Lecture Notes: Intermediate Accounting 2 de Guzman

Investment in Equity Securities

Investment – are assets held by an entity for the accretion of wealth through distribution such as interest, royalties,
dividends, and rentals, for capital appreciation or for other benefits * to the investing entity such as those obtained
through trading relationships.

* Other benefits include ownership control, meeting business requirements, and for protection.

Financial Instrument – is any contract that gives rise to financial asset of one entity and a financial liability or equity
instrument of another entity.

Financial asset – that is (1) cash; (2) an equity instrument of another entity; (3) a contractual right to receive (a) cash or
another financial asset from another entity; or (b) to exchange financial assets or financial liabilities with another entity
under conditions that are potentially favorable to the entity;

Financial liability – (1) a contractual obligation to (a) deliver cash; or (b) to exchange financial assets or financial
liabilities with another entity under conditions that are potentially unfavorable to the entity;

Equity instrument – is any contract that evidences a residual interest in the assets of an entity after deducting all of its
liabilities.

Fair Value – is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
 Hierarchy – (1) quoted price of identical asset in an active market; the quoted price of similar asset in an active
market; and (3) the quoted price of identical and similar asset in an inactive market.
 Active market – a place where transactions are transacted with sufficient regularity and volume to provide
pricing information on an ongoing basis.

Examples of financial asset and financial liability

1. Cash – medium of exchange; the basis of all transactions; deposit of cash;

2. Receivables - contractual right to receive cash in the future; accounts receivable; notes receivable; loans receivable,
bonds receivable
3. Economic benefit to be received or given up is a financial asset other then cash. Ex. Note payable in government
bonds.
4. Contingency – ex. Financial guarantee
5. Finance lease is a financial instrument but not operating lease.
6. Purchase of shares of another entity at less than its market value
7. Investment in shares or other equity instruments issued by another entities

Not a financial instrument

1. Physical asset – does not give rise to a present right to receive cash or another financial asset
2. Prepaid expenses – delivery of goods
3. Liabilities thru statutory requirements

Equity Securities – instrument representing ownership shares and rights, warrants or options to acquire or dispose of
ownership shares at a fixed or determinable price. It does not include redeemable preference shares, treasury shares
and convertible debt.
Categories

1. Trading securities or financial asset at fair value through profit or loss

2. Financial assets at fair value through other comprehensive income
3. Investment in associate
4. Investment in subsidiary
5. Investment in unquoted equity instruments

Trading Securities or Financial Asset at Fair Value Through Profit or Loss

Trading Securities – equity securities that are purchased with the intent of selling them in the “near term” or very soon.
Classified as current asset.

Recognition – initially, at fair value of the consideration given; transaction costs are expensed outright.

Transactions costs – includes fees and commission paid to agents, advisers, brokers, dealers, levies by regulatory
agencies and securities exchange, and transfer taxes and duties; excludes debt premiums or discounts, financing
costs and internal administrative or holding costs.

Subsequent – changes in the fair value of trading securities shall be included in the profit or loss and cannot be
presented in the OCI.

Not held for trading or Financial Asset Through OCI

Recognition – Initially at fair value plus transaction costs. Once elected, it is irrevocable. It is classified as non-current
asset.

Subsequent - Changes in the fair value is included in the OCI and cannot be reclassified to profit or loss under any
circumstances. However, on derecognition, it may be transferred to retained earnings.

Note: On derecognition, gain or loss shall be recognized in the profit or loss (the difference between the consideration
received and the carrying amount of the asset)

Application 1:

On January 1, 2016, an entity purchased marketable equity securities for P 5,000,000. The equity securities qualify as
financial asset held for trading. The entity also paid P 50,000 as commission to the broker. On December 31, 2016, the
trading securities have a fair value of P 6,000,000. On December 31, 2017, trading securities have a fair value of P
4,500,000. On December 31, 2018, the trading securities are sold for P 5,200,000.

Prepare journal entries.

Application 2:

On January 1, 2016, an entity acquired trading securities with the following market value on December 31, 2016:

Cost Market Gain (loss)

ABC preference share 200,000 150,000 (50,000)
XYZ ordinary share 800,000 950,000 150,000
RST ordinary share 1,000,000 1,100,000 100,000
On January 15, 2017, the ABC preference shares is sold for P 80,000. On December 31, 2017, the remaining trading
securities have the following carrying amount and market value:

Carrying amount Market Gain (loss)

XYZ ordinary share 950,000 1,000,000 50,000
RST 1,100,000 1,500,000 400,000

Prepare journal entries.

