FEATURE STORY

Playing for Fun and Profit

Sony (JPN) has thrived for decades despite being engaged in lines of business that are constantly changing. It is not an environment for the timid. Sony began in 1945 as a radio repair shop in Tokyo. Soon, it was making Japan’s first tape recorders. Long before Apple’s (USA) iPod, Sony changed the way the world listened to music by developing high-quality, low-cost transistor radios, which enabled people to listen to music on the go. Then came the Walkman portable tape player, which combined Sony’s tape recorder technology with its ability to make things small. When CDs replaced audio cassettes, Sony was ready with the Discman. Over the years as technologies, tastes, and lifestyles changed, Sony adapted and invested.

Much of Sony's success in electronics is due to the innovative spirit within the Sony Electronics division. As a result of this innovative spirit, Sony has invented many game-changing new products. However, despite its internal successes, Sony has not been afraid to invest in other companies when it saw strategic advantages and opportunities. For example, Sony Electronics recently acquired Hawk-Eye Innovations (GBR) and Chip Plant (JPN) to enhance the competitiveness of its product lines.

One of Sony's most well-known recent successes is the PlayStation® video-gaming console. PlayStations have outsold all competitors. Yet, even in this case, Sony has made strategic investments to strengthen its position. In order to stay on top, Sony’s Computer Entertainment Division has invested in numerous other video-gaming companies including Zipper Interactive (USA), Sucker Punch Productions (USA), and Media Molecule (GBR).

Although Sony is probably best known for technology, the reality is that it engages in many different business lines. Much of its growth outside of electronics has resulted from major strategic acquisitions. Two of its biggest acquisitions occurred when Sony Music Entertainment acquired CBS Records (USA) and when Sony Pictures Entertainment acquired Columbia Pictures Entertainment (USA). In both instances, Sony became a major player by boldly acquiring a large, established business.

Sony has also made investments that were less than 100% acquisitions. For example, it partnered in a 50% joint venture called Sony Ericsson with Ericsson (SWE) to make cell phones. It also has a one-third interest in a joint venture with Sharp (JPN) to make LCD panels, and it acquired a 20% interest in movie company Metro- Goldwyn-Mayer (USA). To succeed in an ever-changing world, Sony will need to continue to innovate internally as well as make smart investments. ■

PREVIEW OF CHAPTER 12

Sony’s (JPN) management believes in aggressive growth through investing in the shares of existing companies. Besides purchasing shares, companies also purchase other securities such as bonds issued by corporations or by governments. Companies can make investments for a short or long period of time, as a passive investment, or with the intent to control another company. As you will see in this chapter, the way in which a company accounts for its investments is determined by a number of factors.

The content and organization of Chapter 12 are as follows.

The Navigator

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   Why Corporations Invest

Learning Objective 1

Discuss why corporations invest in debt and share securities.

Corporations purchase investments in debt or share securities generally for one of three reasons. First, a corporation may have excess cash that it does not need for the immediate purchase of operating assets. For example, many companies experience seasonal fluctuations in sales. A marina has more sales in the spring and summer than in the fall and winter. (The reverse is true for many ski shops.) At the end of an operating cycle, the marina may have cash on hand that is temporarily idle until the start of another operating cycle. It may invest the excess funds to earn a greater return—interest and dividends—than it would get by just holding the funds in the bank. Illustration 12-1 depicts the role that such temporary investments play in the operating cycle.

Excess cash may also result from economic cycles. For example, when the economy is booming, Siemens (DEU) generates considerable excess cash. It uses some of this cash to purchase new plant and equipment, and pays out some of the cash in dividends. But, it may also invest excess cash in liquid assets in anticipation of a future downturn in the economy. It can then liquidate these investments during a recession, when sales slow and cash is scarce.

When investing excess cash for short periods of time, corporations invest in low-risk, highly liquid securities—most often short-term government securities. It is generally not wise to invest short-term excess cash in ordinary shares because share investments can experience rapid price changes. If you did invest your short-term excess cash in shares and the price of the shares declined significantly just before you needed cash again, you would be forced to sell your investment at a loss.

A second reason some companies purchase investments is to generate earnings from investment income. For example, banks make most of their earnings by lending money, but they also generate earnings by investing primarily in debt securities. Conversely, mutual share funds invest primarily in share securities in order to benefit from share-price appreciation and dividend revenue.

Third, companies also invest for strategic reasons. A company can exercise some influence over a customer or supplier by purchasing a significant, but not controlling, interest in that company. Or, a company may purchase a noncontrolling interest in another company in a related industry in which it wishes to establish a presence. A corporation may also choose to purchase a controlling interest in another company. For example, Kraft (USA) recently purchased Cadbury (GBR) to expand its presence in the food industry.

In summary, businesses invest in other companies for the reasons shown in Illustration 12-2.

   Accounting for Debt Investments

Learning Objective 2

Explain the accounting for debt investments.

Debt investments are investments in government and corporation bonds. In accounting for debt investments, companies make entries to record (1) the acquisition, (2) the interest revenue, and (3) the sale.

Recording Acquisition of Bonds

At acquisition, investments are recorded at cost. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus brokerage fees (commissions), if any.

Assume, for example, that Kuhl NV acquires 50 Doan SA 8%, 10-year, €1,000 bonds on January 1, 2017, at a cost of €50,000. The entry to record the investment is:

Recording Bond Interest

The Doan SA bonds pay interest of €4,000 annually on January 1 (€50,000 ×8%). If Kuhl NV’s fiscal year ends on December 31, it accrues the interest of €4,000 earned since January 1. The adjusting entry is:

Kuhl reports Interest Receivable as a current asset in the statement of financial position. It reports Interest Revenue under “Other income and expense” in the income statement.

Kuhl reports receipt of the interest on January 1 as follows.

A credit to Interest Revenue at this time is incorrect because the company earned and accrued interest revenue in the preceding accounting period.

Recording Sale of Bonds

When Kuhl NV sells the bonds, it credits the investment account for the cost of the bonds. Kuhl records as a gain or loss any difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the bonds.

Assume, for example, that Kuhl receives net proceeds of €54,000 on the sale of the Doan SA bonds on January 1, 2018, after receiving the interest due. Since the securities cost €50,000, the company realizes a gain of €4,000. It records the sale as:

Kuhl reports any gains or losses on the sale of debt investments under “Other income and expense” in the income statement.

   Accounting for Share Investments

Learning Objective 3

Explain the accounting for share investments.

Share investments are investments in the shares of other corporations. When a company holds shares (and/or debt) of several different corporations, the group of securities is identified as an investment portfolio.

The accounting for investments in shares depends on the extent of the investor’s influence over the operating and financial affairs of the issuing corporation (the investee). Illustration 12-3 (page 604) shows the general guidelines.

Companies are required to use judgment instead of blindly following the guidelines.¹ We explain the application of each guideline next.

• HELPFUL HINT
The entries for investments in ordinary shares also apply to investments in preference shares.

Holdings of Less than 20%

In accounting for share investments of less than 20%, companies use the cost method. Under the cost method, companies record the investment at cost, and recognize revenue only when cash dividends are received.

RECORDING ACQUISITION OF SHARES

At acquisition, share investments are recorded at cost. Cost includes all expenditures necessary to acquire these investments, such as the price paid plus any brokerage fees (commissions).

For example, assume that on July 1, 2017, Lee Ltd. acquires 1,000 shares (10% ownership) of Beal Ltd. Lee pays HK$405 per share. The entry for the purchase is:

RECORDING DIVIDENDS

During the time Lee owns the shares, it makes entries for any cash dividends received. If Lee receives a HK$20 per share dividend on December 31, the entry is:

Lee reports Dividend Revenue under “Other income and expense” in the income statement. Unlike interest on notes and bonds, dividends do not accrue. Therefore, companies do not make adjusting entries to accrue dividends.

RECORDING SALE OF SHARES

When a company sells a share investment, it recognizes as a gain or a loss the difference between the net proceeds from the sale (sales price less brokerage fees) and the cost of the shares.

Assume that Lee Ltd. receives net proceeds of HK$395,000 on the sale of its Beal shares on February 10, 2018. Because the shares cost HK$405,000, Lee incurred a loss of HK$10,000. The entry to record the sale is:

Lee reports the loss under “Other income and expense” in the income statement.

Holdings Between 20% and 50%

When an investor company owns only a small portion of the ordinary shares of another company, the investor cannot exercise control over the investee. But, when an investor owns between 20% and 50% of the ordinary shares of a corporation, it is presumed that the investor has significant influence over the financial and operating activities of the investee. When an investor has significant influence but not control over an investee, it refers to the investee as an associate. The investor probably has a representative on the associate’s board of directors and, through that representative, may exercise some control over the associate. The associate company in some sense becomes part of the investor company.

Under the equity method, the investor records its share of the net income of the associate in the year when it is earned. An alternative might be to delay recognizing the investor’s share of net income until the associate declares a cash dividend. But, that approach would ignore the fact that the investor and associate are, in some sense, one company, making the investor better off by the associate’s earned income.

Under the equity method, the investor company initially records the investment in ordinary shares of an associate at cost. After that, it adjusts the investment account annually to show the investor’s equity in the associate. Each year, the investor does the following. (1) It increases (debits) the investment account and increases (credits) revenue for its share of the associate’s net income.2 (2) The investor also decreases (credits) the investment account for the amount of dividends received. The investment account is reduced for dividends received because payment of a dividend decreases the net assets of the associate.

• HELPFUL HINT
Under the equity method, the investor recognizes revenue on the accrual basis, i.e., when it is earned by the associate.

RECORDING ACQUISITION OF SHARES

Assume that Milar plc acquires 30% of the ordinary shares of Beck plc for £120,000 on January 1, 2017. The entry to record this transaction is:

RECORDING REVENUE AND DIVIDENDS

For 2017, Beck reports net income of £100,000. It declares and pays a £40,000 cash dividend. Milar records (1) its share of Beck’s income, $\pounds \mathrm{30,000}(30\%\times \pounds \mathrm{100,000})$, and (2) the reduction in the investment account for the dividends received, $\pounds \mathrm{12,000}(\pounds \mathrm{40,000}\times 30\%)$. The entries are:

After Milar posts the transactions for the year, its investment and revenue accounts will show the following.

