CH 17

Investments
Chapter
17
Intermediate Accounting
12th Edition
Kieso, Weygandt, and Warfield
Chapter
17-1 Prepared by Coby Harmon, University of California, Santa Barbara
Learning Objectives
1. Identify the three categories of debt securities and describe
the accounting and reporting treatment for each category.
2. Understand the procedures for discount and premium
amortization on bond investments.
3. Identify the categories of equity securities and describe the
accounting and reporting treatment for each category.
4. Explain the equity method of accounting and compare it to
the fair value method for equity securities.
5. Describe the disclosure requirements for investments in debt
and equity securities.
6. Discuss the accounting for impairments of debt and equity
investments.
7. Describe the accounting for transfer of investment securities
between categories.
Chapter
17-2
Investments
Investments in Debt Investments in Equity Other Reporting

Securities Securities Issues
Held-to-maturity Holdings of less than Financial statement

securities 20% presentation
Available-for-sale Holdings between 20% Impairment of value
securities and 50%
Transfers between
Trading securities Holdings of more than categories
50%
Fair value
controversy
Chapter
17-3
Investments
Different motivations for investing:
To earn a high rate of return.
To secure certain operating or financing

arrangements with another company.
Chapter
17-4
Investments
Companies account for investments based on

 the type of security (debt or equity) and
 their intent with respect to the investment.

Illustration 17-1
Chapter
17-5
Investments in Debt Securities
Debt securities (creditor relationship):
Type Accounting
Category
U.S. government
securities Held-to-maturity
Municipal securities Trading
Corporate bonds Available-for-sale
Convertible debt
Commercial paper
Chapter LO 1 Identify the three categories of debt securities and describe
17-6
Investments in Debt Securities
Accounting for Debt Securities by Category

Illustration 17-2
Chapter LO 1 Identify the three categories of debt securities and describe

17-7
Held-to-Maturity Securities
Classify a debt security as held-to-maturity only

if it has both
(1) the positive intent and
(2) the ability to hold securities to maturity.
Accounted for at amortized cost, not fair value.
Amortize premium or discount using the effective-

interest method unless the straight-line method—
yields a similar result.
Chapter LO 2 Understand the procedures for discount and

17-8
premium amortization on bond investments.
E17-3 (Held-to-Maturity Securities) On January 1, 2006,

Hi and Lois Company purchased 12% bonds, having a
maturity value of $300,000, for $322,744. The bonds
provide the bondholders with a 10% yield. They are dated
January 1, 2006, and mature January 1, 2011, with interest
receivable December 31 of each year. Hi and Lois Company
uses the effective-interest method to allocate
unamortized discount or premium. The bonds are classified
in the held-to-maturity category.
Instructions (a) Prepare the journal entry at the date of
the bond purchase.
17-9
E17-3 (a) Prepare the journal entry at the date of the

bond purchase.
January 1, 2006:
Held-to-Maturity Securities 322,744
Cash 322,744

17-10
E17-3 (b) Prepare a bond amortization schedule.

10%
Cash Interest Premium Carrying
Date Received Revenue Amortized Amount
1/1/06 $ 322,744
12/31/06 $ 36,000 $ 32,274 $ 3,726 319,018
12/31/07 36,000 31,902 4,098 314,920
12/31/08 36,000 31,492 4,508 310,412
12/31/09 36,000 31,041 4,959 305,453
12/31/10 36,000 30,547 * 5,453 300,000
* rounding
17-11
E17-3 (c) (d) Prepare the journal entry to record the

interest received and the amortization for 2006 & 2007.
December 31, 2006:
Cash 36,000
Interest Revenue 32,274
December 31, 2007:

Cash 36,000
17-12
Available-for-Sale Securities
Companies report available-for-sale securities at

 fair value, with
 unrealized holding gains and losses reported as
part of comprehensive income (equity).
Any discount or premium is amortized.

