Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments:...
-
Upload
marjory-burns -
Category
Documents
-
view
218 -
download
0
Transcript of Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments:...
![Page 1: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/1.jpg)
Chapter 12
Investments
![Page 2: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/2.jpg)
Investments 2
Objectives of the Chapter
1.Classification and reporting of Investments: trading securities, available-for-sale securities and held-to-maturity securities.
2.Investments recorded and reported using the equity method.
3. The fair value option reporting for investments.
![Page 3: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/3.jpg)
Investments 3
Securities for Investments Investment in debt securities: include
U.S. treasury securities, municipal securities, corporate bonds, commercial papers, pf stock with a mandatory redemption feature or redeemable at the option of the holder.
Investment in equity securities: include common stock, preferred stock, stock warrants, stock rights, call and put options.
![Page 4: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/4.jpg)
Investments 4
Securities for Investments(cont.)
For reporting purposes, all investments must be classified into one of the following three categories at the reporting date:
1. Trading securities;
2. Available-for-sale securities; or
3. Held-to-maturity securities.
![Page 5: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/5.jpg)
Investments 5
Classification of Investments
1.Trading securities: investments in debt and equity securities held for the purpose of selling them in the near future.
2. Available-for-sale securities: Including debt and equity securities that are not classified as trading securities and not classified as held-to-maturity securities.
![Page 6: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/6.jpg)
Investments 6
Classification of Investments (cont.)
3.Held-to-maturity securities: investments in debt securities with positive intent and ability to hold these securities to maturity.
![Page 7: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/7.jpg)
Investments 7
Classification of Investments (cont.)
Classifications of investments in securities into these three categories and the subsequent reclassification are based on management’s intent and judgment.
![Page 8: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/8.jpg)
Investments 8
Investments - initial recording and end of period reporting (valuation)
1.Initial Recording of all investments: at cost.
2. End of Period Reporting (Valuation):
a. Trading securities: reported at their fair market values on the B/S. The unrealized gains or losses are included in income of the current period.
![Page 9: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/9.jpg)
Investments 9
Investments - initial recording and valuation (cont.)
b. Available-for-sale securities: reported at their fair values on the B/S. The unrealized gains or losses are reported as a separate component of stockholders’ equity until realized.
c. Held-to-maturity securities: reported at their amortized cost.
![Page 10: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/10.jpg)
Investments 10
Investments - dividends and Interest revenue Dividends, interest revenues of
investments in securities and realized gains or losses from sale of investments are reported in the income statement.
![Page 11: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/11.jpg)
Investments 11
Investments - other valuation methods
Other Valuation Methods: a. Equity method: Applied when
investments in equity securities with significant influence over the investee (usually owing 20% - 50% of the voting stock). No recognition of unrealized gains or losses.
Results in a partial consolidation statements for the investor.
![Page 12: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/12.jpg)
Investments 12
Investments - other valuation methods (cont.)
b. Consolidated financial statements Applied when the investor(the parent) controls the investee (the subsidiary) through an investment in equity securities (i.e., the investor owing over 50% of the voting common stock).
![Page 13: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/13.jpg)
Investments 13
Investments - other valuation methods (cont.)
The investor has to issue the consolidated financial statements. No recognition of unrealized gains or losses.
![Page 14: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/14.jpg)
Investments 14
Summary of Accounting for Investments
Reporting of Unrealized HoldingMethod Gains and Losses
A. Invest. In Equity Securities1. No signoficant influencant a. Trading Fair value Income statementb. Available-for-Sale Fair value Stockholders' equity2. Significant influence (20% to 50% ownership) Equity method Not recognized3. Control(more than 50% ownership) Consolidation Not recognizedB. Invest. In Debt Securitiesa. Trading Fair value Income statementb. Available-for-Sale Fair value Stockholders' equityc. Held-to-Maturity Amortized cost Not recognized
![Page 15: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/15.jpg)
Investments 15
Example A:investments classified as available-for- sale securities (SAS)
The accounting treatment (SFAS 115)
(a) initial recording: at cost;
(b) end of period reported: at fair value;
(c) unrealized holding gains or losses: reported as a separate component of stockholders’ equity on B/S;
(d) interests, dividends, realized gains or losses reported on the I/S
![Page 16: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/16.jpg)
Investments 16
Example A:(cont.):
Assume that Green Company acquires the following securities on 5/1/x5:
Shares # per share
A Company common stock 100 $50
B Company common stock 300 $80
C Company preferred stock 200 $120
D Company 10% bonds with a face value of $15,000 at par plus accrued interest (interests are paid on 5/31 & 11/30)
![Page 17: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/17.jpg)
Investments 17
Example A:(cont.)
1. Initial recording on 5/1/x5:
Investments in SAS 68,000*
Invest. Rev. 625**
Cash68,625
Cost = 100 x 50 + 300 x 80 + 200 x 120 + 15,000 = 68,000
** Accrued interests = 15,000 x 10% x 5/12 = $625
![Page 18: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/18.jpg)
Investments 18
Example A: cont.
5/31/x5 Cash 750
Invest. Revenue 750
(the net interest revenue = $750 -625= $125; the interest revenue for 5/1/95 ~ 5/31/95)
11/30/x5 Cash 750
Invest. Revenue 750Note: If the bonds were purchased at a discount or
premium, the discount or premium needs to be amortized when interest revenue is recongized.
![Page 19: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/19.jpg)
Investments 19
Example A: cont.
12/31/x5 Invest. Receivable 125
Invest. Revenue125
Assuming Green received $3,000 for dividends in 20x5
Cash 3,000
Invest. Revenue3,000
![Page 20: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/20.jpg)
Investments 20
Example A:(contd.) The following info. is available on 12/31/x5: (Note:
for investment in bonds, the cost is the amortized cost.)
12/31/x5 Investment ChangeSecurity Cost Fair Value in F.V
A $5,000 $6,200 $1,200B $24,000 $25,100 $1,100C $24,000 $23,200 ($800)D $15,000 $16,500 $1,500
total $68,000 $71,000 $3,000
![Page 21: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/21.jpg)
Investments 21
Example A:(contd.):SAS
12/31/x5 Adjusting entry (for valuation):
Fair Value Adjustment 3,000
Unrealized holding Gains**
on investments-OCI 3,000
** Reported in B/S as other comprehensive income of x5
![Page 22: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/22.jpg)
Investments 22
Balance Sheet Presentation :SAS
Balance Sheet 12/31/x5
Assets Liabilities
Inv. Sec. (at cost) $68,000
Fair Value Adjust. $3,000Stockholders’ Equity:
Inv. Sec. ( at fair Value) $71,000 Accu. Other Comp. Income
Unrealized holding gains (losses) on investment 3,000
![Page 23: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/23.jpg)
Investments 23
Example A: SAS(contd.) The following info. is available on 12/31/x6:
12/31/x6 Investment ChangeSecurity Cost Fair Value in F.V
A $5,000 $6,100 $1,100B $24,000 $22,700 ($1,300)C $24,000 $23,200 ($800)D $15,000 $14,000 ($1,000)
total $68,000 $66,000 ($2,000)
![Page 24: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/24.jpg)
Investments 24
Example A: (cont.):SAS
12/31/x6 Adjusting entry (for valuation):
Unrealized holding Gains
(losses) on investment**-OCI 5,000
Fair Value Adjustment 5,000
• ** Other comprehensive income of x6
![Page 25: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/25.jpg)
Investments 25
Balance Sheet Presentation:SAS
Balance Sheet 12/31/x6
Assets Liabilities
Inv. Sec. (at cost) $68,000
Fair Value Adj. (2,000)
Inv. Sec. (at fair value) $66,000 Stockholders’ Equity:
Accu. Other Comp. Income
Unrealized holding gains (losses) on investment(2,000)
![Page 26: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/26.jpg)
Investments 26
Realized Gains and Losses from Sale of investments
Realized gains and losses are calculated as the difference between the selling price and the cost and is reported in the income statement.
