Chapter 15, Problem 6BTN

To determine

a)

Introduction:

Classification of Long term investments

Long term investments are capital intensive purchases of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company acquires with intent to retain the investments for a period exceeding one year or more.

There are four primary categories of long term investments:

• Held to Maturity Investments $–$ They represent investments that the company intends to hold till the maturity of such instrument. It includes debt securities such as bonds.

• Available for sale Investments $–$ They represent investments that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Significant Interest in Other companies $–$ They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company.

• Controlling Interest in Other companies - They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 51 % or higher of the outstanding equity shares of the other company.

To Prepare:

Transactional data for acquisition of various types of long term securities

Answer to Problem 6BTN

Solution:

Transactional data for acquisition of various types of long term securities is as follows:

• Held to Maturity Debt Securities: Purchase of 10% 10 year Bonds / Debentures of face value of $100,000 for $95,000.

• Equity securities with significant influence: Purchase of 1,000,000 equity shares of company XYZ constituting 40% of the outstanding shares of the company for $10,000,000. XYZ declared profit of $2,500,000 and declared dividends of $1,000,000 for the previous year.

• Available for sale debt and equity securities $–$ Purchase of 100,000 equity shares for $1,000,000. Market price of shares after 18 months is $15 per share and the company intends to sell such shares

• Equity securities with Controlling influence - Purchase of 1,000,000 equity shares of company XYZ constituting 80% of the outstanding shares of the company for $10,000,000. XYZ declared profit of $2,500,000 and declared dividends of $1,000,000 for the previous year.

Explanation of Solution

• Long term investments are acquisition of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company purchases with intent to hold the investments for a period exceeding one year or more.

• Held to Maturity debt securities $–$ They represent investments in debt securities such as bonds and debentures that the company intends to hold till the maturity date. Debt securities are accompanied periodic returns in the form of interest and are purchased at a premium or discount depending upon the market rate of interest prevailing at the time of purchase.

• Equity securities with Significant influence $–$ Significant influence means the power to take decisions pertaining to day to day management and operations of the company.

• If a company purchases equity securities as shares and stocks of another company in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company, then such securities are termed Equity securities with Significant influence.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

• Difference between the Equity securities with Significant influence and Equity securities with Controlling influence is that the former is indicative of participation in operations of the target company without holding full control of the target company and the latter signifies ownership of the target company.

• Available for sale debt and equity securities $–$ They are indicative of investments made in debt and equity securities as shares and stocks, bonds and debentures that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Equity securities with Controlling influence - If a company purchases equity securities as shares and stocks of another company exceeding 51 % of the outstanding equity shares of the other company, then such securities are termed Equity securities with Controlling influence.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

Conclusion

Hence transactional data for long term investments is identified and listed.

To determine

b)

Introduction:

Classification of Long term investments

Long term investments are capital intensive purchases of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company acquires with intent to retain the investments for a period exceeding one year or more.

There are four primary categories of long term investments:

• Held to Maturity Investments $–$ They represent investments that the company intends to hold till the maturity of such instrument. It includes debt securities such as bonds.

• Available for sale Investments $–$ They represent investments that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Significant Interest in Other companies$–$ They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company.

• Controlling Interest in Other companies - They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 51 % or higher of the outstanding equity shares of the other company.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Journal entries for acquisition of the long term investments.

Answer to Problem 6BTN

Solution:

Date	Particulars	Debit	Credit
	Held to maturity debt securities:
	10% Debentures	$100,000
	Gain on Purchase of Investments		$5,000
	Bank		$95,000
	(Being 10% 10 year Debentures of face value of $100,000 purchased for $95,000)
	Equity securities with Significant influence
	Equity shares of XYZ Company	$10,000,000
	Bank		$10,000,000
	(Being 1,000,000 equity shares of company XYZ constituting 40% of the outstanding shares of the company purchased for $10,000,000)
	Available for trade debt and equity securities:
	Equity shares of ABC Company	$1,000,000
	Bank		$1,000,000
	(Being 100,000 equity shares of ABC Company purchased for $1,000,000)
	Equity securities with Controlling influence
	Equity shares of XYZ Company	$10,000,000
	Bank		$10,000,000
	(Being 1,000,000 equity shares of company XYZ constituting 40% of the outstanding shares of the company purchased for $10,000,000)

Explanation of Solution

• Assets and Expenses have debit balances and must be debited in order to increase their balance and credited in order to decrease their balance. Examples $–$ Cash, Investments in Equity shares, Debt securities etc.

• Liabilities and Incomes have credit balances and must be debited in order to decrease their balance and credited in order to increase their balance. Examples $–$ Accounts Payable, Sales revenue.

• In order to record purchase of Held to maturity debt securities, 10% Debentures will be debited by $100,000 , Gain on Purchase of Investments will be credited by $5,000 and Bank will be credited by $95,000 since 10% 10 year Debentures of face value of $100,000 were purchased for $95,000.

