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APPENDIX E
REPORTING AND ANALYZING INVESTMENTS
Learning Objectives
1. Identify the reasons corporations invest in stocks and debt securities.
2. Explain the accounting for debt investments.
3. Explain the accounting for stock investments.
4. Describe the purpose and usefulness of consolidated financial statements.
5. Indicate how debt and stock investments are valued and reported in the financial
statements.
6. Distinguish between short-term and long-term investments.
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Chapter Outline
Learning Objective 1 – Identify the Reasons Corporations Invest in
Stocks and Debt Securities.
Why Corporations Invest—Corporations purchase investments in debt or
equity securities generally for one of three reasons:
▪ They have excess cash that they do not need for immediate purposes. Excess
cash may result from seasonal fluctuations in sales or from economic cycles.
Excess cash is usually invested in low-risk, high-liquidity securities, most often
short-term government securities.
TEACHING TIP
Ask students to find a company in the SEC filings and look at the financial statements and
accompanying notes (http://www.sec.gov/edgar/searchedgar/webusers.htm) to determine
the company’s mix of debt and equity investments. Use this as a starting point to launch your
discussion about the reasons corporations invest.
Learning Objective 2 – Explain the Accounting for Debt Investments.
If a company purchases bonds for $71,000 plus commissions of $2,000, then
the journal entry is:
▪ Recording Bond Interest—When bond interest is received, the debit is to Cash
and the credit is to Interest Revenue (an Other revenues and gains item on the
income statement). If interest is accrued, then the entry is a debit to Interest
Receivable and a credit to Interest Revenue.
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▪ Recording Sale of Bonds—When bonds are sold, any difference between net
proceeds from the sale (sales price less brokerage fees) and the cost of the bonds
is recorded as a gain or loss. If bonds with a cost of $23,000 are sold for a net
amount of $19,000, then the entry is as follows:
Learning Objective 3 – Explain the Accounting for Stock Investments.
Accounting for Stock Investments—Stock investments are investments in the
capital stock of corporations. An investment portfolio consists of securities (stock and/or
debt) of several different corporations held by an investor company.
▪ Accounting for stock investments is based on the extent of the investor’s
influence over the operating and financial affairs of the issuing corporation (the
investee). The guidelines are as follows:
o If the investor holds less than 20% of the investee’s common stock, then
there is a presumed insignificant influence on the investee, and the cost method
is used.
TEACHING TIP
Expand your discussion about investor influence. Include examples like technological
dependency on investor, the extent of investor board of directors representation, the
investor’s role in decision-making for the investee, the investor as a key supplier for the
investee, etc.
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Stock Investments …………………………………………………………………. 40,500
Cash ……………………………………………………….……………………. 40,500
(To record purchase of stock)
If dividends of $2 per share are received, then the journal entry is:
Cash (1,000 $2) ………………………………………………………………….. 2,000
Dividend Revenue ………………………………………………………….. 2,000
(To record receipt of dividends)
Dividend Revenue is an Other revenues and gains item in the income
statement.
If the shares of stock are sold for net proceeds of $39,500, then the journal
entry is:
A gain on sale appears on the income statement as an
Other revenues and gains item. A loss on sale appears on the income
statement as an Other expenses and losses item.
▪ For holdings between 20% and 50%—the equity method is used. The investment
is recorded initially at cost and is adjusted annually to show the investor’s equity in
the investee. The investor debits the investment account and increases (credits)
revenue for its share of the investee’s net income. The investor debits Cash and
o Ranger Corporation purchased 35% of the common stock of Sorter Corporation
for $225,000. The journal entry is:
Stock Investments …………………………………………………………………. 225,000
Cash ……………………………………………………….……………………. 225,000
(To record purchase of Sorter stock)
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o For the year, Sorter reported $150,000 of net income and paid dividends of
$30,000. The journal entries for Ranger are:
Cash ……………………………………………………………………………………. 10,500
Stock Investments ………………………………………………………….. 10,500
(To record dividends received)
Learning Objective 4 – Describe the Purpose and Usefulness of Consolidated
Financial Statements.
Holdings of More Than 50%—A parent company is a company that owns more than
50% of the common stock of another entity. A subsidiary (affiliated) company is the
entity whose stock is owned by the parent company. The parent company has a
controlling interest in the subsidiary company.
TEACHING TIP
Have your students look up a consolidated financial statement on the internet that is different
from the companies listed at the bottom of page E-7. OR give them an interesting company
Learning Objective 5 – Indicate how Debt and Stock Investments are Valued
and Reported in the Financial Statements.
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Valuing and Reporting Investments—Debt and stock investments (in which the
holdings
are less than 20%) are classified into three categories for purposes of valuation and
reporting
at a financial statement date:
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.
o Consider the following example. A corporation owns three trading
securities with a total cost of $89,000. On the financial statements date,
their total fair value is $97,000. The journal entry to record this unrealized
gain is:
Market Adjustment—Trading …………………………………………………… 8,000
Unrealized Gain—Income ……………………………………………….. 8,000
(To record unrealized gain on trading securities)
• The use of the Market Adjustment—Trading account enables the
company to maintain a record of the investment cost. Since this account
o If instead the investments had had a fair value of $88,000, then the journal entry
would have been a debit to Unrealized Loss—Income and a credit to Market
Adjustment—Trading for $1,000. The Unrealized Loss—Income account is
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▪ Available-for-sale securities are reported at fair value with changes reported in
the stockholders’ equity section of the balance sheet. If the intent is to sell the
securities within the next year or operating cycle, then they are classified as current
assets. Otherwise, they are classified as long-term assets in the investments
section of the balance sheet.
Market Adjustment—Available-for-Sale ………………………………………… 8,000
Unrealized Gain or Loss—Equity …………………………………………. 8,000
(To record unrealized gain on available-for-sale securities)
• The Market Adjustment account is added to the investments account to
give the fair value of the investments. The Unrealized Gain or Loss—
Equity account is added to stockholders’ equity on the balance sheet,
not to income on the income statement as is the case with trading
securities.
o If instead the investments had had a fair value of $88,000, then the journal entry
would have been a debit to Unrealized Gain or Loss—Equity and a credit to
Market Adjustment—Available-for-Sale for $1,000. The resulting unrealized loss
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Learning Objective 6 – Distinguish between Short-term and Long-term
Investments.
Balance Sheet Presentation—investments must be classified as either short–term or
long–term.
▪ Short-term investments are those that are readily marketable (can be sold easily
whenever the need for cash arises) and intended to be converted into cash
within the next year or operating cycle, whichever is longer. Short-term investments
are listed immediately below Cash in the current assets section of the balance
sheet because of their high liquidity (nearness to cash). They are reported at fair
value.