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COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...
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COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson ...

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  • 1. Investments in Debt & Equity Securities Chapter 14 S t I c e | S t I c e | S k o u s e n Intermediate Accounting 16E Prepared by: Sarita Sheth | Santa Monica College
  • 2. Learning Objectives
    • Determine why companies invest in other companies.
    • Understand the varying classifications associated with investment securities.
    • Account for the purchase of debt and equity securities.
    • Account for the recognition of revenue from investment securities.
  • 3. Learning Objectives
    • Account for the change in value of investment securities.
    • Account for the sale of investment securities.
    • Record the transfer of investment securities between categories.
    • Properly report purchases, sales, and changes in value of investment securities in the statement of cash flows.
  • 4. Learning Objectives
    • Explain the proper classification and disclosure of investments in securities.
    • Compare the accounting for investment securities under U.S. GAAP with the international standard in IAS 39.
    • Account for the impairment of a loan receivable.
  • 5. Time Line of Issues: Involved with Investment Securities DETERMINE purpose of investment ? CLASSIFY investments a, b, c PURCHASE securities EARN and RECOGNIZE a return Good Buy Corporation $10 par value Good Buy Corporation $10 par value
  • 6. Time Line of Issues: Involved with Investment Securities + + - - MONITOR changes in value SELL securities TRANSFER securities between categories DISCLOSE status of portfolio at the end of the period Good Buy Corporation $10 par value Good Buy Corporation $10 par value a b c
  • 7. Why Companies Invest in Other Companies Safety Cushion Cyclical Cash Needs Investment for a Return Purchase for Control Investment for Influence
  • 8. Stop & Think
    • As of December 31, 2004, Ford Motor owned 33.4% of Mazda. Which ONE of the following possible motivations do you think is the primary motivation for this investment by Ford?
  • 9. Classifications of Investment Securities Available-for-sale Trading Held-to-maturity Debt Equity Method Equity Cost Method
  • 10. Classifications of Investment Securities
    • Debt securities typically have the following characteristics:
      • A maturity value, representing the amount to be repaid to the debt holder at maturity.
      • An interest rate that specifies the periodic interest payments.
      • A maturity date, indicating when the debt obligation will be redeemed.
  • 11. Classifications of Investment Securities
    • Equity securities represent ownership in a company:
      • These shares of stock typically carry with them the right to collect dividends and vote on corporate matters.
      • Equity securities have the potential for significant increases in price.
  • 12. Equity Method Securities
    • Represents ownership in a company.
    • Includes rights to collect dividends and to vote on corporate matters.
    • Potentially purchased with the intent to control or significantly influence the operations of the investee.
    • Despite the general criteria, a 20% investment does not necessarily guarantee significant influence.
  • 13. Different Accounting Treatments
    • Exhibit 14-8
  • 14. Purchases of Debt Securities On May 1, Douglas Company purchases $100,000 in U.S. Treasury notes at 104¼, including brokerage fees. Interest is 9% payable semiannually on January 1 and July 1. The debt securities are classified by the purchaser as trading securities. Accrued interest on May 1 is $3,000, calculated as follows: $100,000 x .09 x 4/12 = $3,000
  • 15. Purchases of Debt Securities Asset Approach Investment in Trading Securities 104,250 Interest Receivable 3,000 Cash 107,250 Purchase date May 1 : Revenue Approach Investment in Trading Securities 104,250 Interest Revenue 3,000 Cash 107,250
  • 16. Purchases of Debt Securities Asset Approach Cash 4,500 Interest Receivable 3,000 Interest Revenue 1,500 Receipt of semiannual payment July 1 : Revenue Approach Cash 4,500 Interest Revenue 4,500
  • 17. Purchase of Equity Securities Citty Co. purchased 1,000 shares of Deli Company common shares at $2 per share. Available-for-Sale Approach Investment in Available-for- Sale Securities- Deli Co. 2,000 Cash 2,000
  • 18. Purchase of Equity Securities Citty Co. purchased 100,000 shares of Deli Co. common shares at $2 per share. Assume that the 100,000 shares purchased represents 20 percent of the outstanding voting stock of Deli Company. This investment gives the investor significant influence over Deli Company.