During the year, the investment account increased £18,000. This increase of £18,000 is explained as follows: (1) Milar records a £30,000 increase in revenue from its share investment in Beck, and (2) Milar records a £12,000 decrease due to dividends received from its share investment in Beck.

Note that the difference between reported revenue under the cost method and reported revenue under the equity method can be significant. For example, Milar would report only $\pounds \mathrm{12,000}(30\%\times \pounds \mathrm{40,000})$ of dividend revenue if it used the cost method.

Holdings of More than 50%

Learning Objective 4

Describe the use of consolidated financial statements.

A company that owns more than 50% of the ordinary shares of another entity is known as the parent company The entity whose shares the parent company owns is called the Subsidiary (affiliated) company. Because of its share ownership, the parent company has a controlling interest in the subsidiary.

When a company owns more than 50% of the ordinary shares of another company, it usually prepares consolidated financial statements. These statements present the total assets and liabilities controlled by the parent company. They also present the total revenues and expenses of the subsidiary companies. Companies prepare consolidated statements in addition to the financial statements for the parent and individual subsidiary companies.

• HELPFUL HINT
If parent (A) has three wholly owned subsidiaries (B, C, and D), there are four separate legal entities. From the viewpoint of the shareholders of the parent company, there is only one economic entity.

Consolidated statements are useful to the shareholders, board of directors, and managers of the parent company. These statements indicate the magnitude and scope of operations of the companies under common control. For example, regulators and the courts undoubtedly used the consolidated statements of AT&T (USA) to determine whether a breakup of the company was in the public interest. Illustration 12-5 lists three companies that prepare consolidated statements and some of the companies they have owned. Appendix 12A discusses how to prepare consolidated financial statements.

   Valuing and Reporting Investments

Learning Objective 5

Indicate how debt and share investments are reported in financial statements.

The value of debt and share investments may fluctuate during the time they are held. For example, in one 12‐month period, the share price of Unilever (NLD) hit a high of $44.41 and a low of $36.57. In light of such price fluctuations, how should companies value investments at the statement of financial position date? Valuation could be at cost, at fair value, or at the lower‐of‐cost‐or‐net realizable value.

Many people argue that fair value offers the best approach because it represents the expected cash realizable value of securities. Fair value is the amount for which a security could be sold in a normal market. Others counter that, unless a security is going to be sold soon, the fair value is not relevant because the price of the security will likely change again.

Categories of Securities

In general, IFRS 9 requires that companies determine how to measure their financial assets based on two criteria: (1) the company’s business model for managing its financial assets, and (2) the contractual cash flow characteristics of the specific financial asset. As a result of applying these criteria, investment securities are generally classified as trading, non‐trading, or held‐for‐collection.

DEBT INVESTMENTS For purposes of valuation and reporting at a financial statement date, companies classify debt investments into two categories.

1. Trading securities are bought and held primarily for sale in the near term to generate income on short‐term price differences. At the financial reporting date, these securities are adjusted to their fair value with changes reported in net income.
2. Held-for-collection securities are debt investments that a company intends to hold, to collect the contractual cash flows. At the financial reporting date, these securities are reported at amortized cost. Amortized cost is the initial cost of the investment, minus any repayments received, and plus or minus cumulative amortization of discounts or premiums. Amortization of bond discounts and premiums using the effective‐interest method is discussed in Appendix 10A.

SHARE INVESTMENTS Share investments do not have fixed interest or principal payment schedules and therefore are never classified as held‐for‐collection securities. Share investments are classified into two categories.

1. Trading securities (as defined above).
2. Non-trading securities are share investments held for purpose other than trading. For example, a company may hold a share investment for strategic reasons, such as to sell a product in a particular area. These securities are accounted for at fair value. The change in fair value during the year is not reported in net income. Instead, the change in value is reported as a component of other comprehensive income in the comprehensive income statement.

Illustration 12-6 shows the valuation guidelines for these securities. These guidelines apply to all debt securities and to those share investments in which the holdings are less than 20%.

TRADING SECURITIES

Companies hold trading securities with the intention of selling them in a short period (generally less than a month). Trading means frequent buying and selling. As indicated in Illustration 12-6, companies adjust trading securities to fair value at the end of each period (an approach referred to as mark‐to‐market accounting). They report changes from cost as part of net income. The changes are reported as unrealized gains or losses because the securities have not been sold. The unrealized gain or loss is the difference between the total cost of trading securities and their total fair value. Companies classify trading securities as current assets.

• HELPFUL HINT
The fact that trading securities are short‐term investments increases the likelihood that they will be sold at fair value (the company may not be able to time their sale) and the likelihood that there will be realized gains or losses.

Illustration 12-7 shows the cost and fair values for investments Pace SA classified as trading securities on December 31, 2017. This was Pace’s first year of operations. Pace has an unrealized gain of €7,000 because total fair value of €147,000 is €7,000 greater than total cost of €140,000.

Pace records fair value and unrealized gain or loss through an adjusting entry at the time it prepares financial statements. In this entry, the company uses a valuation allowance account, Fair Value Adjustment—Trading, to record the difference between the total cost and the total fair value of the securities. The adjusting entry for Pace is:

The use of a Fair Value Adjustment—Trading account enables Pace to maintain a record of the investment cost. It needs actual cost to determine the gain or loss realized when it sells the securities. Pace adds the debit balance (or subtracts a credit balance) of the Fair Value Adjustment—Trading account to the cost of the investments to arrive at a fair value for the trading securities.

The fair value of the securities is the amount Pace reports on its statement of financial position. It reports the unrealized gain in the income statement in the “Other income and expense” section. The term “Income” in the account title Unrealized Gain—Income indicates that the gain affects net income.

If the total cost of the trading securities is greater than total fair value, an unrealized loss has occurred. In such a case, the adjusting entry is a debit to Unrealized Loss—Income and a credit to Fair Value Adjustment—Trading. Companies report the unrealized loss under “Other income and expense” in the income statement.

The Fair Value Adjustment—Trading account is carried forward into future accounting periods. The company does not make any entry to the account until the end of each reporting period. At that time, the company adjusts the balance in the account to the difference between cost and fair value. For trading securities, it closes the Unrealized Gain (Loss)—Income account at the end of the reporting period.

Illustration 12-8 shows the cost and fair values for investments that Pace classified as trading securities on December 31, 2018.

Since the fair value of Pace’s trading securities is €5,000 less than cost at the end of 2018, Pace’s Fair Value Adjustment—Trading account needs to be adjusted to a €5,000 credit balance. It has a €7,000 debit balance from the previous year, so Pace must credit its Fair Value Adjustment—Trading account by $€\mathrm{12,000}(€\mathrm{7,000}+€\mathrm{5,000})$ to achieve a €5,000 credit balance. It debits Unrealized Loss—Income for €12,000 as well. The adjusting entry for Pace is as follows.

NON-TRADING SECURITIES

As indicated earlier, debt investments are classified either as trading or held‐for‐collection securities. Share investments are classified either as trading or non‐trading. Non‐trading securities are share investments that are held for purposes other than trading. If the intent is to sell the securities within the next year or operating cycle, the investor classifies the securities as current assets in the statement of financial position. Otherwise, it classifies them as non‐current assets in the investments section of the statement of financial position.

Companies report non‐trading securities at fair value. The procedure for adjusting to fair value and the unrealized gain or loss for these securities is the same as for trading securities. To illustrate, assume that Ingrao AG has two securities that it classifies as non‐trading. Illustration 12-9 provides information on the cost, fair value, and amount of the unrealized gain or loss on December 31, 2017. This is Ingrao’s first year of operations. There is an unrealized loss of €9,537 because total cost of €293,537 is €9,537 more than total fair value of €284,000.

Both the adjusting entry and the reporting of the unrealized gain or loss for Ingrao’s non‐trading securities differ from those illustrated for trading securities. The differences result because Ingrao does not expect to sell these securities in the near term. Thus, prior to actual sale, it is more likely that changes in fair value may change either unrealized gains or losses. Therefore, Ingrao does not report an unrealized gain or loss in the income statement. Instead, it is a component of other comprehensive income.

In the adjusting entry, Ingrao identifies the fair value adjustment account with non‐trading securities, and it identifies the unrealized gain or loss account with equity. Ingrao records the unrealized loss of €9,537 as follows.

If total fair value exceeds total cost, Ingrao debits Fair Value Adjustment—Non‐Trading and credits Unrealized Gain or Loss—Equity.

The amount of the current period adjustment to the Unrealized Gain or Loss—Equity account is presented in the comprehensive income statement. Suppose that Ingrao had net income during 2017 of €126,200. Its comprehensive income statement would appear as follows.

At December 31, 2017, Ingrao reports on its statement of financial position investments of $€\mathrm{284,000}(\text{cost of }€\mathrm{293,537}-€\mathrm{9,537})$. In its equity section, it reports accumulated other comprehensive income of €9,537. The closing entry to transfer the Unrealized Gain or Loss—Equity to Accumulated Other Comprehensive Income is as follows.

The Accumulated Other Comprehensive Income account aggregates the change in the Unrealized Gain or Loss—Equity account from year to year. Since this was Ingrao’s first year of operations, it started with a balance of zero. The balance in the Accumulated Other Comprehensive Income account, which at this point is a €9,537 loss, is presented by Ingrao in the equity section of its 2017 statement of financial position as follows.