Application 3:

On January 1, 2016, an entity purchased marketable equity securities for P 1,000,000. The entity paid commission and
taxes of P 100,000. On December 31, 2016, the securities have a market value of P 1,300,000. On December 31, 2017,
the securities have a market value of P 1,300,000. On July 1,2018, the securities are sold for P 1,200,000.

Prepare journal entries.

Application 4:

On January 1, 2016, an entity purchased marketable equity securities not qualifying as financial asset held for trading.
The entity selected to present changes in fair value as component of other comprehensive income. On December 31,
2016, the securities have the following cost and market value:

Cost Market Gain (loss)

Security A 1,000,000 1,100,000 100,000
Security B 2,000,000 2,700,000 700,000
Security C 3,000,000 2,800,000 (200,000)

On July 1, 2017, Security A was sold for P 1,400,000. On December 31, 2017, the remaining securities have the following
carrying amount and market value:

Carrying Amount Market Gain (loss)

Security B 2,700,000 3,500,000 800,000
Security C 2,800,000 2,750,000 (50,000)

Prepare journal entries.

Reference: Financial Accounting Volume 1 by Valix, 2016 Edition

PAS, PFRS, 2015 Edition
Intermediate Accounting 2 Investment in Equity Securities de Guzman

Seatwork:

1. On January 1, 2016, Spark Company purchased the following trading securities:

Cost Fair Value December 31, 2016

Aura Company ordinary 600,000 650,000
Bora Company preference 350,000 200,000
Cara Company ordinary 500,000 400,000

On October 1, 2017, the entity sold one-half of Aura Company ordinary for P 375,000. On December 31, 2017, the fair
value of the remaining securities was P 800,000.

Prepare journal entries to record transactions.

2. Transitory Company acquired the following equity securities:

December 31, 2016 Cost Market

Moon Company 200,000 120,000

Star Company 400,000 280,000
Sun Company 600,000 650,000

December 31, 2017 Cost Market

Moon Company 200,000 220,000

Star Company 400,000 300,000
Sun Company 600,000 580,000

The equity securities do not qualify as held for trading. The entity has elected irrevocably to present changes in fair value
in other comprehensive income.

Reference: Financial Accounting Volume 1 by Valix, 2016 Edition

PAS, PFRS, 2015 Edition
MULTIPLE CHOICE:

1. On January 1, 2016, Alexis Company purchased marketable equity securities to be held as “trading” for P 5,000,000.
The entity also paid transaction cost amounting to P 200,000. The securities had a market value of P 5,500,000 on
December 31, 2016 and the transaction cost that would be incurred on sale is estimated at P 100,000. No securities
were sold during 2016. What amount of unrealized gain or loss on these securities should be reported in the 2016
income statement?

2. During 2016, Garr Company purchased marketable equity securities as a trading investment. For the year ended
December 31, 2016, the entity recognized an unrealized loss of P 230,000. There were no security transactions during
2017. The entity provided the following information on December 31, 2017:
Cost Market
Security A 2,450,000 2,300,000
Security B 1,800,000 1,820,000
4,250,000 4,120,000

3. During 2016, Latvia Company purchased trading securities with the following cost and market value on December 31,
2016:
Security Cost Market
A – 1000 shares 200,000 300,000
B – 10,000 shares 1,700,000 1,600,000
C – 20,000 shares 3,100,000 2,900,000

The entity sold 10,000 shares of Security B on January 15, 2017 for P 150 per share. What amount of unrealized gain or
loss should be reported in the income statement for 2016? What amount should be reported as loss on sale of trading
investment in 2017?

4. Carmela Company acquired nontrading equity instrument for P 4,000,000 on March 31, 2016. The equity investment
is classified as financial asset at fair value through OCI. The transaction cost incurred amounted to P 700,000. On
December 31, 2016, the fair value of the instrument was P 5,500,000 and the transaction cost that would be incurred on
the sale of the investment is estimated at P 600,000. What amount of gain should be recognized in other comprehensive
income for the year ended December 31, 2016?