17-13
E17-4 (Available-for-Sale Securities) Assume the same
information as in E17-3 except that the securities are
classified as available-for-sale. The fair value of the bonds
at December 31 for 2006 and 2007 is $320,500 and
$309,000, respectively.
Instructions
(a) Prepare the journal entry at date of bond purchase.
(b) Prepare the journal entries to record the interest
received and recognition of fair value for 2006.
(c) Prepare the journal entry to record recognition of fair
value for 2007.
17-14
E17-4 (a) Prepare the journal entry at date of bond

purchase.
January 1, 2006:
Available-for-Sale Securities 322,744
Cash 322,744

17-15
E17-4 (b) Prepare the journal entries to record the

interest received and recognition of fair value for 2006.
December 31, 2006:
Cash 36,000
Available-for-Sale Securities 3,726
Securities Fair Value Adjustment-AFS 1,482

Unrealized Holding Gain/Loss 1,482
($320,500 – $319,018 = $1,482)

17-16
E17-4 (c) Prepare the journal entry to record recognition

of fair value for 2007.
December 31, 2007:
Unrealized Holding Gain/Loss 7,402
Securities Fair Value Adjustment-AFS 7,402
Available-for-sale bonds at cost $ 314,920

Available-for-sale bonds at fair value 309,000
Unrealized holding gain (loss) (5,920)
Previous securities fair value adjustment—Dr. 1,482
Securities fair value adjustment—Cr. $ (7,402)
17-17
Sale of Available-for-Sale Securities

If company sells bonds before maturity date:
Must make entry to remove the,

 Cost in Available-for-Sale Securities and
 Securities Fair Value Adjustment accounts.
Any realized gain or loss on sale is reported in

the “Other expenses and losses” section of the
income statement.
17-18
Trading Securities
Companies report trading securities at

 fair value, with
 unrealized holding gains and losses reported as
part of net income.
Any discount or premium is amortized.

17-19
Trading Securities
BE17-4 (Trading Securities) Pete Sampras Corporation

purchased trading investment bonds for $40,000 at par.
At December 31, Sampras received annual interest of
$2,000, and the fair value of the bonds was $38,400.
Instructions
 Prepare the journal entry for the purchase of the
investment.
 Prepare the journal entries for the interest received.
 Prepare the journal entry for the fair value
adjustment.
17-20
Trading Securities
BE17-4 Prepare the journal entries for (a) the purchase of

the investment, (b) the interest received, and (c) the fair
value adjustment.
(a) Trading securities 40,000

Cash 40,000
(b) Cash 2,000

Interest revenue 2,000
(c) Unrealized Holding Loss - Income 1,600

Securities Fair Value Adj.- Trading 1,600

17-21
Investments in Equity Securities
Represent ownership of capital stock.
Cost includes:
 price of the security, plus
 broker’s commissions and fees related to purchase.
The degree to which one corporation (investor)

acquires an interest in the common stock of another
corporation (investee) generally determines the
accounting treatment for the investment subsequent
to acquisition.
Chapter LO 3 Identify the categories of equity securities and describe the
17-22
Investments in Equity Securities
Ownership Percentages
0 --------------20% ------------ 50% -------------- 100%

SFAS 115 APBO 18, SFAS 141,
SFAS 142 SFAS 142
No significant Significant Control

influence influence usually exists
usually exists usually exists
Investment Investment Investment valued on

valued using valued using parent’s books using Cost
Fair Value Equity Method or Equity Method
Method Method (investment eliminated in
Consolidation)
17-23
Holdings of Less Than 20%
Accounting Subsequent to Acquisition
Market Price Market Price

Available Unavailable
Value and report the Value and report the
investment using the investment using the
fair value method. cost method.*
* Securities are reported at cost. Dividends are recognized when

received and gains or losses only recognized on sale of securities.

17-24
Accounting and Reporting – Fair Value Method
Because equity securities have no maturity date, companies cannot

classify them as held-to-maturity.
17-25
P17-6 Loxley Company has the following portfolio of

securities at September 30, 2007, its last reporting date.
Trading Securities Cost Fair Value

Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000
On Oct. 10, 2007, the Fogelberg shares were sold at a price

of $54 per share. In addition, 3,000 shares of Los Tigres
common stock were acquired at $59.50 per share on Nov. 2,
2007. The Dec. 31, 2007, fair values were: Petra $96,000, Los
Tigres $132,000, and the Weisberg common $193,000.

