Chapter 8

Investments
Stocks
8-1
Investor (entity that

owns stock or bonds of
a corporation)
Investee (entity that

issues stock)
Bonds
Debtor (entity that

issues bonds)
Copyright 2015 Pearson Education Inc. All rights reserved.
Stock and Bond Prices
During the previous 52 weeks, Intel common stock had a
8-2
High price of $29.27 per share and a low of $19.23 per share
Annual cash dividend was $0.90 per share
17.34 million shares traded the previous day
Stock closed at $21.26, up $0.11 from preceding day
Reporting Investments on the Balance

Sheet
Short-term or long-term
Short-term investments are current assets
8-3
Trading
Held-to-maturity
Available-for-sale
To be listed as short-term
must be liquid (readily convertible to cash), and
intend to convert investment to cash within one year

or to use it to pay a current liability
Investments on the Balance Sheet

Exhibit 8-2 | Reporting Investments on the Balance Sheet
8-4
Learning Objective
1. Analyze and report investments in held-tomaturity debt securities
8-5
ANALYZE AND REPORT INVESTMENTS

IN HELD-TO-MATURITY DEBT SECURITIES
Relationship between issuing corporation and investor
If investing company intends to hold a debt security until

maturity, it accounts for the security at amortized cost
8-6
LO 1

Reported at amortized cost
Interest received semi-annually
Usually issued in $1,000 denominations
Price is quoted as percent of par
Fluctuate with market interest rates

If market rate > face rate, sell at discount
If market rate < face rate, sell at premium
8-7
LO 1

Initially recorded at cost
Interest revenue recorded at semiannual interest

payment date
Premium or discount is amortized
8-8
Carrying value is adjusted towards face value
Face value received at maturity
LO 1

Illustration: Intel Capital
8-9
Purchases $10,000 of 6% CBS bonds at a price of 95.2

on April 1, 2014
Intends to hold bonds until their maturity date, April 1,

2018
Interest dates are semiannual, on April 1 and October 1
Bonds mature on April 1, 2018, they will be outstanding

for four years (48 months)
LO 1

Intel Capital records the purchase of $10,000 of 6% CBS bonds
at a price of 95.2 on April 1, 2014.
Bond issue price = $10,000 x 0.952 = $9,520
Account
Apr 1
Held-to-Maturity Investment
Debit
Credit
9,520
9,520
Cash
To purchase bond investment
8-10
LO 1

Intel Capital purchased $10,000 of 6% CBS bonds at a price of
95.2 on April 1, 2014. Intel records the receipt of interest and
amortization of the discount on October 1, 2014, as follows:
Account
Oct 1
Cash ($10,000 x .06 x 6/12)
Debit
Credit
300
300
Interest Revenue
To receive semiannual interest
Oct 1
Interest Revenue
60 *
60
Amortize discount on bond investment

8-11
* [($10,000 - $9,520) 48] x 6 = 60

LO 1

Intel Capital purchased $10,000 of 6% CBS bonds at a price of
95.2 on April 1, 2014. At December 31, 2014, Intel Capitals
year-end adjustments are:
Account
Dec 31
Interest Receivable
Debit
Credit
150
150
Interest Revenue
$10,000 x 0.06 x 3/12
Dec 31
Interest Revenue
30
30
[($10,000 - $9,520) 48] x 3

8-12
LO 1

Financial statements of Intel Capital at December 31, 2014
By April 1, 2018 (maturity date) carrying value will equal face value
8-13
LO 1
Learning Objective
2. Analyze and report investments in available-forsale securities
8-14

IN AVAILABLE-FOR-SALE SECURITIES
Available-for-Sale Securities
8-15
Less than 20% ownership
Long-term
Recorded at cost
Adjusted to fair value at

each reporting period
Exhibit 8-3 | Accounting Methods for LongTerm Stock Investments by Percentage

of Ownership
LO 2

Illustration: Intel purchases 1,000 shares of Hewlett-Packard
common stock at the market price of $44 per share. Intel intends to
hold this investment for longer than a year and therefore treats it as
a long-term available-for-sale security (AFSS). Intels entry to
record the investment is
Account
Oct 23
Investment in AFSS (1,000 x $44)
Debit
Credit
44,000
44,000
Cash
Purchase investment
8-16
LO 2

