Chapter 9--Learning Objectives 1.Explain the recognition and measurement issues associated with investments.

Chapter 9--Learning Objectives

1. Explain the recognition and measurement issues associated with investments

The primary accounting standards for investments are:

FASB SFAS No. 115

For all debt securities

For equity investments of less than 20 percent

APB Opinion No. 18

For equity investments of more than 20 percent

Major provisions of SFAS No. 115

Investments accounted for at fair value or amortized cost

Investments classified as:

1. Trading securities

2. Available-for-sale

3. Held-to-maturity

Passive investments and significant influenceA passive investment is one in which the

investor has no ability to exercise significant influence over the investee

Significant influence is presumed to exist with ownership of 20 percent to 50 percent of the voting stock of the investee

Investment classifications

Trading securities

Debt and equity securities bought and held principally for the purpose of sale in the near term

Available-for-sale securities

Debt and equity securities neither trading nor held-to-maturity

Held-to-maturity securities

Debt securities that the entity has the positive intent and ability to hold to maturity

Accounting requirements forTrading securities(investments less than 20 percent)

Changes in market value recognized as gain or loss in current period income

Securities reported at market value

Accounting requirements forAvailable-for-sale securities(investments less than 20 percent)Changes in market value recognized as

separate component of shareholders’ equity until realized

Securities reported at market value

Accounting requirements forHeld-to-maturity securities(debt securities only)Changes in market value not recognized

Securities reported at amortized cost

Major provisions of APB Opinion No. 18

Applies to ownership of equity securities greater than 20 percent

For ownership of 20 to 50 percent, use the equity method

For ownership of greater than 50 percent, use consolidated financial statements

The equity method(equity investments of 20 to 50 %)

Investments recorded at cost

Investment increased for proportionate share of net income

Investment decreased for:

1. Dividends received

2. Extra depreciation

3. Amortization of goodwill

Consolidate financial statements(equity investments of more than50 percent)

This material is

beyond the scope

of our course

(so much GAAP, so little time)


2. Record and report transactions for debt-security investments and equity-security investments of less than 20%

Held to maturity debt securities

Record acquisitions at cost

Investment in Debt Securities XXXCash XXX

Record interest as income

Cash XXXInterest Income XXX


If purchased at premium, include in cost


Amortize by reducing investment valueCash XXX

Interest Revenue XXXInvestment in Debt Securities XXX


If purchased at discount, record at cost


Amortize by increasing investment valueCash XXXInvestment in Debt Securities XXX

Interest Revenue XXX


Ignore market value changes for held to maturity debt securities !

Sale of held to maturity debt securities before maturity

Accrue interest as required

Determine amortized cost

Compare with selling price

Recognize gain or loss based on difference between amortized cost (book value) and selling price

Available for sale debt securities

Procedures for purchase, interest, and premium or discount amortization are same as for held to maturity debt securities

Exception: Market value changes are adjusted for


If market value is above amortized cost

Adjustment to Market XXXUnrealized Holding Gain XXX

“Adjustment to Market” is shown on the balance sheet along with the investment account

“Unrealized Gain” is shown as a separate account in the equity section


If market value is below amortized cost

Unrealized Holding Loss XXXAdjustment to Market XXX

“Adjustment to Market” is shown on the balance sheet along with the investment account as a reduction of value

“Unrealized Loss” is shown as a separate negative account in the equity section

Debt Securities--Trading

Recorded at cost Amortization ignored Changes in fair value recorded in current

income

Accounting for equity trading securities


Investment in Trading Securities XXXCash XXX

Record dividends and interest as income

Cash XXXDividend Income XXX

Accounting for equity trading securities

If market value on reporting date is lower than original cost

Loss on Holding Equity Securities XXXInvest. in Trading Securities XXX

If market value is higher than costInvest. in Trading Securities XXX

Gain on Holding Equity Sec. XXX

Available for sale equity securities


Investment in AFS Securities XXXCash XXX

Record dividends and interest as income

Cash XXXDividend Income XXX


If market value on reporting date is lower than original cost

Unrealized Loss on AFS Sec. XXXInvestment in AFS Securities XXX

The “Unrealized Loss” account is shown as a separate component of stockholders’ equity (a reduction in this case)