17-26
P17-6 Prepare the journal entries to record the sale,

purchase, and adjusting entries related to the trading
securities in the last quarter of 2007.
Portfolio at September 30, 2007
Trading Securities Cost Fair Value
Dan Fogelberg, Inc. common (5,000 shares) $ 225,000 $ 200,000
Petra, Inc. preferred (3,500 shares) 133,000 140,000
Tim Weisberg Corp. common (1,000 shares) 180,000 179,000
$ 538,000 $ 519,000
Securities Fair Value Adjustment - credit ($19,000)

17-27
P17-6 Prepare the journal entries to record the sale,

purchase, and adjusting entries related to the trading
securities in the last quarter of 2007.
October 10, 2007 (Fogelberg):
Cash (5,000 x $54) 270,000
Trading securities 225,000
Gain on sale 45,000
November 2, 2007 (Los Tigres):

Trading securities (3,000 x $59.50) 178,500
Cash 178,500

17-28
P17-6 Portfolio at December 31, 2007

Unrealized
Trading Securities Cost Fair Value Gain (Loss)
Petra, Inc. preferred $ 133,000 $ 96,000 $ (37,000)
Tim Weisberg Corp. common 180,000 193,000 13,000
Los Tigres common 178,500 132,000 (46,500)
$ 491,500 $ 421,000 (70,500)
Prior securities fair value adjustment balance (19,000)
Securities fair value adjustment $ (51,500)
December 31, 2007:

Unrealized holding loss - income 51,500
Securities fair value adj. - Trading 51,500
17-29
P17-6 How would the entries change if the securities

were classified as available-for-sale?
The entries would be the same except that the

Unrealized Holding Gain or Loss—Equity account is
used instead of Unrealized Holding Gain or Loss—
Income.
The unrealized holding loss would be deducted from
the stockholders’ equity section rather than charged
to the income statement.

17-30
Holdings Between 20% and 50%
An investment (direct or indirect) of 20 percent or

more of the voting stock of an investee should lead
to a presumption that in the absence of evidence to
the contrary, an investor has the ability to exercise
significant influence over an investee.
In instances of “significant influence,” the investor

must account for the investment using the equity
method.
Chapter LO 4 Explain the equity method of accounting and compare

17-31
it to the fair value method for equity securities.
Equity Method
Record the investment at cost and subsequently
adjust the amount each period for
 the investor’s proportionate share of the
earnings (losses) and
 dividends received by the investor.
If investor’s share of investee’s losses exceeds the carrying

amount of the investment, the investor ordinarily should
discontinue applying the equity method.
17-32
E17-17 (Equity Method) On January 1, 2007, Pennington

Corporation purchased 30% of the common shares of
Edwards Company for $180,000. During the year,
Edwards earned net income of $80,000 and paid
dividends of $20,000.
Instructions
Prepare the entries for Pennington to record the
purchase and any additional entries related to this
investment in Edwards Company in 2007.

17-33
E17-17 Prepare the entries for Pennington to record the

purchase and any additional entries related to this
investment in Edwards Company in 2007.
Investment in Stock 180,000
Cash 180,000
Investment in Stock 24,000

Investment Revenue ($80,000 x 30%) 24,000
Cash 6,000
Investment in Stock ($20,000 x 30%) 6,000
17-34
Holdings of More Than 50%
Controlling Interest - When one corporation

acquires a voting interest of more than 50 percent
in another corporation
 Investor is referred to as the parent.
 Investee is referred to as the subsidiary.
 Investment in the subsidiary is reported on
the parent’s books as a long-term investment.
 Parent generally prepares consolidated
financial statements.
17-35
Financial Statement Presentation
Report trading securities at aggregate fair value

as current assets.
Report held-to-maturity and available-for-sale

securities as current or noncurrent.
 Aggregate fair value, gross unrealized holding
gains, gross unrealized losses, amortized cost
basis by type (debt and equity), and
information about the maturity of debt
securities.
Chapter LO 5 Describe the disclosure requirements for
17-36
investments in debt and equity securities.
Disclosures Required under the Equity Method

1. Name of each investee and percentage ownership.
2. Accounting policies of the investor.
3. Difference between amount in the investment account
and amount of underlying equity in the net assets of the
investee.
4. The aggregate value of each identified investment
based on quoted market price (if available).
5. When material, present information concerning assets,
liabilities, and results of operations of the investees.
17-37
Reclassification Adjustments
Company needs a reclassification adjustment when
it reports
 realized gains or losses as part of net income
but also
 shows the amounts as part of other
comprehensive income in the current or in
previous periods.