At each future statement of financial position date, Ingrao adjusts the Fair Value Adjustment—Non‐Trading and the Unrealized Gain or Loss—Equity accounts to show the difference between cost and fair value at the time. Illustration 12-12 shows the cost and fair values for investments Ingrao classified as non‐trading securities on December 31, 2018, its second year of operations.

he fair value of Ingrao’s non‐trading securities is €1,637 more than cost at the end of 2018, Ingrao’s Fair Value Adjustment—Non‐Trading account needs to be adjusted to a €1,637 debit balance. It has a €9,537 credit balance from the previous year, so Ingrao must debit its Fair Value Adjustment—Non‐Trading account by $€\mathrm{11,174}(€\mathrm{9,537}+€\mathrm{1,637})$ to achieve a €1,637 debit balance. It credits Unrealized Gain or Loss—Equity for €11,174 as well. The adjusting entry for Ingrao is as follows.

The amount of the current period adjustment to the Unrealized Gain or Loss—Equity account is presented in the comprehensive income statement. Suppose that Ingrao had net income during 2018 of €201,400. Its comprehensive income statement would appear as follows.

At December 31, 2018, Ingrao reports on its statement of financial position investments of $€\mathrm{295,174}(\text{cost of }€\mathrm{293,537}+€\mathrm{1,637})$. In its equity section, it reports accumulated other comprehensive income of €1,637. The closing entry to transfer the Unrealized Gain or Loss—Equity to Accumulated Other Comprehensive Income is as follows.

The balance in the Accumulated Other Comprehensive Income account of €1,637 is presented by Ingrao in the equity section of its 2018 statement of financial position as follows.

Statement of Financial Position Presentation

Learning Objective 6

Distinguish between short‐term and long‐term investments.

In the statement of financial position, companies classify investments as either short‐term or long‐term. Trading securities are always classified as short‐term. Non‐trading securities and held‐for‐collection securities can be either short‐term or long‐term depending on the circumstances.

SHORT-TERM INVESTMENTS

Short-term investments (also called marketable securities) are securities held by a company that are (1) readily marketable and (2) intended to be converted into cash within the next year or operating cycle, whichever is longer. Investments that do not meet both criteria are classified as long-term investments.

READILY MARKETABLE An investment is readily marketable when it can be sold easily whenever the need for cash arises. Short‐term paper³ meets this criterion. It can be readily sold to other investors. Shares and bonds traded on organized securities exchanges are readily marketable. They can be bought and sold daily. In contrast, there may be only a limited market for the securities issued by small corporations, and no market for the securities of a privately held company.

INTENT TO CONVERT Intent to convert means that management intends to sell the investment within the next year or operating cycle, whichever is longer. Generally, this criterion is satisfied when the investment is considered a resource that the investor will use whenever the need for cash arises. For example, a ski resort may invest idle cash during the summer months with the intent to sell the securities to buy supplies and equipment shortly before the winter season. This investment is considered short‐term even if lack of snow cancels the next ski season and eliminates the need to convert the securities into cash as intended.

Because of their high liquidity, short‐term investments appear immediately above Cash in the “Current assets” section of the statement of financial position. They are reported at fair value. For example, Pace SA would report its trading securities as shown in Illustration 12-15.

LONG-TERM INVESTMENTS

Companies generally report long‐term investments in a separate section of the statement of financial position immediately above “Current assets,” as shown later in Illustration 12-18 (page 616). Long‐term investments in held‐for‐collection debt securities are reported at amortized cost. Long‐term investments in non‐trading share investments are reported at fair value. Investments in ordinary shares accounted for under the equity method are reported at equity.

Presentation of Realized and Unrealized Gain or Loss

Companies must present in the financial statements gains and losses on investments, whether realized or unrealized. In the income statement, companies report gains and losses in the non‐operating activities section under the categories listed in Illustration 12-16. Interest and dividend revenue are also reported in that section.

In a comprehensive income statement, companies report unrealized gains or losses on non‐trading securities as other comprehensive income or loss. In the statement of financial position, companies report in the equity section accumulated other comprehensive income or loss. Illustration 12-17 shows the statement of financial position of equity assuming that Dawson plc has share capital—ordinary of £3,000,000, retained earnings of £1,500,000, and an accumulated other comprehensive loss of £100,000.

Note that the presentation of accumulated other comprehensive loss is similar to the presentation of the cost of treasury shares in the equity section (it decreases equity). Accumulated other comprehensive income is added to equity. Reporting the unrealized gain or loss as components of other comprehensive income and in the equity section serves two purposes. (1) It reduces the volatility of net income due to fluctuations in fair value. (2) It informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value.

Companies must report items such as unrealized gains or losses on non‐trading securities as part of comprehensive income. Unrealized gains and losses on non‐trading securities therefore affect comprehensive income (and equity) but are not included in the computation of net income.

Classified Statement of Financial Position

We have presented many sections of classified statements of financial position in this and preceding chapters. The classified statement of financial position in Illustration 12-18 includes, in one place, key topics from previous chapters: the issuance of par value ordinary shares, restrictions of retained earnings, and issuance of bonds. From this chapter, the statement includes (highlighted in red) short‐term and long‐term investments. The investments in short‐term securities are considered trading securities. The long‐term investments in shares of less than 20% owned companies are considered non‐trading securities. Illustration 12-18 also includes a long‐term investment reported at equity and descriptive notations within the statement, such as the cost flow method for valuing inventory and one note to the statement.

APPENDIX 12APreparing Consolidated Financial Statements

Learning Objective *7

Describe the form and content of consolidated financial statements as well as how to prepare them.

Most of the large corporations are holding companies that own other corporations. They therefore prepare consolidated financial statements that combine the separate companies.

Consolidated Statement of Financial Position

Companies prepare consolidated statements of financial position from the individual statements of their affiliated companies. They do not prepare consolidated statements from ledger accounts kept by the consolidated entity because only the separate legal entities maintain accounting records.

All items in the individual statements of financial position are included in the consolidated statement except amounts that pertain to transactions between the affiliated companies. Transactions between the affiliated companies are identified as intercompany transactions. The process of excluding these transactions in preparing consolidated statements is referred to as intercompany eliminations. These eliminations are necessary to avoid overstating assets, liabilities, and equity in the consolidated statement of financial position. For example, amounts owed by a subsidiary to a parent company and the related receivable reported by the parent company would be eliminated. The objective in a consolidated statement is to show only obligations to and receivables from parties who are not part of the affiliated group of companies.

To illustrate, assume that on January 1, 2017, Powers plc pays £150,000 in cash for 100% of Serto plc’s ordinary shares. Powers records the investment at cost. Illustration 12-A presents the separate statements of financial position of the two companies immediately after the purchase, together with combined and consolidated data.⁵ Powers obtains the balances in the “combined” column by adding the items in the separate statements of the affiliated companies. The combined totals do not represent a consolidated statement of financial position because there has been a double‐counting of assets and equity in the amount of £150,000.

•HELPFUL HINT Eliminations are aptly named because they eliminate duplicate data. They are not adjustments.

⁵We use condensed data throughout this material to keep details at a minimum.

The Investment in Serto ordinary shares that appears on the statement of financial position of Powers represents an interest in the net assets of Serto. As a result, there has been a double‐counting of assets. Similarly, there has been a double‐counting in equity because the ordinary shares of Serto are completely owned by the shareholders of Powers.

The balances in the consolidated data column are the amounts that should appear in the consolidated statement of financial position. The double‐counting has been eliminated by showing Investment in Serto at zero and by reporting only the share capital and retained earnings of Powers as equity.

USE OF A WORKSHEET—COST EQUAL TO BOOK VALUE

The preparation of a consolidated statement of financial position is usually facilitated by the use of a worksheet. As shown in Illustration 12A-2 the worksheet for a consolidated statement of financial position contains columns for (1) the statement of financial position data for the separate legal entities, (2) intercompany eliminations, and (3) consolidated data. All data in the worksheet relate to the preceding example in which Powers plc acquires 100% ownership of Serto plc for £150,000. In this case, the cost of the investment, £150,000, is equal to the book value $\left[\pounds \mathrm{150,000}\right(\pounds \mathrm{225,000}-\pounds \mathrm{75,000}\left)\right]$ of the subsidiary’s net assets. The intercompany elimination results in a credit to the investment account maintained by Powers for its balance, £150,000, and debits to the Share Capital and Retained Earnings accounts of Serto for their respective balances, £100,000 and £50,000.

•HELPFUL HINT As in the case of the worksheets explained earlier in this textbook, consolidated worksheets are also optional.

It is important to recognize that companies make intercompany eliminations solely on the worksheet to present correct consolidated data. Neither of the affiliated companies journalizes or posts the eliminations. Therefore, eliminations do not affect the ledger accounts. Powers’ investment account and Serto’s share capital and retained earnings accounts are reported by the separate entities in preparing their own financial statements.

•HELPFUL HINT The consolidated worksheet is another useful spreadsheet application. This is an easier worksheet to attempt since the required instructions are very straightforward.

USE OF A WORKSHEET—COST ABOVE BOOK VALUE

The cost of acquiring the ordinary shares of another company may be above or below its book value. The management of the parent company may pay more than book value for the shares. Why? Because it believes the fair values of identifiable assets such as land, buildings, and equipment are higher than their recorded book values. Or, it may believe the subsidiary’s future earnings prospects warrant a payment for goodwill.

To illustrate, assume the same data used above, except that Powers plc pays £165,000 in cash for 100% of Serto’s ordinary shares. The excess of cost over book value is $\pounds \mathrm{15,000}(\pounds \mathrm{165,000}-\pounds \mathrm{150,000})$. Powers recognizes this amount separately in eliminating the parent company’s investment account, as shown in Illustration.12A-3 Total assets and total equity and liabilities are the same as in the preceding example (£600,000). However, in this case, total assets include £15,000 of Excess of Cost Over Book Value of Subsidiary and current assets are £15,000 less due to the higher price paid to Serto. The disposition of the excess is explained in the next section.

