APPENDIX D
INVESTMENTS IN OTHER CORPORATIONS
Student Learning Objectives and Related Assignment Materials
Student Learning Objectives
Mini-Exercises
Exercises
Coached
Problems
Problems
(Groups
A & B)
Not applicable
1, 2, 3, 4, 5, 6, 7
1, 2, 3, 4, 5, 6, 7
1, 2
A1, A2
Overview
This appendix introduces the controversy surrounding the use of fair values in mark–to-market accounting
for investments in other corporations.
Synopsis of Appendix Revisions
• New focus company (Google, Inc.) to provide contemporary context for topics
• New discussion of Google’s acquisitions of YouTube, Nest, and DoubleClick
• Revised discussion of mergers and acquisitions
PowerPoint Slides
PowerPoint® Slides
D-2 through D-26
Appendix Outline
Teaching Notes
I. An Overview
A. Reasons Companies Invest:
1. The nature of their business requires it; investments are
significant assets to these companies.
2. Excess cash may be invested to earn a return on idle
funds until they are needed for other purposes.
3. To expand the company’s presence in a related industry
or market with the purpose of influencing, but not
controlling, the company’s policies and activities.
4. To control another company, either by purchasing it
directly or by becoming the majority shareholder.
B. Identifying Investment Types and Accounting Methods—
Method is directly related to the purpose of the investment
Balance sheet presentation
illustrated in Exhibit D.1
1. Passive Investments—Investments made to earn a high
rate of return on funds that may be needed in the future
for either short- or long-term purposes.
a. Investments in equity securities
i. Presumed to be passive if the investing company
owns less than 20 percent of the other company’s
outstanding voting shares or any amount of
nonvoting shares.
ii. The fair value method is used to measure and
report these investments.
b. Investments in debt securities
i. Always considered to be passive.
ii. If the company intends to sell before maturity, they
are treated as equity securities and reported using
the fair value method.
iii. If the company intends and has the ability to hold
until maturity, they are measured and reported at
amortized cost.
2. Investments in Stock for Significant Influence
a. Active investments—Those in which a company owns
enough stock in another business to influence or
control that business.
b. An investor or company policies is said to have
significant influence when it owns enough shares of
voting stock of another company to have an important
impact on its operating and financing policies.
i. Significant influence is presumed to exist if the
investing company owns from 20 to 50 percent of
the outstanding voting shares.
ii. Various other factors may also indicate significant
influence.
iii. The equity method is used to measure and report
this type of investment.
Appendix Outline
Teaching Notes
3. Investments in Stock for Control
a. Control—The ability to determine the operating and
financial policies of another company through
ownership of its voting stock.
b. Control is presumed when the investing company
owns more than 50% of the outstanding voting stock.
c. These investments are accounted for by combining the
two companies using the consolidated statement
method.
III. Accounting for Passive Investments
A. Debt Instruments Held to Maturity: Amortized Cost Method
1. When management has the intent and ability to hold a
bond investment until the maturity date, it is reported the
account, Investments Held to Maturity.
2. Bonds are reported at amortized cost—that is, at cost
adjusted for the amortization of any bond discount or
premium.
a. Bond Purchases—Following the cost principle, the
bond’s total cost is debited to the Investments Held to
Maturity account.
b. Interest Earned
i. If the bonds were purchased at par value, there is
no premium or discount to amortize and the book
value remains constant over the life of the
investment.
ii. In such situations, the revenue earned on the
investment each period is measured as the amount
of interest collected in cash or accrued at year-end.
Comparable to interest on
notes receivable (covered in
Chapter 8).
iii. Interest Revenue is reported in the Other Items
section of the income statement.
c. Principal at Maturity—At maturity, the receipt of the
face value is recorded.
3. If the bond investment is sold before maturity, any
difference between the fair value (the proceeds from the
sale) and the net book value (the unamortized cost) is
reported in the income statement as a gain or loss on the
sale.
4. If management intends to sell the bonds before (or is
unable to hold them until) the maturity date, they should
be treated in the same way as stock investments classified
as available-for-sale securities. (See below.)
