CH 12: Equity Investments & Debt Investments (Concepts from slides)

What is an equity investment?

money that is invested in a company by purchasing shares of that company in the stock market.
-These shares are typically traded on a stock exchange, but can be privately held.

-Owners of common stock will typically have a vote on key decisions made by the company

What are the three categories for investing in equity?

1. Does not have significant influence (<20%)

2. Has significant influence ( 20-50%)

3. Control (>50%)

What are the four steps for accounting for equity investments?

1. Purchasing equity security

2. Recognizing Income - treatment of dividends and net income

3. Fair Value Changes (unrealized holding gains and losses)

4. Selling the investment (realized gains and losses)

What are the accounts in the journal entry for a purchase/initial investment (>20%)?

DR: Investment - Equity Securities

CR: Cash

What are the accounts in the journal entry for dividends received (>20%)?

DR: Cash

CR: Dividend Revenue

What is the journal entry for income (>20%)?

NO ENTRY

What are the accounts in the journal entry for fair value changes (increase or a decrease (>20% control)?

Increase:
DR: Fair Value Adjustment - Equity Securities
CR: Unrealized Gain on investment - Equity Securities

Decrease:
DR: Unrealized Loss on Investment -- Equity Securities (Income Statement)
CR: Fair Value Adjustment - Equity Securities

What are the accounts in the journal entry for sale of investment (>20% control)?

If value increased:
DR: Cash

CR: Fair Value Adjustment - Equity Securities

CR: Investment - Equity Security

If value decreased:
DR: Cash

DR: Fair Value Adjustment - Equity Securities
CR: Investment - Equity Security

What are the accounts in the journal entry for a purchase/initial investment (20%-49%)?

DR: Investment in Equity Affiliate
CR: Cash

What are the accounts in the journal entry for a purchase/initial investment (20%-49%)?

DR: Investment in Equity Affiliate
CR: Investment Revenue

What are the accounts in the journal entry for collecting dividends (20-49%)?

DR: Cash
CR: Investment in Equity Affiliate

What is the journal entry for fair value changes (20-49% control)?

NO ENTRY

What are the accounts in the journal entry for Sale of Investment (Gain or Loss)(20-49%)?

Gain
DR: Cash
CR: Investment in Equity Affiliate (adj book value)
CR: Gain on Investment

Loss
DR: Cash

DR: Loss on Investment

CR: Investment in Equity Affiliate (adj book value)

If you are trying to control the company (50%<)?

You have to consolidate the other company into your own financial statements.

On January 1, Year 1, Big Company purchased 25% of Small Company for $200,000. During Year 1, Big Company had net income of $1,200,000, and Small Company had net income of $60,000. Additionally, Small Company paid total dividends during Year 1 of $20,000. Show the journal entries to record (1) the investment, (2) the effect of Small Company’s income on Big Company, and (3) the effect of Small Company’s dividends on Big Company

Initial Investment:
DR: Investment in Equity Affiliate 200,000

CR: Cash 200,000

Small Company’s Income
DR: Investment in Equity Affiliate 15,000
CR: Investment Revenue 15,000

Small Company’s Dividends
DR: Cash 5,000
CR: Investment in Equity Affiliate 5,000

What is a debt investment?

Bond or other debt security that has a specified date when it will mature with interest paid at specified dates

What are the three types of debt investments?

1. Held-to-Maturity (HTM)

2. Trading Security (TS)

3. Available-for-sale (AFS)

What are Held-to maturity (HTM) investments?

“positive intent & ability” to hold to maturity

What are trading securities?

Held in active trading account for immediate resale (typically hold asset 3 month or less)

What are the 4 recording events of debt investments?

1. Purchase of debt (same for all 3)

2. Receiving Interest (same for all 3)

3. Changes in Fair Value

4. Eliminating Investment