Ch (17)

Why corporation invest

Corporation purchase investment in debts or stock securities generally for one of three
reasons:

First :
A corporation may have excess cash that it doesn’t not need for the immediate
purchase of operating assets.

These companies may invest the excess funds to earn a greater return than they would
gest bu just holding the fund in the bank.

A second reason some companies such as banks purchase investments is to generate

earnings from investment income. Although banks make most of their earnings by
lending money, they also generate earnings by investing in debt and equity securities.

Third reason companies may invest for strategic reasons. a company may purchase a
non controlling interest in another company in a relates industry in which it wishes to
establish a presence , a company may also choose to purchase a controlling interest in
another company this might be done to enter a new industry without incurring the risk
associated with starting point. The purchase of a company that in your industry is
called a vertical acquisition, in a horizontal acquisition you purchase a company that
does the same activity as your company.

Accounting for debt investment :

Debt investment are investments in government and corporation bonds, in accounting
for debt investment entries are required to record the acquisition , interest revenue ,
and sales of bonds.

Note: at acquisition , the cost principle is applied , cost include all expenditures
necessary to acquire these investments.

Example :
kuhl corporation acquires 50 doan inc, 8%, 10 year, $1,000 bonds on January
1,2005, for %54,000 , including brokerage fees of $1,000.

The entry to record the investment:

Jan, 1 Debt investments 54,000

Cash 54,000
If The bonds pay interest of $2,000 semiannually on july 1 and January 1.

Solution
Interest = 50,000 × 8% × ½ = 2,000

The entry to record receipt of interest on july 1

July. 1 Cash 2,000
Interest revenue 2,000

The entry to record receipt of interest on dec 31

Dec. 31 Interest receivable 2,000
Interest revenue 2,000

When the interest is received on jan 1

Jan 1 Cash 2,000
Interest receivable 2,000

Recording sale of bonds

Example :
Assume that kuhl corporation receives net proceeds of $58,000 on the sale of the
doan inc. bonds on January 1, 2006 , after receiving the interest due. Since the
securities cost $54,000, a gain of $4,000 has been realized.

Entry to record the sale:

July 1 Cash 58,000
Debt investments 54,000
Gain on sale of debt investments 4,000

Accounting for stock investment :

Stock investment are investments in the capital stock of corporations. When a
company holds stock or debt of various corporations, the group of securities is
identified as an investment portfolio.

Investor’s ownership Presumed influence Accounting guidelines

interest in investee’s on investee
common stock
Less than 20% Insignificant Cost method

Between 20% and 50% Significant Equity method

More than 50% Controlling Consolidated financial

statement
Case (1) holdings of less than 20%

The cost method is used, under this method.

the investment is recorded at cost, and revenues is recognized only when cash
dividends are received.

Example :
Assume that on july 1, 2005 , sanchez corporation acquires 1,000 shares (10%
ownership ) of beal corporation common stock. Sanchez pays $40 per share plus
brokerage fees of $500.

Solution
The entry for the purchase is :
July 1 Stock investments 40,500
Cash 40,500

During the time the stock is held, entries are required for any cash dividends received
by sanchez corporation on December 31.

Journal entry
Dec. Cash ( 1,000 × $2) 2,000
31 Dividend revenue 2,000

Note that  dividend revenue is reported under ‘’ other revenues and gain in the
income statement since dividends don’t accrue, adjusting entries are not made to
accrue dividends.

When sale of stock

Example:
sanchez corporation receives net proceeds of $39,500 on the sale of its beal stock on
February 10,2006. Because the stock cost $40,500 , a loss of $1,000 has been
incurred.

The entry to record the sale:

Feb. 10 Cash 39,500
loss on sale of debt investments 1,000
stock investments 40,500
Case (2) holding between 20% and 50%:
Equity method is used, the investment is common stock is initially recorded at cost,
and then the investment account is adjusted annually to show the investor’s equity in
the investee company.

Example
Milar corporation acquires 30% of the common stock of Beck company for $120,000
on January 1, 2005

Jan. 1 Stock investments 120,000

Cash 120,000

For 2005, Beck reports net income of $100,000. It declares and pays a $40,000 cash
dividend,

Milar is required to record

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%)
Dec. Stock investments 30,000
31 Revenue from investment in Beck Co. 30,000
Dec Cash 12,000
31 Stock investment 12,000

Case (3)
Holding more than 50% :
A company owns more than 50% of the common stock of an other company is known
as a parent company.

The entity whose stock owned by the parent company is called the subsidiary
company. The company is perceived to have a controlling interest in the subsidiary
due to its stock ownership.

When one company owns more than 50% of the common stock of another company,
consolidated financial statements are usually prepared.

Financial statement presentation of debt and stock investments:

Fair value is the amount for which a security could be sold in a normal market and
offers the best approach at investment valuation since it represents the expected cash
realizable value of the securities. For purposes of valuation and reporting at a
financial statement date, debt and stock investments are classified into the following:

 Trading securities.
 Available for sale securities.
 Held to maturity securities.

1) trading securities
Are held with the intention of selling them in a short period less than a month,
and are reported at fair value, and change from cost are reported as part of net
income. The changes from cost are reported as unrealized gains or losses since
the securities have not been sold.

The unrealized gains or losses is fair value – total cost of trading securities)

Example
Pace corporation on decemer 31,2005 has the cost and fair value for investments
classified as trading securities.

Trading securities, December 31,2005

Investments Cost Fair value Unrealized gain
(loss)
Yorkvile company 50,000 48,000 (2,000)
bonds 90,000 99,000 9,000
Kodak company
stock
Total 140,000 147,000 7,000

Dec 31 Market adjustment – trading 7,000

Unrealized gain – income 7,000

Available for sale securities

Are held with the intention of selling them in the near future, and are reported at fair
value and changes from cost are reported as part of net income.

The changes are reported as unrealized gains or losses since the securities have not
been sold . the unrealized gains or losses is (fair value – total cost of the securities )

Example
Pace corporation on decemer 31,2005 has the cost and fair value for investments
classified as available for sale securities.
 Available for sale securities, December 31,2005
Investments Cost Fair value Unrealized gain
(loss)
Yorkvile company 93,537 103,600 10,063
bonds 200,000 180,400 (19,600)
Kodak company
stock
Total 293,537 284,000 (9,537)

Entry

Dec 31 Unrealized loss – equity 9,537

Market adjustment – available 9,537
for sale