Appendix E Flashcards
Three reasons why Corporations invest in debt or equity securities:
- To house excess cash until needed
- Earnings from investment income
- To meet strategic goals
Typical investment: to house excess cash until needed
Low-risk, high-liquidity, short-term securities such as government-issued securities
Typical investment: to generate earnings
Banks and financial institutions often purchase debt securities, while mutual funds and index funds purchase stock securities
Typical investment: to meet strategic goals
Stocks of companies in a related industry or in an unrelated industry that the company wishes to enter
Debt investments
Investments in government and corporation bonds
What is included in cost of investments?
All costs (price paid plus brokerage fees) - commissions
*Cost principle applies*
Journal entry to acquire investment
Dr. Debt investments XXX
Cr. Cash XXX
Journal entry: gain on sale of bond investments
Dr. Cash 58,000
Cr. Debt Investments 54,000
Cr. Gain on Sale of Debt Investments 4,000
Stock investments
Investments in the capital stock of corporations
Investment portfolio
When a company holds stock (and/or debt) of several different corporations, the group of securities is an investment portfolio
Investor’s Ownership Interest in Investee’s Common Stock: Less than 20%
Presumed influence on investee: insignificant
Accounting guidelines: Cost method
Investor’s Ownership Interest in Investee’s Common Stock: Between 20% and 50%
Presumed influence on investee: significant
Accounting guidelines: equity method
Investor’s Ownership Interest in Investee’s Common Stock: More than 50%
Presumed influence on Investee: controlling
Accounting guidelines: Consolidated financial statements
Cost method with stock investments
Companies record the investment at cost and recognize revenue only when cash dividends are received
Journal entry for purchase of stock
Dr. Stock Investments XXX
Cr. Cash XXX
Journal entry if dividends are received (less than 20% ownership)
Dr. Cash XXX
Cr. Dividend Revenue XXX
Journal entry for sale of stock with loss (less than 20% ownership)
Dr. Cash 39,500
Dr. Loss on Sale of Stock Investments 1,000
Cr. Stock Investments 40,500
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
Journal entry when a company (who owns 30%) has its invested company report net income of 100,000
Dr. Stock Investments 30,000
Cr. Revenue from Investment in Beck Company 30,000
Parent company
A company that owns more than 50% of the common stock of another entity
Subsidiary (affiliated) comapny
The entity whose stock is owned by the parent company
Controlling interest
Ownership of more than 50% of the common stock of another entity
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
Who are consolidated statements useful to?
Stockholders
Board of directors
Management of the parent company
Fair value
Amount for which a security could be sold in a normal market
pro: it represents the expected cash realizable value of securities
con: unless a security is to be sold soon, not relevant because the price will likely change again
3 categories of securities:
(for purposes of valuation and reporting at a financial statement date)
- Trading securities
- Available-for-sale securities
- Held-to-maturity securities
Trading securities
Securities bought and held primarily for sale in the near term to generate income on short-term price differences
Available-for-sale securities
Securities that are held with the intent of selling them sometime in the future
Held-to-maturity securities
Debt securities that the investor has the intent and ability to hold to their maturity date
Valuation of Trading securities
At fair value with changes reported in net income
Valuation of available-for-sale securities
At fair value with changes reported in the stockholders’ equity section
Valuation of held-to-maturity securities
at amortized cost
Intention of trading securites
Selling them in a short period of time (less than a month)
Trading
means frequent buying and selling
Mark-to-market
A method of accounting for certain investments that requires that they be adjusted to their fair value at the end of each period
Unrealized gain or loss =
Total cost - Total fair value
Journal entry for an unrealized gain on trading securities
Dr. Market Adjustment-Trading XXX
Cr. Unrealized Gain-Income XXX
Journal entry to record unrealized loss (available-for-sale)
Dr. Unrealized Gain or Loss-Equity
Cr. Market Adjustment-Available-for-Sale
Short-term investments (marketable securities)
Investments that are readily marketable and intended to be converted into cash within the next year of operating cycle, whichever is longer
Two criteria of short-term investments (marketable securities)
- Readily marketable
- Intended to be converted into cash within next year or operating cycle, whichever is longer
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
Readily marketable
When it can be sold easily whenever the need for cash arises
ex. short-term paper, stocks and bonds traded on organized securities markets
Intent to convert
Management intends to sell the investment within the next year or operating cycle, whichever is longer
ex. Ski company that invests in securities but intends to sell them before next ski season
Trading securities are always _________
short-term
Available-for-sale securities can be either _________________
short-term or long-term
Reporting the unrealized gain or loss in the stockholders’ equity section for two purposes:
- Reduces the volatility of net income due to fluctuations in fair value
- Informs the financial statement user of the gain or loss that would occur if the company sold the securities at fair value
Other Revenue and Gains
Interest Revenue
Dividend Revenue
Gain on Sale of Investments
Unrealized Gain-Income
Other Expenses and Losses
Loss on Sale of Investments
Unrealized Loss-Income