CONTENT OF A CONSOLIDATED STATEMENT OF FINANCIAL POSITION

To illustrate a consolidated statement of financial position, we will use the worksheet shown in Illustration.12A-3 This worksheet shows an excess of cost over book value of £15,000. In the consolidated statement of financial position, Powers first allocates this amount to specific assets, such as plant and equipment and inventory, if their fair values on the acquisition date exceed their book values. Any remainder is considered to be goodwill. For Serto, assume that the fair value of the plant and equipment is £155,000. Thus, Powers allocates £10,000 of the excess of cost over book value to plant and equipment, and the remainder, £5,000, to goodwill. Illustration12A-4 shows the condensed consolidated statement of financial position of Powers plc.

Through innovative financial restructuring, The Coca‐Cola Company (USA) at one time eliminated a substantial amount of non‐intercompany debt. It sold to the public 51% of two bottling companies. The “49% solution,” as insiders call the strategy, enabled Coca‐Cola to keep effective control over the businesses. It also swept $3 billion of debt from its consolidated statement of financial position because it no longer consolidated the two bottling companies. Finally, the new companies obtained independent access to equity markets to satisfy their own large appetites for capital.

Consolidated Income Statement

Affiliated companies also prepare a consolidated income statement. This statement shows the results of operations of affiliated companies as though they are one economic unit. This means that the statement shows only revenue and expense transactions between the consolidated entity and companies and individuals who are outside the affiliated group.

Consequently, all intercompany revenue and expense transactions must be eliminated. Intercompany transactions such as sales between affiliates and interest on loans charged by one affiliate to another must be eliminated. A worksheet facilitates the preparation of consolidated income statements in the same manner as it does for the statement of financial position.

Solutions

PRACTICE EXERCISES

Journalize debt investment transactions, accrue interest, and record sale.

(LO 2)

1. Chen Company purchased 70 Feng Company 6%, 10-year, NT$10,000 bonds on January 1, 2017, for NT$700,000. The bonds pay interest annually on January 1. On January 1, 2018, after receipt of interest, Chen Company sold 42 of the bonds for NT$391,000.

Instructions

Prepare the journal entries to record the transactions described above.

Solution

Journalize share investment transactions.

(LO 3)

2. Cannon AG had the following transactions in 2017 pertaining to share investments.

Feb.	1	Purchased 600 of Ronin ordinary shares (2%) for €6,000 cash.
July	1	Received cash dividends of €1 per share on Ronin shares.
Sept.	1	Sold 300 shares of Ronin shares for €4,200.
Dec.	1	Received cash dividends of €1 per share on Ronin shares.

Instructions

Journalize the transactions.

Solution

3. Sunshine Ltd. started business on January 1, 2017, and has the following data at December 31, 2017.

Prepare adjusting entries for fair value, and indicate statement presentation for two classes of securities.

(LO 5)

Securities	Cost	Fair Value
Trading	£120,000	£125,000
Non-trading	100,000	96,000

The non-trading securities are held as a long-term investment.

Instructions

1. Prepare the adjusting entries to report each class of securities at fair value.
2. Indicate the statement presentation of each class of securities and the related unrealized gain (loss) accounts.

Solution

---

PRACTICE PROBLEM

Journalize transactions and prepare adjusting entry to record fair value.

(LO 3, 5)

In its first year of operations, DeMarco plc had the following selected transactions in share investments that are considered trading securities.

June	1	Purchased for cash 600 shares of Sanburg for £24.50 per share.
July	1	Purchased for cash 800 shares of Cey plc at £33.75 per share.
Sept.	1	Received a £1 per share cash dividend from Cey plc.
Nov.	1	Sold 200 shares of Sanburg for cash at £26.25 per share.
Dec.	15	Received a £0.50 per share cash dividend on Sanburg shares.

At December 31, the fair values per share were Sanburg £25 and Cey £30.

Instructions

1. Journalize the transactions.
2. Prepare the adjusting entry at December 31 to report the securities at fair value.

Solution

WileyPLUS

Brief Exercises, DO IT! Review, Exercises, and Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: Asterisked Questions, Exercises, and Problems relate to material in the appendix to the chapter.

QUESTIONS

1. What are the reasons that corporations invest in securities?

2. 1. What is the cost of an investment in bonds?
   2. When is interest on bonds recorded?

3. Tino Martinez is confused about losses and gains on the sale of debt investments. Explain to Tino (a) how the gain or loss is computed, and (b) the statement presentation of the gains and losses.

4. Kolkata Ltd. sells Gish’s bonds costing Rs40,000 for Rs45,000, including Rs500 of accrued interest. In recording the sale, Kolkata books a Rs5,000 gain. Is this correct? Explain.

5. What is the cost of an investment in shares?

6. To acquire Kinston plc shares, R. Neal pays £63,200. What entry should be made for this investment?

7. 1. When should a long-term investment in ordinary shares be accounted for by the equity method?
   2. When is revenue recognized under this method?

8. Rijo SA uses the equity method to account for its ownership of 30% of the ordinary shares of Pippen Packing. During 2017, Pippen reported a net income of €80,000 and declares and pays cash dividends of €10,000. What recognition should Rijo give to these events?

9. What constitutes “significant influence” when an investor’s financial interest is below the 50% level?

10. Distinguish between the cost and equity methods of accounting for investments in shares.

11. What are consolidated financial statements?

12. What are the classification guidelines for investments at a statement of financial position date?

13. Tina Eddings is the controller of Mendez SLU. At December 31, the company’s investments in trading securities cost €74,000. They have a fair value of €70,000. Indicate how Tina would report these data in the financial statements prepared on December 31.

14. Using the data in Question 13, how would Tina report the data if the investment were long-term and the securities were classified as non-trading?

15. Hashmi Company’s investments in non-trading securities at December 31 show total cost of £195,000 and total fair value of £205,000. Prepare the adjusting entry.

16. Using the data in Question 15, prepare the adjusting entry assuming the securities are classified as trading securities.

17. What is the year-end accounting treatment of the account Unrealized Loss—Equity?

18. What purposes are served by reporting Unrealized Gain or Loss—Equity in the equity section rather than including it in income?

19. Altoona Wholesale Supply owns shares in Key Ltd. Altoona intends to hold the shares indefinitely because of some negative tax consequences if sold. Should the investment in Key be classified as a short-term investment? Why or why not?

20. 1. What asset and equity balances are eliminated in preparing a consolidated statement of financial position for a parent and a wholly owned subsidiary?
    2. Why are they eliminated?

21. Yinhu Company pays HK$318,000,000 to purchase all the outstanding ordinary shares of Lia Ltd. At the date of purchase, the net assets of Lia have a book value of HK$290,000,000. Yinhu’s management allocates HK$20,000,000 of the excess cost to undervalued land on the books of Lia. What should be done with the rest of the excess?

BRIEF EXERCISES

Journalize entries for debt investments.

(LO 2)

BE12-1 Kimmel Industries AG purchased debt investments for CHF50,000 on January 1, 2017. On July 1, 2017, Kimmel received cash interest of CHF1,600. Journalize the purchase and the receipt of interest. Assume that no interest has been accrued.

Journalize entries for share investments.

(LO 3)

BE12-2 On August 1, Paul Company buys 1,000 ordinary shares of Merlynn for €35,700. On December 1, Paul sells the share investments for €40,000 in cash. Journalize the purchase and sale of the ordinary shares.

Record transactions under the equity method of accounting.

(LO 3)

BE12-3 Kayser Company owns 25% of Plano Company. For the current year, Plano reports net income of €190,000 and declares and pays a €40,000 cash dividend. Record Kayser’s equity in Plano’s net income and the receipt of dividends from Plano.

Prepare adjusting entry using fair value.

(LO 5)

BE12-4 The cost of the trading securities of Hardy Company at December 31, 2017, is £62,000. At December 31, 2017, the fair value of the securities is £59,000. Prepare the adjusting entry to record the securities at fair value. This is the company’s first year of operations.

Indicate statement presentation using fair value.

(LO 5, 6)

BE12-5 For the data presented in BE12-4, show the financial statement presentation of the trading securities and related accounts.

Prepare adjusting entry using fair value.

(LO 5)

BE12-6 Amazonas SA holds as a long-term investment non-trading share securities costing R$72,000. At December 31, 2017, the fair value of the securities is R$66,000. Prepare the adjusting entry to record the securities at fair value. This is the company’s first year of operations.

Indicate statement presentation using fair value.

(LO 5)

BE12-7 For the data presented in BE12-6, show the financial statement presentation of the non-trading securities and related accounts. Assume the non-trading securities are non-current.

Prepare investments section of statement of financial position.

(LO 5, 6)

BE12-8 Gurnee Limited has the following long-term investments: (1) Ordinary shares of Kornas Co. (10% ownership) held as non-trading securities, cost £108,000, fair value £115,000. (2) Ordinary shares of Kozanecki OAO. (30% ownership), cost £210,000, equity £270,000. Prepare the investments section of the statement of financial position.

Prepare partial consolidated worksheet when cost equals book value.

(LO 7)

BE12-9 Paula Company acquires 100% of the ordinary shares of Shannon Company for €190,000 cash. On the acquisition date, Shannon’s ledger shows Share Capital—Ordinary €120,000 and Retained Earnings €70,000. Complete the worksheet for the following accounts: Paula—Investment in Shannon Ordinary Shares, Shannon—Share Capital—Ordinary, and Shannon—Retained Earnings.

Prepare partial consolidated worksheet when cost exceeds book value.

(LO 7)

BE12-10 Data for the Paula and Shannon companies are given in BE12-9. Instead of paying €190,000, assume that Paula pays €200,000 to acquire the 100% interest in Shannon Company. Complete the worksheet for the accounts identified in BE12-9 and for the excess of cost over book value.

EXERCISES

Understand debt and share investments.

(LO 1)

E12-1 Mr. Wellington is studying for an accounting test and has developed the following questions about investments.