Appendix Outline
Teaching Notes
B. Available-for-Sale Securities: Fair Value Method
1. When the investing company owns less than 20 percent of
the outstanding voting stock in another company or any
level of nonvoting stock, its investment in equity
securities is considered passive.
2. Among the assets and liabilities shown on the balance
sheet, only passive investments in marketable securities
are reported using the fair value method.
3. Classifying Passive Investments
a. Trading Securities—Securities purchased with the
intent of selling them in the near future at a profit.
i. This approach is similar to the one taken by many
mutual funds whose portfolio managers actively
buy and sell securities.
ii. Trading securities are classified as current assets on
the balance sheet.
b. Available-for-Sale Securities—Securities purchased
with excess funds, with the intent of earning a return
until the funds are needed by the company’s operating
or financing activities.
i. Most companies do not actively trade the securities
of other companies; instead, they invest to earn a
return on funds they may need for future operating
purposes.
ii. Available-for-sale securities are classified as either
current or noncurrent assets on the balance sheet,
depending on whether management intends to sell
them within the next year.
4. Recording and Reporting Available-for-Sale Securities
Illustrated in Exhibit D.2
a. Applying the fair value method:
i. The cost of each passive investment is recorded as
an asset called Available-for-Sale Securities.
✓ Supplemental Enrichment
Activity (Activity) #1
ii. At period-end, these investments are adjusted to
their fair value.
• Adjustment involves increasing or decreasing
the asset, Available-for-sale Securities, and
recording this change in investment value as
Net Unrealized Losses/Gains.
• The net amount of the unrealized losses/gains
is included in Accumulated Other
Comprehensive Income in the Stockholders’
Equity section of the balance sheet.
• Dividends received are reported as Dividend
Revenue on the income statement.
Appendix Outline
Teaching Notes
b. Related journal entries:
i. Purchase of Stock—The purchase of the
investment is recorded with a debit to Available–
for-Sale Securities and a credit to Cash.
ii. Dividends Earned—The receipt of dividends from
the investee is recorded with a debit to Cash and a
credit to Dividend Revenue.
iii. Year-End Valuation
• When the fair value of the securities increases,
the increase is recorded with a debit to
Available-for-Sale Securities and a credit to
Net Unrealized Gains (Losses).
• When the fair value of the securities
decreases, the decrease is recorded with a
debit to Net Unrealized Gains (Losses) and a
credit to Available-for-Sale Securities.
iv. Disposal of Securities
• When available-for-sale securities are sold,
Cash is increased and two accounts on the
balance sheet are eliminated: Available-for-
Sale Securities and Net Unrealized
Losses/Gains.
• If a gain is realized, it is recorded in the Gain
on Sale of Investments account; if a loss is
realized, it is recorded in the Loss on Sale of
Investments account.
• Gain on Sale of Investments and Loss on Sale
of Investments accounts are reported on the
income statement with other nonoperating
items.
5. Comparison of Available-for-Sale and Trading Securities
Illustrated in Exhibit D.3
a. Available-for-Sale Securities
i. The balance in the Net Unrealized Losses/Gains
account is reported as a separate component of
stockholders’ equity under Accumulated Other
Comprehensive Income.
ii. The Net Unrealized Losses/Gains account is not
reported on the income statement because it does
not affect net income.
Appendix Outline
Teaching Notes
b. Trading Securities
✓ Activity #2
i. The amount of the adjustment to record unrealized
holding losses/gains is included in each period’s
income statement (that is, it is treated as if it were
realized).
ii. The amount recorded with Net Unrealized
Losses/Gains on trading securities is closed to
Retained Earnings at the end of the period.
The “Spotlight on Financial
iii. When selling a trading security, Cash and only one
other balance sheet account are affected: Trading
Securities.
Reporting” feature addresses
the reporting the fair value of
investments
III. Accounting for Influential Investments
A. Investments Involving Significant Influence: Equity Method
✓ Activity #3
1. Equity method—Used when an investor can exert
significant influence over an investee, which is presumed
if the investor owns between 20% and 50% of the
investee’s outstanding voting stock.