• In order to record purchase of Equity securities with Significant influence, Equity shares of XYZ Company will be debited by $10,000,000, Bank will be credited by $10,000,000 (Being 1,000,000 equity shares of company XYZ constituting 40% of the outstanding shares of the company were purchased for $10,000,000.

• In order to record purchase of Available for trade debt and equity securities, Equity shares of ABC Company will be debited by $1,000,000 and Bank will be credited by $1,000,000 (Being 100,000 equity shares of ABC Company were purchased for $1,000,000.

• In order to record purchase of Equity securities with Controlling influence, Equity shares of XYZ Company will be debited by $10,000,000 and Bank will be credited by $10,000,000 (Being 1,000,000 equity shares of company XYZ constituting 40% of the outstanding shares of the company were purchased for $10,000,000.

Conclusion

Hence the entries for acquisition are prepared

To determine

c)

Introduction:

Classification of Long term investments

Long term investments are capital intensive purchases of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company acquires with intent to retain the investments for a period exceeding one year or more.

There are four primary categories of long term investments:

• Held to Maturity Investments $–$ They represent investments that the company intends to hold till the maturity of such instrument. It includes debt securities such as bonds.

• Available for sale Investments $–$ They represent investments that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Significant Interest in Other companies $–$ They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company.

• Controlling Interest in Other companies - They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 51 % or higher of the outstanding equity shares of the other company.

To Determine:

Information needed to complete period end closing for the long term investments

Explanation of Solution

• In order to record period end closing of Held to maturity debt securities, the interest receivable on the debentures will be recorded as an asset.

• In order to record period end closing of Equity securities with Significant influence, Profits received from XYZ Company will be added to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments.

• In order to record period end closing of Available for trade debt and equity securities, the market value of the securities shall be required to be recorded and any diminution in value must be recognized in the books as a loss. Any increase in the value however, is to recorded only at the time of actual realization.

• In order to record period end closing of Equity securities with Controlling influence, Profits received from XYZ Company will be added to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments.

Conclusion

Hence the information required for period end closing is identified.

To determine

d)

Introduction:

Classification of Long term investments

Long term investments are capital intensive purchases of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company acquires with intent to retain the investments for a period exceeding one year or more.

There are four primary categories of long term investments:

• Held to Maturity Investments $–$ They represent investments that the company intends to hold till the maturity of such instrument. It includes debt securities such as bonds.

• Available for sale Investments $–$ They represent investments that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Significant Interest in Other companies $–$ They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company.

• Controlling Interest in Other companies - They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 51 % or higher of the outstanding equity shares of the other company.

Journal Entries

• Journal entries are the first step in recording financial transactions and preparation of financial statements.

• These represent the impact of the financial transaction and demonstrate the effect on the accounts impacted in the form of debits and credits.

• Assets and expenses have debit balances and Liabilities and Incomes have credit balances and according to the business transaction, the accounts are appropriately debited will be credited by credited to reflect the effect of business transactions and events.

To Prepare:

Year end closing entries for long term investments

Answer to Problem 6BTN

Solution:

Date	Particulars	Debit	Credit
	Held to maturity debt securities:
	Interest receivable	$10,000
	Interest Income		$10,000
	(Being 10% interest receivable on Debentures of face value of $100,000 recorded.)
	Equity securities with Significant influence
	Equity shares of XYZ Company	$1,000,000
	Profit from Investment		$1,000,000
	(Being 40% Profit from Investment in shares of XYZ Company recorded)
	Dividend Income from Investment	$400,000
	Equity shares of XYZ Company		$400,000
	(Being dividend from Investment in shares of XYZ Company recorded)
	Available for trade debt and equity securities:
	Loss due to reduction in value of shares	$5,000
	Equity shares of ABC Company		$5,000
	(Being 100,000 equity shares of ABC Company purchased for $1,000,000)
	Equity securities with Controlling influence
	Equity shares of XYZ Company	$2,000,000
	Profit from Investment		$2,000,000
	(Being 40% Profit from Investment in shares of XYZ Company recorded)
	Dividend Income from Investment	$800,000
	Equity shares of XYZ Company		$800,000
	(Being dividend from Investment in shares of XYZ Company recorded)

Explanation of Solution

• Assets and Expenses have debit balances and must be debited in order to increase their balance and credited in order to decrease their balance. Examples $–$ Cash, Investments in Equity shares, Debt securities etc.

• Liabilities and Incomes have credit balances and must be debited in order to decrease their balance and credited in order to increase their balance. Examples $–$ Accounts Payable, Sales revenue.

• In order to record period end closing of Held to maturity debt securities, the interest receivable on the debentures will be recorded as an asset. Interest receivable will be debited by $10,000 and Interest Income will be credited by $10,000 (Being 10% interest receivable on Debentures of face value of $100,000 was recorded.

• In order to record period end closing of Equity securities with Significant influence, Profits received from XYZ Company will be added to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments.

• Equity shares of XYZ Company will be debited by $1,000,000 and Profit from Investment will be credited by $1,000,000 (Being 40% Profit from Investment in shares of XYZ Company was recorded). XYZ Company declared a profit of $2,500,000 and 40% of the company’s share of profits $2,500,000 is $1,000,000.

