1. The problems of accounting for investments involve measurement, recognition, and
disclosure. Investments are generally classified as either debt securities or equity securities.
Chapter 17 covers both temporary and long-term investments. The first section presents
accounting for debt securities; the second section covers accounting for equity securities;
and the remainder of the chapter presents the equity method of accounting, disclosure
requirements, impairments, and accounting for the transfer of investment securities between
2. (S.O. 1) Debt Securities are instruments representing a creditor relationship with an
enterprise. Debt securities include U.S. government securities, municipal securities,
corporate bonds, convertible debt, commercial paper, and all securitized debt instruments.
*Note: All asterisked (*) items relate to material contained in the Appendix to the chapter.
3. Debt securities are grouped into the following three separate categories:
a. Held-to-maturity: Debt securities that the enterprise has the positive intent and ability to
hold to maturity.
b. Trading: Debt securities bought and held primarily for sale in the near term to generate
income on short-term price differences.
c. Available-for-sale: Debt securities not classified as held-to-maturity or trading securities.
Held-to-Maturity Debt Securities
4. Held-to-maturity debt securities are accounted for at amortized cost, not fair value. A Held-to
Maturity Securities account is used to indicate the type of debt security purchased.
Available-for-Sale Debt Securities
5. Available-for-sale debt securities are reported at fair value. The unrealized gains and losses
related to changes in the fair value of available-for-sale debt securities are recorded in an
unrealized holding gain or loss account. This account is reported as other comprehensive
income and as a separate component of stockholders’ equity until realized. A valuation
account called “Securities Fair Value Adjustment (Available-for-Sale)” is used instead of
debiting or crediting the Available-for-Sale Securities account to enable the company to
maintain a record of its amortized cost.
6. When an available-for-sale debt security is sold, the realized gain or loss is reported in the
Other Revenues and Gains section or the Other Expenses and Losses section of the income
7. Trading securities are reported at fair value, with unrealized holding gains and losses
reported as part of net income. A holding gain or loss is the net change in the fair value of a
security from one period to another, exclusive of dividend or interest revenue recognized but
not received. A valuation account called “Securities Fair Value Adjustment (Trading)” is used
instead of debiting or crediting the Trading Securities account.
Amortization on Bond Investments
8. (S.O. 2) The effective-interest method is required to amortize premium or discount unless
some other method—such as the straight-line method—yields a similar result. The effective-
interest method is applied to bond investments in a fashion similar to that described for
bonds payable. The effective-interest rate or yield is computed at the time of investment and
is applied to its beginning carrying amount (book value) for each interest period to compute
interest revenue. The investment carrying amount is increased by the amortized discount or
decreased by the amortized premium in each period.
9. (S.O. 3) Equity securities are described as securities representing ownership interest such
as common, preferred, or other capital stock. They also include rights to acquire or dispose
of ownership interests at an agreed upon or determinable price such as warrants, rights, and
call options or put options.
10. The degree to which one corporation (investor) acquires an interest in the common stock of
another corporation (investee) generally determines the accounting treatment for the
investment subsequent to acquisition. Investments by one corporation in the common stock
of another and the accounting method to be used can be classified according to the
percentage of the voting stock of the investee held by the investor:
a. Less than 20% Fair Value Method
b. Between 20% and 50% Equity Method
c. More than 50% Consolidated Statements
Fair Value Method
11. When an investor has an interest of less than 20%, it is presumed that the investor has little
or no influence over the investee. If market prices are available, the investment is valued and
reported subsequent to acquisition using the fair value method. The fair value method
requires that companies classify equity securities at acquisition as available-for-sale
securities or trading securities.
12. When acquired, available-for-sale equity securities are recorded at cost. Net income earned
by the investee is not considered a proper basis for recognizing income from the investment
by the investor. Therefore, net income is not considered earned by the investor until cash
dividends are declared by the investee. The net unrealized gains and losses related to
changes in the fair value are recorded in an Unrealized Holding Gain or Loss-Equity account
that is reported as a part of other comprehensive income and as
a separate component of stockholders’ equity until realized. The offsetting portion of the
entry is debited or credited to the valuation account, Securities Fair Value Adjustment
(Available for Sale).
13. The accounting entries to record trading equity securities are the same as for available-for-sale
equity securities except for recording the unrealized holding gain or loss. For trading equity
securities, the unrealized holding gain or loss is reported as part of net income.