  • 19. PV of Debt Securities On January 1, 2004, Silmaril Technologies purchased 5-year, 10% bonds with a face value of $100,000 and interest payable semiannually on January 1 and July 1. The market rate on bonds of similar quality and maturity is 8%. Investment in Trading Securities 108,100 Cash 108,100 Present value of principal: FV = $100,000; N = 10; I = 4% $ 67,556 Present value of interest payments: PMT = $5,000; N = 10; I = 4% 40,554 Total present value of the bonds $108,110
  • 20. Interest Revenue for Debt Securities (Trading) When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash 5,000 Interest Revenue 5,000
  • 21. Interest Revenue for Debt Securities (Held-to-Maturity) When the first interest payment is received from Silmaril, the following entry would be made: July 1 Cash 5,000 Interest Revenue 4,324 Maturity Securities 676 $108,110 x .04
  • 22. Interest Revenue for Debt Securities (Held-to-Maturity) When the second interest payment is received, the interest revenue is determined by the yield times the bond carrying value. July 1 Cash 5,000 Interest Revenue 4,297 Maturity Securities 703 $107,434 x .04
  • 23. Determining the Appropriate Accounting Method 0% 20% 50% 100% No significant influence Significant influence Control Ownership Percentage Account for as trading or available-for-sale Equity method Equity method and consolidation procedures
  • 24. Stop & Think
    • Theoretically, we should amortize the discount or premium associated with trading and available-for-sale debt securities just as we do with held to maturity securities. Why don’t we?
  • 25. Determining the Appropriate Accounting Method
    • Equity securities are classified as trading or available for sale when ownership is less than 20 percent.
    • The equity method is used when the investor has the ability to significantly influence or control the investee’s operations.
  • 26. Determining Accounting Method
    • Effect 14-9
  • 27. Revenue for Equity Securities Classified as Trading and AFS Deli Co. announces dividends of $0.25 per share. Assume that Citty Co. owns 1,000 shares Cash 250 Dividend Revenue 250
  • 28. Revenue for Equity Securities Classified as Trading and AFS Deli Company announces dividends of $0.25 per share. Assume that Citty Co. owns 100,000 which represents 50 percent of the outstanding voting stock. Cash 25,000 Investment in Deli Co Stock 25,000
  • 29. Revenue for Equity Securities Classified as Trading and AFS Deli Company reports income for the year, $250,000. Assume Citty owns 50% of outstanding voting stock. Investment in Deli Co Stock 125,000 Income from Investment in Deli Co Stock 125,000
  • 30. Equity Method: Purchase for More than Book Value Deli Company reports income for the year, $250,000. Assume Citty owns 50% of outstanding voting stock. Investment in Deli Co Stock 125,000 Income from Investment in Deli Co Stock 125,000
  • 31. Equity Method: Purchase for More than Book Value The net assets of Stewart Inc. was $500,000 at the time Phillips Manufacturing Co. purchased 40% of the common shares for $250,000 on January 1, 2005. The market value of the net assets of Stewart Inc. would be $625,000, which is $125,000 more than the book value. Only $50,000 of this is attributed to depreciable assets. $250,000 ÷ .40 The average remaining life of the depreciable assets is 10 years and the special operating license is to be amortized over 20 years. Additional depreciation ($50,000 x 0.40)/10 $2,000 License amortization ($75,000 x 0.40)/20 1,500 $3,500
  • 32. Equity Method: Purchase for More than Book Value Investment in Stewart Inc. Common Stock Acquisition cost 250,000 Share of earnings 60,000 Dividends 28,000 Additional depreciation 2,000 Additional amortization 1,500 310,000 31,500 Balance 278,500 Stewart Inc. declared and paid dividends of $70,000 to common stockholders during 2005, and it reported net income of $150,000 for the year ended December 31, 2005.