1. What are three reasons why companies purchase investments in debt or share securities?
2. Why would a corporation have excess cash that it does not need for operations?
3. What is the typical investment when investing cash for short periods of time?
4. What are the typical investments when investing cash to generate earnings?
5. Why would a company invest in securities that provide no current cash flows?
6. What is the typical share investment when investing cash for strategic reasons?

Instructions

Provide answers for Mr. Wellington.

Journalize debt investment transactions and accrue interest.

(LO 2)

E12-2 Floyd Limited had the following transactions pertaining to debt investments.

Jan. 1, 2017	Purchased 50 8%, £1,000 Petal Co. bonds for £50,000 cash. Interest is payable annually on January 1.
Dec.31, 2017	Accrued interest on the Petal Co. bonds.
Jan. 1, 2018	Received interest on Petal Co. bonds.
Jan. 1, 2018	Sold 30 Petal Co. bonds for £33,500.

Instructions

1. Journalize the transactions.
2. Prepare the adjusting entry for the accrual of interest at December 31, 2018.

Journalize debt investment transactions, accrue interest, and record sale.

(LO 2)

E12-3 Brook Company Ltd. purchased 70 Meissner Company AG 9%, 10-year, €1,000 bonds on January 1, 2017, for €70,000. The bonds pay interest annually on January 1. On January 1, 2018, after receipt of interest, Brook Company sold 40 of the bonds for €40,300.

Instructions

Prepare the journal entries to record the transactions described above.

Journalize share investment transactions.

(LO 3)

E12-4 Diann Company Ltd. had the following transactions pertaining to share investments.

Feb.	1	Purchased 600 ordinary shares of Ronn (2%) for £6,200.
July	1	Received cash dividends of £1 per share on Ronn ordinary shares.
Sept.	1	Sold 300 ordinary shares of Ronn for £4,300.
Dec.	1	Received cash dividends of £1 per share on Ronn ordinary shares.

Instructions

1. Journalize the transactions.
2. Explain how dividend revenue and the gain (loss) on sale should be reported in the income statement.

Journalize transactions for investments in shares.

(LO 3)

E12-5 Spring Ltd. had the following transactions pertaining to investments in ordinary shares.

Jan.	1	Purchased 2,500 ordinary shares of Angeltide Limited (5%) for €142,100.
July	1	Received a cash dividend of €2.80 per share.
Dec.	1	Sold 500 ordinary shares of Angeltide Limited for €31,200.
Dec.	31	Received a cash dividend of €2.90 per share.

Instructions

Journalize the transactions.

Journalize transactions for investments in shares.

(LO 3)

E12-6 On February 1, Minitori Company SpA purchased 500 ordinary shares (2% ownership) of Becker Company for €30.80 per share. On March 20, Minitori Company sold 100 shares of Becker for €2,850. Minitori received a dividend of €1.00 per share on April 25. On June 15, Minitori sold 200 shares of Becker for €7,310. On July 28, Minitori received a dividend of €1.25 per share.

Instructions

Prepare the journal entries to record the transactions described above.

Journalize and post transactions under the equity method.

(LO 3)

E12-7 On January 1, Vince SpA purchased a 25% equity in Morelli SpA for £180,000. At December 31, Morelli declared and paid a £36,000 cash dividend and reported net income of £160,000.

Instructions

1. Journalize the transactions.
2. Determine the amount to be reported as an investment in Morelli at December 31.

Journalize entries under cost and equity methods.

(LO 3, 5)

E12-8 Presented below are two independent situations.

1. Chicory Cosmetics acquired 15% of the 200,000 ordinary shares of Racine Fashion at a total cost of €13 per share on March 18, 2017. On June 30, Racine declared and paid a €60,000 dividend. On December 31, Racine reported net income of €122,000 for the year. At December 31, the market price of Racine Fashion was €15 per share. The shares are classified as non-trading.
2. Frank, Ltd., obtained significant influence over Nowak Industries by buying 30% of Nowak’s 30,000 outstanding ordinary shares at a total cost of €9 per share on January 1, 2017. On June 15, Nowak declared and paid a cash dividend of €30,000. On December 31, Nowak reported a net income of €80,000 for the year.

Instructions

Prepare all the necessary journal entries for 2017 for (a) Chicory Cosmetics and (b) Frank, Ltd.

Understand the usefulness of consolidated statements.

(LO 4)

E12-9 Edna Company purchased 70% of the outstanding ordinary shares of Damen Limited.

Instructions

1. Explain the relationship between Edna Company and Damen Limited.
2. How should Edna account for its investment in Damen?
3. Why is the accounting treatment described in (b) useful?

Prepare adjusting entry to record fair value, and indicate statement presentation.

(LO 5, 6)

E12-10 At December 31, 2017, the end of its first year of operations, the trading securities for Geneva, AG are as follows.

Instructions

1. Prepare the adjusting entry at December 31, 2017, to report the securities at fair value.
2. Show the statement of financial position and income statement presentation at December 31, 2017, after adjustment to fair value.

Prepare adjusting entry to record fair value, and indicate statement presentation.

(LO 5, 6)

E12-11 Data for investments in shares classified as trading securities are presented in E12-10. Assume instead that the investments are classified as non-trading securities. They have the same cost and fair value. The securities are considered to be a long-term investment.

Instructions

1. Prepare the adjusting entry at December 31, 2017, to report the securities at fair value.
2. Show the statement of financial position presentation at December 31, 2017, after adjustment to fair value.
3. E. Devonshire, a member of the board of directors, does not understand the reporting of the unrealized gains or losses. Write a letter to Ms. Devonshire explaining the reporting and the purposes that it serves.

Prepare adjusting entries for fair value, and indicate statement presentation for two classes of securities.

(LO 5, 6)

E12-12 Zippydah Company SE has the following data at December 31, 2017.

Securities	Cost	Fair Value
Trading	€120,000	€124,000
Non-trading	100,000	94,000

The non-trading securities are held as a long-term investment. This is the first year of the company’s operations.

Instructions

1. Prepare the adjusting entries to report each class of securities at fair value.
2. Indicate the statement presentation of each class of securities and the related unrealized gain (loss) accounts.

Prepare consolidated worksheet when cost exceeds book value.

(LO 7)

E12-13 On January 1, 2017, Lennon Enterprises acquires 100% of Ono Ltd. for £220,000 in cash. The condensed statements of financial position of the two corporations immediately following the acquisition are as follows.

Instructions

Prepare a worksheet for a consolidated statement of financial position.

Prepare consolidated worksheet when cost exceeds book value.

(LO 7)

*E12-14 Data for the Lennon and Ono corporations are presented in E12-13. Assume that instead of paying £220,000 in cash for Ono Ltd., Lennon Enterprises pays £225,000 in cash. Thus, at the acquisition date, the assets of Lennon Enterprises are current assets £55,000, investment in Ono Ltd. ordinary shares £225,000, and plant and equipment (net) £300,000.

Instructions

Prepare a worksheet for a consolidated statement of financial position.

PROBLEMS: SET A

Journalize debt investment transactions and show financial statement presentation.

(LO 2, 5, 6)

P12-1A Yuen Long Carecenters Ltd. provides financing and capital to the healthcare industry, with a particular focus on nursing homes for the elderly. The following selected transactions relate to bonds acquired as an investment by Yuen Long, whose fiscal year ends on December 31.

2017
Jan.	1	Purchased at face value HK$2,000,000 of Franco Nursing Centers, Inc., 10-year, 7% bonds dated January 1, 2017, directly from Franco. Interest is paid on January 1 of each year.
Dec.	31	Accrual of interest at year-end on the Franco bonds.

(Assume that all intervening transactions and adjustments have been properly recorded and that the number of bonds owned has not changed from December 31, 2017, to December 31, 2019.)

2020
Jan.	1	Received the annual interest on the Franco bonds.
Jan.	1	Sold HK$1,000,000 Franco bonds at 105.
Dec.	31	Accrual of interest at year-end on the Franco bonds.

Instructions

(a) Gain on sale of debt investments HK$50,000

1. Journalize the listed transactions for the years 2017 and 2020.
2. Show the statement of financial position presentation of the bonds and interest receivable at December 31, 2017. Assume the investments are considered long-term.

Journalize investment transactions, prepare adjusting entry, and show statement presentation.

(LO 2, 3, 5, 6)

P12-2A In January 2017, the management of Stefan Company SE concludes that it has sufficient cash to permit some short-term investments in debt and share securities. During the year, the following transactions occurred.

Feb.	1	Purchased 600 ordinary shares of Superior for €32,400.
Mar.	1	Purchased 800 ordinary shares of Pawlik for €20,400.
Apr.	1	Purchased 50 €1,000, 7% Venice bonds for €50,000. Interest is payable annually on October 1.
July	1	Received a cash dividend of €0.60 per share on the Superior ordinary shares.
Aug.	1	Sold 200 ordinary shares of Superior at €57 per share.
Sept.	1	Received a €1 per share cash dividend on the Pawlik ordinary shares.
Oct.	1	Received the interest on the Venice bonds.
Oct.	1	Sold the Venice bonds for €49,000.

At December 31, the fair value of the Superior ordinary shares was €55 per share. The fair value of the Pawlik ordinary shares was €24 per share.

Instructions

Gain on sale of share investments €600

1. Journalize the transactions and post to the accounts Debt Investments and Share Investments. (Use the T-account form.)
2. Prepare the adjusting entry at December 31, 2017, to report the investment securities at fair value. All securities are considered to be trading securities.
3. Show the statement of financial position presentation of investment securities at December 31, 2017.
4. Identify the income statement accounts and give the statement classification of each account.

Journalize transactions and adjusting entry for share investments.

(LO 3, 5, 6)

P12-3A On December 31, 2016, Ogallala Associates owned the following securities, held as a long-term investment. The securities are not held for influence or control of the investee.

Ordinary Shares	Shares	Cost
Carlene Co.	2,000	£60,000
Riverdale Co.	5,000	45,000
Raczynski Co.	1,500	30,000

On December 31, 2016, the total fair value of the securities was equal to its cost. In 2017, the following transactions occurred.