This is due to the unrealized gain/loss of SAS is never recognized in the income statement.
![Page 27: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/27.jpg)
Investments 27
Example B: SAS In 20x7, Green sold 100 shares of A stock
for $6,000. J.E. to record this transaction
Cash 6,000 Investments in SAS (at cost) 5,000
Gain on sale of investments 1,000
![Page 28: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/28.jpg)
Investments 28
Example B (cont.): SAS Also in 20x7, Green sold 300 share of B for
$22,000J.E. to record this transaction
Cash 22,000 Loss on sale of investments 2,000
Investments (at cost) 24,000
![Page 29: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/29.jpg)
Investments 29
Example B:(cont.) (with a fair value adjustment account) :SAS
Before the adjusting entry on 12/31/x7:
Fair Value adjustment Investment (at cost)
1/1/x7 3,000 5,000 68,000 5,000a
24,000b
2,000
39,000
a. from sale of Stock A
b. From sale of Stock B
![Page 30: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/30.jpg)
Investments 30
Example B:(contd.):SAS The following info. is available on 12/31/x7:
12/31/x7 Investment ChangeSecurity Cost Fair Value in F.V
C $24,000 $26,000 $2,000D $15,000 $12,000 -3,000
Total $39,000 $38,000 ($1,000)
![Page 31: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/31.jpg)
Investments 31
Example B:SAS
![Page 32: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/32.jpg)
Investments 32
Balance Sheet Presentation:SAS
Balance Sheet 12/31/x7
Assets Liabilities
Investment Securities
at Cost $39,000
Fair Value Adjus. (1,000) Stockholders’ Equity:
Invest. Sec. (at fair) $38,000 Accu. Other Comp. Income
Unrealized holding gains (losses) on investment(1,000)
![Page 33: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/33.jpg)
Investments 33
Impairment of Securities Available-for-Sale If the decline in the fair value of securities
available-for-sale is NOT temporary (i.e., a bankruptcy filing), the value of the securities should be written down to the fair value.
The amount of the write-down should be treated as a realized loss and is included in the income of the year.
![Page 34: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/34.jpg)
Investments 34
Investments Classified as Trading Securities
The accounting treatment (SFAS 115)
(a) initial recording: at cost;
(b) end of period reported: at fair value;
(c) unrealized holding gains or losses: reported in the income statement;
(d) interests, dividends, realized gains or losses reported in the income statement
![Page 35: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/35.jpg)
Investments Classified as Trading Securities (contd.) Trading securities are held primarily by
banks and stock brokers. FASB 115 applies to all specialized industries.
For trading securities, the realized gains and losses are computed as the difference of the selling price and the fair value (NOT the cost) recorded in the most recent balance sheet date.
This is due to the unrealized holding gain/loss for trading sec. is recognized in the previous income statement.
Investments 35
![Page 36: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/36.jpg)
Example C: same infor. as in Example A on p20 but for Trading Securities Valuation on 12/31/x5
12/31/x5 Adjusting entry for valuation (a direct adjustment to the investment account):
Investment Securities* 3,000
Unrealized holding Gains**
on investments-I/S 3,000*the bal. of the investment securities account
equals $71,000, the fair value, after the adjustment.
** Reported in the income statement of x5 and will be closed to income summary at the end of x5.
Investments 36
![Page 37: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/37.jpg)
Example C(contd.): same as in Example A on p23 Except for Trading Securities Valuation on 12/31/x6
12/31/x6 Valuation adjusting entry (a direct adjustment):
Unrealized holding Gains
on investment * - I/S 5,000
Investment Securities** 5,000• *Reported in the income statement of x6.• **The bal. of investment securities equals
$66,000, the fair value, after the adjustment.
Investments 37
![Page 38: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/38.jpg)
Example D: same as in Example B on p27 Except for Sale of Trading Securities
In 20x7, Green sold 100 shares of A stock for $6,000. J.E. to record this transaction
Cash 6,000 Loss on Sale of Investment 100
Investments in Trading Sec. 6,100*
*The investment account is at the fair value. Unlike the SAS, the unrealized Gains (Losses) of trading securities have been closed to the Income Summary at the end of 20x6.
Investments 38
![Page 39: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/39.jpg)
Example D (contd.): same as in Example B on p28 Except for Sale of Trading Securities Also in 20x7, Green sold 300 share of B for
$22,000J.E. to record this transaction
Cash 22,000Loss on sale of investments 700
Investments (at fair value) 22,700
* The investment account is at the fair value.
Investments 39
![Page 40: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/40.jpg)
Example D (contd.): same as in Example B on p30
The following info. is available on 12/31/x7: 12/31/x6 12/31/x7 Change cost Fair Value Fair Value in F.V C $24,000 $23,200 $26,000 $2,800 ↑ D $15,000 $14,000 $12,000 (2,000)↓ $39,000 $37,200 $38,000 ($800)↓
Investments 40
![Page 41: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/41.jpg)
Example D (contd.)
The information on p40 indicates that the fair value of securities C and D equals $37,200 and $38,000 on 12/31/x6 and 12/31/x7, respectively.
Since the trading securities account balance is at the fair value (under the direct adjustment), the end of period valuation adjustment is to increase the trading securities investment account by $800.
Investments 41
![Page 42: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/42.jpg)
Example D (Contd.)
The Adjusting entry on 12/31/x7
Investment in Trading Securities* 800
Unrealized Holding Gain**-I/S 800
• *The investment bal. equals $38,000, the fair value, after the adjustment.
• **Reported in the income statement
Investments 42
![Page 43: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/43.jpg)
Investments 43
Investments in Held to Maturity Securities (debt securities only)
The account treatment (SFAS No. 115):
(a) Initial Recording: at cost*(not using a discount or a premium account);
(b)End of Period Reporting: at amortized cost;
(c)Unrealized Holding Gains or Losses:not recognized.