5. On December 31, 2016, Fay Company appropriately reported a P 100,000 unrealized loss. There was no change during
2017 in the composition of the portfolio of nontrading equity securities held at fair value through OCI.

Security Cost Market (12/31/2017)

A 1,200,000 1,300,000
B 900,000 500,000
C 1,600,000 1,500,000
What is the market value of the investment on December 31, 2016? What amount of loss on these securities should
be included in the Statement of Comprehensive Income for the year ended December 31, 2017 as component of other
OCI? What cumulative amount of loss on these securities should be reported in the Statement of Changes in Equity for
the year ended December 31, 2017 as component of other comprehensive income?

6. Benguet Company began operations on January 1, 2016. The following information pertains to the December 31, 2016
portfolio of equity securities:

Trading Nontrading
Aggregate cost 4,000,000 6,000,000
Aggregate market value 3,700,000 5,500,000
Aggregate lower or market
Applied to each security. 3,500,000 5,300,000
The market declines are judged to be “other than temporary”. The nontrading securities are designated at fair value
through other comprehensive income. What amount should be reported as total loss on these securities in the income
statement for 2016?

7. Judicious Company acquired an equity investment a number of years ago for P 3,000,000 and classified it as at fair
value through other comprehensive income. On December 31, 2016, the cumulative loss recognized in other
comprehensive income was P 400,000 and the carrying amount of the investment was P 2,600,000. On December 31,
2017, the issuer of the equity instrument was in severe financial difficulty and the fair value of the equity investment had
fallen to P 1,200,000. What cumulative amount of unrealized loss should be reported as component of other
comprehensive income in the statement of changes in equity for the year ended December 31, 2017?

8. On January 1, 2016, Lebanon Company purchased equity securities to be held at fair value through other
comprehensive income. On December 31, 2016, the cost and the market values were:
Cost Market
Security X 2,000,000 2,400,000
Security Y 3,000,000 3,500,000
Security Z 5,000,000 4,900,000

9. On January 1, 2016, Caraga Company purchased equity securities to be held as financial asset at fair value through
other comprehensive income.
Cost Market (12/31/2016) Market (12/31/2017)
Security R 3,000,000 3,200,000 -
Security S 4,000,000 3,500,000 3,700,000
Security T 5,000,000 4,600,000 4,700,000

On January 31, 2017, the entity sold security R for P 3,500,000. What amount should be recognized directly to retained
earnings as a result of the sale of the investment in 2017? What cumulative unrealized gain or loss on the remaining
financial asset should be reported in the statement of changes in equity?

10. At the beginning of the current year, Remington Company acquired 200,000 ordinary shares of Universal Company
for P 9,000,000. At the time of purchase, Universal Company had outstanding 800,000 shares with a carrying amount of
36,000,000. The following events took place during the current year:
 Universal company reported net income of P 1,800,000 for the current year.
 Remington Company received from Universal Company a dividend of P.75 per ordinary share.
 The market price of Universal Company share had temporarily declined to P 40.
Remington Company has elected irrevocably to measure the investment at fair value through other comprehensive
income. What is the carrying amount of the investment at year-end?
EQUITY INVESTMENT ACQUIRED BY EXCHANGE:

1. Fair value of the asset given up

2. Fair value of the asset received
3. Carrying amount of the asset given up

LUMP SUM ACQUISITION

 Single cost is allocated to the securities acquired on the basis of their fair value.

INVESTMENT IN UNQUOTED EQUITY INSTRUMENT

 In the absence of the fair value, it shall be measured at cost.

SALE OF EQUITY SECURITIES

 Same class acquired on different dates at different costs and a portion of it is subsequently sold, the entity shall
determine the cost using either FIFO or average approach.

SUBSEQUENT TRANSACTIONS

1. SHARE SPLIT

 Share split reduction in the par or stated value of share capital accompanied by a proportionate increase in the
number of shares outstanding.
 Does not affect equity of the issuing corporation.
 Memorandum entry

2. DIVIDENDS

 Date of declaration – dividend revenue is recognized;

 Dividend on – the sale of shares between the date of declaration and the date of record; Included in the market
price of shares is the right to dividends.
 Ex- dividend – the sale of shares between the date of record and the date of payment. Excluded in the market
price of shares is the right to dividends.

