Ch. 1: Investment Accounts

1. Ch. 1: Investment Accounts

2. Learning objectives • record 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.

3. Investments Investments with fixed interest/returns Investment without fixed interest/returns Debentures Preference shares Government bonds Ordinary shares Concept Chart

4. 1.1: Investments without Fixed Interest These are mainly ordinary shares. A. ACCOUNTING PROCEDURES

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

6. 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.

7. Investment – Ordinary Shares in Lucky Ltd. Date Particulars N I C Date Particulars N I C $ 1996 $ $ $ 1996 $ $ 1/1 Bank –purchase (1000*096)+100 1000 1060 30/6 Bank – dividend (1,000 x 0.1) 100 31/12 P&L – gain 570-(1060*500/1000) 40 31/12 Bank – sale (500*1.2-30) 500 570 31/12 Bal. c/f 500 530 31/12 P&L-dividend 100 1,000 100 1100 1000 100 1100

8. 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

9. B. Accounting for a Bonus Issue and a Rights Issue • 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).

10. Dr Bank Cr Investment Account (capital column) With the sale proceeds • 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. • Renounce the rights No entry • Selling the rights

11. Dr Investment Account (Capital column) Cr Bank With the price paid for the shares Dr Investment( Capital column) Cr Bank No entry should be made in the nominal column With the price paid for the extra rights Dr Investment (Capital column) Cr Bank With the price paid for the shares • Take up the rights • Buy extra rights from other shareholders and take up the rights

13. Example 2 • A 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.

14. Investment Account (Extract) N I C N I C $ $ $ $ $ $ Bonus Issue 1000 - - Bank - - 200

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

16. Investment – Ordinary Shares in Benson Ltd. N I C N I C $ 1996 $ $ $ 1996 $ $ 1/2 Bank – purchases 150000 300000 31/12 Bal. c/f 180200 345320 1/6 Bank(200*$0.1) 20 1/7 Bank – rights issue (W1) 30200 45300 180,200 345320 180,200 345320 W1: Nominal value of shares purchased=(150000/5+200)*$1=$30200 Cost of investment=30200*$1.5=$45300

17. 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

18. Dec income Nov cost 30/11/2000 bought 31/12/2000 received interest at once Part of the cost represents income

19. D. Cost of investment There are 2 methods for calculating the cost of the investments: • Weighted average method • Using this method, the cost of the investment sold is determined by the average of investment held. • 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.

20. Example 4 • Fortune Ltd. had the following transactions in ordinary shares of Joyce Ltd., during the year ended 31 December 1996.

21. 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.

22. Weighted average method Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1996 $ $ $ 1996 $ $ 1/1 Bank – purchases 10000 10500 1/3 Bank – sales ($8,000 - $50) 4000 7950 ½ Bank – purchases 20000 30000 31/3 Bonus issue ($10,000 + $20,000 – $4,000)/10 2600 31/3 Bank – dividend (10,000 + 20,000 – 4,000) x 0.2 5200 20/11 Bank – purchases of 250 rights 31/5 Bank – sales 8000 20000 30/11 Bank – sales ($15,000 - $50) 6000 14950 25/11 Bank – purchases (W1) 4620 5544 31/12 P&L – dividend received 5200 31/12 Bal. c/f 19220 23683 31/12 P&L – gain on disposal (W2) 20859 37,220 5200 66853 37,220 5200 66853 W1 No. of rights taken up:(10000+20000+2600-4000-8000)/5+500=4650 Cost of investment =4620*$1.2=$5544

23. W2 Profit or loss on disposal 1st disposal: $ Sales proceeds 7950 Less cost of investments(10500+30000)*4000/10000+20000 5400 Profit on disposal 2550 2nd disposal: Sales proceeds 20000 Less cost of investments(10500+30000- 5400)*8000/10000+20000+2600-4000 9818 Profit on disposal 10182 3rd disposal: Sales proceeds 7950 Less cost of investments(10500+30000+250+5544-5400 -9818)*6000/10000+20000+2600+4620 7393 Profit on disposal 7557 Total profit on disposal= 2550+10182+7557=20289

