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1. Determine why companies invest in other companies.
2. Understand the varying classifications associated with investment securities.
3. Account for the purchase of debt and equity securities.
4. Account for the recognition of revenue from investment securities.
Learning Objectives
5. Account for the change in value of investment securities.
6. Account for the sale of investment securities.
7. Record the transfer of investment securities between categories.
8. Properly report purchases, sales, and changes in value of investment securities in the statement of cash flows.
Learning Objectives
9. Explain the proper classification and disclosure of investments in securities.
10.Compare the accounting for investment securities under U.S. GAAP with the international standard in IAS 39.
11.Account for the impairment of a loan receivable.
Time Line of Issues: Involved with Investment Securities
DETERMINE purpose of investment
?
CLASSIFY investments
a, b, c
Good Buy Corporatio
n$10 par value
PURCHASE securities
Good Buy Corporatio
n$10 par value
EARN and RECOGNIZE a
return
Good Buy Corporatio
n$10 par value
+ +
--
MONITOR changes in
value
Good Buy Corporatio
n$10 par value
SELL securities
TRANSFER securities between
categories
a bc
DISCLOSE status of portfolio
at the end of the period
Time Line of Issues: Involved with Investment
Securities
Why Companies Invest in Other Companies
Safety Cushion
Cyclical Cash Needs
Investment for a Return
Purchase for Control
Investment for Influence
Stop & Think
As of December 31, 2004, Ford Motor owned 33.4% of
Mazda. Which ONE of the following
possible motivations do you think is the primary motivation for this
investment by Ford?
Classifications of Investment Securities
Available-for-sale
TradingHeld-to-maturit
y
DebtDebt
Equity Method
EquityEquity
Cost Method
Classifications of Investment Securities
• Debt securities typically have the following characteristics:
1. A maturity value, representing the amount to be repaid to the debt holder at maturity.
2. An interest rate that specifies the periodic interest payments.
3. A maturity date, indicating when the debt obligation will be redeemed.
Classifications of Investment Securities
• Equity securities represent ownership in a company:
1. These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.
2. Equity securities have the potential for significant increases in price.
Equity Method Securities
• Represents ownership in a company. • Includes rights to collect dividends
and to vote on corporate matters.• Potentially purchased with the intent
to control or significantly influence the operations of the investee.
• Despite the general criteria, a 20% investment does not necessarily guarantee significant influence.
Different Accounting Treatments
• Exhibit 14-8
Purchases of Debt Securities
On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9% payable semiannually on January 1 and July 1. The debt securities are classified
by the purchaser as trading securities.
Accrued interest on May 1 is $3,000, calculated as follows:
$100,000 x .09 x 4/12 = $3,000
Purchases of Debt Securities
Asset ApproachAsset Approach
Investment in Trading Securities 104,250Interest Receivable 3,000
Cash 107,250
Purchase date May 1 :
Revenue ApproachRevenue Approach
Investment in Trading Securities 104,250Interest Revenue 3,000
Investment in Available-for- Sale Securities- Deli Co. 2,000
Cash 2,000
Purchase of Equity Securities
Citty Co. purchased 100,000 Citty Co. purchased 100,000 shares of Deli Co. common shares of Deli Co. common
shares at $2 per share.shares at $2 per share.
Assume that the 100,000 shares purchased represents 20 percent of the outstanding voting
stock of Deli Company. This investment gives the investor significant influence over Deli Company.
PV of Debt Securities
On January 1, 2004, Silmaril Technologies purchased 5-year, 10% bonds with a face value of $100,000 and interest payable
semiannually on January 1 and July 1. The market rate on bonds of similar quality and
maturity is 8%.Present value of principal:
FV = $100,000; N = 10; I = 4%
$ 67,556Present value of interest payments:
PMT = $5,000; N = 10; I = 4%
40,554Total present value of the bonds
$108,110Investment in Trading Securities 108,100Cash
108,100
Interest Revenue for Debt Securities (Trading)
When the first interest payment is received from
Silmaril, the following entry would be made:
July 1 Cash 5,000
Interest Revenue 5,000
Interest Revenue for Debt Securities (Held-to-Maturity)
When the first interest payment is received from
Silmaril, the following entry would be made:
July 1 Cash 5,000
Interest Revenue 4,324 Maturity Securities 676
$108,110 x .04
Interest Revenue for Debt Securities (Held-to-Maturity)
When the second interest payment is received, the
interest revenue is determined by the yield times
the bond carrying value.July 1
Cash 5,000Interest Revenue 4,297
Maturity Securities 703
$107,434 x .04
Determining the Appropriate Accounting Method
0% 20% 50% 100%
No significantinfluence
Significantinfluence Control
Ownership Percentage
Account for as trading or
available-for-saleEquity method
Equity method and consolidation
procedures
Stop & Think
Theoretically, we should amortize the discount or premium associated with trading and available-for-sale debt securities just as we do with held to maturity securities. Why don’t we?
