Notes. 351 Spring Accounting. Investments. Chapter 12. Over 50% Less than 20% Equity Method. Consolidation. Held to Maturity.

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Meredith Dennis
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1 Notes hapter 12 ccounting 351 Spring 2011 alifnia State University, Nthridge 1 Investments Less than 20% 20-50% FS 115; S S and 35 Equity Method Significant influence Over 50% onsolidation ontrol What was management s s intent when making the investment? Trading Mark to Market Expected to be traded within 3 months. vailable f Sale Mark to Market Not held-to to- maturity trading securities. Held to Maturity mtized Debt securities No clearly determinable market value. 2 Held to Maturity lpha purchased 10%, 10-year $ Beta bonds on July 1 f $88,530 when other bonds are paying 12%. Interest is paid on June 30 and December 31. $ x = $57,350 $ x = 31,180 $88,530 Discount = $ - $88,530 = $ (future interest) The bonds sell f $88, (88.53% of $) Investment in Held-to to-maturity 88,530 Discount on Bonds Payable Bonds Payable 88,

2 If purchased on pril 1 (in between interest payment dates): On June 30, lpha will receive $ (6 months) of interest but will have earned only $2,500 (3 months) of interest. 6 Interest payments = $ x 10% x 12 = $ lpha will prepay the interest ($2,500) that won t t be earned by June 30. Investment in Held-to to-maturity Interest Receivable ($ x 10% x ¼) June 30 Interest Receivable Investment in Held-to to-maturity June 30 2,500 2,500 91,030 2,500 2,500 91,030 4 Balance Sheet Investment in HTM $ Less: $ 88,530 Face Value = $ arrying Value = 88,530 Discount = $ 10% = face interest rate 12% = market interest rate (Straight-line Method) $ discount/20 periods = $574 Rounded (Effective Interest Method) $88,530 x 6% = $5, - $ = $ $ Rounded Dec 31 5, 5 Face interest rate = 10% Market interest rate = 12% Face interest rate = 12% Market interest rate = 10% Investment in HTMS Investment in HTMS Discount on Bond Inv Premium on Bond Inv 12,463 88, ,463 $88,530 x 6% - $ = $ Rounded $112,463 x 5% - $6,000 = $377 Rounded Discount on Bond Inv 377 Premium on Bond Inv 377 6,000 6,000 In 6 months ($88,530 + ) x 6% - $ = $331 In 6 months ($112, ) x 5% - $6,000 = $396 Discount on Bond Inv Premium on Bond Inv

3 Purchased the following equity securities. Trading B Investment in Trading End of year 1 B $1 $1 Unrealized Loss on Trading Fair Value djustment Trading 3 Market Value $1 1 $30, In year 2, sold the B securities f $7,000 Loss on Sale of Trading Investment in Trading 7,000 1,000 End of year 2 $1 $2 Market Value $19,000 $27,000 Fair Value djustment Trading Required entry in Year 2 Year 2 Ending Balance Year 1 Ending Balance Fair Value djustment Trading Unrealized Gain on Trading 8 Income Statement (Year 1) Other expenses and losses: Unrealized loss on trading securities $ Balance Sheet (Year 1) ssets Investment in trading securities Less: FV adjustment trading securities $30,

4 Income Statement (Year 2) Other revenues and gains: Unrealized gain on trading securities $ Other expenses and losses: Loss on sale of trading securities $1,000 Balance Sheet (Year 2) ssets Investment in trading securities dd: FV adjustment trading securities $2 $27, Purchased the following equity securities. vailable f Sale B $1 Investment in vailable-f 3 3 End of year 1 B $1 Market Value $1 1 $30,000 Unrealized Loss on vailable-f Fair Value djustment vailable-f 11 In year 2, sold the B securities f $7,000 Loss on Sale of vailable-f Investment in vailable-f 7,000 1,000 End of year 2 $1 $2 Market Value $19,000 $27,000 Fair Value djustment vailable-f Required entry in Year 2 Year 1 Ending Balance Year 2 Ending Balance Fair Value djustment vailable-f Unrealized Gain on vailable-f 12 4

5 omprehensive Income ll changes in equity (net assets) except those resulting from investments by and distributions to owners. ontrolled by external market conditions, not a result of operations. + Other omprehensive Income (OI) omprehensive Income Net Income Feign urrency Translation djustment Unrealized Gains/Losses on vailable-f Impairment of Investment in Debt Deferred Gains/Losses on Derivative Financial Instruments Minimum Pension Liability 13 omprehensive Income ombined Statement of omprehensive Income Sales of goods sold Gross profit Operating expenses Feign currency translation adjustment Unrealized gains/losses on available- Impairment of investment in debt securities Deferred gains/losses on derivative financial instruments Minimum pension liability omprehensive income Sales of goods sold Gross profit xxxxxxx Income Statement omprehensive Income Statement Other comprehensive income Feign currency translation adjustment Unrealized gains/losses on available- Impairment of investment in debt securities Deferred gains/losses on derivative financial instruments Minimum pension liability omprehensive income 14 Statement of Stockholders Equity ccum omp Retained Other ommon Income Earnings omp Inc Stock Beginning balance omprehensive income $9 $ $1 $70,000 Other comprehensive income $ Translation adjustment Unrealized gains/losses Impairment losses Derivative gains/losses Minimum pension liability omprehensive income $3, Ending balance $98,700 $1 $16,700 $70,000 Balance Sheet Stockholders equity ommon stock Retained earnings ccumulated other comprehensive income stockholders equity $70, ,700 $98,700 IS 39 ll unrealized gains/losses are repted in net income. 15 5