(d)Interests and realized gains (Losses) on Sale : all included in income.
* the present value
![Page 44: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/44.jpg)
Investments 44
Investments in Held-to-Maturity (HTM) Securities
APB opinion No.21 recommends separate disclosure of face amount ($100,000) and the discount ($1,000).
However, most investors do not use separate accounts for face value and the unamortized discount (or premium).
The discount ($1,000) will be amortized to increase the interest revenue using the effective interest method.
![Page 45: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/45.jpg)
Investments 45
Example E: amortization of discount or premium of investments in held-to-maturity
Assume that Green acquires an investment in bonds that will be held to maturity with a face value of $100,000 for $102,458.71 on 1/1/x5. The stated interest rate is 13% and interests are paid on 6/30 and 12/31. The bonds mature on 12/31/x7. The effective interest rate is 12%*
* 102,458.71 = 100,000 x 0.70496 + 6,500 x 4.91732
semiannual effective interest rate = 6%
6 period 6 period ?%
![Page 46: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/46.jpg)
Investments 46
Example E:(contd.)
J.E1/1/x5
Investment in Bonds - held-to-maturity 102,458.71
Cash 102,456.71
6/10/x5Cash 6,500
Interest Revenue* 6,147.52 Inv. in Bonds 352.48
![Page 47: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/47.jpg)
Example E: record the premium in a separate account (An alternative)
J.E1/1/x5
Investment in Bonds 100,000 Prem. on Bond Inv. 2,458.71
Cash 102,456.71
6/10/x5Cash 6,500
Interest Revenue* 6,147.52 Prem. on Bond Inv. 352.48
Investments 47
![Page 48: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/48.jpg)
Investments 48
Example E:(contd.)
* Interest Rev. = Present Value x Effective Rate = 102,458.71 x 6% = 6,147.52
Amortization of Premiums(discounts) on investments decreases (increases) interest revenue.
![Page 49: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/49.jpg)
Investments 49
Bond Investment Interest revenue and Premium Amortization Schedule
Effective Interest MethodInterest Investment in Carrying Value of
Cash Revenue Debt Securities Investment in Date Debita Creditb Creditc Debt Securitiesd
1/1/x5 102,458.71$ 6/30/x5 6,500.00$ 6,147.52$ 352.48$ 102,106.23
12/31/x5 6,500.00 6,126.37 373.63 101,732.606/30/x6 6,500.00 6,103.96 396.04 101,336.56
12/31/x6 6,500.00 6,080.19 419.81 100,916.756/30/x7 6,500.00 6,055.01 444.99 100,471.76
12/31/x7 6,500.00 6028.24c 471.76 100,000.00
![Page 50: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/50.jpg)
Investments 50
Bond Investment Interest revenue and Premium Amortization Schedule:(contd.)
Straight-Line Method
Cash Debt Securities revenue Investment in
Date Debita Creditb Creditc Debt Securitiesd
1/1/x5 102,458.71$ 6/30/x5 6,500.00$ 409.79$ 6,090.21$ 102,106.23
12/31/x6 6,500.00 409.79 6,090.21 101,732.60 6/30/x6 6,500.00 409.79 6,090.21 101,336.56
12/31/x6 6,500.00 409.79 6,090.21 100,916.75 6/30/x7 6,500.00 409.79 6,090.21 100,471.76
12/31/x7 6,500.00 409.79 6,090.21 100,000.00
![Page 51: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/51.jpg)
Investments 51
Example F:Investment in HTM at a Discount
Assume that HTM investments on p45 were acquired at a discount for $97,616.71. The effective interest rate is 14%.1/1/x5 Invest. in Bonds- held to maturity 97,616.71 Cash 97,616.71
6/30 Cash 6,500 Invest. in Bonds 333.17
Interest Revenue* 6833.17
* Interest Revenue = Present value x 14% x 6/12 = 97,616.71 x 14% x 6/12
![Page 52: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/52.jpg)
HTM Example F (contd.): Discount Recorded in a Separate Account1/1/x5 Invest. In Bonds 100,000 Cash 97,616.71 Discount on Bond Inv. 2,383.29
6/30 Cash 6,500 Discount on Bond Inv. 333.17
Interest Revenue* 6833.17
Investments 52
![Page 53: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/53.jpg)
Investments 53
Bond Investment Interest Revenue and Discount Amortization Schedule
Effective Interest Method
Cash Revenue Debt Securities Investment in Date Debita Creditb Debit c Debt Securitiesd1/1/x5 97,616.71$
6/30/x5 6,500.00$ $6,833.17 333.17$ 97,949.88 12/31/x5 6,500.00 6,881.45 356.49 98,306.37 6/30/x6 6,500.00 6,908.15 381.45 98,687.82 12/31/x6 6,500.00 6,908.15 408.15 99,095.97 6/30/x7 6,500.00 6,936.72 436.72 99,532.69 12/31/x7 6,500.00 6,967.31 467.31 100,000.00
![Page 54: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/54.jpg)
Investments 54
Amortization for Bonds Acquired
Between Interest DatesExample G
13% bonds with a face value of $200,000 were purchased for $204,568.5 plus the accrued interest of $6,500 on 4/3/x5.
Interests were paid on 6/30 and 12/31 and the bonds mature on 12/31/x7. The effective rate is 12%
![Page 55: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/55.jpg)
Investments 55
Amortization for Bonds Acquired
Between Interest DatesExample G(cont.)
Bond Investment Interest Revenue and Premium Amortization Schedule (Effective Interest Method)
Investment Carrying valueInterest in Debt of Investment
Cash Revenue HTM in Debt
Date Debita Creditb Creditc HTMd
1/1/x5 204,921.00$ 6/30/x5 13,000.00$ 12,295.00$ 705.00$ 204,216.00 12/31/x5 13,000 12,252.96 747.04 203,468.96 6/30/x6 13,000 12,208.14 791.86 202,677.10 12/31/x6 13,000 12,160.63 839.37 201,837.73 6/30/x7 13,000 12,110.26 889.74 200,947.99
12/31/x7 13,000 12,052.01e 947.99 200,000.00
![Page 56: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/56.jpg)
Investments 56
Amortization for Bonds Acquired
Between Interest DatesExample G(cont.)
a. 200,00 x 13% x6/12.
b Previous investment carrying value x 0.12 x 6/12.
c. a - b.
d. Previous investment carrying value - c.
e. Difference $4.87 due to rounding error.
![Page 57: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/57.jpg)
Investments 57
Amortization for Bonds Acquired
Between Interest DatesExample G(cont.)
