Investment.ppt

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Ch. 1: Investment Accounts

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Learning objectivesrecord the purchases and sales of investments in shares, debentures and government stock

without dividend complications;at ex. dividend;at cum. dividend;

account for dividends and interest received on investments;account for a bonus issue; and account for a right issue.

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Concept ChartInvestments

Investments withfixed interest/returns

Ordinary sharesDebentures

Preference sharesGovernment bonds

Investment without fixedinterest/returns

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1.1: Investments without Fixed Interest

These are mainly ordinary shares.A. ACCOUNTING PROCEDURES

Transactions Accounting entries

1. Cost of investment purchased (cost + other acquisition cost, e.g. brokerage fees, commission and stamp duty)

Dr Investments (Capital+nominal)Cr Bank

2. Receipt of dividend Dr BankCr Investment Income

3. Sale of investment (proceeds – other selling expenses e.g brokerage fees, commission and stamp duty)

Dr BankCr Investments (capital+nominal)

4. Profit on sale on investment (reverse the entries for a loss on the sale of the investment)

Dr Investments(Capital)Cr Profit and Loss

5. Transfer of income to the profit and loss account at the end of the accounting year

Dr Investment IncomeCr Profit and Loss

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On the purchase of an investment, the total cost ( commission, brokerage and expenses) are recorded in the investment account.

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Example 1

On 1 January 1996, Fortune Ltd. Purchased 1,000 $1 ordinary shares in Lucky Ltd. At 96. The brokerage fee incurred was $100.On 30 June 1996, Fortune Ltd. Received a dividend of $0.1 per share.On 31 December 1996, Fortune Ltd. Sold 500 shares at 120. A $30 brokerage fee was paid.

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Investment – Ordinary Shares in Lucky Ltd.Date Particulars N I C

$ $ $1996

1/1 Bank –purchase

(1000*096)+100 1000 106031/12 P&L – gain

570-(1060*500/1000) 40

31/12 P&L-dividend 100

Date Particulars N I C$ $ $1996

30/6 Bank – dividend

(1,000 x 0.1) 10031/12 Bank – sale

(500*1.2-30) 500 570

31/12 Bal. c/f 500 530

1,000 100 1100 1000 100 1100

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Profit & Loss Account for the year ended 31 December 1996 (Extract)

$

Gross Profit X

Add:Gain on Disposal of Investment 40

Investment Income 100

Balance Sheet as at 31 December 1996 (Extract)

$

Fixed Assets

Investment 530

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B. Accounting for a Bonus Issue and a Rights Issue

1. Bonus issue• bonus issue is an issue of ordinary shares

out of a company’s reserve to its shareholders instead of a cash dividend.

• No double entry would be made in the books of the shareholders,

• The value of the issue should be entered on the debit side of the nominal column of the investment account (on a memorandum basis only).

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2. Rights issue• Right issue is an issue of the rights

to the existing shareholders to subscribe ordinary shares at a price lower than market value. There are 3 ways the shareholders holding the rights can respond.

1. Renounce the rightsNo entry

2. Selling the rights

Dr BankCr Investment Account (capital column)

With the sale proceeds

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3. Take up the rights

4. Buy extra rights from other shareholders and take up the rights

Dr Investment Account (Capital column)Cr Bank

With the pricepaid for the shares

Dr Investment( Capital column)Cr BankNo entry should be made in thenominal column

With the pricepaid for the extrarights

Dr Investment (Capital column)Cr Bank

With the pricepaid for the shares

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Example 2A company received 1,000 bonus shares of a par value of $1 and a market value of $1.2, and rights to subscribe 1,000 shares. The company sold 1,000 rights for $0.2 each.

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Investment Account (Extract)N I C$ $ $

Bonus Issue 1000 - -

N I C$ $ $

Bank - - 200

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Example 3The following transactions took place for the year ended 31 December 1996.

1996

Feb 1 The company purchased 150,000 ordinary shares in Benson Ltd. of $1 each for $300,000.

May 1 Benson Ltd. declared it would give members the rights to apply for one share for every five held on 1 April 1996 at a price of $1.5 per share fully payable on application.

June 1 The company purchased the rights for 200 shares from other shareholders of Benson Ltd. at $0.1 per share.

July 1 Applied and paid for all shares in Benson Ltd. on all rights held.

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Investment – Ordinary Shares in Benson Ltd.

N I C$ $ $1996

1/2 Bank – purchases 150000 300000

1/6 Bank(200*$0.1) 20 1/7 Bank – rights issue

(W1) 30200 45300

N I C$ $ $1996

31/12 Bal. c/f 180200 345320

180,200 345320

180,200 345320

W1:Nominal value of shares purchased=(150000/5+200)*$1=$30200Cost of investment=30200*$1.5=$45300

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C. Profit or Loss on the Disposal of Investments

Profit or loss on disposal of investments is calculated by this equation:Profit on disposal = Sale proceeds-cost

of investment sold = (Selling price-

Selling expense) – Cost of investment sold

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Nov cost Dec income

30/11/2000 bought 31/12/2000 received interest at once

Part of the cost represents income

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D. Cost of investmentThere are 2 methods for calculating the cost of

the investments:

1. Weighted average method• Using this method, the cost of the

investment sold is determined by the average of investment held.

