Investments in Stocks and Bonds of Other Companies

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Investments in Stocks and Bonds of Other Companies
Chapter 23
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Classifications of Investments

• Less than 20 ownership
• investor company has no influence over the
  investee
• 20 to 50 ownership
• investor company has significant influence over
  the investee
• More than 50 ownership
• investor company has control over the investee

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Accounting for Investments Exhibit 23-1
Type of Investment Method Investments in
Common Stock No influence Market value
method Significant influence Equity
method Control Consolidation
method Investments in Bonds Available-for-sale
Market value method Held-to-maturity
Amortized cost method
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Market Prices of Stocks and Bonds

• Publicly traded companies
• Stockbroker
• Stock exchange
• Over-the-counter market

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Market Value Method

• Used for available-for-sale securities
  (marketable securities)
• Stock - less than 20 ownership
• Bonds - when investor does not expect to hold the
  bonds until their maturity date

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Purchase of Marketable Securities
Investment in Available-for-Sale Securities
Cash
12,000
12,000
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Recording Dividends and Interest
Cash
Dividend (Interest) Revenue
200
200

• Recorded when the cash dividend or bond interest
  is received
• Reported in the other items section on the
  income statement

8
Reporting Ending Market Value

• Marketable securities are reported on the balance
  sheet at the market value of the portfolio
• Investment account is increased or decreased
  for the change in market value

9
Recording Increase in Market Value of Investments
Investment in Available-for-Sale Securities
Unrealized Increase in Market Value of Investments
Bal. 12,000
500
500
Bal. 12,500
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Sale of Investments

• When a company sells an investment, it must
  record
• Cash received
• Reduction in the Investments account
• Adjustment to the Unrealized Increase (or
  Decrease) account
• Gain or loss on the sale

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Recording Sale of Investments
Unrealized Increase in Market Value of Investments
Cash
Bal. 500
4,800
600
Bal. 100
Investment in Available-for-Sale Securities
Gain on Sale of Investments
Bal. 12,500
800
4,600
Bal. 7,900
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Affect on the Cash Flow Statement

• Cash paid for investment - outflow for an
  investing activity
• Cash received from the sale of investment -
  inflow from an investing activity
• Dividends and interest received - inflows from
  operating activities

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Equity Method

• Used when there is significant influence over the
  operations
• Stock - between 20 and 50 ownership

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Reasons for Using the Equity Method

• The market value of the common stock of the
  investee is not a good indicator of the total
  value of the investment
• The dividends received are not a good indicator
  of the increase in the investor companys wealth
• The investor may be able to influence the
  dividend policy and thereby affect the cash
  payments it receives

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Recording Investments Using the Equity Method
Investment Cost Income Earned - Dividends
Received where Income Earned Investees Net
Income X Investors Ownership
and Dividends Received Total Dividends Paid
by Investee X Investors Ownership
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Affect on the Cash Flow Statement

• Cash paid for investment - outflow for an
  investing activity
• Cash received from the sale of investment -
  inflow from an investing activity
• Dividends and interest received - inflows from
  operating activities

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Consolidated Financial Statements

• Control over the investee - more than 50
  ownership
• Parent company - investor
• Subsidiary company - investee
• Includes the sum of the information in the
  accounting records of the separate companies

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Accounting for a Controlling Interest

• Purchase is recorded at cost in an Investment
  account
• Equity method is used for accounting during the
  year
• Eliminations are made at the end of the year to
  produce consolidated statements

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Segment Reports

• An operating segment is a component of a company
• that earns revenues and incurs expenses
• whose performance is reviewed regularly by the
  companys top executive
• for which financial information is available

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Information Included in a Segment Report

• Operating profit or loss
• Assets
• General information (e.g., types of products,
  geographical areas)

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Investments in Held-to-Maturity Bonds

• Investor has the intent and the ability to hold
  the bonds until maturity
• Bonds may be purchased at face value, a premium
  or a discount
• Purchase of bonds are recorded at cost in an
  Investment in Held-to-Maturity Bonds account

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Amortized Cost Method

• Used when bonds are purchased at a premium or
  discount
• Same as the effective interest method used in
  Chapter 22

Interest Revenue for Period Book Value of
Investment at Beginning of Period X Yield
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Affect on the Cash Flow Statement

• Cash paid for investment - outflow for an
  investing activity
• Cash received from the sale of investment -
  inflow from an investing activity equal to amount
  of original investment
• Interest received - inflows from operating
  activities

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Conclusion

• An investor accounts for its investments in stock
  depending on the amount of influence over the
  investee.
• An investor accounts for its investments in bonds
  depending on how long it expects to hold the
  bonds.