Illustration: Assume that Intel receives a $0.20 cash dividend per
share on the Hewlett-Packard stock. Intels entry to record receipt
of the dividend is
Account
Nov 14
Cash (1,000 x $20)

Dividend Revenue
Debit
Credit
200
200
Received Cash Dividend
8-17
LO 2
The Fair Value Adjustment (AFSS)

GAAP requires available-for-sale securities be reported at
fair value as of the balance sheet date
Three approaches to determine fair value
8-18
Level 1: Quoted prices in active markets for identical

assets
Level 2: Estimates based on prices for similar assets
Level 3: Estimates based on companys own estimates
LO 2

Carrying Amount of Investment
Original cost of investment
Debit balance in Allowance to

Adjust Investments to Market
If fair
value >
cost
OR
Credit balance in Allowance to
Adjust Investments to Market
8-19
If fair
value <
cost
LO 2

Illustration: Continuing with the previous example, assume that
the quoted market price of the stock is $46.50, making fair value of
the 1,000 shares of Hewlett-Packard common stock $46,500 on
December 31, 2014. In this case, Intel makes the following entry to
adjust the investment to fair value:
Account
Dec 31
Allowance to Adjust Investment in AFSS to Market
Unrealized Gain on Investment in AFSS
Debit
Credit
2,500
2,500
($46,500 - $44,000)
8-20
LO 2

Illustration:
If investments fair value increases, allowance is debited
8-21
LO 2

Unrealized Gains and Losses
Fair value
declines
DEBIT
Unrealized loss on
investments
Reported as
element of other
comprehensive
income
Fair value
increases
8-22
CREDI
T
Unrealized gain on
investments
LO 2

Unrealized Gain (or Loss) on Investment in AFSS account
Change in owners equity
8-23
Reported as element of accumulated other

comprehensive income
Bypasses net income
Reported in separate
Statement of comprehensive income or
Section of income statement below net income in a

combined statement of income and comprehensive
income
LO 2

Statement of Comprehensive Income
8-24
LO 2
Selling an Available-for-Sale Investment

Suppose Intel sells its entire investment in Hewlett-Packard stock
for $43,000 during 2015. Intel would record the sale as follows:
Account
May 19
Debit
Credit
2,500
2,500
Eliminate unrealized gain on AFSS sold

May 19
Cash
43,000
Loss on Sale of Investment in AFSS

Investment in AFSS
1,000
44,000
Sold investment
8-25
LO 2
Suppose Intel Corporation holds the following available-for-sale

securities as long-term investments at December 31, 2015:
Show how Intel will report long-term investments on its December

31, 2015, balance sheet.
Answer
:
8-26
Assets
Investment in AFSS
$83,000
LO 2
Illustration
Journalize the following long-term available-for-sale security
transactions of Barbara Brothers Department Stores:
a. Purchased 410 shares of California Fine Foods common stock
at $35 per share, with the intent of holding the stock for the
indefinite future.
b. Received a cash dividend of $1.90 per share on the California
Fine Foods investment.
c. At year-end, adjusted the investment account to fair value of
$41 per share.
d. Sold the California Fine Foods stock for the price of $25 per
share.
8-27
LO 2
Illustration: Journal entries for long-term available-for-sale

security transactions of Barbara Brothers Department Stores:
Account
a.
Investment in AFSS (410 x $35)
Debit
14,350
14,350
Cash
b.
Cash (410 x $1.90)
779
779
Dividend Revenue
c.
Credit
2,460
2,460
(410 shares x ($41 - $35) = $2,460)
8-28
LO 2
Illustration: Journal entries for long-term available-for-sale

security transactions of Barbara Brothers Department Stores:
Account
d.
Debit
Credit
2,460
2,460
Eliminate unrealized gain on AFSS sold

d.
Cash (410 x $25)

Loss on Sale of Investment in AFSS
Investment in AFSS
10,250
4,100
14,350
Sold investment
8-29
LO 2
Learning Objective
3. Analyze and report investments in affiliated
companies using the equity method
8-30
ANALYZE AND REPORT INVESTMENTS IN