2. First-in-first-out method• Using this method, the cost of the

investment sold is determined by the unit price of the investment that is purchased earliest.

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Example 4• Fortune Ltd. had the following

transactions in ordinary shares of Joyce Ltd., during the year ended 31 December 1996.

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Jan 1 Purchased 10,000 ordinary shares of $1 each in Joyce Ltd. at a cost of $10,500.

Feb 1 Purchased 20,000 ordinary shares of $1 each in Joyce Ltd. at $1.5 per share.Mar 1 Sold 4,000 ordinary shares in Joyce Ltd. at $2 per share. Selling

expenses were $50.Mar 31 Joyce Ltd. made a one for 10 bonus issue.Mar 31 Received interim dividend of 20 cents per share from Joyce Ltd.

The new shares did not rank for the dividend.May 31 Sold 8,000 ordinary shares in Joyce Ltd. For $20,000.Nov 1 Joyce Ltd. gave shareholders the rights to apply for one share of

every five shares held on 31 August at a price of $1.2 per share fully payable on application.

Nov 20 Purchased the rights for 500 shares from other shareholders of Joyce Ltd. at $0.5 per share.

Nov 25 Applied and paid for all shares in Joyce Ltd. On all rights held.Nov 30 Sold 6,000 ordinary shares in Joyce Ltd. at $2.5 per share. Selling expenses were $50.

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Investment – Ordinary Shares in Joyce Ltd.Date Particulars N I C

$ $ $1996

1/1 Bank – purchases 10000 10500

31/3 Bonus issue

($10,000 + $20,000 –

$4,000)/10 260020/11 Bank – purchases of 250

rights

Date Particulars N I C

$ $ $1996

1/3 Bank – sales ($8,000

- $50) 4000 7950


(10,000 + 20,000 –

4,000) x 0.2 5200 31/5 Bank – sales 8000 20000

37,220 5200 66853 37,220 5200 66853

½ Bank – purchases 20000 30000

25/11 Bank – purchases (W1) 4620 5544 31/12 P&L – dividend

received 520031/12 P&L – gain

on disposal (W2) 20859

30/11 Bank – sales

($15,000 - $50) 6000 1495031/12 Bal. c/f 19220 23683

Weighted average methodWeighted average method

W1 No. of rights taken up:(10000+20000+2600-4000-8000)/5+500=4650 Cost of investment =4620*$1.2=$5544

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W2 Profit or loss on disposal1st disposal: $Sales proceeds 7950Less cost of investments(10500+30000)*4000/10000+20000 5400Profit on disposal 2550

2nd disposal:Sales proceeds 20000Less cost of investments(10500+30000- 5400)*8000/10000+20000+2600-4000 9818Profit on disposal 10182

3rd disposal:Sales proceeds 7950Less cost of investments(10500+30000+250+5544-5400 -9818)*6000/10000+20000+2600+4620 7393Profit on disposal 7557

Total profit on disposal= 2550+10182+7557=20289

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$ $ $1996

1/1 Bank – purchases 10000 10500

31/3 Bonus Issue

($10,000 + $20,000 –

$4,000)/10

25020/11 Bank – purchases

of right

Date Particulars N I C

$ $ $1996

1/3 Bank – sales ($8,000 - $50) 4,000

31/5


(10,000 + 20,000 – 4,000) x 0.2

6,000 14,950

Bank - sales 8,000 20,000

37,220 5200 66694 37,220 5200 66694

½ Bank – purchases 20000 30000

25/11 Bank – purchases 4,620 5,544

31/12 P&L – dividend received 5200 31/12 P&L – gain of

disposal (W3) 20400

7,950

5,200

30/11 Bank – sales ($15,000 - $50)

31/12 Bal. c/f 19220 23794

First-in-first-out methodFirst-in-first-out method

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W3 Profit or loss on disposal1st disposal: $Sales proceeds 7950Less cost of investments(10500*4000/10000 4200Profit on disposal 3750

2nd disposal:Sales proceeds 20000Less cost of investments10500*6000/10000+30000*2000/20000 9300 Profit on disposal

10700

3rd disposal:Sales proceeds 14950Less cost of investments30000*6000/20000 9000Profit on disposal 5950

Total profit on disposal=3750+10700+5950=20400

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1.2: Investments with Fixed Interest

They can be preference shares, debentures and government stocks.Investment income is distributed once or twice a year at given dates.A company is only entitled to income from an investment for the exact period that the investment is held.If the acquisition occurs between 2 payments dates, either the seller or the buyer will have the rights to receive interest. However some interest belongs to the seller and some belongs to the buyer; adjustments are to be made for the accrued income.

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The price of the investment does not include the right to the next instalment of interest…..ex div….excluding dividend.