6 Income Statement (Year 1) Other comprehensive income Unrealized loss on available-f xxxxx sale securities $ Balance Sheet (Year 1) ssets Investment in available-f Less: FV adjustment available-f $30,000 Stockholders Equity apital stock xxxxxx Retained earnings xxxxxx ccumulated other comprehensive income: Less: Unrealized loss on available-f f-sale 16 securities $ Income Statement (Year 2) Other expenses and losses: Loss on sale of available-f $1,000 Other comprehensive income Unrealized gain on available-f xxxxx sale securities $ Balance Sheet (Year 2) ssets Investment in available-f $2 dd: FV adjustment available-f $27,000 Stockholders Equity apital stock xxxxxx Retained earnings xxxxxx ccumulated other comprehensive income: dd: Unrealized gain on available-f f-sale 17 securities $ Facts: : Purchased an equity security f $10. Investment TS 10 Investment FSS t year-end, end, the value is $15. FV djustment TS 5 Unrealized Gain 5 NI The security is sold f $12. Unrealized Loss TS 5 NI FV djustment - TS 5 12 Investment TS 10 Gain on Sale 2 NI Unrealized Loss TS 5 12 FV djustment - TS 5 Investment TS 10 Gain on Sale 2 FV djustment FSS 5 Unrealized Gain 5 OI Unrealized Loss 5 FV djustment - FSS 5 12 Investment FSS 10 Gain on Sale 2 NI Unrealized Loss 5 12 FV djustment - FSS 5 Investment FSS Gain on Sale 2 OI 6

7 Equity Method Used when the invest is able to exercise significant control o influence over the investee (20-50% guideline). lpha purchased 25% of the common stock of Beta f $200, ,000 Beta repted net income f the year of $240, ,000 Investment Revenue Beta paid a dividend of $36, ,000 9,000 60,000 9, t the time of purchase, Beta s s FV = $600,000$ and BV = $540,000$ 540,000. $200,000 FV ($600,000 x 25%) $150,000 BV ($540,000 x 25%) $13 $50,000 Goodwill $1 Inventy Depreciable ssets $ $/ 5-year 5 life Investment Revenue Investment Revenue IS 28 lpha would be required to change Beta s s accounting policies to its own when applying the equity method. 20 Held-to to- Maturity Security How sset is Repted mtized urrent LT hange in Value Not recognized Net Income Interest revenue Realized G/L vailable- f-sale Security Trading Security Equity Method Fair value urrent LT Fair value urrent Histical cost (adjusted f changes in investee net assets) Repted in SH Equity as ccum Other omprehensive Income & I/S as Other omp Income Repted on I/S as unrealized G/L Not recognized Interest/Dividends Realized G/L Interest/Dividends Unrealized G/L Realized G/L Investee s s earnings losses 21 7

8 Fair Value Option - FS 159; S vailable-f f- Sale Held-to to-maturity Equity Method lassified as Equity Method Elect Fair Value Option Election is Irrevocable lassified as Trading Repted at Fair Value Unrealized Gains/Losses repted as net income onvergence 22 lpha purchased 25% of Beta f $200,000 and elected the fair value option. The fair value and book value of Beta s s net assets were $800,000 (not $600,000 and $540,000). t year-end, end, Beta repted the following: = $240,000 ($240,000 x 25% = $60,000) Dividends paid = $36,000 ($36,000 x 25% = $9,000) Beta s s fair value = $1, ($1, x 25% = $27) Use the equity method the entire year and make the fair value adjustment at year-end. end. (1) Find the carrying value $200,000 Share of Beta s s income +60,000 Share of Dividends -9,000 arrying value $251, (2) Find the unrealized gain/loss Unrealized gain/loss = $27-251,000 = $24,000 gain Fair Value djustment Unrealized Gain 24,000 24,000 (3) Find what is included in net income Share of Beta s s income $60,000 Unrealized gain 24,000 Included in net income $84,

9 Treat as a trading security the entire year and make the entire fair value adjustment at year-end. end. (1) Find the unrealized gain/loss Unrealized gain/loss = $27-200,000 = $7 gain Fair Value djustment Unrealized Gain 7 7 (2) Find what is included in net income Dividend income $ 9,000 Unrealized gain 7 Included in net income $84, Impairment of Investments S Impairment = FV is less than (amtized) cost. Other Than Tempary Impairment (OTTI) FS Equity (not trading securities) HTM FS Debt annot assert the intent and ability to hold f recovery. Severity, duration, & financial condition are facts. Intent to sell (at a loss) Required to sell (me likely than not) Non-Recovery (befe selling) redit loss (recognize in earnings) redit loss = amtized cost basis minus PV of expected cash flow. Non-credit loss (recognize in OI) Recognize in earnings Recognize in earnings 26 Facts: 5%, 10-year, $ bond = $ Interest = $500 per year fter 5 years, FV = $6,000 Loss = $ - $6,000 = $4,000 Future cash flow: Principal = $7,000 Interest = 4% $400 PV of principal = $7,000 x = $5,485 PV of interest = $400 x = 1,732 PV of future cash flow = $7,217 redit loss = $ - $7,217 = $2,783 Non-credit loss = $4,000 - $2,783 = $1,217 Earnings OI 27 9

Answer Key Unit 1: Financial Accounting

Answer Key Unit 1: Financial Accounting nswer Key Unit 1: Financial ccounting Module 1: ccounting Theory, Recording and ontrol Systems 1.1.1 ccounting Fundamentals No. nswers Further explanations 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1 16 17 18 19