• Dividend Income from Investment will be debited by $400,000 and Equity shares of XYZ Company will be credited by $400,000 (Being dividend from Investment in shares of XYZ Company was recorded. XYZ Company declared dividend of $1,000,000 and 40% of the company’s share of dividend of $1,000,000 is $400,000.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

• In order to record period end closing of Available for trade debt and equity securities, the market value of the securities shall be required to be recorded and any diminution in value must be recognized in the books as a loss. Any increase in the value however, is to recorded only at the time of actual realization. In the given instance it is assumed that the market value of the share is $95,000 and loss of $5,000 is hence recorded.

• In order to record period end closing of Equity securities with Controlling influence, Profits received from XYZ Company will be added to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments

• Equity shares of XYZ Company will be debited by $2,000,000 and Profit from Investment will be credited by $2,000,000 (Being 40% Profit from Investment in shares of XYZ Company was recorded). XYZ Company declared a profit of $2,500,000 and 80% of the company’s share of profits $2,500,000 is $2,000,000.

• Dividend Income from Investment will be debited by $800,000 and Equity shares of XYZ Company will be credited by $800,000 (Being dividend from Investment in shares of XYZ Company was recorded. XYZ Company declared dividend of $1,000,000 and 80% of the company’s share of dividend of $1,000,000 is $800,000.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

Conclusion

Hence the period end closing entries are prepared.

To determine

e)

Introduction:

Classification of Long term investments

Long term investments are capital intensive purchases of financial assets such as shares and stocks, bonds and debentures, property, land etc. that the company acquires with intent to retain the investments for a period exceeding one year or more.

There are four primary categories of long term investments:

• Held to Maturity Investments $–$ They represent investments that the company intends to hold till the maturity of such instrument. It includes debt securities such as bonds.

• Available for sale Investments $–$ They represent investments that the company intends to hold for a period exceeding one year but with an intention to sell at the best available opportunity in the foreseeable future.

• Significant Interest in Other companies $–$ They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 25 % $–$ 50 % of the outstanding equity shares of the other company.

• Controlling Interest in Other companies - They represent investments made by a company in equity securities such as shares and stocks, of another company, usually in the range of 51 % or higher of the outstanding equity shares of the other company.

To Prepare:

Balance Sheet Section depicting long term investments

Answer to Problem 6BTN

Solution:

Held to Maturity Debt Securities:

Balance Sheet
As At 31 December 20xx
Assets	Amount ($)	Amount ($)
Current Assets
Interest Receivable	10,000
Total Current Assets		10,000
Investments
10% Debentures	100,000
Total Investments		100,000
Total Assets		110,000

Equity securities with Significant influence:

Balance Sheet
As At 31 December 20xx
Assets	Amount ($)
Investments
40% Equity Shares of XYZ Company	$ 10,000,000.00
Add: Profits received	$ 1,000,000.00
Less: Dividends Received	$ 400,000.00
Carrying value of investments		$ 10,600,000.00
Total Assets		$ 10,600,000.00

Available for trade debt and equity securities:

Balance Sheet
As At 31 December 20xx
Assets	Amount ($)
Investments
40% Equity Shares of XYZ Company	$ 100,000.00
Less: Diminiution in value	$ 5,000.00
Carrying value of investments		$ 95,000.00
Total Assets		$ 95,000.00

Equity securities with Controlling influence:

Balance Sheet
As At 31 December 20xx
Assets	Amount ($)
Investments
40% Equity Shares of XYZ Company	$ 10,000,000.00
Add: Profits received	$ 2,000,000.00
Less: Dividends Received	$ 800,000.00
Carrying value of investments		$ 11,200,000.00
Total Assets		$ 11,200,000.00

Explanation of Solution

• Assets and Expenses have debit balances and must be debited in order to increase their balance and credited in order to decrease their balance. Examples $–$ Cash, Investments in Equity shares, Debt securities etc.

• Liabilities and Incomes have credit balances and must be debited in order to decrease their balance and credited in order to increase their balance. Examples $–$ Accounts Payable, Sales revenue.

• Closing Value of Held to maturity debt securities and the interest receivable on the debentures will be recorded as assets.

• Carrying value of Equity securities with Significant influence is calculated by adding Profits received from XYZ Company to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

• Closing of Available for trade debt and equity securities, the market value of the securities shall be required to be recorded and any diminution in value must be recognized in the books as a loss. Any increase in the value however, is to recorded only at the time of actual realization. In the given instance it is assumed that the market value of the share is $95,000 and loss of $5,000 is hence recorded.

• Carrying value of Equity securities with Controlling influence is calculated by adding Profits received from XYZ Company to the investment and dividends received shall be reduced from the investment as per the equity method of accounting for investments.

• Any profits received from such investment are added to the investment value and the dividends received are reduced from the cost of the investment and the net value of the investment is reflected in the balance sheet.

Conclusion

Hence the balance sheet extracts are prepared.