Aug.	1	Received £0.70 per share cash dividend on Carlene Co. ordinary shares.
Sept.	1	Sold 2,000 ordinary shares of Riverdale Co. for cash at £8 per share.
Oct.	1	Sold 800 ordinary shares of Carlene Co. for cash at £33 per share.
Nov.	1	Received £1 per share cash dividend on Raczynski Co. ordinary shares.
Dec.	15	Received £0.70 per share cash dividend on Carlene Co. ordinary shares.
	31	Received £1 per share annual cash dividend on Riverdale Co. ordinary shares.

At December 31, the fair values per share of the ordinary shares were Carlene Co. £32, Riverdale Co. £8, and Raczynski Co. £18.

Instructions

(b) Unrealized loss €3,600

1. Journalize the 2017 transactions and post to the account Share Investments. (Use the T-account form.)
2. Prepare the adjusting entry at December 31, 2017, to show the securities at fair value. The shares should be classified as non-trading securities.
3. Show the statement of financial position presentation of the investments at December 31, 2017. At this date, Ogallala Associates has share capital—ordinary £1,500,000 and retained earnings £1,000,000.

Prepare entries under the cost and equity methods, and tabulate differences.

(LO 3)

P12-4A Control Alt Design Ltd. acquired 30% of the outstanding ordinary shares of Walter Company on January 1, 2017, by paying £800,000 for the 45,000 shares. Walter declared and paid £0.30 per share cash dividends on March 15, June 15, September 15, and December 15, 2017. Walter reported net income of £320,000 for the year. At December 31, 2017, the market price of Walter ordinary shares was £24 per share.

Instructions

(a) Total dividend revenue €54,000

(b) Revenue from share investments €96,000

1. Prepare the journal entries for Control Alt Design for 2017, assuming Control Alt Design cannot exercise significant influence over Walter. Use the cost method and assume that Walter ordinary shares should be classified as a trading security.
2. Prepare the journal entries for Control Alt Design for 2017, assuming Control Alt Design can exercise significant influence over Walter. Use the equity method.
3. Indicate the statement of financial position and income statement account balances at December 31, 2017, under each method of accounting.

Journalize share investment transactions and show statement presentation.

(LO 3, 5, 6)

P12-5A The following securities are in Pascual Company SA’s portfolio of long-term non-trading securities at December 31, 2016.

	Cost
1,000 shares of Reginald SA ordinary shares	R£52,000
1,400 shares of Elderberry A/S ordinary shares	84,000
1,200 shares of Mattoon AG preference shares	33,600

On December 31, 2016, the total cost of the portfolio equaled total fair value. Pascual had the following transactions related to the securities during 2017.

Jan.	20	Sold all 1,000 ordinary shares of Reginald at R$54.80 per share.
	28	Purchased 400 R$70 par value ordinary shares of Hachito Ltd. at R$79.20 per share.
	30	Received a cash dividend of R$1.05 per share on Elderberry ordinary shares.
Feb.	8	Received cash dividends of R$0.40 per share on Mattoon preference shares.
	18	Sold all 1,200 preference shares of Mattoon at R$26.30 per share.
July	30	Received a cash dividend of R$1.00 per share on Elderberry ordinary shares.
Sept.	6	Purchased an additional 600 R$70 par value ordinary shares of Hachito at R$82 per share.
Dec.	1	Received a cash dividend of R$1.35 per share on Hachito ordinary shares.

At December 31, 2017, the fair values of the securities were:

Elderberry A/S ordinary shares	R$64 per share
Hachito Ltd. ordinary shares	R$72 per share

Instructions

(a) Gain on sale of share investments R$2,800

(c) Unrealized loss R$3,280

1. Prepare journal entries to record the transactions.
2. Post to the investment account. (Use T-account.)
3. Prepare the adjusting entry at December 31, 2017 to report the portfolio at fair value. Also prepare the required closing entry related to the investment securities.
4. Show the statement of financial position presentation at December 31, 2017, for the investment-related accounts.

Prepare a statement of financial position.

(LO 5, 6)

P12-6A The following data, presented in alphabetical order, are taken from the records of Radar Industries Ltd.

Accounts payable	€ 240,000
Accounts receivable	140,000
Accumulated depreciation—buildings	180,000
Accumulated depreciation—equipment	52,000
Allowance for doubtful accounts	6,000
Bonds payable (10%, due 2023)	540,000
Buildings	950,000
Cash	42,000
Dividends payable	80,000
Equipment	275,000
Fair value adjustment—non-trading securities (Dr)	8,000
Goodwill	200,000
Income taxes payable	120,000
Inventory	170,000
Investment in Mara ordinary shares (30% ownership), at equity	380,000
Investment in Sasse ordinary shares (10% ownership), at cost	278,000
Land	390,000
Notes payable (due 2018)	70,000
Prepaid insurance	16,000
Retained earnings	103,000
Share capital—ordinary (€10 par value; 500,000 shares authorized, 150,000 shares issued)	1,500,000
Share premium—ordinary	130,000
Short-term investments, at fair value (and cost)	180,000
Unrealized gain—non-trading securities	8,000

The investment in Sasse ordinary shares is considered to be a long-term non-trading security.

Instructions

Total assets €2,791,000

Prepare a classified statement of financial position at December 31, 2017.

Prepare consolidated worksheet and statement of financial position when cost exceeds book value.

(LO 7)

P12-7A Liu Limited purchased all the outstanding ordinary shares of Yang Plastics, Ltd. on December 31, 2017. Just before the purchase, the condensed statements of financial position of the two companies appeared as follows.

Liu used current assets of ¥1,218,000 to acquire the shares of Yang Plastics. The excess of this purchase price over the book value of Yang Plastics’ net assets is determined to be attributable ¥84,000 to Yang Plastics’ plant and equipment and the remainder to goodwill.

Instructions

(b) Excess of cost over book value ¥115,000

1. Prepare the entry for Liu Limited’s acquisition of Yang Plastics, Ltd. shares.
2. Prepare a consolidated worksheet at December 31, 2017.
3. Prepare a consolidated statement of financial position at December 31, 2017.

PROBLEMS: SET B

Journalize debt investment transactions and show financial statement presentation.

(LO 2, 5, 6)

P12-1B Cheese Farms is a grower of hybrid seed corn for Steenbergen Genetics Limited. It has had two exceptionally good years and has elected to invest its excess funds in bonds. The selected transactions, shown below, relate to bonds acquired as an investment by Cheese Farms, whose fiscal year ends on December 31.

2017
Jan.	1	Purchased at face value $400,000 of Stombaugh Corporation 10-year, 6% bonds dated January 1, 2017, directly from the issuing corporation.
Dec.	31	Accrual of interest at year-end on the Stombaugh bonds. Interest is paid on January 1 of each year.

(Assume that all intervening transactions and adjustments have been properly recorded and the number of bonds owned has not changed from December 31, 2017, to December 31, 2019.)

2020
Jan.	1	Received the annual interest on the Stombaugh bonds.
Jan.	1	Sold $240,000 of Stombaugh bonds at 112.
Dec.	31	Accrual of interest at year-end on the Stombaugh bonds.

Instructions

(a) 2017: Gain on sale of debt investments $28,800

1. Journalize the listed transactions for the years 2017 and 2020.
2. Show the statement of financial position presentation of the bonds and interest receivable at December 31, 2017. Assume the investments are considered long-term.

Journalize investment transactions, prepare adjusting entry, and show statement presentation.

(LO 2, 3, 5, 6)

P12-2B In January 2017, the management of Izmir A.Ş. concludes that it has sufficient cash to purchase some short-term investments in debt and share securities. During the year, the following transactions occurred.

Feb.	1	Purchased 500 ordinary shares of Joy for 30,800.
Mar.	1	Purchased 600 ordinary shares of Aurelius for 20,300.
Apr.	1	Purchased 40 1,000, 9% Sikich bonds for 40,000. Interest is payable annually on October 1.
July	1	Received a cash dividend of 0.60 per share on the Joy ordinary shares.
Aug.	1	Sold 300 ordinary shares of Joy at 69 per share.
Sept.	1	Received a 1 per share cash dividend on the Aurelius ordinary shares.
Oct.	1	Received the interest on the Sikich bonds.
Oct.	1	Sold the Sikich bonds for 44,000.

At December 31, the fair value of the Joy ordinary shares was 66 per share. The fair value of the Aurelius ordinary shares was 29 per share.

Instructions

(b) Unrealized loss 2,020

1. Journalize the transactions and post to the accounts Debt Investments and Share Investments. (Use the T-account form.)
2. Prepare the adjusting entry at December 31, 2017, to report the investments at fair value. All securities are considered to be trading securities.
3. Show the statement of financial position presentation of investment securities at December 31, 2017.
4. Identify the income statement accounts and give the statement classification of each account.

Journalize transactions and adjusting entry for share investments.

(LO 3, 5, 6)

P12-3B On December 31, 2016, Eli Associates owned the following long-term investments.

Ordinary Shares	Shares	Cost
Trowbridge Co.	4,000	€96,000
Holly Co.	5,000	30,000
Oriental Motors Co.	3,000	60,000

On this date, the total fair value of the securities was equal to its cost. The securities are not held for influence or control over the associates. In 2017, the following transactions occurred.

Aug.	1	Received €0.50 per share cash dividend on Trowbridge Co. ordinary shares.
Sept.	1	Sold 1,500 ordinary shares of Holly Co. for cash at €8.50 per share.
Oct.	1	Sold 600 ordinary shares of Trowbridge Co. for cash at €30 per share.
Nov.	1	Received €1 per share cash dividend on Oriental Motor Co. ordinary shares.
Dec.	15	Received €0.60 per share cash dividend on Trowbridge Co. ordinary shares.
	31	Received €1 per share annual cash dividend on Holly Co. ordinary shares.

At December 31, the fair values per share of the ordinary shares were Trowbridge Co. €23, Holly Co. €7, and Oriental Motors Co. €19.

