Intermediate Financial Accounting II

Chapter 17- Investments

Accounting for Investments in Debt Securities:

  • Defined - instruments representing a creditor relationship with an entity
  • Include - US govt securities, municipal securities, corporate bonds, convertible debt, commercial paper (excludes trade accounts receivable and loans receivable)
  • Three categories:
    • Held-to-maturity - positive intention and ability to hold until maturity
    • Trading - bought and held primarily for sale in the near term
    • Available for Sale - securities that are not held-to-maturity or trading securities

 

Accounting for Held-to-Maturity Debt Securities:

  • Account for at amortized cost (not fair value)
  • Effective interest method is applied to bond investments similar to accounting for bonds payable
  • Use of a separate discount or premium account as a valuation account is ok, but doesn't generally happen in practice.

 

Accounting for Available for Sale Debt Securities:

  • Accounted for at their fair value
  • Unrealized holding gains and losses
    • Result from changes in fair market value. Calculated as the difference between FMV and the carrying value of the investment
    • Report as a separate component of stockholders' equity
  • Securities Fair Value Adjustment account (asset valuation account) is used to record the difference between fair value and amortized cost.

 

  • If sold before maturity -
    • Amortize discount/premium up to date of sale
    • Remove the amortized cost from Available for Sale category
    • Realized gain/loss reported in income statement

Accounting for Trading Debt Securities:

  • Accounted for at fair value
  • Unrealized holding gains and losses are reported as part of income
  • Any discount or premium is not amortized

 

Investment in Equity Securities

  • Defined - securities representing ownership interests such as common, preferred or other capital stock
  • Classified according to ownership percentage
    • Holdings of less than 20% (fair value method) - owner has little influence over the investee
    • Holdings between 20% and 50% (equity method) - owner exercises significant influence over operating and financial policies of investee
    • Holdings of more than 50% (consolidated statements) - NOT COVERED IN THIS CLASS - investor has a controlling interest in the investee

Holdings of less than 20% (fair value method)

  • Available for Sale securities - initially recorded at cost
    • Net unrealized holding gains or losses
    • Separate component of stockholders' equity
  • Trading Securities

 

    • Accounting is basically the same as for available for sale securities
    • Difference - unrealized holding gains and losses are recorded as part of income
  • There is no Held to Maturity category due to the nature of these investments



Holdings Between 20% and 50% (equity method)

  • Purpose - to reflect investee's earnings as adjustments to the investor's investment
    • Investment account is increased by the investor's share of the earnings of the investee
    • Investment account is decreased by the investor's share of the losses of the investee and any dividends received
  • Fair values are not used
  • Difference between the investor's original cost and the investor's proportionate share of the book value of the investee at the date of acquisition is amortized

 

Disclosures:

  • Balance Sheet
    • Trading securities are reported as current assets
    • Available for sale securities
      • Debt - classify as current or noncurrent based on maturities and expectations regarding sales and redemptions in the next year
      • Equity - classify as current if they are available for use in current operation
    • Held-to-maturity debt securities should be classified as current or noncurrent based on the maturity date of individual securities
  • Income Statement
    • Unrealized holding gains and losses from trading securities reported through income
    • Unrealized holding gains and losses from available-for-sale securities are reported as a separate component of stockholders' equity
  • Other substantive disclosures

 

Impairment of Value

  • Impaired when - decline in value of investment is considered to be more than temporary
    • Debt securities - determine whether probable that the investor will be unable to collect all amounts due according to the contractual terms.
    • Equity securities - consider impairment anytime that realizable value is less than carrying amount
  • Write cost basis of security down to impaired value

 

  • Amount of impairment is a realized loss



Transfers between Categories

  • Accounted for at their fair value
  • Fair value used to ensure that a company cannot escape recognition of fair value simply by transferring to held-to-maturity.

 

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