Determining the Appropriate Determining the Appropriate Accounting MethodAccounting Method
• Equity securities are classified as trading or available for sale when ownership is less than 20 percent.
• The equity method is used when the investor has the ability to significantly influence or control the investee’s operations.
Determining Accounting Method
• Effect 14-9
Revenue for Equity Securities Classified as Trading and AFS
Deli Co. announces Deli Co. announces dividends of $0.25 dividends of $0.25 per share. Assume per share. Assume that Citty Co. owns that Citty Co. owns
1,000 shares1,000 shares
Cash 250
Dividend Revenue 250
Revenue for Equity Securities Classified as Trading and AFS
Deli Company Deli Company announces dividends of announces dividends of
$0.25 per share. Assume $0.25 per share. Assume that Citty Co. owns that Citty Co. owns
100,000 which 100,000 which represents 50 percent of represents 50 percent of the outstanding voting the outstanding voting
stock.stock.
Cash 25,000
Investment in Deli Co Stock 25,000
Revenue for Equity Securities Classified as Trading and AFS
Deli Company reports Deli Company reports income for the year, income for the year,
$250,000. Assume Citty $250,000. Assume Citty owns 50% of owns 50% of
Investment in Deli Co Stock 125,000Income from Investment in Deli Co Stock 125,000
Equity Method: Purchase for More than Book Value
The net assets of Stewart Inc. was $500,000 at the time Phillips Manufacturing Co. purchased 40% of the common shares for $250,000 on January 1, 2005. The market value of the net
assets of Stewart Inc. would be $625,000, which is $125,000 more than the book value. Only $50,000 of this is attributed to depreciable
Stewart Inc. declared and paid dividends of $70,000 to common stockholders during 2005, and it reported net income of $150,000 for the
year ended December 31, 2005.
Accounting for the Change in Value of Securities
Classification
of Security
Disclosedat
Report FMV
TradingFair marketvalue
Incomestatement
Held-to-
maturity
Amortized
cost
Not
recognized
Available-for-sale
Fair marketvalue
Stockholder’sequity
Change On
Accounting for the Change in Value of Securities
Eastwood Inc. purchased the following securities on March 23, 2007.
Trading securities:Purchase price (Security #1) $ 8,000Value end of year (#1) $ 7,000
Purchase price (#2) $ 3,000Value end of year (#2) $ 3,500
Available-for-sale securities:Purchase price (#3) $ 5,000Value end of year (#3) $ 6,100
Accounting for the Change in Value of Securities
Eastwood Inc. purchased the following securities on March 23, 2007 (cont.)
Available-for-sale securities:Purchase price (#4)$12,000Value end of year (#4)$11,500
Held-to-maturity securities:Purchase price (#5)$20,000Value end of year (#5)$19,000
Accounting for the Change in Value of Securities
Initial Purchase EntryInitial Purchase Entry
Investment in Trading Securities 11,000Investment in Available-for-Sale Securities 17,000Investment in Held-to-Maturity Securities 20,000
Cash 48,000
By the end of the year, the value of the trading trading securitiessecurities decreased from $11,000 to $10,500.
December 31, 2005:Unrealized Loss on Trading Securities 500
Market Adjustment—Trading Securities 500
Accounting for the Change in Value of Securities
December 31, 2005:Market Adjustment—Available-for-Sale
Securities 600 Unrealized Increase/Decrease in Value of Available-for-Sale Securities
600
By the end of the year, the value of By the end of the year, the value of the available-for-sale securities the available-for-sale securities
increased from $17,000 to $17,600.increased from $17,000 to $17,600.
By the end of the year, the value of By the end of the year, the value of the available-for-sale securities the available-for-sale securities
increased from $17,000 to $17,600.increased from $17,000 to $17,600.
Accounting for the Change in Value of Securities
FASB No. 115 puts an end to “cherry-picking.” This is the practice of
selectively selling securities whose prices have increased, while
keeping those that have experienced losses or have maintained their
historical cost.