Verifying the purchase price of example G :Present value of the bond on 1/1/x5 => 200,000 x 0.705 + 13,000 x 4.917 = $204,921
Interest Revenue for 1/1/95 - 6/30/x5 $204,921 x 12% x 6/12 = 12,295
Cash Received for interest (1/1/x5 - 6/30/x5)$200,000 x 13% x 6/12 = 13,000
Premium amortized for the period of 1/1/x5 - 6/30/x5 =>13,000 -12,295 = 705 (for 6 months)Premium amortized for the period of 1/1/x5 - 4/1/x5 =>705 x 3/6 = 352.5 (for 3 months of the first period)Therefore, the P.V. of the bond on 4/1/x5 => $204,921 -352.5 = $204,568.5
![Page 58: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/58.jpg)
Investments 58
Amortization for Bonds Acquired Between Interest Dates
Example G(cont.)4/3/x5Investment in bonds- HTM 204,568.5Interest Receivable 6,500
Cash 211,068.5
6/30/x5Cash 13,000
Interest Receivable 6,500Interest Revenue 6,147.5Investment in bondds- HTM 352.6
![Page 59: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/59.jpg)
Investments 59
Amortization for Bonds Acquired Between Interest Dates
Example G(cont.)12/31/x5
Cash 13,000
Interest Revenue* 12,252.96
Inv. In Bonds- HTM** 747.04* P.V. of bond on 7/1/x5 => P.V. of Bond on 1/1/x5 minus premium amortized for the period of 1/1/x5 - 6/30/x5 => $204,921 - 352.5 -352.5 = $204,216
Interest revenue of the 2nd. Period (7/1/x5 -12/31/x5) =>$204,216 x 0.12 x 6/12 = 12,252.96
** Amortization of Premium for 7/1/x5 - 12/31/x5 period.
![Page 60: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/60.jpg)
Investments 60
Sale of Investment in Securities Held to Maturity Before Maturity
This should not occur unless circumstances changed.
If it does occur, update the interest revenue and the amortization of premium or discount from last interest payment date to the sale date.
To determine the gains or losses, compare selling price (excluding accrued interests) with the updated carrying value.
![Page 61: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/61.jpg)
Investments 61
Sale of Investment in SecuritiesHeld to Maturity Before Maturity
Example H:13% bonds with a face value of $100,000 were purchased on 1/1/x5 for $97,616.71 as in example F. The bonds were sold on 3/31/x6 for $102,000 plus accrued interest effective interest rate is 14%.
(1) (2) (3) (4)Interest Sated Dis. P.V.
Date Revenue Interest Amortized of Invest1/1/x5 - - - 97,616.71
6/30/x5 6833.17 6,500.00 333.17 97,949.88 12/31/x5 6856.49 6,500.00 356.49 98,306.37 6/30/x6 6881.45 6,500.00 381.45 98,687.82
![Page 62: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/62.jpg)
Investments 62
Sale of Investment in SecuritiesHeld to Maturity Before Maturity
Example H:(contd.)(1) = (4) * 0.07
(2) = face amount * 0.065
(3) = (1) - (2)
(4) = P.V. at beginning + (3)
* Interest Revenue for 1/1/96 - 3/31/96
=> 6881.45 * 3/6 = 3440.72
Dis. Amortized for 1/1/96 - 3/31/96
=> 381.45 * 3/6 = 190.73
![Page 63: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/63.jpg)
Investments 63
Sale of Investment in SecuritiesHeld to Maturity Before Maturity
Example H:(contd.)Investment in Debt Securities Held to Maturity
97,616.71
6/30/x5 333.17
12/31/x5 356.49
3/31/x6 190.17*
*Interest Revenue= (P.V. on 1/1/x6) x 14% x 3/12= (98,306.39) x 14% x 3/12= 3,440.72
97616.71 + 333.17 + 356.49 = 98,306.37
98,496.54
![Page 64: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/64.jpg)
Investments 64
Sale of Investment in SecuritiesHeld to Maturity Before Maturity
Example H:(contd.)J.E3/31/x6
Interest Receivable 3,250
Investment in Debt Sector190.73
Interest Revenue 3440.72 Cash (102,000 + 3,250) 105,250
Investment in Debt 98,496.54
Interest receivable 3,250
Gain on Sale of Invest. in Debt 3,503.46
![Page 65: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/65.jpg)
Investments 65
Sale of Investment in SecuritiesHeld to Maturity Before Maturity
Example H:(contd.)Gains= Selling pirce (excluding accrued interest)- Carrying value (updated with amort. of pemium)
=102,000-98,496.54 =3,503.46
![Page 66: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/66.jpg)
Investments 66
The Fair Value Option for Financial Assets (SFAS 159) SFAS159 allows companies to choose
reporting most financial assets at fair value including security investments classified as available-for-sale (SAS) and held-to-maturity (HTM).
This decision of reporting these investments at fair value is irrevocable.
Once the decision is made for a SAS or a HTM security, the company would report that security as a trading security.
![Page 67: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/67.jpg)
Investments 67
The Fair Value Option (contd.)
When electing the fair value option to account for SAS or HTM, the fair value adjustment for these securities should be made indirectly using a valuation account (i.e., the fair value adjustment account).
The fair value adjustment should not be made directly to the trading security account.
The unrealized gain or loss would be reported in the income statement.
![Page 68: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/68.jpg)
Example I: Same infor. as in Example A on p20, Investment in SAS-Fair Value Option Reporting The fair value option reporting was elected for all
investments in SASa. The following entry would be recorded on 12/31/x5:
Fair Value Adjustmentb 3,000 Unrealized Holding Gain/Lossc 3,000 a The fair value option can be applied on an instrument-by-
instrument basis. bThe adjustment to fair value is made indirectly and the SAS
investment is reported as trading securities on the B/S at the fair value. C Reported in the income statement
Investments 68
![Page 69: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/69.jpg)
Example I: Same infor. as in Example A on p23, Investment in SAS-Fair Value Option Reporting
The following entry would be recorded on 12/31/x6:
Unrealized holding Gain/Loss a 5,000 Fair Value Adjustment b 5,000
a Reported in the income statementB An indirect adjustment; the SAS is reported
as trading securities on the B/S at fair value.
Investments 69
![Page 70: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/70.jpg)
Example J: Same infor. as in Example B on p27, Investment in SAS-Fair Value Option Reporting
In 20x7, Green sold 100 shares of A stock for $6,000. J.E. to record this transaction
Cash 6,000 Loss on sale of invest. 100
Investments (at cost) 5,000 Fair Value Adjustment * 1,100
*For stock A, the cost is $5000 while the fair value on 12/31/x6 is $6,100 (see P23).
Investments 70
![Page 71: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/71.jpg)
Investments 71
Transfers Between Reporting Categories
Investment classification is reassessed at each reporting date.Securities investments can be reclassified* at the reporting date if a different reporting category is more appropriate.*an unusual event, disclosures of reasons are required
![Page 72: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/72.jpg)
Investments 72
Transfers (contd.)
At reclassification:1) The security is updated to its fair value.2) The security is transferred at its fair value.