2. Recording Investments Under the Equity Method
a. Purchase of Stock—The purchase of the investment is
recorded with a debit to Investments in Affiliates and
a credit to Cash.
b. Affiliate Earnings
i. When the investee reports net income for the year,
its percentage share of the investee’s net income is
recorded with a debit to the Investments in
Affiliates account.
ii. The Equity in Affiliate Earnings account, which is
credited, is reported on the income statement with
other nonoperating items.
c. Dividends Received—The receipt of dividends from
the investee is recorded with a debit to Cash and a
credit to Investments in Affiliates (for the investor’s
share of the dividends).
d. Disposal of Stock
i. Companies record any sale of stock in affiliated
companies in the same way as sales of other assets.
ii. The sale is recorded with a debit to Cash, a credit
to Investment in Affiliates (for the cost of the
percentage of stock sold), and a credit (debit) to
Gain (or Loss) on Sale of Investments (for the
difference).
Appendix Outline
Teaching Notes
3. Reporting Investments under the Equity Method
a. On the balance sheet, the Investments in Affiliates
account is reported as a long-term asset.
b. However, as the year-end entries show, the investment
account does not reflect either cost or fair value
because of the following:
i. The investment account increased with the cost of
the purchased shares and the proportional share of
the investee’s income.
ii. The investment account decreased with the
dividends received from the investee, the
proportional share of any investee losses, and any
sale of shares in the investee.
c. At the end of the accounting period, the investment
account is not adjusted to reflect changes in the fair
value of securities accounted for under the equity
method.
d. When the securities are sold, accountants record the
difference between the cash received and the book
value of the investment as a Gain (Loss) on Sale of
Investments and report the amount on the income
statement in the Other Items section.
The “Spotlight on Ethics”
feature addresses the impact
of improper influence.
B. Investments with Controlling Interests: Consolidated
Statements
1. Why Control Other Companies?
a. Reasons for acquiring ownership of more than 50% of
another company’s outstanding voting stock:
i. Vertical integration—One company acquires
another company that operates on a different level
in the distribution channel. .
ii. Horizontal growth—Such acquisitions involve
companies that operate on the same level of the
distribution channel.
iii. Synergy—Two companies operating together may
be more profitable than two companies operating
separately
Appendix Outline
Teaching Notes
2. What are Consolidated Statements?
a. Merger—Occurs when one company purchases all
assets and liabilities of another company and the
acquired company’s corporate status is terminated and
its operations are merged with the acquiring
corporation.
b. Parent company—The entity that controls another
company.
c. Subsidiary company—The entity that is controlled
by the parent.
d. Consolidated financial statements—Combine the
operations of the parent and subsidiary companies into
a single set of statements, usually identified by the
word consolidated in the statement titles.
i. Consolidated statements may be thought of as
adding together the financial statements for two or
more companies so that they appear to be a single
company.
ii. Combining all financial information into one set of
consolidated statements gives users better
information on the size and scope of operations in
companies controlled by the parent corporation.
e. When consolidated statements are prepared,
intercompany items such as loans from the parent
company to the subsidiaries must be eliminated.
All four methods of
accounting are summarized in
Exhibit D.4.
Supplemental Enrichment Activities
Note: These activities would be suitable for individual or group activities.
1. Handout D–1
Use Handout D–1 for an in-class activity to review the equity method. The solution follows the
handout master.
2. Handout D–2
Use Handout D–2 for an in-class activity to review the accounting for available-for-sale securities.
The solution follows the handout master.
3. Handout D–3
Use Handout D–3 for an in-class activity to review the accounting for trading securities. The solution
follows the handout master.
Handout D–1
BELLOWS CORP.
1. Bellows Corp. had $100,000 in its Cash account on January 1, 2016. On June 15, 2016, Bellows
Corp. acquired 100 shares of Sonny, Inc. for $75 per share. Assume that Bellows considers the stock
as a security available for sale. Prepare the journal entry required to record this transaction and, after
entering the beginning Cash account balance, post it to the appropriate T-accounts:
June 15
2. On September 15, 2016, Bellows Corp. received dividends from Sonny of $2 per share. Prepare the
journal entry required to record this transaction and update the appropriate T-accounts:
Sep. 15
3. At December 31, 2016, the value of the stock was $120 per share. Prepare the journal entry required
to record this transaction and update the appropriate T-accounts:
Computation of amount:
Dec. 31