Accounting for the Change in Value of Securities
Partial Balance Sheet for Eastwood Inc.Assets
Invest. in trading securities $11,000 Market adjustment—trading sec. (500)
$10,500Invest. in available-for-sale sec. $17,000 Market adjustment 600 17,600Invest. in held-to-maturity sec. 20,000
$48,100Stockholders’ Equity
Add unrealized increase in available-for-sale securities $ 600
Partial Income Statement for Eastwood Inc.
Other expenses and losses:Unrealized loss on trading
securities $500
Sale of SecuritiesTo record accrued revenue and amortize premium:Apr. 1
Interest Receivable 2,500Investment in Held-to
Maturity Securities 395Interest Revenue 2,105
Entry to record sale:Apr. 1 Cash 103,000Realized Loss on Sale of Securities 4,353
Interest Receivable 2,500Investment in Held-to
Maturity Securities 104,853
Stop & Think
What is the difference between realized and recognized?
Transferring Securities Between Categories
Transferred Treatment of Change in Value
From tradingAny unrealized change in value not previously recognized will be recognized in net income in the current period.
To tradingAny unrealized change in value not previously recognized will be recognized in net income in the current period.
From held to maturity to available for sale
Recognize any unrealized change in value in a stockholders’ equity account.
From available for sale to held to maturity
Any unrealized change in value recorded in a stockholders’ equity account is to be amortized over the security’s remaining life using the effective-interest method.
Statement of Financial Standards No. 115, par. 15d
Stop & Think
Which ONE of the following statements is correct with respect to ALL
transfers of investment securities from one category to another?
Transferring Securities Between Categories
Assume:Cost of trading security$3,000Fair market value, end of 2007 3,600Fair market value at transfer date 3,800
Investment in Available-for-Sale Securities 3,800
Market Adjustment--Trading Securities 600
Unrealized Gain on Transferof Securities 200
Investment in Trading Securities 3,000
Transferring Securities Between Categories
Assume: Transfer from the available-for-sale category to the trading security category.
Cost of available-for-sale security $12,000Fair market value, end of 2006 10,700
Investment in Trading Securities 10,300Market Adjustment--Trading Securities 1,300Unrealized Loss on Transfer of Securities 1,700
Unrealized Increase/Decrease in Value of Available-for- Sale Securities 1,300Investment in Available-for-
Sale Securities 12,000
Transferring Securities Between Categories
Assume: Record a transfer from held-to-maturity to the available-for-sale category.
Cost of held-to-maturity security$20,000Fair market value, Dec. 31, 2006 20,700Investment in Available-for-
Sale Securities 20,400 Unrealized Increase/ Decrease
in Value of Available-for-Sale Securities 400
Investment in Held-to- Maturity Securities 20,000
Transferring Securities Between Categories
Assume: Record a transfer from available-for-sale (AFS) to held-to-maturity
Cost of available-for-sale securities$5,000Fair market value, end of 2006 6,500Fair market value at transfer date 5,900
Investment in Held-to-Maturity Securities 5,900Unrealized Increase/Decrease in Value of AFS Securities 600
Investment in AFS Securities 5,000Market Adjustment—AFS
Securities 1,500
Cash Flows from Gains and Losses on Available-for-Sale
Caesh Company began with a $1,000 investment on January 1, 2007.
Cash sales $1,700Cash expenses (1,400)Purchases of investment securities (600)Sale of investment securities (costing $200) 170
The market value of the remaining securities was $500 on December
31, 2005.
Cash Flows from Gains and Losses on Available-for-Sale
Sales $1,700Expenses (1,400
)Operating income $ 300Realized loss on sale of securities (30
) Net income $ 270Caesh Company will report a $100 unrealized increase in the value of it available-for-sale
portfolio.
This $100 unrealized increase is reported as an increase in Accumulated Other Comprehensive
Income.
Cash Flows from Gains and Losses on Available-for-Sale
The statement of cash flows for Caesh Company for 2007 appear as follows:
Operating activities:Net income $ 270Plus realized loss on sale of securities 30 $
300Investing activities:
Purchase of investment securities $(600)Sale of investment securities 170 (430)
Financing activities:Initial investment by owner 1,000
Net increase in cash $ 870
Classification and Disclosure• Trading securities
– The change in net unrealized holding gain or loss that is included in the income statement.• Available-for-sale securities
– Aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type.
– The proceeds from sales of available-for-sale securities and the gross realized gains and losses on those sales and the basis on which cost was determined in computing realized gains and losses.
• Available-for-sale securities (continued):– The change in net unrealized holding gain
or loss on available-for-sale securities that has been included in stockholders’ equity during the period.