Reporting and Analyzing Investments

Accounting for Stock Investments

Learning Objectives

• LO 1 Explain how to account for debt investments (skipped in this lecture).
• LO 2 Explain how to account for equity investments.
• LO 3 Discuss how debt and stock investments are reported in the financial statements (focusing on stock investments).

Reasons for Corporations to Purchase Investments

• Excess cash available.
• To generate earnings from investment income.
• For strategic reasons.

Accounting for Stock Investments: Ownership Percentages

The accounting method depends on the investor's influence over the investee's operating and financial affairs.

• Holdings of Less Than 20%
  • Companies use the cost method.
  • Investment is recorded at cost.
  • Revenue is recognized only when cash dividends are received.
  • Cost includes all expenditures to acquire the investments (price paid + brokerage fees).

Recording Acquisition of Stock (Less Than 20%)

Illustration: Sanchez Corporation acquires 1,000 shares (10% ownership) of Beal Corporation common stock at $40$ per share on July 1, 2022.

Entry:

July 1  Stock Investments (1,000 x $40)  40,000
        Cash                                   40,000

Recording Dividends (Less Than 20%)

Illustration: Sanchez receives a $2$ per share dividend on December 31.

Entry:

Dec. 31  Cash (1,000 x $2)            2,000
         Dividend Revenue              2,000

Recording Sale of Stock (Less Than 20%)

Illustration: Sanchez Corporation receives net proceeds of $39,500$ on the sale of Beal stock on February 10, 2023. The stock cost $40,000$, resulting in a $500$ loss.

Entry:

Feb. 10  Cash                              39,500
         Loss on Sale of Stock Investments  500
         Stock Investments                40,000

• Holdings Between 20% and 50%
  • Equity Method:
    • The investor records the investment at cost.
    • The investment amount is adjusted annually for:
      • Proportionate share of the investee's earnings (losses).
      • Dividends received.

Journal Entries (20% - 50%)

Illustration: Milar Corporation acquires 30% of Beck Company for $120,000$ on January 1, 2022. Beck reports net income of $100,000$ and paid dividends of $40,000$ for 2022.

Entries:

Jan. 1  Stock Investments         120,000
        Cash                      120,000

Dec. 31  Stock Investments ($100,000 × 30%)  30,000
         Revenue from Stock Investments       30,000

Dec. 31  Cash ($40,000 x 30%)           12,000
         Stock Investments                12,000

Investments and Revenue Accounts (20% - 50%)

Illustration: (Same as above)

After Milar posts the transactions, its investment and revenue accounts reflect these entries.

Question

Under the equity method, the investor records dividends received by crediting:

• Dividend Revenue

• Investment Income

• Revenue from Investment

• Stock Investments (Correct Answer)

• Holdings of More Than 50%

  • Controlling Interest:
    • The investor is the parent.
    • The investee is the subsidiary.
    • The parent generally prepares consolidated financial statements.
    • Consolidated statements show the magnitude and scope of operations under common control.

Reporting Stock Investments in Financial Statements

Valuation and reporting depend on the level of influence.

• Equity Securities Adjusting Entry for Less Than 20% Holdings

Illustration: Shelton Corporation has two equity securities with less than 20% ownership.

Dec. 31  Fair Value Adjustment—Stock  1,800
         Unrealized Gain or Loss—Income    1,800

Balance Sheet Presentation

• Short-Term Investments (Marketable Securities):

  • Readily marketable.
  • Intended to be converted into cash within one year or the operating cycle (whichever is longer).
  • Reported at fair value.
  • Trading securities are always classified as short-term.
  • Available-for-sale securities can be short-term or long-term.

• Long-Term Investments:

  • Available-for-sale securities are reported at fair value.
  • Investments in common stock accounted for under the equity method are reported at equity.

Presentation of Realized and Unrealized Gain or Loss