3) Any unrealized holding gain or loss should be accounted for in a
manner consistent with the new reporting category.
![Page 73: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/73.jpg)
Investments 73
Transfers :(contd.)
The accounting Treatments for Transfers:
From
SAS,HTM
To
Trading
Treatment
The unrealized gain or loss included in current earnings.
![Page 74: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/74.jpg)
Investments 74
Transfers :(contd.)
The accounting Treatments for Transfers:
From
Trading
To
Available
Held to Maturity
Treatment
No accounting for the unrealized gain or loss (it has been recognized in income)
![Page 75: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/75.jpg)
Investments 75
Transfers :(contd.)
From
Held to Maturity
To
SAS
Treatment
The unrealized gain or loss reported in the balance sheet as a separate component of stockholders’ equity
![Page 76: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/76.jpg)
Investments 76
Transfers :(contd.)
The accounting Treatments for Transfers:
From
SAS
To
HTM
Treatment
Fair value of SAS became the amortized cost of HTM. (amortized the unrealized gain or loss to earnings over the remaining life of the securities.)
![Page 77: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/77.jpg)
Investments 77
Transfers :(contd.)
Example 1: Transfer from SAS to Trading:
Using the example of Green Company and instead of selling security A (cost is $5,000) in 20x7, Green decided to transfer security A from SAS security category to trading security category when security A’s fair value is $6,300 on 12/31/20x7. The transfer is recorded as follows:
![Page 78: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/78.jpg)
Investments 78
Transfers :from SAS to Trading
* (Fair value of security A on 12/31/x6 is $6,100)
1. Fair Value Adjustment 200 Unrealized gain or loss 2002. Investment in Trading 6,300 Unrealized gain/ loss 1,300 Investment in SAS (at cost) 5,000 Fair Value Adjustment (for A) 1,300 Gain on Transfer of Securities 1,300
![Page 79: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/79.jpg)
Investments 79
Transfers : from Trading to SAS
Example 2: From Trading to SAS
Assume the same facts as example 1 expect security A is being transferred from Trading to SAS. The transfer is recorded as:
Investment in Trading 200Unrealized Gain / Loss 200
Investment in SAS 6,300 nvestment in Trading 6,300
![Page 80: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/80.jpg)
Investments 80
Transfers:(contd.)
3.From held-to-maturity to Available (or Trading): Bonds with a face amount of $10,000 was purchased at par and was included in the held-to-maturity category. When the fair value is $9,500, the company transfers the bonds into the available-for- sale category.
![Page 81: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/81.jpg)
Investments 81
Transfers:(contd.)
The transfer is recorded as follows:Investment in SAS 9,500*Unrealized Gain or Loss in Value of Investment in SAS 500 Investment in HTM 10,000*
Note: the new carry value is $9,500. The unrealized gain or loss is reported in the stockholder’s equity section of the Balance Sheet.
![Page 82: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/82.jpg)
Investments 82
Transfers :(contd.)
* or any amortized cost if the bonds were purchased at discount or premium. The unrealized account will be adjusted accordingly.** If the transfer is to Trading category, the gain or loss will be included in income.Alternative J.E. for the transfer:Investment in T. S. 9,500Loss 500Investment in HTM 10,000
![Page 83: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/83.jpg)
Investments 83
Financial Statement Classification
a.Trading securities: current assets.
b.Securities-available-for-sale (SAS): Current or noncurrent depends on whether the securities will be sold in one year or one operating cycle, whichever is longer.
c.Securities-held-to-maturity:current or noncurrent assets.
![Page 84: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/84.jpg)
Investments 84
Financial Statement Classification
Trading securities related cash flows are classified as cash flows of operating activities while cash flows from all other types of securities are reported as cash flows of investing activities.
![Page 85: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/85.jpg)
Investments 85
Financial Statement DisclosureDisclosure notes for investments should
include:
a. Amortized cost (cost basis).
b.Gross unrealized gains.
c. Gross unrealized losses.
d. Estimated fair value.
![Page 86: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/86.jpg)
Investments 86
Impairment of Value
If the decline in the fair value of investment is NOT temporary (I.e., a bankruptcy filing), the value of the securities should be written down to the fair value.
The amount of the write-down should be treated as a realized loss and is included in the income of the year.
![Page 87: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/87.jpg)
Investments 87
Impairment of Value (in Debt Investment)
Impairment occurs for debt securities when company cannot collect all the amount due from debt securities investments.
![Page 88: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/88.jpg)
Investments 88
Impairment of Value (in Debt Investment) (cont.)
The amount of write down is included in the Income statement as a realized loss.
The fair value becomes the “New” cost and is not changed for the subsequent recovery in the fair value.
![Page 89: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/89.jpg)
Investments 89
Impairment:(contd.)
Example a: Tracy company had an investment categorized as held to maturity with an amortized cost of $21,500 and a fair value of $6,500. If the decline is Not temporary, the accounting treatment is:
Loss on Impairment 15,000
Investment in Debt Securities Held to Maturity 15,000
![Page 90: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/90.jpg)
Investments 90
Impairment:(contd.)
Example a(contd.): The $6,500 became the “new” cost. Interest revenue is computed using the effective interest needed based on the new effective rate.
![Page 91: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/91.jpg)
Investments 91
Impairment of Value (contd.):
For investment in debt securities classified as SAS experienced a decline in value other than temporary, the accounting treatments are:
1.Eliminate the unrealized gain or loss related to the securities.
2.Write down to the fair value and recognize the write down as a realized Loss.
Therefore, the fair value becomes the new cost basis.
![Page 92: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/92.jpg)
Investments 92
Impairments:(contd.) Example b: (debt investment classified as SAS)
In 20x7, Hinges' investment in D company had a fair value of $5,000. The cost of this investment is $15,000 and the fair value of D company investment is 13,000 on 12/31/x6. This investment was classified as SAS. The J.E. to record the impairment are :
![Page 93: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/93.jpg)
Impairments:(contd.) Example b: (debt investment classified as SAS)
Fair Value Adjustment 2,000 Unrealized Holding Gain/Loss 2,000 Eliminate the unrealized gain/loss
Loss on Impairment 10,000 Investment in SAS 10,000 Write down to the fair value
Investments 93
![Page 94: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/94.jpg)
Investments 94
Impairments:(contd.) Example c:
If the debt investment is classified as trading securities, the following entry will be recorded for the write-down:
Loss on Impairment 8,000
Investment in Trading 8,000 Securities
![Page 95: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/95.jpg)
Investments 95
Impairment of Value ( in equity securities)
SFAS No. 115 does not provide precise guideline to determine the impairment for equity securities.
Whenever the realizable value is lower than the carrying amount of the investment, an impairment should be considered.
Accounting treatment for the write down is similar to that of the debt securities as in examples b and c.
