investments in debt and equity securities

Investments inDebt and EquitySecurities

Investments inDebt and EquitySecurities

C H A P T E R 13

Learning Objective 1

Understand why companies invest in other companies.

A Cash Flow Pattern

Companies often need cash flow from sources other than their own operations because the company’s own cash flow

might vary greatly over the course of a year.

AverageCash

Needs

1/1 6/30 12/31

Actual Cash on Hand

Excess cash(used for short-term investments)

Insufficient cash(relieved byshort-termborrowing)

What Are Some Other Reasons Companies Invest Their Excess

Cash?

Learning Objective 2

Understand the different classifications for securities.

Define Two Classifications for Securities.

Debt Securities

Equity Securities (Stock)

Classifying Securities

Investments

Debt Equity

Securities—Matching

Method used to account for an investment in the stock of another company when significant influence can be imposed (presumed when 20 to 50 percent of the outstanding voting stock is owned).

Equity Method SecuritiesHeld-to-Maturity Securities

Debt securities purchased by an investor with the intent of holding the securities until they mature.

Securities—Matching

Debt and equity securities not classified as trading, held-to-maturity, or equity method securities.

Debt and equity securities purchased with the intent of selling them should the need for cash arise or to realize short-term gains.

Trading SecuritiesAvailable-for-Sale Securities

Classifying Securities

Held-to-Maturity

Available-for-Sale

EquityMethod

Debt Equity

Trading

Investments

Classifying Securities

Debt Equity

Held-to-Maturity Trading

Available-for-Sale

EquityMethod

Investments

Classifying Securities—Fill in the Chart

Held-to- Maturity

Trading

Available-for-Sale

EquityMethod

Classification Disclosed atReporting ofChanges in FMV

Learning Objective 3

Account for the purchase, recognition of revenue, and sale of trading and available-for-sale securities.

Purchase of Securities

Caribou Corp. purchased the following securities on January 1, 2006. Record the appropriate entry.

1 Debt Trading $ 3,0002 Equity Trading 15,5003 Debt Available-for-sale 10,0004 Equity Available-for-sale 7,300

Type Classification

Cost(including

broker’s fees)

Purchase of Securities

1 Debt Trading $ 3,0002 Equity Trading 15,5003 Debt Available-for-sale 10,0004 Equity Available-for-sale 7,300

Type Classification

Cost(including

broker’s fees)

Accounting for Return Earned on an Investment

Buffalo Corp. earned the following return on their owned securities. Record the journal entry.

1 Debt $2702 Equity $8953 Debt 9204 Equity 560

Security Interest Dividends

Accounting for the Sale of Securities

Buffalo Corp. sold Security 2 for $17,000. The historical cost was $15,500. Record the entry.

1 Debt Trading $ 3,0002 Equity Trading 15,5003 Debt Available-for-sale 10,0004 Equity Available-for-sale 7,300

Type Classification

Cost(including

broker’s fees)

What Are Realized Gains and Losses?

Learning Objective 4

Account for changes in the value of securities.

What Are Unrealized Gainsand Losses?

Accounting for Changes in Value — Trading Securities

The following market values were recorded for Buffalo Corp.’s portfolio on December 31, 2006. Record the changes in the values of the securities.

1 Trading $ 3,000 $ 2,8003 Available-for-sale 10,000 10,5004 Available-for-sale 7,300 9,250

TypeHistorical

CostMarket Value

12/31/06

Accounting for Changes in Value — Available-for-Sale

1 Trading $ 3,000 $ 2,8003 Available-for-sale 10,000 10,5004 Available-for-sale 7,300 9,250

TypeHistorical

CostMarket Value

12/31/06

The following market values were recorded for Buffalo Corp.'s portfolio on December 31, 2007. Record the subsequent change in the trading security.

Subsequent Changesin Value

1 Trading $ 3,000 $ 3,1003 Available-for-sale 10,000 10,3004 Available-for-sale 7,300 9,500

TypeHistorical

CostMarket Value

12/31/07

Expanded MaterialLearning Objective 5

Account for held-to-maturity securities.

The Moose Company purchased a 5-year, $500,000 bond and received interest payments of 10 percent, payable semiannually. Assume the effective rate is 12 percent. Record the investment.

Initial Purchase of Held-to-Maturity Securities

Initial Purchase of Held-to-Maturity Securities

1. Semiannual interest payments$ 25,000Present value of interest annuity $184,002

2. Principal of bonds $500,000Present value of bonds 279,197

3. Present value of investment $463,199

Bonds PurchasedBetween Interest DatesAssume the bond purchased by the Moose Company paid interest on July 1 and January 1 of each year. If the Moose Company purchased the bond on April 31, 2006, how will the purchase be recorded?

Define Amortization Methods for Bond Premiums and

Discounts

Straight-Line Amortization

Effective-Interest Amortization

Straight-Line Amortization

The Rhinoceros Company purchased a 12 percent, 5-year, $10,000 bond for $8,658 on the issuance date. The interest payments are made semiannually. Using the straight-line method, record the first interest payment received.

Effective-Interest Amortization

The Rhinoceros Company purchased a 12 percent, 5-year, $10,000 bond for $8,658 on the issuance date. The interest payments are made semiannually and the market rate is 16 percent. Using the effective-interest method, record the first interest payment received.

Hint:Won’t you need an amortization table?

Cash Interest Amortized InvestmentPayment Received Earned Amount Balance

Effective-Interest Amortization

Effective-Interest Amortization

The Rhinoceros Company purchased a 12 percent, 5-year, $10,000 bond for $8,658 on the issuance date. The interest payments are made semiannually and the market rate is 16 percent. Using the effective-interest method, record the first interest payment received.

Sale or Maturity of Bonds

The Rhinoceros Company holds the bond until maturity. Record the entry for the receipt of the bond principal.

Sale or Maturity of Bonds

What journal entry is required if the Rhinoceros Company sells the bond for $9,900 before maturity when the balance in the bond account is $9,800?

Expanded MaterialLearning Objective 6

Understand the Basics of Consolidated Financial Statements

When Should the Equity Method Be Used?

Illustrating the Equity Method

Brown Tree Co. purchased 100 shares of Koala Corp. common shares at $2 per share, representing a 20 percent ownership in the company. Record Brown Tree’s transactions using the equity method.

Illustrating the Equity Method

Brown Tree Co. purchased 100 shares of Koala Corp. common shares at $2 per share, representing a 20 percent ownership in the company. Record the $0.80 per share dividend. Record the entry.

Illustrating the Equity Method

Brown Tree Co. purchased 100 shares of Koala Corp. common shares at $2 per share, representing a 20 percent ownership in the company. Koala Corp. announces a $10,000 earnings for the year. Record the appropriate entries.

What is the Objective of Consolidated Financial Statements?

What are Notable Items Concerning the Statements?

You Have Completed Chapter 13