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Flashcards in Appendix E Deck (49):
1

Three reasons why Corporations invest in debt or equity securities:

1. To house excess cash until needed 

2. Earnings from investment income 

3. To meet strategic goals

2

Typical investment: to house excess cash until needed

Low-risk, high-liquidity, short-term securities such as government-issued securities

3

Typical investment: to generate earnings

Banks and financial institutions often purchase debt securities, while mutual funds and index funds purchase stock securities

4

Typical investment: to meet strategic goals

Stocks of companies in a related industry or in an unrelated industry that the company wishes to enter

5

Debt investments

Investments in government and corporation bonds

6

What is included in cost of investments?

All costs (price paid plus brokerage fees) - commissions

*Cost principle applies*

7

Journal entry to acquire investment

Dr. Debt investments XXX

Cr. Cash XXX

8

Journal entry: gain on sale of bond investments

Dr. Cash 58,000

Cr. Debt Investments 54,000

Cr. Gain on Sale of Debt Investments 4,000

9

Stock investments

Investments in the capital stock of corporations

10

Investment portfolio

When a company holds stock (and/or debt) of several different corporations, the group of securities is an investment portfolio

11

Investor's Ownership Interest in Investee's Common Stock: Less than 20%

Presumed influence on investee: insignificant

Accounting guidelines: Cost method

12

Investor's Ownership Interest in Investee's Common Stock: Between 20% and 50%

Presumed influence on investee: significant

Accounting guidelines: equity method

13

Investor's Ownership Interest in Investee's Common Stock: More than 50%

Presumed influence on Investee: controlling

Accounting guidelines: Consolidated financial statements

14

Cost method with stock investments

Companies record the investment at cost and recognize revenue only when cash dividends are received

15

Journal entry for purchase of stock

Dr. Stock Investments XXX

Cr. Cash XXX

16

Journal entry if dividends are received (less than 20% ownership)

Dr. Cash XXX

Cr. Dividend Revenue XXX

17

Journal entry for sale of stock with loss (less than 20% ownership)

Dr. Cash 39,500

Dr. Loss on Sale of Stock Investments 1,000

Cr. Stock Investments 40,500

18

Equity method

An accounting method in which the investment in common stock is initially recorded at cost, and the investment account is then adjusted annually to show the investor's equity in the investee

19

Journal entry when a company (who owns 30%) has its invested company report net income of 100,000

Dr. Stock Investments 30,000

Cr. Revenue from Investment in Beck Company 30,000

 

20

Parent company

A company that owns more than 50% of the common stock of another entity 

21

Subsidiary (affiliated) comapny

The entity whose stock is owned by the parent company

22

Controlling interest

Ownership of more than 50% of the common stock of another entity

23

Consolidated financial statements

Financial statements that present the assets and liabilities controlled by the parent company and the total revenues and expenses of the subsidiary companies

24

Who are consolidated statements useful to?

Stockholders

Board of directors

Management of the parent company

25

Fair value

Amount for which a security could be sold in a normal market

pro: it represents the expected cash realizable value of securities

con: unless a security is to be sold soon, not relevant because the price will likely change again

26

3 categories of securities:

(for purposes of valuation and reporting at a financial statement date)

1. Trading securities

2. Available-for-sale securities

3. Held-to-maturity securities

27

Trading securities

Securities bought and held primarily for sale in the near term to generate income on short-term price differences

28

Available-for-sale securities

Securities that are held with the intent of selling them sometime in the future

29

Held-to-maturity securities

Debt securities that the investor has the intent and ability to hold to their maturity date

30

Valuation of Trading securities

At fair value with changes reported in net income

31

Valuation of available-for-sale securities

At fair value with changes reported in the stockholders' equity section

32

Valuation of held-to-maturity securities

at amortized cost

33

Intention of trading securites

Selling them in a short period of time (less than a month)

34

Trading

means frequent buying and selling

35

Mark-to-market

A method of accounting for certain investments that requires that they be adjusted to their fair value at the end of each period

36

Unrealized gain or loss = 

Total cost - Total fair value

37

Journal entry for an unrealized gain on trading securities

Dr. Market Adjustment-Trading XXX

Cr. Unrealized Gain-Income XXX

38

Journal entry to record unrealized loss (available-for-sale)

Dr. Unrealized Gain or Loss-Equity

Cr. Market Adjustment-Available-for-Sale

39

Short-term investments (marketable securities)

Investments that are readily marketable and intended to be converted into cash within the next year of operating cycle,  whichever is longer

40

Two criteria of short-term investments (marketable securities)

1. Readily marketable

2. Intended to be converted into cash within next year or operating cycle, whichever is longer

41

Long-term investments

Investments that are not readily marketable or that management does not intend to convert into cash within the next year or operating cycle, whichever is longer

42

Readily marketable

When it can be sold easily whenever the need for cash arises

ex. short-term paper, stocks and bonds traded on organized securities markets

43

Intent to convert

Management intends to sell the investment within the next year or operating cycle, whichever is longer

ex. Ski company that invests in securities but intends to sell them before next ski season

44

Trading securities are always _________

short-term

45

Available-for-sale securities can be either _________________

short-term or long-term

46

Reporting the unrealized gain or loss in the stockholders' equity section for two purposes:

1. Reduces the volatility of net income due to fluctuations in fair value

2. Informs the financial statement user of the gain or loss that would occur if the company sold the securities at fair value

47

Other Revenue and Gains

Interest Revenue

Dividend Revenue

Gain on Sale of Investments

Unrealized Gain-Income

48

Other Expenses and Losses

Loss on Sale of Investments

Unrealized Loss-Income

49