![Page 96: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/96.jpg)
Investments 96
Equity Method
APB Opinion No.18 requires the use of equity method by an investor who is able to exercise significant influence over the operating and financial policies of an investee. In the absence to the contrary, an investment of 20% or more in the outstanding common stock of the investee leads to the presumption of significant influence.
![Page 97: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/97.jpg)
Investments 97
Equity Method
Exceptions: there are cases that investors hold 20% or more of the outstanding common stock of an investee but do not have significant influence. In these cases, the equity method should not be used. FASB Interpretation No. 35 provides examples of these cases:
![Page 98: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/98.jpg)
Investments 98
Equity Method:(contd.)
1.The investee challenges the investor's ability to exercise significant influence (through litigation or complaints to regulators).
2.Majority of investee’s ownership is concentrated among a small group of shareholders who operate the investee without regards the views of the investor;
![Page 99: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/99.jpg)
Investments 99
Equity Method:(contd.)
3.The investor tries and fails to obtain representation on the investees board of directors;
4.The investor signs an agreement to give up significant shareholder rights.
5.The investor could not acquire financial information needed to apply the equity method (i.e., fair market value of depreciable assets).
![Page 100: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/100.jpg)
Investments 100
Equity Method:(contd.)
On the other hand, the investor may own less than 20% of the voting shares but is able to exercise significant influence over the investee.The equity method should be applied in this case.
![Page 101: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/101.jpg)
Investments 101
Consolidated Financial Statements and the Equity Method When a company acquires 51% or more of
the voting stock of another company, the acquiring firm has the controlling interest and is called the parent while the investee company is called the subsidiary.
Both companies continue to operate as separate legal entities and report separate financial statements .
The parent company also reports consolidated financial statements (F/S).
![Page 102: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/102.jpg)
Investments 102
Consolidated Financial Statements and the Equity Method (contd.) Consolidated F/S combine the parent and
subsidiary F/S into a single aggregate set of F/S.
When a purchase method is used to account for the acquisition, the acquired company's assets are reported on the consolidated F/S at their fair values, not their book values.
![Page 103: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/103.jpg)
Investments 103
Consolidated Financial Statements and the Equity Method (contd.) If the purchase price is greater than the fair
value of the acquired net assets (fair value of assets - fair value of liabilities), the excess amount is recorded as goodwill.
The depreciation of the acquired company's assets is based on the fair value on the consolidated F/S.
This depreciation expense is greater than that of using the book value as the deprecation base.
![Page 104: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/104.jpg)
Investments 104
Consolidated Financial Statements and the Equity Method (contd.) The goodwill is NOT subject to amortization
on the consolidated F/S (SFAS No.142).a
The incremental depreciation expense will reduce the net income reported on the consolidated F/S.
The investment account of the equity method is to approximate the net outcome of the consolidated F/S for the investor.
a. Effective date for SFAS 142 is for fiscal years beginning after 12/15/2001. SFAS 142 is to apply to all goodwill. Goodwill acquired after 6/30/2001 is subject immediately to nonamortization of SFAS 142.
![Page 105: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/105.jpg)
Investments 105
The Accounting Procedures of the Equity Method
The investment is originally recorded at cost but is subsequently adjusted each period for the changes in the net assets of the investee. The investment is increased (decreased) by the investor's proportionate shares of investee’s net income (loss) and decreased by the dividends received.
![Page 106: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/106.jpg)
Investments 106
The Accounting Procedures of the Equity Method
The Investee’s net income is further adjusted by the following:
1. Elimination of intercompany transaction impact;
2. the depreciation of investee’s assets step-upa (if there is any)
a. fair value of investee’s depreciable assets - book value of these assets
![Page 107: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/107.jpg)
Investments 107
The Accounting Procedures of the Equity Method:(contd.)
Treat the proportionate share of investee extraordinary items as investor's extraordinary items.
Similar principle applies to investee’s discontinued operation results and cumulative effect from accounting method change).
![Page 108: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/108.jpg)
Investments 108
Summary of the Equity Method Procedures:
Investment = Acquisition Cost + Investor’s Share of Investee's Net Income (N/I) - Dividends Received
Where:
Investor’s Share of Investee's Income =
(Investee’s N/I x owner. %) - Adjustments
Dividends Received =
Total Div. Paid by Investee x ownership %
![Page 109: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/109.jpg)
Investments 109
Summary of the Equity Method Procedures (contd.):
Adjustments include:
a. elimination of intercompany transaction impact
b. the depreciation of investee’s depreciable assets step-up
![Page 110: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/110.jpg)
Investments 110
Summary of the Equity Method Procedures (contd.):
Investment Cost Share of Income Share of dividends Share of depre. on assets step-up
![Page 111: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/111.jpg)
Investments 111
Example: Equity Method Investments
On 1/1/x5, Clibron Company purchases 4,200 shares of common stock of the Sam Corporation which has 16,800 shares of common stock outstanding on 1/1/x5.
Thus, Cliborn has 25% of the ownership and significant influence is presumed to exist. The acquisition cost for the 4,200 shares is $125,000.
The following information concerning Sam Corporation is also available on 1/1/x5:
![Page 112: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/112.jpg)
Investments 112
Example:(contd.)
B/S Book Value Fair Market ValueDepreciable assets (remaining life, 10 year) $400,000 $ 450,000Other nondepreciatble assets (e.g., land) $190,000 $ 226,000Total $ 590,000 $ 676,000Liabilities $ 200,000 $ 200,000Common Stock $ 250,000Retained Earnings $ 140,000
$ 590,000
![Page 113: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/113.jpg)
Investments 113
Example:(contd.)
Also, no intercompany transactions occur during the year.
Sam Corp. paid $20,000 dividends on 8/28/x5, and reported net income for 20x5 of $81,000 consisting of ordinary income of $75,000 and an extraordinary gain of $6,000.
These events are recorded on Cliborn Company’s book as follows:
![Page 114: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/114.jpg)
Investments 114
Example:(contd.)
1.To record the investment on 1/1/x5: Investment in Stock 125,000 Cash
125,000
2.To record the receipt of dividends on 8/28/x5:
Cash (20,000 x 25%) 5,000Investment in Stock 5,000
![Page 115: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/115.jpg)
Investments 115
Example:(contd.)
3.To record Cliborn Company’s 25% share in the year’s net income:12/31/x5
Investment in Stock 20,250a
Investment Income: ordinary 18,750b
Investment Income: extra 1,500c
a. $81,000 x 25% b. $75,000 x 25% c. 6,000 x 25%
![Page 116: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/116.jpg)
Investments 116
Example:(contd.)
4. Adjustments: To reduce the investment by the
proportionate depreciation of invstee’s depreciable assets step-up:Investment Income: ordinary 1,250a
Investment in Stock 1,250
a.[(450,000 - 4000,000) x 25%] / 10
![Page 117: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/117.jpg)
Investments 117
Example:(contd.)