Instructions

(a) Gain on sale, €3,750 and €3,600

1. Journalize the 2017 transactions and post to the account Share Investments. (Use the T-account form.)
2. Prepare the adjusting entry at December 31, 2017, to show the securities at fair value. The shares should be classified as non-trading securities.
3. Show the statement of financial position presentation of the investment-related accounts at December 31, 2017. At this date, Eli Associates has share capital—ordinary €2,000,000 and retained earnings €1,200,000.

Prepare entries under the cost and equity methods, and tabulate differences.

(LO 3)

P12-4B Tuecke’s Concrete acquired 20% of the outstanding ordinary shares of Drew, Ltd. on January 1, 2017, by paying $1,100,000 for 40,000 shares. Drew declared and paid a $0.50 per share cash dividend on June 30 and again on December 31, 2014. Drew reported net income of $600,000 for the year. At December 31, 2017, the market price of Drew’s ordinary shares was $30 per share.

Instructions

(a) Total dividend revenue $40,000

(b) Revenue from share investment $120,000

1. Prepare the journal entries for Tuecke’s Concrete for 2017, assuming Tuecke’s cannot exercise significant influence over Drew. Use the cost method and assume Drew ordinary shares should be classified as non-trading.
2. Prepare the journal entries for Tuecke’s Concrete for 2017, assuming Tuecke’s can exercise significant influence over Drew. Use the equity method.
3. Indicate the statement of financial position and income statement account balances at December 31, 2017, under each method of accounting.

Journalize share investment transactions and show statement presentation.

(LO 3, 5, 6)

P12-5B The following are in Verbitsky’s Company’s portfolio of long-term non-trading securities at December 31, 2016.

	Cost
700 shares of Sasha OAO ordinary shares	€35,000
900 shares of Ukraine OAO ordinary shares	42,000
800 shares of Zaba OAO preference shares	22,400

On December 31, the total cost of the portfolio equaled total fair value. Verbitsky’s Company had the following transactions related to the securities during 2017.

Jan.	7	Sold all 700 ordinary shares of Sasha at €56 per share.
	10	Purchased 300 €70 par value ordinary shares of Vanucci SpA at €78.50 per share.
	26	Received a cash dividend of €1.15 per share on Ukraine ordinary shares.
Feb.	2	Received cash dividends of €0.40 per share on Zaba preference shares.
	10	Sold all 800 preference shares of Zaba at €26 per share.
July	1	Received a cash dividend of €1.05 per share on Ukraine ordinary shares.
Sept.	1	Purchased an additional 800 €70 par value ordinary shares of Vanucci SpA at €75 per share.
Dec.	15	Received a cash dividend of €1.50 per share on Vanucci SpA ordinary shares.

At December 31, 2017, the fair values of the securities were:

Ukraine OAO ordinary shares	€48 per share
Vanucci SpA ordinary shares	€72 per share

Instructions

(a) Loss on sale €1,600

(c) Unrealized loss €3,150

1. Prepare journal entries to record the transactions.
2. Post to the investment account. (Use T-account.)
3. Prepare the adjusting entry at December 31, 2017, to report the portfolio at fair value. Also prepare the closing entry required for the investment accounts.
4. Show the statement of financial position presentation at December 31, 2017, for the investment-related accounts.

Prepare a statement of financial position.

(LO 5, 6)

P12-6B The following data, presented in alphabetical order, are taken from the records of Redlands Enterprises AG.

Accounts payable	CHF 375,000
Accounts receivable	135,000
Accumulated depreciation—buildings	270,000
Accumulated depreciation—equipment	80,000
Allowance for doubtful accounts	10,000
Bonds payable (10%, due 2027)	570,000
Buildings	1,350,000
Cash	210,000
Dividends payable	75,000
Equipment	415,000
Goodwill	300,000
Income taxes payable	180,000
Inventory	255,000
Investment in Bonita AG shares (30% ownership), at equity	900,000
Land	780,000
Notes payable (due 2018)	110,000
Prepaid insurance	25,000
Retained earnings	480,000
Share capital—ordinary (CHF5 par value; 500,000 shares authorized, 440,000 shares issued)	2,200,000
Share premium—ordinary	300,000
Short-term investments, at fair value (and cost)	280,000

Instructions

Prepare a classified statement of financial position at December 31, 2017.

Total assets CHF4,290,000

Prepare consolidated worksheet and statement of financial position when cost exceeds book value.

(LO 7)

P12-7B Patel Company Ltd. purchased all the outstanding ordinary shares of Singh Company Ltd. on December 31, 2017. Just before the purchase, the condensed statements of financial position of the two companies were as follows.

Patel used current assets of €700,000 to acquire the shares of Singh. The excess of this purchase price over the book value of Patel’s net assets is determined to be attributable €25,000 to Singh’s plant and equipment and the remainder to goodwill.

Instructions

(c) Excess of cost over book value €35,000

1. Prepare the entry for Patel Company’s acquisition of Singh Company shares.
2. Prepare a consolidated worksheet at December 31, 2017.
3. Prepare a consolidated statement of financial position at December 31, 2017.

COMPREHENSIVE PROBLEM: CHAPTERS 11 TO 12

CP12 Part I Mindy Feldkamp and her two colleagues, Oscar Lopez and Lori Melton, are personal trainers at an upscale health spa/resort in Madrid. They want to start a health club that specializes in health plans for people in the 50+ age range. The growing population in this age range and strong consumer interest in the health benefits of physical activity have convinced them they can profitably operate their own club. In addition to many other decisions, they need to determine what type of business organization they want. Oscar believes there are more advantages to the corporate form than a partnership, but he hasn’t yet convinced Mindy and Lori. They have come to you, a small-business consulting specialist, seeking information and advice regarding the choice of starting a partnership versus a corporation.

Instructions

1. Prepare a memo (dated May 26, 2016) that describes the advantages and disadvantages of both partnerships and corporations. Advise Mindy, Oscar, and Lori regarding which organizational form you believe would better serve their purposes. Make sure to include reasons supporting your advice.

Part II After deciding to incorporate, each of the three investors receives 20,000 €2 par ordinary shares on June 12, 2016, in exchange for their co-owned building (€200,000 fair value) and €100,000 total cash they contributed to the business. The next decision that Mindy, Oscar, and Lori need to make is how to obtain financing for renovation and equipment. They understand the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business.

Instructions

1. Prepare notes for a discussion with the three entrepreneurs in which you will compare the consequences of using equity versus debt financing. As part of your notes, show the differences in interest and tax expense assuming €1,400,000 is financed with ordinary shares, and then alternatively with debt. Assume that when ordinary shares are used, 140,000 shares will be issued. When debt is used, assume the interest rate on debt is 9%, the tax rate is 32%, and income before interest and taxes is €300,000. (You may want to use an electronic spreadsheet.)

Part III During the discussion about financing, Lori mentions that one of her clients, Roberto Marino, has approached her about buying a significant interest in the new club. Having an interested investor sways the three to issue equity securities to provide the financing they need. On July 21, 2016, Mr. Marino buys 90,000 shares at a price of €10 per share.

The club, LifePath Fitness, opens on January 12, 2017, and after a slow start begins to produce the revenue desired by the owners. The owners decide to pay themselves a share dividend since cash has been less than abundant since they opened their doors. The 10% share dividend is declared by the owners on July 27, 2017. The market price of the shares is €3 on the declaration date. The date of record is July 31, 2017 (there have been no changes in share ownership since the initial issuance), and the issue date is August 15, 2017. By the middle of the fourth quarter of 2017, the cash flow of LifePath Fitness has improved to the point that the owners feel ready to pay themselves a cash dividend. They declare a €0.05 cash dividend per share on December 4, 2017. The record date is December 14, 2017, and the payment date is December 24, 2017.

Instructions

1. (1) Record all of the transactions related to the ordinary shares of LifePath Fitness during the years 2016 and 2017. (2) Indicate how many shares are issued and outstanding after the share dividend is issued.

Part IV Since the club opened, a major concern has been the pool facilities. Although the existing pool is adequate, Mindy, Oscar, and Lori all desire to make LifePath a cutting-edge facility. Until the end of 2017, financing concerns prevented this improvement. However, because there has been steady growth in clientele, revenue, and income since the third quarter of 2017, the owners have explored possible financing options. They are hesitant to issue shares and change the ownership mix because they have been able to work together as a team with great effectiveness. They have formulated a plan to issue secured term bonds to raise the needed €600,000 for the pool facilities. By the end of December 2017, everything was in place for the bond issue to go ahead. On January 1, 2018, the bonds were issued for €548,000. The bonds pay annual interest of 6% on January 1 of each year. The bonds mature in 10 years, and amortization is computed using the straight-line method.

Instructions

1. Record (1) the issuance of the secured bonds, (2) the adjusting entry required on December 31, 2018, (3) the interest payment made on January 1, 2019, and (4) the interest accrual on December 31, 2019.

Part V Mr. Marino’s purchase of the shares of LifePath Fitness was done through his business. The share investment has always been accounted for using the cost method on his firm’s books. However, early in 2019 he decided to take his company public. He is preparing an IPO (initial public offering), and he needs to have the firm’s financial statements audited. One of the issues to be resolved is to restate the share investment in LifePath Fitness using the equity method, since Mr. Marino’s ownership percentage is greater than 20%.

Instructions

1.  
   1. Give the entries that would have been made on Marino’s books if the equity method of accounting for investments had been used from the initial investment through 2018. Assume the following data for LifePath.

      	2016	2017	2018
      Net income	€30,000	€70,000	€105,000
      Total cash dividends	€2,100	€20,000	€50,000

   2. Compute the balance in the Share Investments account (as it relates to LifePath Fitness) at the end of 2018.

   MATCHA CREATIONS

(Note: This is a continuation of the Matcha Creations problem from Chapters 1—11.)