AFFILIATED COMPANIES USING THE
EQUITY METHOD
Buying a Large Stake in Another Company
Method used when investor owns between 20 50% of

investees voting stock
8-31
Investor has significant influence over investee

operations
Investment initially recorded at cost
Investor records its share of investee net income and

dividends
LO 3
Equity-Method Investments
Illustration: January 1, 2014, Intel pays $490 million for 49% of the
ownership of IM Flash Technologies, LLC. Intels entry to record the
purchase of this investment follows (in millions):
Account
Jan 1
Equity-method Investment
Credit
490
490
Cash
8-32
Debit
LO 3
Illustration: IM Flash Technologies reports net income of $300
million for 2014, Intel records 49% of this amount as follows (in
millions):
Account
Dec 31 Equity-method Investment
Debit
Credit
147
Equity-method Investment Revenue
147
Net income $300 million x 49% = $147 million
8-33
LO 3
Illustration: IM Flash declares and pays a cash dividend of $200
million, Intel receives 49% of this dividend and records this entry
(in millions):
Account
Dec 31 Cash
Debit
Credit
98
98
Dividends $200 million x 49% = $98 million
8-34
LO 3
Illustration: Intels Equity-method Investment account at
December 31, 2014, shows Intels equity in the net assets of IM
Flash Technologies (in millions):
8-35
LO 3
Intel Corporation December 31, 2014
8-36
LO 3
Illustration: Intels sale of 20% of the IM Flash Technologies
common stock for $100 million on January 1, 2015 would
be recorded as follows (in millions):
Account
Jan 1
Debit
Cash
100.0
Loss on Sale Equity-method Investment
Purchase of 49%
% of investee income
Dividends received
$ 490
+ 147
- 98
7.8
107.8
8-37
Credit
x 20% = $107.8
LO 3
Summary of Accounting:
8-38
LO 3
Illustration
Larsen Corporation owns equity-method investments in several
companies. Suppose Larsen paid $1,800,000 to acquire a 40%
investment in Lim Software Company. Lim Software reported net
income of $650,000 for the first year and declared and paid cash
dividends of $450,000.
Requirements
1. Record the following in Larsens journal: (a) purchase of the
investment, (b) Larsens proportion of Lim Softwares net
income, and (c) receipt of the cash dividends.
2. What is the ending balance in Larsens investment account?
8-39
LO 3
Illustration: Journal entries for equity-method investment

transactions of Larsen Corporation:
Account
a.
Debit
1,800,000
1,800,000
Cash
b.
Credit
260,000
260,000
Equity-method Investment Revenue

($650,000 x 40%)
c.
Cash ($450,000 x 40%)

8-40
180,000
180,000
LO 3
Illustration: What is the ending balance in Larsens investment

account?
Purchase
$1,800,000
Earnings
260,000
180,000
Dividends
End balance $1,880,000
8-41
LO 3
Learning Objective
4. Analyze and report controlling interests in other
corporations using consolidated financial
statements
8-42
CONTROLLING INTERESTS IN OTHER

CORPORATIONS USING CONSOLIDATED
FINANCIAL STATEMENTS
Why Buy Controlling Interest in Another
Company?
8-43
Investor controls investee
Owns more than 50% of investees voting stock
Investor can elect majority of board members
Investor is called the parent company
Investee is called the subsidiary
LO 4
Why Buy Controlling Interest in Another

Company?
McAfee, Inc. is a Subsidiary of Intel Corporation. Stockholders
of Intel control McAfee, Inc., as shown in Exhibit 8-4
Exhibit 8-4
8-44
LO 4
Consolidation Accounting
Method of combining financial statements of all

companies controlled by same stockholders
Result is a single set of statements as if parent and its

subsidiaries are one company
Gives better perspective on total operations than

individual statements
Worksheet is used to combine parent and sub accounts
8-45
Intercompany accounts are eliminated
LO 4
Consolidation Accounting
Exhibit 8-6 | Parent Company

with Consolidated Subsidiaries
and an Equity-Method Investment
Consolidated
entities are enclosed
by the dashed line
8-46
LO 4
Consolidated Balance Sheet Work Sheet

Exhibit 8-7 | Work Sheet for a Consolidated Balance Sheet
8-47
LO 4
Examine Exhibit 8-7. Why does the consolidated stockholders

equity ($176,000 + $155,000) exclude the equity of Subsidiary
Corporation?
Answer
:
The stockholders equity of the consolidated entity is that of the

parent only.
To include the stockholders equity of the subsidiary as well as the
investment in the subsidiary on the parents books would be
double counting.
8-48
LO 4
Goodwill and Noncontrolling Interest