3. STOCK DIVIDENDS OR BONUS ISSUE

 Shares of another entity declared as dividends are not stock dividends but PROPERTY DIVIDENDS;
 Kinds: “same as those held” and “different from those held”;
 Not income; no assets distributed; equity is the same before and after;
 More shares but at a reduce market value.
 Same class – memo entry; increase the shares but reduce the market value.
 Different class – preference shares as dividend; proportion the cost of the ordinary shares to preference share
according to the market value of the shares.
 Entries: Dr: Investment in preference shares; Cr: Investment in ordinary shares

4. SHARES RECEIVED IN LIEU OF CASH DIVIDENDS

 It is income; measured at income at fair value coz in effect it’s property dividends.
 In the absence of the fair value, the income is equal to the cash dividends that would have been received.
 Entries: Dr: Investment in equity securities; Cr: Dividend income
5. CASH RECEIVED IN LIEU OF STOCK DIVIDENDS

 “AS IF” approach, meaning, stock dividends are assumed to be received and subsequently sold at the cash
received. Therefore, a gain or loss may be recognized.

6. REDEMPTION OF SHARE

7. STOCK RIGHTS (RIGHT OF PRE-EMPTION) OR RIGHT ISSUE

THEORETICAL FAIR VALUE OF SHARE RIGHT

Value of one right = MV of share right on/ Number of rights to purchase +1

Value of one right – MV of share ex-right – subscription price/ Number of rights to purchase one share

PROBLEMS:
1. On January 1, 2016, ABC Company purchased 40,000 shares at P 100 per share to be held for trading. Brokerage fees
amounted to P 120,000. A P5 dividend per share had been declared on December 15, 2015 to be paid on March 31,
2016 to shareholders of record on January 31, 2016. No other transactions occurred in 2016 affecting the investment.
What is the initial measurement of the investment?

2. On January 1, 2016, Adam Company purchased as a long-term investment unlisted 100,000 ordinary shares of Mill
Company for P 40 a share. On December 28, 2016, Adam Company sold 80,000 shares of Mill Company for a P50 a
share. For the year ended December 31, 2016, what amount should be reported as gain on disposal of long-term
investment?

3. Cobb Company purchased 10,000 shares representing 2% ownership of Roe Company on February 15, 2016. Cobb
Company received a stock dividend of 2,000 shares on March 31, 2016, when the carrying amount per share was P 350
and the market value per share was P 400. Roe Company paid a cash dividend of P 15 per share on September 15, 2016.
In the income statement for the year ended October 31, 2016, what amount should be reported as dividend income?

4. During 2016, Lawan Company bought the shares of Burwood Company as follows:

June 1 20,000 shares @ P 100 2,000,000

December 1 30,000 shares @ P 120 3,600,000
5,600,000
Transactions for 2017
January 10 Received cash dividend at P 10 per share
January 20 Received 20% stock dividend.
December 10 Sold 30,000 shares at P 125 per share.

If the FIFO approach is used, what is the gain on the sale of the shares? If average, what is the gain on sale?

5. Wood Company owns 20,000 shares of Arlo Company’s 200,000 shares of P 100 par, 6% cumulative, nonparticipating
preference share capital and 10,000 shares representing 2% ownership of Arlo’s ordinary share capital. During 2016,
Arlo declared and paid preference dividends of P2,400,000. No dividends had been declared or paid during 2015. In
addition, Wood received a 5% stock dividend on ordinary shares from Arlo when the quoted market price of Arlo’s
ordinary share was P 10. What amount should be reported as dividend income for 2016?

6. Day Company received dividends from share investments during the year ended December 31, 2016 as follows:
 A stock dividend of 4,000 shares from Parr Company on July 31, 2016 when the market price of Parr’s share was
P 20. Day owns less than 1% of Parr’s share capital.
 A cash dividend of P 150,000 from Lark Company in which Day owns a 25% interest. A majority of Lark’s
directors are also directors of Day.
What amount of dividend revenue should be reported in 2016?

7.Wray Company provided the following data for 2016:

 On September 1, Wray received a P 500,000 cash dividend from Seco Company in which Wray owns a 30%
interest.
 On October 1, Wray received a P 60,000 liquidating dividend from King Company. Wray owns a 5% interest in
King.
 Wray owns a 2% interest in Bow Company, which declared a P 2,000,000 cash dividend on November 15, 2016
payable on January 15, 2017.