Goodwill:Purchase price - fair value of net assets acquired
Fair value of net assets (assets –liabilities) =$676,000 - $200,000= $476,000
Investor's share of the fair value of net assets= $476,000*25% = $119,000
Goodwill = $125,000 - 119,000 = $6,000
![Page 118: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/118.jpg)
Investments 118
Summary of the Equity Method Procedures (contd.):
Investment (12/31/x5) Cost 125,000 Share of Income 20,250 5,000 Dividends 1,250 Incremental Depr.
Balance 139,000
![Page 119: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/119.jpg)
Investments 119
Financial Statement Disclosures
The Investment in stock account is disclosed in the long-term investment section of the 12/31/x5 Balance Sheet of Cliborn Company as follows:
Investment in Sam Corp. Acquisition Price (1/1/x5) $125,000Add: Shares of 20x5 reported
ordinary Income $18,750 Shares of 20x5 reported extraordinary Income 1,500 20,250 145,000 Less: Dividends Paid (8/28/x5) $5,000Depreciation on Excess Market Value of Acquired Assets 1,250 ($6,250)
Carrying Value $139,000
![Page 120: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/120.jpg)
Investments 120
Financial Statement Disclosures :(contd.)The total amount of Investee income disclosed on Cliborn income statement for 20x5 is $18,700, which consists of $17,200 income from continuing operations and $1,500 of an extraordinary income.The supporting schedule is as follows:Shares of 20x5 Ordinary Income $18,750Less: Depreciation on Excess M.V. of
Acquired Assets ($1,250)
Ordinary Investment Income $17,500Plus: Share of extraordinary Income $1,500Net Investment Income $19,000
![Page 121: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/121.jpg)
Fair Value Option for Investments Accounted for Under the Equity Method
When the fair value option is elected to report investments accounted for under the equity method, the investments are reported at the fair value.
The investments are not reclassified as trading securities as in the case of fair value option reporting for SAS or HTM.
Investments 121
![Page 122: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/122.jpg)
Fair Value Option for Equity Method Investments (Contd.) The investments are reported on a
separate line in the balance sheet or with other equity method investments with the fair value in a parenthesis.
The unrealized holding gain/loss is reported in the income statement.
Investments 122
![Page 123: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/123.jpg)
Example: Fair Value Option for Equity Method Investments Using the example on p111-120, Clibron
Corporation has been applying the equity method to account for its investment in Sam Corporation, the investment account balance under the equity method is $139,000 on 12/31/20x5(see the t-account on p118).
Assuming the fair value of Sam Corporation on 20x5 is $700,000, the fair value of Clibrone’s 25% share of Sam Corp. would be $175,000.
Investments 123
![Page 124: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/124.jpg)
Example: Fair Value Option for Equity Method Investments (Contd.) If Clibron had been using the equity method
to account for its investments in Sam Corp. but elected the fair value option reporting for this investment on 12/31/x5, the following adjustment would be made by Clibron Corp. on 12/31/x5:
Fair Value Adjustment* 36,000 Unrealized Holding Gain** 36,000 *to adjust the investment account to fair value of
$175,000 ** reported in the income statementInvestments 124
![Page 125: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/125.jpg)
Example: Fair Value Option for Equity Method Investments (Contd.) The contribution to the earnings from
investment in Sam Corp equals: $19,000 (net investment income
recognized under the equity method, see p 120) +$36,000 (fair value adjust.) = $55,000
Investments 125
![Page 126: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/126.jpg)
Example: Fair Value Option for Equity Method Investments (Contd): An Alternative If Clibron has been using the fair value
reporting for its investment in Sam and made its fair value adjusting on 12/31/x5, the following entries would have been recorded in 20x5 for this invement:
1/1 Investment 125,000 Cash 125,000 8/28 Cash 5,000 Investment Revenue 5,000
Investments 126
![Page 127: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/127.jpg)
Example: Fair Value Option for Equity Method Investments (Contd): An Alternative
12/31/x5 Fair Value Adjustment * 50,000 Unrealized Holding Gain** 50,000 * to adjust the investment to the fair value of
$175,000 ** reported in the income statement The contribution to the earnings from
investment in Sam equals: $55,000 (i.e., $5,000+50,000).
Investments 127
![Page 128: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/128.jpg)
Investments 128
Change from Equity method:
When the ownership falls below 20%, the investor may lose significant influence over the investee and the use of the equity method is no longerappropriate.
The investment should be accounted for under the fair value method.
![Page 129: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/129.jpg)
Investments 129
Change from Equity method (contd.):
No adjustment is made to the carrying amount of the investment account.
The carrying amount of the investment on the date of change becomes the new cost basis.
The equity method is simply discontinued and the appropriate new method is applied from then on.
![Page 130: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/130.jpg)
Investments 130
Change to Equity method:
Change to Equity method: The investment account is retroactively adjusted to the balance as if the equity method always had been used. An example of changing from accounting the investment as SAS to the equity method:Procedures:
![Page 131: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/131.jpg)
Investments 131
Change to Equity method:
1. Eliminate the unrealized gain or loss (i.e., adjust the investment account to the cost) 2. Adjust the investment account retroactively: Investment in Stock $$
Retained Earnings $$$$ = its previous percentage of( investee's
adjusted income - Dividends) prior to the change.
![Page 132: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/132.jpg)
Investments 132
Change to Equity method (contd.):
Prior financial statements should be restated using the equity method for comparative purposes.The income effect for years prior to those shown in the comparative statements is reported as an adjustment to the beginning retained earnings of the earliest year reported on the R/E statement.
![Page 133: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/133.jpg)
Investments 133
Sale of Equity Method Investment
A gain or loss is recognized as the difference between the selling price and the carrying amount of the investment account.
![Page 134: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/134.jpg)
Investments 134
Conclusion
Different methods in accounting for investments will not affect the cash flows, but only the income number.
Equity method is to prevent income manipulation by investees who have significant influence on dividend policy.
![Page 135: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/135.jpg)
Investments 135
Additional IssuesA. Reporting for non marketable securities: non marketable securities are stock or bonds issued by a privately-held company whose securities are not traded in a “qualifying” market. Reporting for these securities does not follow the guidance of SFAS 115. These securities are typically reported at their historical cost and the unrealized gains and losses are ignored.
![Page 136: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/136.jpg)
Investments 136
Additional Issues (contd.)
B.Stock Dividends and Splits
No journal entry is needed to account for either the stock dividends or the splits. However, a memo is required to indicate that the cost of shares is reduced.
![Page 137: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/137.jpg)
Investments 137
Additional Issues:(contd.) Example of stock dividends:
2,000 shares of Kell Co. common stock were originally purchased for $30 per share by the Smith Co. Two months later, Kell issued a 50% stock dividend. Therefore, Smith received another 1,000 shares. The following memo is to reflect the stock dividend received by Smith:
![Page 138: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/138.jpg)
Investments 138
Additional Issues:(contd.) Example of stock dividends:
memo: Received 1,000 shares of Kell Company common stock as a stock dividend. The cost of the shares is now $20 per share, computed as follows: $60,000 / (2,000 + 1,000) = $20.Subsequently, 500 shares of investment were sold for $25 per share. The fair value at the most recent B/S data was $23 per share. The journal entry to record this transaction is:
![Page 139: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/139.jpg)
Investments 139
Additional Issues:(contd.) Example:(contd.)