MC12 Mei-ling has been approached by Ken Thornton, a shareholder of The Beanery Coffee. Ken wants to retire and would like to sell his 1,000 shares in The Beanery Coffee, which represents 30% of all shares issued. The Beanery is currently operated by Ken’s twin daughters, who each own 35% of the ordinary shares. The Beanery not only operates a coffee shop but also roasts and sells beans to retailers, under the name “Rocky Mountain Beanery.”

Ken has met with Curtis and Mei-ling to discuss the business operation. All have concluded that there would be many advantages for Matcha & Coffee Creations to acquire an interest in The Beanery Coffee. Despite the apparent advantages, however, Mei-ling and Curtis are still not convinced that they should participate in this business venture.

Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this problem.

   BROADENING YOUR PERSPECTIVE

■Financial Reporting and Analysis

Financial Reporting Problem: TSMC, Ltd. (TWN)

BYP12-1 The fi nancial statements of TSMC are presented in Appendix A. The complete annual report, including the notes to the fi nancial statements, is available in the Investors section of the company’s website at www.tsmc.com.

Instructions

1. See Note 4 to the fi nancial statements and indicate what the consolidated fi nancial statements include.
2. Using TSMC’s consolidated statement of cash fl ows, determine how much was spent for capital acquisitions during the current year.

Comparative Analysis Problem: Nestlé SA (CHE) vs. Petra Foods Ltd. (SGP)

BYP12-2 Nestlé’s financial statements are presented in Appendix B. Financial statements of Petra Foods are presented in Appendix C. Complete annual reports, including notes to the fi nancial statements, are available in the Investor Relations sections at www.nestle.com and www.petrafoods.com.

Instructions

1. Based on the information contained in these fi nancial statements, determine the following for each company.

   (1) Net cash provided (used) for investing (investment) activities for the current year (from the statement of cash fl ows).

   (2) Cash used for capital expenditures during the current year.

2. Each of Nestlé’s fi nancial statements is labeled “consolidated.” What has been consolidated? That is, from the contents of Nestlé’s annual report, identify by name the divisions that have been consolidated.

Real-World Focus

BYP12-3 Most publicly traded companies are examined by numerous analysts. These analysts often don’t agree about a company’s future prospects. In this exercise, you will fi nd analysts’ ratings about companies and make comparisons over time and across companies in the same industry. You will also see to what extent the analysts experienced “earnings surprises.” Earnings surprises can cause changes in share prices.

Address: biz.yahoo.com/i/ or go to www.wiley.com/college/weygandt

Steps

1. How many analysts rated the company?
2. What percentage rated it a strong buy?
3. What was the average rating for the week?
4. Did the average rating improve or decline relative to the previous week?
5. What was the amount of the earnings surprise percentage during the last quarter?

■Critical Thinking

Decision-Making Across the Organization

BYP12-4 At the beginning of the question-and-answer portion of the annual shareholders’ meeting of Kemper Ltd., shareholder Mike Kerwin asks, “Why did management sell the holdings in UMW Company at a loss when this company has been very profi table during the period Kemper held its shares?”

Since president Tony Chavez has just concluded his speech on the recent success and bright future of Kemper, he is taken aback by this question and responds, “I remember we paid £1,300,000 for those shares some years ago. I am sure we sold these shares at a much higher price. You must be mistaken.”

Kerwin retorts, “Well, right here in footnote number 7 to the annual report it shows that 240,000 shares, a 30% interest in UMW, were sold on the last day of the year. Also, it states that UMW earned £520,000 this year and paid out £160,000 in cash dividends. Further, a summary statement indicates that in past years, while Kemper held UMW shares, UMW earned £1,240,000 and paid out £440,000 in dividends. Finally, the income statement for this year shows a loss on the sale of UMW shares of £180,000. So, I doubt that I am mistaken.”

Red-faced, president Chavez turns to you.

Instructions

With the class divided into groups, answer the following.

1. What dollar amount did Kemper receive upon the sale of the UMW shares?
2. Explain why both shareholder Kerwin and president Chavez are correct.

Communication Activity

BYP12-5 Bunge Company Ltd. has purchased two securities for its portfolio. The fi rst is a share investment in Longley Industries, one of its suppliers. Bunge purchased 10% of Longley with the intention of holding it for a number of years but has no intention of purchasing more shares. The second investment was a purchase of debt securities. Bunge purchased the debt securities because its analysts believe that changes in market interest rates will cause these securities to increase in value in a short period of time. Bunge intends to sell the debt securities as soon as they have increased in value.

Instructions

Write a memo to Max Scholes, the chief fi nancial offi cer, explaining how to account for each of these investments. Explain what the implications for reported income are from this accounting treatment.

Ethics Case

BYP12-6 Bartlet Financial Services Company holds a large portfolio of debt and share securities as an investment. The total fair value of the portfolio at December 31, 2017, is greater than total cost. Some securities have increased in value and others have decreased. Deb Faust, the fi nancial vice president, and Jan McCabe, the controller, are in the process of classifying for the fi rst time the securities in the portfolio.

Faust suggests classifying the securities that have increased in value as trading securities in order to increase net income for the year. She wants to classify the securities that have decreased in value as long-term non-trading securities, so that the decreases in value will not affect 2017 net income.

McCabe disagrees. She recommends classifying the securities that have decreased in value as trading securities and those that have increased in value as long-term non-trading securities. McCabe argues that the company is having a good earnings year and that recognizing the losses now will help to smooth income for this year. Moreover, for future years, when the company may not be as profi table, the company will have built-in gains.

Instructions

1. Will classifying the securities as Faust and McCabe suggest actually affect earnings as each says it will?
2. Is there anything unethical in what Faust and McCabe propose? Who are the stakeholders affected by their proposals?
3. Assume that Faust and McCabe properly classify the portfolio. At year-end, Faust proposes to sell the securities that will increase 2017 net income, and McCabe proposes to sell the securities that will decrease 2017 net income. Is this unethical?

Answers to Insight and Accounting Across the Organization Questions

1. p. 602 Hey, I Thought It Was Safe! Q: Why is the fl uctuating value of bonds of concern if a company intends to hold them until maturity? A: If a company has to sell its investment in bonds before maturity, the sale proceeds may be substantially less than the original purchase price due to rising interest rates, thus causing an investment loss.
2. p. 607 Who’s in Control? Q: Where on adidas’s statement of fi nancial position will you fi nd its investment in Rockport? A: Because adidas owns Rockport, adidas does not report Rockport in the investment section of its statement of fi nancial position. Instead, Rockport’s assets and liabilities are included and commingled with the assets and liabilities of adidas.

   A Look at U.S. GAAP

Learning Objective 8

Compare the accounting for investments under IFRS and U.S. GAAP.

The accounting and reporting for investments under IFRS and GAAP are very similar.

■ Key Points

Similarities

• The basic accounting entries to record the acquisition of debt securities, the receipt of interest, and the sale of debt securities are the same under IFRS and GAAP.
• Both IFRS and GAAP require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents.
• The basic accounting entries to record the acquisition of share investments, the receipt of dividends, and the sale of share securities are the same under IFRS and GAAP.
• Both IFRS and GAAP require that companies determine how to measure their fi nancial assets based on two criteria:
  • The company’s business model for managing their fi nancial assets; and
  • The contractual cash fl ow characteristics of the fi nancial asset.

If a company has (1) a business model whose objective is to hold assets in order to collect contractual cash fl ows and (2) the contractual terms of the fi nancial asset gives specifi ed dates to cash fl ows that are solely payments of principal and interest on the principal amount outstanding, then the company should use cost (often referred to as amortized cost).

For example, assume that Mitsubishi (JPN) purchases a bond investment that it intends to hold to maturity (held-for-collection). Its business model for this type of investment is to collect interest and then principal at maturity. The payment dates for the interest rate and principal are stated on the bond. In this case, Mitsubishi accounts for the investment at cost. If, on the other hand, Mitsubishi purchased the bonds as part of a trading strategy to speculate on interest rate changes (a trading investment), then the debt investment is reported at fair value. As a result, only debt investments such as receivables, loans, and bond investments that meet the two criteria above are recorded at amortized cost. All other debt investments are recorded and reported at fair value.

Similarities

• Both IFRS and GAAP use the same criteria to determine whether the equity method of accounting should be used—that is, signifi cant infl uence with a general guide of over 20% ownership. IFRS uses the term associate investment rather than equity investment to describe its investment under the equity method.
• Under IFRS, both the investor and an associate company should follow the same accounting policies. As a result, in order to prepare fi nancial information, adjustments are made to the associate’s policies to conform to the investor’s books. GAAP does not have that requirement.
• Both IFRS and GAAP use held-for-collection (debt investments), trading (both debt and equity investments), and non-trading equity investment classifi cations. These classifi cations are based on the business model used to manage the investments and the type of security.
• The accounting for trading investments is the same between GAAP and IFRS. Also, held-forcollection investments are accounted for at amortized cost. Gains and losses on non-trading equity investments (IFRS) are reported in other comprehensive income.
• Unrealized gains and losses related to non-trading securities are reported in other comprehensive income under GAAP and IFRS. These gains and losses that accumulate are then reported in the statement of fi nancial position.

Differences

• The basis for consolidation under IFRS is control. Under GAAP, a bipolar approach is used, which is a risk-and-reward model (often referred to as a variable-entity approach) and a votinginterest approach. However, under both systems, for consolidation to occur, the investor company must generally own 50% of another company.
• Under GAAP, companies use Other Revenues and Gains or Other Expenses and Losses in its income statement presentation. Under IFRS, companies will generally classify these items as unusual items or fi nancial items.

■ Looking to the Future

As indicated earlier, both the FASB and IASB have indicated (conceptually) that they believe that all fi nancial instruments should be reported at fair value and that changes in fair value should be reported as part of net income. However, both the FASB and IASB have decided to permit amortized cost for debt investments held-for-collection. Hopefully, they will eventually arrive at fair value measurement for all fi nancial instruments.

■ GAAP Practice