What amount should be reported as dividend income for 2016?

8. During 2016, Neil Company held 30,000 shares of Brock Company’s 10,000 outstanding shares and 6,000 shares of
Amal Company’s 300,000 outstanding shares. During the year, Neil received P300,000 cash dividend from Brock,
P15,000 cash dividend and 3% stock dividend from Amal. The closing price of Amal share is P 150. What amount should
be reported as dividend revenue for 2016?

9. On March 1, 2016, Evan Company purchased 10,000 ordinary shares at P 80 per share. On September 30, 2016, Evan
received 10,000 stock rights to purchase an additional 10,000 shares at P 90 per share. The stock rights had an expiration
date on February 1, 2017. On September 30, 2016, the share had a market value P95 and the stock right had a market
value of P 5. What amount should be reported on September 30, 2016 for investment in stock rights?

10. Rice Company owned 30,000 ordinary shares of Wood Company acquired on July 31, 2016, at a total cost of P
1,100,000. On December 1, 2016, Rice received 30,000 stock rights from Wood. Each right entitles the holder to acquire
one share at P45. The market price of Wood’s share on this date was P 50 and the market price of each right was P10.
Rice sold the rights on December 31, 2016 for P 450,000 less a P 10,000 commission.

11. Adam Company owned 50,000 ordinary shares of Bland Company. These 50,000 shares were purchased by Adam for
P 120 per share. On August 30, 2016, Bland distributed 50,000 stock rights to Adam. Adam was entitled to buy one new
share of Bland Company for P90 cash and two of these rights. On August 30, 2016 each share had a market value of P
130 and each right had a market value of P 20. What total cost should be recorded for the new shares that are acquired
by exercising the rights?

12. Excelsia Company issued rights to subscribe to its stock, the ownership of 4 shares entitling the shareholders to
subscribe for 1 share at P100. Jealina Company owns 50,000 shares of Excelsia Company with total cost of P 5,000,000.
The share is quoted right-on at P125. What is the cost of P 5,000,000? The share is quoted right-on at 125. What is the
cost of the new investment if all of the stock rights are exercised by the investor?

13. On January 1, 2016, Mylene Company purchased 50,000 shares of another entity for P 3,600,000. On October 1,
2016, the entity received 50,000 stock rights from the investee. Each right entitled the shareholder to acquire one share
for P 85. The market price of the investee’s share was P 100 immediately before the rights were issued and P90
immediately after the rights were issued. On December 1, 2016, the entity exercised all stock rights. On December 31,
2016, the entity sold 25,000 shares at P 90 per share. The stock rights are not accounted for separately. The FIFO
approach is used. What is the gain on sale of investment that should be recognized in 2016?

14. 2014:
Jan. 1. Christopher Company purchased 20,000 shares of Bay Company, P 100 par, at P 110 per share.
Mar. 1. Bay Company issued rights to Christopher Company, each permitting the purchase of ¼ share at par. No
entry was made. The bid price of the share was 140 and there was no quoted price for the rights.
April 1. Christopher Company paid for the new shares charging the payment to the investment account. Since
Christopher Company felt that it had been assessed by Bay Company, the dividends received from Bay Company
in 2014 and 2015 were credited to the investment account until the debit for payment of the new share was
fully offset.
December 31. Christopher Company received annual dividend of P 250,000 from Bay Company.
2015:
Dec. 31. Christopher Company received annual dividend of P 250,000 from Bay Company.
2016:
Jan. 1. Christopher Company received 50% stock dividend from Bay Company. On same date, the shares
received as stock dividend were sold at P 160 per share and the proceeds were credited to income.
Dec. 31. The shares of Bay Company were split 2 for 1. Christopher Company found that each new share was
worth P5 more than the P 110 paid for the original shares. Accordingly, Christopher Company debited the
investment account with the additional shares received at P 110 per share and credited to income.
2017:
June 30 Christopher Company sold one-half of the investment at P 92 per share and credited the proceeds to
the investment account.
 What is the balance of the investment on Dec. 31, 2017 as it was kept by Christopher Company? Using the
average method, what is the correct balance of the investment on December 31, 2017? What is the net adjustment to
retained earnings on December 31, 2017? What amount of gain on sale of investment should be reported in 2017?