Cash 12,500Unrealized Gain and Loss in Value of SAS 1,500
Investment in SAS 11,500Gain on Sale of Investments ** 2,500
* Cost per share has been reduced from $30 to $20 per share due to stock dividends.** ($25 - 20) * 500 = 2,500
![Page 140: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/140.jpg)
Investments 140
Additional Issues:(contd.)
C.Stock Warrants Stock warrants are certificates that enable
their holders to purchase a specific number of shares at a predetermined price.
No additional cost is incurred when the warrants are received by the corporation holding the investment in common stock.
It is necessary to assign a portion of the cost of the stock (investment) to the warrants upon their receipt of warrants.
![Page 141: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/141.jpg)
Investments 141
Additional Issues:(contd.)
C.Stock Warrants (contd.) The amount is determined by use of a weighted average based on the market value of the stock ex right and the market value of the warrants.
The accounting for any subsequent purchases of shares (or any sale of warrants) would use the amount assigned to the warrants.
![Page 142: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/142.jpg)
Investments 142
Additional Issues:(contd.)
D.Convertible Bonds Investments in convertible bonds would be included in the available for sale (or trading) category and valued at fair value. When these convertible bonds are converted into stocks,memo is required to specify the number of shares that are now owned instead of bonds.
![Page 143: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/143.jpg)
Investments 143
Additional Issues:(contd.)
E.Cash Surrender Value of Life Insurance
Portion of insurance premiums paid for executives may be returned to the company upon the cancellation of the policy.
This guaranteed cash returned upon the cancellation of an insurance is called “ Cash Surrender Value” of an insurance plan.
![Page 144: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/144.jpg)
Investments 144
Additional Issues:(contd.)
E. (contd.)This portion of the insurance premiums (equal to the cash surrender value) should be reported as a long- term investment on the balance sheet, rather than an insurance expense.
Example: At the beginning of the year, the Mele Co. pays an annual insurance premium of $5,500 to cover the lives of its officers. The following entry is recorded:
![Page 145: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/145.jpg)
Investments 145
Additional Issues:(contd.) Example:
Prepaid Insurance 5,500Cash 5,500
According to the terms of the insurance contract the cash surrender value of the policy increases from $7,200 to 8,300 during that year. The adjusting entry at the end of year to record the insurance expense and the increase in cash surrender value is as follows:
![Page 146: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/146.jpg)
Investments 146
Additional Issues:(contd.) Example:(contd.)
Insurance Expense 4,400 Cash Surr. Value of Life Ins. 1,100 Prepaid Insurance 5,500
Upon the death of any of insurance officer, Mele would debit cash for the proceeds received from the insurance company, credit cash surrender value and any difference will be reported as an ordinary gain.
For tax purchases, the premiums are Not tax deductible and the gain is not taxable.
![Page 147: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/147.jpg)
Investments 147
Additional Issues:(contd.)
F.Investments in Funds
Assets (i.e., securities, cash,..) could be placed in special funds for specific purposes (i.e. for the retirement of long-term liabilities (bond sinking fund), etc).
Assets placed in the funds are not available for normal operations because of the contractual arrangement. Therefore, long-term funds are reported as investments on the balance sheet.
![Page 148: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/148.jpg)
Investments 148
Additional Issues:(contd.)
F.Investments in Funds (contd.)
The accounts used in connection with a bond sinking fund are:
Sinking Fund Cash, Sinking Fund Securities, Sinking Fund Revenues, Sinking Fund Expenses, Allowance for Change in Value of Sinking Fund Securities, Unrealized Gain/Loss in Value of Sinking Fund Securities, and loss on Sale of Sinking Fund Securities and Loss on Sale of Sinking Fund Securities.
![Page 149: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/149.jpg)
Investments 149
Impairment of Receivable due to Troubled Debt Restructuring The receivable is settled outright (example is from p589 of Spiceland, etc.
textbook) First Prudent is owed $30 million by
Brillard Properties under a 10% note with two years remaining.
The previous year’s interest was not received due to financial difficulties of Brillard.
First Prudent agrees to settle the receivable and the accrued interest in exchange for property with a fair value of $20 million on 1/1/x3.
![Page 150: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/150.jpg)
Impairment of Receivable due to Troubled Debt Restructuring (contd.) J.E. ($ in millions)
Land 20 Loss on T/D restructuring 13 Interest receivable 3
Note receivable 30
Investments 150
![Page 151: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/151.jpg)
Impairment of Receivable due to Troubled Debt Restructuring (contd.)
The receivable is continued but with modified terms: (p589 of Spiceland, etc.)
Same information as on p148, except First Prudent agrees to forgive the interest accrued, reduce the remaining two interest payments to $2 million each and reduce the principal to $25 million.
Investments 151
![Page 152: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/152.jpg)
Investments 152
Impairment of Receivable due to Troubled Debt Restructuring (contd.) Carrying value of the loan: $33 million Present value of future
cash flows of receivable (24,132,330)
Loss from the settlement $8,867,670
PV=$2 millionx1.73554+$25 millionx0.82645
![Page 153: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/153.jpg)
Investments 153
Impairment of Receivable due to Troubled Debt Restructuring (contd.) J.E.(1/1/x3) Loss on T/B restructuring 8,867,670 Interest receivable 3,000,000 Note receivable 5,867,670*
* $30 million-24,132,330 (PV of future cash flows from the settlement)
1/1/x4 Cash 2,000,000 Note Receivable 413,233 Interest Revenue* 2,413,233 *10% interest on the balance of N/R on
1/1/x3
![Page 154: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/154.jpg)
Impairment of Receivable due to Troubled Debt Restructuring (contd.)
The balance of Note Receivable on 1/1/x4 = 24,132,330 +413,233 = 24,545,563 = present value of Note receivable on 1/1/x4 =
$2 million x0.9091+25,000,000x0.9091
Investments 154
![Page 155: Chapter 12 Investments 2 Objectives of the Chapter 1.Classification and reporting of Investments: trading securities, available-for-sale securities and.](https://reader035.fdocuments.us/reader035/viewer/2022062407/56649e0e5503460f94af89c9/html5/thumbnails/155.jpg)
Impairment of Receivable due to Troubled Debt Restructuring (contd.)
1/1/x5 (receipt of $2 million interest and $25 million of principal)
Cash 2,000,000 Note Receivable 454,570 Interest Revenue 2,454,570* *10% interest on the bal. of N/R on 1/1/x4 Cash 25,000,000 Note Receivable 25,000,000
Investments 155