14. (S.O. 4) When an investor has a holding interest of between 20% and 50% in an investee
corporation, the investor is generally deemed to exercise significant influence over operating
and financial policies of the investee. The FASB has also listed other factors to consider in
determining whether an investor can exercise “significant influence” over an investee. In
instances of “significant influence,” the investor is required to account for the investment
using the equity method.
15. Under the equity method the investment’s carrying amount is periodically increased
(decreased) by the investor’s proportionate share of the earnings (losses) of the investee and
decreased by all dividends received by the investor from the investee. The investor must
record as separate components the amount of ordinary and extraordinary income as
reported by the investee.
16. Under the equity method, if an investor’s share of the investee’s losses exceeds the carrying
amount of the investment, the investor should discontinue applying the equity method and
not recognize additional losses (unless the investor’s loss is not limited or if return to
profitability appears to be assured).
17. The following transactions illustrate the journal entries for an investment accounted for under
the equity method.
a. On 1/3/09 Workowski Corporation purchased 55,000 shares (26%) of Wendy Company at
a cost of $8 per share.
Investment in Wendy Company ........................ 440,000
Cash ............................................................ 440,000
b. At the end of 2009 Wendy Company reported net income of $350,000 (all ordinary).
Workowski’s share is $91,000 ($350,000 x .26).
Investment in Wendy Company ........................ 91,000
Revenue from Investment ........................... 91,000
c. In early 2010, Wendy Company paid a $75,000 dividend. Workowski’s share is $19,500
($75,000 X .26).
Cash ................................................................. 19,500
Investment in Wendy Company ................... 19,500
d. Wendy Company reported a $215,000 net loss (all ordinary) in 2010. Workowski’s share
Loss on Investment ........................................... 55,900
Investment in Wendy Company ................... 55,900
Consolidated Financial Statements
18. When one corporation (the parent) acquires a voting interest of more than 50% in another
corporation (the subsidiary), the investor corporation is deemed to have a controlling
interest. When the parent treats the subsidiary as an investment, consolidated financial
statements are generally prepared. The subject of when and how to prepare consolidated
financial statements is discussed extensively in advanced accounting.
Fair Value Option
19. Companies have the option to report most financial assets and liabilities at fair value, with
gains and losses reported in net income. The fair value option is only available at the
acquisition date or date incurred, and applies on a security-by-security basis. When the fair
value option in selected, it must be used for the life of the instrument.
20. When the fair value option is used for
a. Available-for-sale securities, gains and losses related to changes in fair value are
reported in net income (rather than as part of comprehensive income).
b. Equity method investments, the investor does not report it share of the investee income
or loss, rather, changes in the fair value of the investment are reported in net income.
Likewise, the receipt of dividends would be recorded as dividend revenue rather than as a
reduction of the investment account.
c. Financial liabilities, a company revalues its own liabilities, with gains and losses
reported in net income. That is, when the market price of a company’s bonds declines,
the company will reduce the liability and record a gain in the income statement.
21. (S.O. 6) Each period every investment must be evaluated to determine if it has suffered
a loss in value that is other than temporary (an impairment). If an investment is deemed
impaired, the cost basis of the individual security is written down to a new cost basis. The
amount of the writedown is accounted for as a realized loss and, therefore, included in net
22. (S.O. 7) As indicated, unrealized holding gains and losses related to available-for-sale
securities are reported as part of other comprehensive income. The reporting of changes in
unrealized gains or losses in comprehensive income is straightforward unless securities are
sold during the year—then a reclassification adjustment is necessary to ensure that gains
and losses are not counted twice.
Transfers Between Categories
23. (S.O. 8) Transfers between any of the investment categories are accounted for at fair value.
The text gives an illustration of measurement basis and how Stockholders’ Equity and Net
Income are impacted upon a transfer between investment categories.
ACCOUNTING FOR DEBT SECURITIES BY CATEGORY
SCHEDULE OF INTEREST REVENUE AND BOND DISCOUNT
AMORTIZATION—EFFECTIVE INTEREST METHOD
ACCOUNTING AND REPORTING FOR EQUITY
SECURITIES BY CATEGORY
ACCOUNTING FOR TRANSFERS
SUMMARY OF TREATMENT OF MAJOR DEBT
AND EQUITY SECURITIES