16 Investments

LEARNING OBJECTIVES
After studying this chapter, you should be able to:
1 Accounting for Held-to-maturity 4 Accounting for Equity Holdings
debt securities of less than 20%
2 Accounting for Available-for-sale 5 Accounting for Equity more than
debt securities equal 20% and less than 50%
3 Accounting for debt Trading
securities
Types of Investments

Keep yourself liquid. Diversify.

Financial Assets
A financial asset is an asset whose value comes from a contractual claim
to cash flows.
Debt Investment Classifications

1) Held-to-Maturity
➢The company has
a. the positive intent and
b. ability to hold to maturity

2) Trading
➢ To sell in the near term to generate income on short-term price
differences

3) Available-for-sale Examples of Debt Securities:

➢Not one of the above two • U.S. government securities
• Municipal securities
• Corporate bonds
• Convertible debt
• Commercial paper
 Accounting for Debt Securities by Category

• Amortized cost is the acquisition cost adjusted for the amortization of

discount or premium, if appropriate.
• Fair value is the market price of similar securities
• For trading and available-for-sale securities, you still need to calculate
the amortized cost.
• The unrealized holding gains or loss is the difference of amortized cost & fair value
Investments in Debt Securities : 1. Held-to-
Maturity Securities
• Companies use held-to-maturity securities for the following reasons.
• To earn a spread (net income) on the difference between the
collection of interest revenue and the payment of interest expense
on borrowed funds
• To diversify their portfolio of investments
• To eliminate the volatility in reported earnings or reported capital,
• When purchased, it is recognized at acquisition cost
DR Debt Investments
CR Cash
• When, effective interest rate > coupon rate then amortize discount
• When, effective interest rate < coupon rate then amortize premium
• using the effective-interest method or straight-line method.
Held-to-Maturity Securities (Amortized Cost) –
Initial Recognition
E16.5 On January 2, 2020, Phantom Company acquires $200,000 of
Spiderman Products, Inc., 9% bonds at a price of $185,589. Interest is
received on January 1 of each year, and the bonds mature on January 1,
2023. The investment will provide Phantom Company a 12% yield. The
bonds are classified as held-to-maturity. Journalize the entry on January
1, 2020.
Effective Interest Rate

Debt Investments 185,589

Cash 185,589
Schedule of Bond Discount Amortization:
Effective- Interest Method
Cash
Received Interest Carrying
= Stated Revenue Bond Discount Amount of
Interest = Effective Amortization Bonds
Rate X Yield X = Interest = Issue Price +
Face Carrying Revenue – Accumulated
Date Value Amount Cash Received Amortization
1/2/20 — — — $185,589.00

1/1/21 $18,000 $22,270.68* $4,270.68** 189,859.68

1/1/22 18,000 22,783.16 4,783.16 194,642.84

1/1/23 18,000 23,357.16 5,357.16 200,000.00

**Interest Revenue first year = $185,589 X .12 = $22,270.68

**Bond Discount Amortization first year = $22,270.68 - 18,000 = $ 4,270.68
Subsequent Journal Entries for Held-to-
Maturity Securities
Cash
Received Interest Carrying
= Stated Revenue Bond Discount Amount of
Interest = Effective Amortization Bonds
Rate X Yield X = Interest = Issue Price +
Face Carrying Revenue – Accumulated
Date Value Amount Cash Received Amortization
1/2/20 — — — $185,589.00

1/1/21 $18,000 $22,270.68 $4,270.68 189,859.68

1/1/22 18,000 22,783.16 4,783.16 194,642.84

1/1/23 18,000records
Phantom Company 23,357.16
the receipt of5,357.16
the first interest200,000.00
payment and
amortizes the discount on January 1, 2021, as follows:
Cash 18,000
Debt Investments 4,270.68
Interest Revenue 22,270.68
Subsequent Journal Entries for Held-to-
Maturity Securities
Cash
Received Interest Carrying
= Stated Revenue Bond Discount Amount of
Interest = Effective Amortization Bonds
Rate X Yield X = Interest = Issue Price +
Face Carrying Revenue – Accumulated
Date Value Amount Cash Received Amortization
1/2/20 — — — $185,589.00
1/1/21 $18,000 $22,270.68 $4,270.68 189,859.68
If Phantom Company
1/1/22 18,000 is 22,783.16
on a calendar-year basis, it accrues
4,783.16 interest
194,642.84
and amortizes the discount at December 31, 2020, as follows:
1/1/23 18,000 23,357.16 5,357.16 200,000.00
Interest Receivable 18,000
Debt Investments 4,270.68
Interest Revenue 22,270.68
On January 01, 2021 it records interest in cash received as follows:
Cash 18,000
Interest Receivable 18,000
Subsequent Journal Entries for Held-to-
Maturity Securities
Cash
Received Interest Carrying
= Stated Revenue Bond Discount Amount of
Interest = Effective Amortization Bonds
Rate X Yield X = Interest = Issue Price +
Face Carrying Revenue – Accumulated
Date Value Amount Cash Received Amortization
1/2/20 — — — $185,589.00
1/1/21 $18,000 $22,270.68* $4,270.68** 189,859.68

1/1/22 As of December
18,000 31, 2020 on 4,783.16
22,783.16 the balance sheet
194,642.84
Current Assets
1/1/23 18,000 23,357.16 5,357.16 200,000.00
Interest Receivable $18,000
Long term Investments
Debt Investments (Held-to-Maturity) $189,859.68
Income Statement as for the year 2021
Other revenues and gains
Interest Revenue $ 22,270.68
Concept Check
On January 3, 2020, Moss Company acquires $500,000 of
Adam Company’s 10-year, 10% bonds at a price of $532,090 to
yield an effective return of 9%. Interest is payable each
December 31. The bonds are classified as held-to-maturity.

What is the amount of interest revenue that would be recognized

in 2020 related to these bonds?

a. $50,000
b. $53,208
c. $47,888
d. $47,698
Concept Check
Patton Company purchased $1,500,000 of 10% bonds of Scott Company on
January 1, 2021, paying $1,410,375. The bonds mature January 1, 2031;
interest is payable each July 1 and January 1. The bond is discounted to a
total of $89,625 to reflect the effective yield of 11%. Patton Company uses the
effective-interest method and plans to hold these bonds to maturity.

On July 1, 2021, Patton Company should recognize interest revenue from the
Scott Company bonds by

a. $77,571.
b. $55,283.
c. $82,500.
d. $75,000.
Concept Check
Patton Company purchased $1,500,000 of 10% bonds of Scott Company on
January 1, 2021, paying $1,410,375. The bonds mature January 1, 2031;
interest is payable each July 1 and January 1. The bond is discounted to a
total of $89,625 to reflect the effective yield of 11%. Patton Company uses the
effective-interest method and plans to hold these bonds to maturity.

On July 1, 2021, Patton Company should increase its Debt Investments

account due to discount amortization by

a. $8,970.
b. $5,140.
c. $4,485.
d. $2,571.