It is NOT shown on the income statement


If market value on reporting date is higher than original cost

Investment in AFS Securities XXXUnrealized Gain on AFS Sec. XXX

The “Unrealized Gain” account is shown as a separate component of stockholders’ equity (an increase in this case)

It is NOT shown on the income statement

Transfers between categories

Base classification on management intentTransfer between categories based on fair market

value at time of transferRecognize any unrealized holding gain or loss at

time of transferInclude in income for securities transferred into or

from trading categoryShow as separate stockholders’ equity item for

securities transferred into available for sale category from held-to-maturity

Impairment of Securities

Permanent loss.Security written down to fair value

Loss included in earnings as realized


3. Record and report equity-security investment transactions of greater than 20%

The equity method

Used for situations in which more than 20 percent of the voting stock is owned

If more than 50 percent is owned, consolidated financial statements are prepared

Thus, the equity method applies to situations of 20 to 50 percent

Equity method procedures

Record purchase of investment at cost

Investment in Other Company XXX

Cash XXX


Increase investment value on reported earnings

Investment in Other Company XXXInvestment Income XXX

Decrease investment value on reported losses

Investment Income (Loss) XXXInvestment in Other Company XXX


Decrease investment value on dividends

Cash XXX

Investment in Other Company XXX


Amortize differences between the book value and the fair market value of investee depreciable assets over the asset lives

Amortization of goodwill reduces investment income and investment value

Investor’s share of any extraordinary items or changes in accounting principle are shown as such (must be material)

Investments and cash flows

Cash flows from purchases, sales and maturities of trading securities are operating activities on the cash flow statement

Cash flows from purchases, sales and maturities of available for sale and held to maturity securities are investing activities on the cash flow statement


4. Record and report transactions for funds and life insurance investments

Sinking funds

Funds set aside for retirement of debts

Accounting for funds

Recording contributions to fund

Sinking Fund Cash XXXCash XXX

Recording purchase of fund investments

Sinking Fund Investments XXXSinking Fund Cash XXX


Receipt of investment income

Sinking Fund Cash XXXSinking Fund Revenue XXX

Payment of expenses

Sinking Fund Expense XXXSinking Fund Cash XXX


Sale of investments

Sinking Fund Cash XXX

Sinking Fund Investments XXX

Gain on Sale of Inv. XXX


Bond maturity and closing of fund

Bonds Payable XXX

Cash XXX

Sinking Fund Cash XXX

Cash surrender value of life insurance

Businesses frequently purchase life insurance policies on key personnel

Term life insurance is accounted for simply as an expense

Whole-life policies have cash surrender values and loan values

The increase in cash value is accounted for as an investment

Life insurance entriesfor policies with cash surrender value

Payment of premium

Life Insurance Expense XXX

Cash Surrender Value of LI XXX

Cash XXX

Life insurance entriesfor policies with cash surrender value

Death of key person, receipt of benefit

Cash XXX

Cash Surrender Value of LI XXX

Gain on Life Insurance XXX


5. Analyze the impact of the different accounting methods for investments on profitability and liquidity measures

The differences between the methods of accounting for investmentscan affect income

Changes in market value are

included in income for trading securities

but not for others

Investee reported profits are included

in income under the equity method

but not under the cost method

The differences between the methods of accounting for investmentscan affect liquidity

Trading securities and some available

for sale securities are treated as

current assets

But other investments are not classified

as current assets


6. Understand the concept and complexities associated with derivative financial instruments

What are derivatives ?

Financial instruments that provide the holder with the right or obligation to participate in the price changes of an underlying asset

Underlying assets may involve interest rates, price indexes, or other market indicators

Example

Derivative Financial Instruments

Manage financial risk due to changes in– Fair values– Cash flows– Foreign currency exchange rates

Derivatives as Hedges

Fair value hedges Cash flow hedges Foreign currency hedges

Accounting for gains & losses

Report gains & losses in income for– Hedges with no designation– Fair value hedges

Report gains & losses in other comprehensive income for– Effective cash flow hedges– Foreign currency hedges

Chapter 9--Learning Objectives 1.Explain the recognition and measurement issues associated with investments.

Documents

sale securities debt

debt securitiesxxx slide

maturity slide

market value slide

trading securities investments

sale securities investments

percent slide

realized securities