24. First-in-first-out method Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1996 $ $ $ 1996 $ $ 1/1 Bank – purchases 10000 10500 1/3 Bank – sales ($8,000 - $50) 4,000 7,950 ½ Bank – purchases 20000 30000 31/3 Bonus Issue ($10,000 + $20,000 – $4,000)/10 31/3 Bank – dividend (10,000 + 20,000 – 4,000) x 0.2 5,200 20/11 Bank – purchases of right 31/5 Bank - sales 8,000 20,000 250 30/11 Bank – sales ($15,000 - $50) Bank – purchases 25/11 4,620 5,544 6,000 14,950 31/12 P&L – dividend received 5200 31/12 Bal. c/f 19220 23794 31/12 P&L – gain of disposal (W3) 20400 37,220 5200 66694 37,220 5200 66694

25. W3 Profit or loss on disposal 1st disposal: $ Sales proceeds 7950 Less cost of investments(10500*4000/10000 4200 Profit on disposal 3750 2nd disposal: Sales proceeds 20000 Less cost of investments10500*6000/10000+30000*2000/20000 9300 Profit on disposal 10700 3rd disposal: Sales proceeds 14950 Less cost of investments30000*6000/20000 9000 Profit on disposal 5950 Total profit on disposal=3750+10700+5950=20400

26. 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.

27. 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.

28. 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

29. Dr Investment (N+C) Dr Investment Income (I) Cr Bank With the cost of the investment With the excess income receivable With the total amount paid Accounting entries:

30. Example 5 • On 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.

31. Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1994 $ $ $ 1994 $ $ 31/4 Bank – purchases 10000 400 8800 (10000*0.9+200-400) 30/6 Bank – dividend 600 (10000*12%*1/2) 31/12 Bank – dividend 600 31/12 P&L – dividend 800 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

32. 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 x Add 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

33. Dr Investment (C+N) Cr Bank Dealing price Dr Investment (C) Cr Investment Income Interest given up for the period from acquisition to the coming payment date Accounting entries:

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

35. Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1994 $ $ $ 1994 $ $ 30/4 Bank – purchases 10000 9200 (10000*09+200) 30/4 Investment – ex. Div 200. 31/12 Bank – dividend 600 30/4 Investment Income – ex. div. 200 31/12 Bal. c/f 10000 9400 31/12 P&L –dividend 800 10,000 800 9400 10,000 800 9400 Dividend given up to seller (from acquisition to the coming payment date) = $10,000 x 12% x 2/12 = $200

36. 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 price x Less Brokerage fee/ Commission x x Less Accrued income given up by seller (Nominal value*Interest rate*No. of months from last x payment date to date/12) x

37. Dr Bank Cr Investment Income (I) Cr Investment (C+N) With the total sale proceeds With accrued income given upWith the net sale proceeds Accounting entries

38. Example 7 • The 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.

39. Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1995 $ $ $ 1995 $ $ 1/1 Bal. b/f 10000 8800 ½ Bank – sales 5000 50 4450 (5000*095-250-50) 31/12 P&L – dividend 650 31/12 P&L – profit on disposal 50 (4450-8800*5000/10000) 30/6 Bank – dividend 300 31/12 Bank – dividend 300 31/12 Bal. c/f 5000 4400 10,000 650 8850 10,000 650 8850 Dividend given up by seller (from the last payment date to the date of sale) = $5,000 x 12% x 1/12 = $50

40. 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 x Less brokerage fee / commission x Dealing Price X Add Dividend given up by buyer X X (Nominal value*Interest rate*No. of month from acquisition To the coming payment date)

41. Dr Bank Cr Investment Dealing price Dr Investment Income Cr Investment Excess income receivable for the period from sale to the coming payment date Accounting entries:

42. Example 8 • The 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

43. Investment – Ordinary Shares in Joyce Ltd. Date Particulars N I C Date Particulars N I C $ 1996 $ $ $ 1996 $ $ 1/1 Bal. b/f 5000 4400 ¼ Bank – sales 5000 4300 ($5000*0.9-200) 1/4 Investment – ex. div. 150 ¼ Investment Income – ex. div. 150 31/12 P&L – dividend 150 31/12 P&L – profit on disposal 50 (4450-8800*5000/10000) 30/6 Bank – dividend 300 5,000 300 4450 5,000 300 4450 Dividend given up by buyer (from sale to the coming payment date)= $5,000 x 12% x 3/12 = $150

44. Investment 9% Debenture interest payable 1 April and 1 October May 31 purchased 40,000 at 96 cum. int