) commercial paper (notes) issued by corporations with good credit ratings.