  • 33. Accounting for the Change in Value of Securities Disclosed at Report FMV Trading Fair market value Income statement Change On Classification of Security Held-to- maturity Amortized cost Not recognized Available- for-sale Fair market value Stockholder’s equity
  • 34. Accounting for the Change in Value of Securities
    • Eastwood Inc. purchased the following securities on March 23, 2007.
    • Trading securities:
      • Purchase price (Security #1) $ 8,000
      • Value end of year (#1) $ 7,000
      • Purchase price (#2) $ 3,000
      • Value end of year (#2) $ 3,500
    • Available-for-sale securities:
      • Purchase price (#3) $ 5,000
      • Value end of year (#3) $ 6,100
  • 35. Accounting for the Change in Value of Securities
    • Eastwood Inc. purchased the following securities on March 23, 2007 (cont.)
      • Available-for-sale securities:
      • Purchase price (#4) $12,000
      • Value end of year (#4) $11,500
    • Held-to-maturity securities:
      • Purchase price (#5) $20,000
      • Value end of year (#5) $19,000
  • 36. Accounting for the Change in Value of Securities Initial Purchase Entry Investment in Trading Securities 11,000 Investment in Available-for-Sale Securities 17,000 Investment in Held-to-Maturity Securities 20,000 Cash 48,000 By the end of the year, the value of the trading securities decreased from $11,000 to $10,500. December 31, 2005: Unrealized Loss on Trading Securities 500 Market Adjustment—Trading Securities 500
  • 37. Accounting for the Change in Value of Securities December 31, 2005: Market Adjustment — Available-for-Sale Securities 600 Unrealized Increase/Decrease in Value of Available-for-Sale Securities 600 By the end of the year, the value of the available-for-sale securities increased from $17,000 to $17,600.
  • 38. Accounting for the Change in Value of Securities
    • FASB No. 115 puts an end to “cherry-picking .” This is the practice of selectively selling securities whose prices have increased, while keeping those that have experienced losses or have maintained their historical cost.
  • 39. Accounting for the Change in Value of Securities
    • Partial Balance Sheet for Eastwood Inc.
    • Assets
    • Invest. in trading securities $11,000
    • Market adjustment—trading sec. (500 ) $10,500
    • Invest. in available-for-sale sec. $17,000
    • Market adjustment 600 17,600
    • Invest. in held-to-maturity sec. 20,000
    • $48,100
    • Stockholders’ Equity
    • Add unrealized increase in
    • available-for-sale securities $ 600
    Partial Income Statement for Eastwood Inc. Other expenses and losses: Unrealized loss on trading securities $500
  • 40. Sale of Securities To record accrued revenue and amortize premium: Apr. 1 Interest Receivable 2,500 Investment in Held-to Maturity Securities 395 Interest Revenue 2,105 Entry to record sale: Apr. 1 Cash 103,000 Realized Loss on Sale of Securities 4,353 Interest Receivable 2,500 Investment in Held-to Maturity Securities 104,853
  • 41. Stop & Think
    • What is the difference between realized and recognized?
  • 42. Transferring Securities Between Categories Transferred Treatment of Change in Value From trading Any unrealized change in value not previously recognized will be recognized in net income in the current period. To trading Any unrealized change in value not previously recognized will be recognized in net income in the current period. From held to maturity to available for sale Recognize any unrealized change in value in a stockholders’ equity account. From available for sale to held to maturity Any unrealized change in value recorded in a stockholders’ equity account is to be amortized over the security’s remaining life using the effective-interest method. Statement of Financial Standards No. 115, par. 15d
  • 43. Stop & Think
    • Which ONE of the following statements is correct with respect to ALL transfers of investment securities from one category to another?
  • 44. Transferring Securities Between Categories
    • Assume:
      • Cost of trading security $3,000
      • Fair market value, end of 2007 3,600
      • Fair market value at transfer date 3,800
    Investment in Available-for-Sale Securities 3,800 Market Adjustment--Trading Securities 600 Unrealized Gain on Transfer of Securities 200 Investment in Trading Securities 3,000
  • 45. Transferring Securities Between Categories
    • Assume: Transfer from the available-for-sale category to the trading security category.