17-38
Impairment of Value
Impairments of debt and equity securities are

• losses in value that are determined to be other
than temporary,
• based on a fair value test, and
• are charged to income.
Chapter
17-39 LO 6 Discuss the accounting for impairments of debt and equity investments.
Transfers Between Categories
Transfers between Trading and Available-for-Sale
Security transferred at fair value.
Unrealized gain or loss at date of transfer

increases or decreases stockholders’ equity.
Unrealized gain or loss at date of transfer is

recognized in income.
Chapter LO 7 Describe the accounting for transfer of

17-40 investment securities between categories.
Transfer from Held-to-Maturity to

Available-for-Sale
• Security transferred at fair value.
• Separate component of stockholders’ equity is
increased or decreased by the unrealized gain or
loss at date of transfer .
• NO impact of transfer on net income.

Transfer from Available-for-Sale to

Held-to-Maturity
• Security transferred at fair value.
• Unrealized gain or loss at date of transfer
carried as a separate component of stockholders’
equity is amortized over the remaining life of the
security.
• NO impact of transfer on net income.

Fair Value Controversy
Major Unresolved Issues
Measurement Based on Intent
Gains Trading
Liabilities Not Fairly Valued
Subjectivity of Fair Values
Chapter
17-43
Copyright
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information contained herein.
Chapter
17-44

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Investments

Investments in Debt Investments in Equity Other Reporting

Held-to-maturity Holdings of less than Financial statement

Different motivations for investing:

To earn a high rate of return.

To secure certain operating or financing

Companies account for investments based on

 their intent with respect to the investment.

Debt securities (creditor relationship):

Accounting for Debt Securities by Category

Chapter LO 1 Identify the three categories of debt securities and describe

Classify a debt security as held-to-maturity only

Accounted for at amortized cost, not fair value.

Amortize premium or discount using the effective-

Chapter LO 2 Understand the procedures for discount and

E17-3 (Held-to-Maturity Securities) On January 1, 2006,

E17-3 (a) Prepare the journal entry at the date of the

Chapter LO 2 Understand the procedures for discount and

E17-3 (b) Prepare a bond amortization schedule.

E17-3 (c) (d) Prepare the journal entry to record the

December 31, 2007:

Companies report available-for-sale securities at

Any discount or premium is amortized.

Chapter LO 2 Understand the procedures for discount and

E17-4 (a) Prepare the journal entry at date of bond

Chapter LO 2 Understand the procedures for discount and

E17-4 (b) Prepare the journal entries to record the

Securities Fair Value Adjustment-AFS 1,482

Chapter LO 2 Understand the procedures for discount and

E17-4 (c) Prepare the journal entry to record recognition

Available-for-sale bonds at cost $ 314,920

Sale of Available-for-Sale Securities

Must make entry to remove the,

 Securities Fair Value Adjustment accounts.

Any realized gain or loss on sale is reported in

Companies report trading securities at

Any discount or premium is amortized.

Chapter LO 2 Understand the procedures for discount and

BE17-4 (Trading Securities) Pete Sampras Corporation

BE17-4 Prepare the journal entries for (a) the purchase of

(a) Trading securities 40,000

(b) Cash 2,000

(c) Unrealized Holding Loss - Income 1,600

Chapter LO 2 Understand the procedures for discount and

Represent ownership of capital stock.

The degree to which one corporation (investor)

0 --------------20% ------------ 50% -------------- 100%

No significant Significant Control

Investment Investment Investment valued on

Accounting Subsequent to Acquisition

Market Price Market Price

* Securities are reported at cost. Dividends are recognized when

Chapter LO 3 Identify the categories of equity securities and describe the

Accounting and Reporting – Fair Value Method

Because equity securities have no maturity date, companies cannot

P17-6 Loxley Company has the following portfolio of

Trading Securities Cost Fair Value

On Oct. 10, 2007, the Fogelberg shares were sold at a price

Chapter LO 3 Identify the categories of equity securities and describe the