Where it does include the right to receive the next instalment of interest…..cum div…….including dividend.

All prices are cum div. Unless stated the otherwise.

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A. Purchase at Cum. Div / Cum. Int.

The buyer of investments has the rights to receive the entire income payable on the first payment date after acquisition. The extra income for the period from last payment to acquisition reduces the cost of the investments.

Cost of investment $

Purchase price x

Add Brokerage fee / Commission x

x

Less Accrued income given up by seller

(Nominal value*Interest rate*No. of months from the last x payment date to acquisition) / 12 x

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Dr Investment (N+C)Dr Investment Income (I)Cr Bank

With the cost of the investmentWith the excess income receivableWith the total amount paid

Accounting entries:

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Example 5On 31 April 1994, Gordon Ltd. purchased $10,000 of 12% preference shares in Joyce Ltd. cum. div. at 90. A $200 brokerage fee was paid. Interest was paid on 31 December and 30 June every year.

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$ $ $1994

31/4 Bank – purchases 10000 400 8800

(10000*0.9+200-400)

31/12 P&L – dividend 800


30/6 Bank – dividend 600

(10000*12%*1/2)31/12 Bank – dividend 600 31/12 Bal. c/f 10000 8800

10,000 1200 8800

10,000 1200 8800

Dividend given up by seller (from the last payment date to acquisition)

= $10,000 x 12% x 4/12 = $400

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B. Purchase at Ex. Div. / Ex. Int.

The buyer of investments does not have the rights to receive any interest / dividend income payable on the first payment date after acquisition. The income given up should be included in the cost of the investments.

Cost of investment $Purchase price xAdd Brokerage / commission x

Dealing Price X Add interest given up to seller

(Nominal value*interest rate*no. of months from acquisition to the coming payment date/12)

X

X

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Accounting entries:

Dr Investment (C+N)Cr BankDr Investment (C)Cr Investment Income

Dealing price

Interest given up for the period fromacquisition to the coming payment date

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Example 6The facts are the same as Example 5, except that the investment was purchased at ex. div.

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$ $ $199430/4 Bank – purchases 10000 9200

(10000*09+200)

31/12 P&L –dividend 800


30/4 Investment – ex. Div 200.31/12 Bank – dividend 600

31/12 Bal. c/f 10000 9400

10,000 800 9400 10,000 800 9400

30/4 Investment Income

– ex. div. 200

Dividend given up to seller (from acquisition to the coming payment date)

= $10,000 x 12% x 2/12 = $200

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C. Sell at Cum. Div. / Cum. Int.

The seller of investments gives up the rights to receive the income on the first payment date after sale. The income given up reduces the net sale proceeds. The net sale proceeds should be calculated in the following way.Net sale proceeds: $Selling pricexLess Brokerage fee/ Commission

xx

Less Accrued income given up by seller(Nominal value*Interest rate*No. of months from last xpayment date to date/12) x

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Accounting entries

Dr BankCr Investment Income (I)Cr Investment (C+N)

With the total sale proceedsWith accrued income given upWith the net sale proceeds

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Example 7The facts are the same as in Example 5. On 1 Feb 1995, Gordon Ltd. sold $5,000 12% preference shares in Joyce Ltd. cum. div. At 95. A $250 commission was paid.

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$ $ $1995

1/1 Bal. b/f 10000 8800



½ Bank – sales 5000 50 4450

(5000*095-250-50)


31/12 Bal. c/f 5000 4400

10,000 650 8850 10,000 650 8850

31/12 P&L – profit

on disposal 50

(4450-8800*5000/10000)


Dividend given up by seller (from the last payment date to the date of sale)

= $5,000 x 12% x 1/12 = $50

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D. Sell at Ex. Div./Ex. Int.The seller will receive the income on the first payment date after sale. The extra income increases the total sale proceeds.Total Sales Proceeds $Selling Price xLess brokerage fee / commission x

Dealing Price X Add Dividend given up by buyer

X

X(Nominal value*Interest rate*No. of month from acquisitionTo the coming payment date)

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Accounting entries:

Dr BankCr InvestmentDr Investment IncomeCr Investment

Dealing price

Excess income receivable for the periodfrom sale to the coming payment date

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Example 8The facts are the same as in Example 7. On 1 April 1996, Gordon Ltd. sold $5,000 12% preference shares in Joyce Ltd. ex. div. At 90. A $200 commission was paid

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$ $ $1996

1/1 Bal. b/f 5000 44001/4 Investment – ex. div. 150


¼ Bank – sales 5000 4300

($5000*0.9-200)

¼ Investment Income

– ex. div. 150

5,000 300 4450 5,000 300 4450

31/12 P&L – profit on

disposal 50 (4450-8800*5000/10000)



Dividend given up by buyer (from sale to the coming payment date) = $5,000 x 12% x 3/12 = $150

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Investment

9% Debenture interest payable 1 April and 1 October

May 31 purchased 40,000 at 96 cum. int

Investment.ppt

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