Noncontrolling
Interest
Goodwill
8-49
Arises when parent

pays more to acquire a
subsidiary than the fair
value of its net assets
Arises when parent

company owns less
than 100% of
subsidiary stock
Recorded as an
intangible asset
Recorded as a
separate account in the
stockholders equity
section
LO 4
Income of a Consolidated Entity

Illustration: Suppose Parent Company owns all the stock of
Subsidiary S-1 and 60% of the stock of Subsidiary S-2. During the
year just ended, Parent earned net income of $330,000, S-1
earned $150,000, and S-2 had a net loss of $100,000. Parent
Company would report net income computed as follows:
8-50
Advance slide in presentation mode to reveal answers

LO 4
Accounting Methods for Long-Term Investments

Type of Long-Term Investment
Intel owns a portfolio of bond
and other debt securities as well
as equity securities (less than
20%)
that itbetween
intends 20
to hold
Intel owns
50%longof
term
investee/affiliate stock
Accounting
Method
Available-forsale
Equity
Intel owns more than 50% of

investee stock
Consolidation
Intel owns bonds that it intends

to hold to maturity
Amortized cost
8-51
LO 4
Many U.S. companies conduct a large part of their

business abroad. Intel, General Electric, and PepsiCo,
among others, are more active in other countries
than they are in the United States. In fact, Intel earns 84% of its
revenue outside the United States. Exhibit 8-8 shows the
approximate percentages of international revenues for these
companies.
LO 4
Foreign Currencies and Exchange Rates
International business often results in companies

receiving or paying in a foreign currency
Measure of one nations currency against another:
Conversion of an item in one currency to another:
8-53
Foreign-currency exchange rate
Translation
LO 4
Factors Affecting Exchange Rates

Ratio of Imports to
Exports
8-54
If exports exceed
imports, increase in
demand drives up price
of currency
If imports exceed
exports, supply
increases and currency
price falls
Rate of Return in
Capital Markets
If high, increases
international
investments and
demand for currency
LO 4
Foreign Currency Translation Adjustments
8-55
Foreign subsidiaries financial statements are translated

into US dollars
Assets and liabilities at current exchange rates
Stockholders equity at historical exchange rates
Difference cause out-of-balance condition
Translation adjustment needed to balance
LO 4

Illustration: Intel has an Italian subsidiary whose financial
statements are expressed in euros (the European currency).
Intel must consolidate the Italian subsidiarys financials into its
own statements. When Intel acquired the Italian company in
2009, a euro was worth $1.35 (assumed). When the Italian firm
earned its retained income during 20092014, the average
exchange rate was $1.30 (assumed). On the balance sheet
date in 2014, a euro is worth only $1.20 (assumed).
Exhibit 8-10 shows how to translate the Italian companys
balance sheet into dollars.
8-56
LO 4

Illustration: Exhibit 8-10 shows how to translate the Italian
companys balance sheet into dollars
Exhibit 8-10
8-57
Foreign-currency translation adjustment is the balancing amount

that brings total liabilities and equity into agreement with total assets
LO 4
Learning Objective
5. Report investing activities on the statement of
cash flow
8-58
REPORT INVESTING ACTIVITIES ON THE

STATEMENT OF CASH FLOWS
Exhibit 8-11 | Intel Corporations Investing Activities on the Statement of Cash Flows
8-59
LO 5
Learning Objective
6. Explain the impact of the time value of money on
certain types of investments
8-60
IMPACT OF THE TIME VALUE OF MONEY

ON CERTAIN TYPES OF INVESTMENTS
Time Value of Money
8-61
Money earns interest over time
Interest is the cost of using money
To borrowers, interest is the fee
To lenders, interest is the revenue earned
LO 6
TIME VALUE OF MONEY

Future Value
Value at a specified date in the future
Suppose you invest $4,545 in corporate bonds that pay

10% interest each year. After one year, the value of your
investment has grown to $5,000
Exhibit 8-12 | Future

Value of an Investment
8-62
LO 6
TIME VALUE OF MONEY

Future Value
To calculate, need three inputs:

1. Amount of initial payment (or receipt)
2. Length of time between investment and future receipt (or
payment)
3. Interest rate
Compound interest is interest you receive on the interest you

have already earned
8-63
LO 6
TIME VALUE OF MONEY

Future Value
The following table shows interest revenue earned on the
original $4,545 investment each year for five years at 10%:
8-64
LO 6
Present Value
Value on a given date of a future payment or series of

future payments, discounted to reflect the time value of
money
Often called discounting
To simplify calculations
8-65
Present value tables
Excel software
Single amount or annuity
LO 6
Present Value
Illustration: In our investment example, the future receipt is
$5,000. The investment period is one year. Assume that you
demand an annual interest rate of 10% on your investment. With
all three factors specified, you can compute the present value of
$5,000 at 10% for one year:
8-66
LO 6
Present Value
Illustration: If the $5,000 is to be received two years from now, you
will pay only $4,132 for the investment, as shown in Exhibit 8-13.
Exhibit 8-13 | Present Value: An Example
Difference of $868 between amount invested ($4,132) and amount to

be received ($5,000) is the return on investment
8-67
LO 6
Present Value Tables

Illustration: Compute the present value of $5,000 at 10% for one
year:
Present Value?
Future Value $5,000
What table do we use?
8-69
LO 6
Present Value Tables

i=10%
n=1
$5,000
Future Value
8-70
.909
Factor
$4,545
Present Value
LO 6
Present Value of an Ordinary Annuity

Ordinary annuity investments provide multiple receipts of an
equal amount at fixed year-end intervals over the investments
duration
Illustration: Compute the present value an investment that
promises annual cash receipts of $10,000 to be received at the
end of each year for three years. Assume a 12% return on
investment.
Present Value?
Future Values
$10,000 $10,000 $10,000
0
8-71
6
LO 6
Present Value of an Ordinary Annuity

i=12%
n=3
$10,000
Future Receipts
8-72
2.402
Factor
$24,020
Present Value
LO 6
Present Value of an Investment in Bonds

Illustration: Compute the present value of 9% five-year bonds
of Southwest Airlines from the standpoint of an investor
Face value of bonds is $100,000
Face interest rate is 9% annually
Market interest rate is assumed to be 10% annually
8-73
Bonds pay 4 1/2% interest semiannually
5% rate used to compute present value
Market price of these bonds is $96,149
LO 6
Present Value of an Investment in Bonds

Illustration: Compute the present value of 9% five-year bonds
of Southwest Airlines from the standpoint of an investor
8-74
LO 6
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Investments

Investor (entity that

Investee (entity that

Debtor (entity that

Copyright 2015 Pearson Education Inc. All rights reserved.

Stock and Bond Prices

During the previous 52 weeks, Intel common stock had a

Annual cash dividend was $0.90 per share

17.34 million shares traded the previous day

Stock closed at $21.26, up $0.11 from preceding day

Copyright 2015 Pearson Education Inc. All rights reserved.

Reporting Investments on the Balance

Short-term investments are current assets

must be liquid (readily convertible to cash), and

intend to convert investment to cash within one year

Investments on the Balance Sheet

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

If investing company intends to hold a debt security until

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Reported at amortized cost

Interest received semi-annually

Usually issued in $1,000 denominations

Price is quoted as percent of par

Fluctuate with market interest rates

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Initially recorded at cost

Interest revenue recorded at semiannual interest

Premium or discount is amortized

Carrying value is adjusted towards face value

Face value received at maturity

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Purchases $10,000 of 6% CBS bonds at a price of 95.2

Intends to hold bonds until their maturity date, April 1,

Interest dates are semiannual, on April 1 and October 1

Bonds mature on April 1, 2018, they will be outstanding

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Cash ($10,000 x .06 x 6/12)

Amortize discount on bond investment

* [($10,000 - $9,520) 48] x 6 = 60

ANALYZE AND REPORT INVESTMENTS

[($10,000 - $9,520) 48] x 3

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Copyright 2015 Pearson Education Inc. All rights reserved.

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Less than 20% ownership

Adjusted to fair value at

Exhibit 8-3 | Accounting Methods for LongTerm Stock Investments by Percentage

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Investment in AFSS (1,000 x $44)

Copyright 2015 Pearson Education Inc. All rights reserved.

ANALYZE AND REPORT INVESTMENTS

Cash (1,000 x $20)