C H A P T E R

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• C H A P T E R

Investments in Debt and Equity Securities
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Learning Objective 1

• Understand why companies invest in other
  companies.

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A Cash Flow Pattern

• Companies often need cash flow from sources other
  than their own operations because the companys
  own cash flow might vary greatly over the course
  of a year.

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What Are Some Other Reasons Companies Invest
Their Excess Cash?

• To earn a return.
• Banks give a fixed return.
• Investing in stocks or bonds of other companies
  may earn a higher rate of return (and demand a
  higher degree of risk).
• The ability to ensure a supply of raw materials.
• To influence a board of directors.
• To diversify their product offerings.
• Less expensive than RD.

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Learning Objective 2
Understand the different classifications for
securities.
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Define the Two Classifications for Securities.

• Debt Securities
• Financial instruments issued by a company that
  carry with them a promise of interest payments
  and the repayment of principal.
• Equity Securities (Stock)
• Shares of ownership in a corporation that can
  change significantly in value and that provide
  for a return to investors in the form of
  dividends.

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Classifying Securities
Investments
Debt
Equity
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Classifying SecuritiesMatching
Equity Method Securities Held-to-Maturity
Securities
Debt securities purchased by an investor with the
intent of holding the securities until they
mature.

• 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).

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

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

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Classifying Securities
Debt
Equity
Available- for-Sale
Equity Method
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Classifying Securities
Investments
Debt
Equity
Held-to- Maturity
Available- for-Sale
Equity Method
Trading
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Classifying Securities Fill in the Chart
Fair value Fair value Amortized cost Cost
adjusted for changes in net assets of investee
Income statement Stockholders equity Not
recognized Not recognized
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Learning Objective 3
Account for the purchase, recognition of revenue,
and sale of trading and available-for-sale
securities.
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Purchase of Securities
Caribou Corp. purchased the following securities
on January 1, 2003. Record the appropriate entry.
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Purchase of Securities
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Accounting for Return Earned on an Investment
Buffalo Corp. earned the following return on
their owned securities. Record the journal entry.
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Accounting for the Sale of Securities
Buffalo Corp. sold Security 2 for 17,000. The
historical cost was 15,500. Record the entry.
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What Are Realized Gains and Losses?

• Gains and losses resulting from the sale of
  securities in an arms-length transaction.

At the end of the accounting period, any gain or
loss on the sale of securities must be included
on the income statement.
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Learning Objective 4
Account for changes in the value of securities.
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What Are Unrealized Gains and Losses?
Gains and losses resulting from changes in the
value of securities that are still being held.
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Accounting for Changes in Value Trading
Securities
The following market values were recorded for
Buffalo Corp.s portfolio on December 31, 2003.
Record the changes in the values of the
securities.
Historical Cost
Market Value 12/31/03
Type
1 Trading 3,000 2,800 3 Available-for-sale
10,000 10,500 4 Available-for-sale 7,300 9,250
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Accounting for Changes in Value
Available-for-Sale
Historical Cost
Market Value 12/31/03
Type
1 Trading 3,000 2,800 3 Available-for-sale 10
,000 10,500 4 Available-for-sale 7,300 9,250
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Subsequent Changesin Value
The following market values were recorded for
Buffalo Corp.'s portfolio on December 31, 2004.
Record the subsequent change in the trading
security.
1 Trading 3,000 3,100 3 Available-for-sale 1
0,000 10,300 4 Available-for-sale 7,300 9,500
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Expanded Material Learning Objective 5
Account for held-to-maturity securities.
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Example Initial Purchase of 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.
1. Semiannual interest payments
25,000 Present value of interest
annuity 184,002 2. Principal of
bonds 500,000 Present value of bonds
279,197 3. Present value of investment 463,199

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Example Initial Purchase of Held-to-Maturity
Securities
1. Semiannual interest payments
25,000 Present value of interest
annuity 184,002 2. Principal of
bonds 500,000 Present value of bonds
279,197 3. Present value of investment 463,199
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Bonds PurchasedBetween Interest Dates
Assume 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, 2003, how will the purchase be recorded?
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Accounting for Amortization of Premiums and
Discounts. Define.

• Straight-Line Amortization
• A method of systematically writing off a bond
  discount or premium in equal amounts each period
  until maturity.
• Effective-Interest Amortization
• A method of systematically writing off a bond
  premium or discount that takes into consideration
  the time value of money and results in an equal
  rate of amortization for each period.

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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.
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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.
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Effective-Interest Amortization
Cash Interest Amortized
Investment Payment Received Earned Amount
Balance (0.16 x 0.5 x Balance)
8,658 1 600 693 93 8,751
2 600 700 100 8,851 3
600 708 108 8,959 4 600
717 117 9,076 5 600 726
126 9,202 6 600 736 136
9,338 7 600 747 147 9,485
8 600 759 159 9,644 9
600 772 172 9,816 10 600
784 184 10,000
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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.
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Sale or Maturity of Bonds
The Rhinoceros Company holds the bond until
maturity. Record the entry for the receipt of
the bond principal.
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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?
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Expanded Material Learning Objective 6
Account for securities using the equity method.
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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 Trees transactions using both the
available-for-sale method and the equity method.
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Illustrating the Equity Method
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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.