      • Cost of available-for-sale security $12,000
      • Fair market value, end of 2006 10,700
    Investment in Trading Securities 10,300 Market Adjustment--Trading Securities 1,300 Unrealized Loss on Transfer of Securities 1,700 Unrealized Increase/Decrease in Value of Available-for- Sale Securities 1,300 Investment in Available-for- Sale Securities 12,000
  • 46. Transferring Securities Between Categories
    • Assume: Record a transfer from held-to-maturity to the available-for-sale category.
      • Cost of held-to-maturity security $20,000
      • Fair market value, Dec. 31, 2006 20,700
    Investment in Available-for- Sale Securities 20,400 Unrealized Increase/ Decrease in Value of Available-for-Sale Securities 400 Investment in Held-to- Maturity Securities 20,000
  • 47. Transferring Securities Between Categories
    • Assume: Record a transfer from available-for-sale (AFS) to held-to-maturity
    • Cost of available-for-sale securities $5,000
    • Fair market value, end of 2006 6,500
    • Fair market value at transfer date 5,900
    Investment in Held-to-Maturity Securities 5,900 Unrealized Increase/Decrease in Value of AFS Securities 600 Investment in AFS Securities 5,000 Market Adjustment—AFS Securities 1,500
  • 48. Cash Flows from Gains and Losses on Available-for-Sale Caesh Company began with a $1,000 investment on January 1, 2007. Cash sales $1,700 Cash expenses (1,400) Purchases of investment securities (600) Sale of investment securities (costing $200) 170 The market value of the remaining securities was $500 on December 31, 2005.
  • 49. Cash Flows from Gains and Losses on Available-for-Sale Caesh Company will report a $100 unrealized increase in the value of it available-for-sale portfolio. This $100 unrealized increase is reported as an increase in Accumulated Other Comprehensive Income. Sales $1,700 Expenses (1,400 ) Operating income $ 300 Realized loss on sale of securities (30 ) Net income $ 270
  • 50. Cash Flows from Gains and Losses on Available-for-Sale The statement of cash flows for Caesh Company for 2007 appear as follows: Operating activities: Net income $ 270 Plus realized loss on sale of securities 30 $ 300 Investing activities: Purchase of investment securities $(600) Sale of investment securities 170 (430) Financing activities: Initial investment by owner 1,000 Net increase in cash $ 870
  • 51. Classification and Disclosure
    • Trading securities
      • The change in net unrealized holding gain or loss that is included in the income statement.
    • Available-for-sale securities
      • Aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type.
      • The proceeds from sales of available-for-sale securities and the gross realized gains and losses on those sales and the basis on which cost was determined in computing realized gains and losses.
  • 52.
    • Available-for-sale securities (continued):
      • The change in net unrealized holding gain or loss on available-for-sale securities that has been included in stockholders’ equity during the period.
    • Held-to-maturity securities:
      • Aggregate fair value, gross unrealized holding gains and gross unrealized holding losses, and amortized cost basis by major security type.
      • The company should disclose information about contractual maturities.
    Classification and Disclosure
  • 53. International Accounting for Investment Securities
    • The differences in U.S. and international accounting standards are disappearing.
    • However, understanding the differences allows the user to better use and interpret the global statements.
    • IAS 39 covers the accounting for investment securities.
  • 54. IAS 39 Provisions
    • All financial assets and financial liabilities are initially measured at cost.
    • After initial recognition, all financial assets are to be remeasured to fair value except for:
      • Debt securities intended to be held until maturity
      • Financial assets whose fair value cannot be reliably determined.
    • After acquisition, financial liabilities are to be measured at the original recorded amount, less repayments and amortization.
    • A company can report unrealized gains and losses in one of two ways:
      • In net income of the period or
      • In net income for unrealized gains and losses on trading securities and as part of equity for “nontrading” securities.
  • 55. Accounting for the Impairment of a Loan
    • Occasionally, market value may not exist for the investment.
    • The investor must assess the collectibility of the investment and if and “impairment exists.
    • An adjustment must be made to the value of the receivable.
    • Impairment is measured by comparing the present value of expected future cash flows with the carrying value of the investment.

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