Investment advince from wayne lippman : lippman & Associates CPA's

Investments brought to you
By Wayne Lippman
And Lippman & Associates
CPA’s Inc.
http://lippmancpas.com

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.

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.

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.

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.

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.

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.

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.

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.

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.

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.

Investments 12
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).

Investments 13
methods (cont.)
The investor has to issue the
consolidated financial statements.
No recognition of unrealized gains or
losses.

Investments 14
Summary of Accounting for
Investments
Reporting of Unrealized Holding
Method Gains and Losses
A. Invest. In Equity Securities
1. No signoficant influencant
a. Trading Fair value Income statement
b. Available-for-Sale Fair value Stockholders' equity
2. Significant influence
(20% to 50% ownership) Equity method Not recognized
3. Control
(more than 50% ownership) Consolidation Not recognized
B. Invest. In Debt Securities
a. Trading Fair value Income statement
b. Available-for-Sale Fair value Stockholders' equity
c. Held-to-Maturity Amortized cost Not recognized

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

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)

Investments 17
Example A:(cont.)
1. Initial recording on 5/1/x5:
Investments in SAS 68,000*
Invest. Rev. 625**
Cash 68,625
Cost = 100 x 50 + 300 x 80 + 200 x 120 +
15,000 = 68,000
** Accrued interests = 15,000 x 10% x 5/12 = $625

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 750
Note: If the bonds were purchased at a
discount or premium, the discount or premium
needs to be amortized when interest revenue
is recongized.

Investments 19
Example A: cont.
12/31/x5 Invest. Receivable 125
Invest. Revenue 125
Assuming Green received $3,000 for
dividends in 20x5
Cash 3,000
Invest. Revenue 3,000

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 Change
Security Cost Fair Value in F.V
A $5,000 $6,200 $1,200
B $24,000 $25,100 $1,100
C $24,000 $23,200 ($800)
D $15,000 $16,500 $1,500
total $68,000 $71,000 $3,000

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

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

Investments 23
Example A: SAS(contd.)
The following info. is available on 12/31/x6:
A $5,000 $6,100 $1,100
B $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)

Investments 24
Example A: (cont.):SAS
12/31/x6 Adjusting entry (for valuation):
Unrealized holding Gains
(losses) on investment**-OCI 5,000
• ** Other comprehensive income of x6

Investments 25
Balance Sheet Presentation:SAS
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
(losses) on investment(2,000)

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.

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

Investments 28
Example B (cont.): SAS
Also in 20x7, Green sold 300 share of B for
$22,000
J.E. to record this transaction
Cash 22,000
Loss on sale of investments 2,000
Investments (at cost) 24,000

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

Investments 30
Example B:(contd.):SAS
C $24,000 $26,000 $2,000
D $15,000 $12,000 -3,000
Total $39,000 $38,000 ($1,000)

Investments 31
Example B:SAS
The Adjusting entry on 12/31/x7
Unrealized Gains (Losses) on Investment** 1,000
Note: before the adjustment, the ending bal. of fair
value adjustment and unrealized holding gain/loss
equal $2,000 (credit) and $2,000 (debit),
respectively. After the adjustment, the bal. of fair
value adj. And unrealized holding G/L equal
$1,000 (credit) and $1,000 (debit), respectively.

Investments 32
Balance Sheet Presentation:SAS
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
(losses) on investment(1,000)

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.

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

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

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

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

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

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
$22,000
J.E. to record this transaction
Cash 22,000
Loss on sale of investments 700
Investments (at fair value) 22,700
* The investment account is at the fair value.
Investments 39

Example D (contd.): same as in Example B on p30
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

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

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

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

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.

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 ?%

Investments 46
Example E:(contd.)
J.E
1/1/x5
Investment in Bonds -
held-to-maturity 102,458.71
Cash
102,456.71
6/10/x5
Cash 6,500
Interest Revenue* 6,147.52
Inv. in Bonds 352.48

Example E: record the premium in a
separate account (An alternative)
J.E
1/1/x5
Investment in Bonds 100,000
Prem. on Bond Inv. 2,458.71
Cash 102,456.71
6/10/x5
Cash 6,500
Prem. on Bond Inv. 352.48
Investments 47

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.

Investments 49
Bond Investment Interest revenue and
Premium Amortization Schedule
Effective Interest Method
Interest 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 6,126.37 373.63 101,732.60
6/30/x6 6,500.00 6,103.96 396.04 101,336.56
12/31/x6 6,500.00 6,080.19 419.81 100,916.75
6/30/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

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

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

HTM Example F (contd.): Discount
Recorded in a Separate Account
1/1/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

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 Securitiesd
1/1/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

Investments 54
Amortization for Bonds Acquired
Between Interest Dates
Example 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%

Investments 55
Example G(cont.)
Bond Investment Interest Revenue and
Premium Amortization Schedule (Effective
Interest Method)
Investment Carrying value
Interest 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

Investments 56
Example 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.

Investments 57
Example 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

Investments 58
Example G(cont.)
4/3/x5
Investment in bonds- HTM 204,568.5
Interest Receivable 6,500
Cash 211,068.5
6/30/x5
Cash 13,000
Interest Revenue 6,147.5
Investment in bondds- HTM 352.6

Investments 59
Example G(cont.)
12/31/x5
Cash 13,000
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.

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.

Investments 61
Sale of Investment in Securities
Held 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 Invest
1/1/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

Investments 62
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

Investments 63
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

Investments 64
Example H:(contd.)
J.E
3/31/x6
Investment in Debt Sector 190.73
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

Investments 65
Example H:(contd.)
Gains= Selling pirce (excluding accrued
interest)- Carrying value
(updated with amort. of pemium)
=102,000-98,496.54 =3,503.46

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.

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

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.
b
The 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

Example I: Same infor. as in Example A on p23,
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 statement
B
An indirect adjustment; the SAS is reported
as trading securities on the B/S at fair value.
Investments 69

Example J: Same infor. as in Example B on p27,
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

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

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.

Investments 73
Transfers :(contd.)
The accounting Treatments for
Transfers:
From
SAS,HTM
To
Trading
Treatment
The unrealized gain
or loss included in
current earnings.

Investments 74
Transfers :(contd.)
Transfers:
From
Trading
To
Available
Held to Maturity
Treatment
No accounting for
the unrealized gain
or loss (it has been
recognized in
income)

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

Investments 76
Transfers :(contd.)
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.)

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:

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 200
2. 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

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 200
Unrealized Gain / Loss 200
Investment in SAS 6,300
nvestment in Trading 6,300

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.

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.

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. 9,500
Loss 500
Investment in HTM 10,000

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.

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.

Investments 85
Financial Statement Disclosure
Disclosure notes for investments should
include:
a. Amortized cost (cost basis).
b.Gross unrealized gains.
c. Gross unrealized losses.
d. Estimated fair value.

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.

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.

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.

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

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.

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.

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 :

Impairments:(contd.)
Example b: (debt investment classified as SAS)
Unrealized Holding Gain/Loss
2,000
Eliminate the unrealized gain/loss
Investment in SAS 10,000
Write down to the fair value
Investments 93

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:
Investment in Trading 8,000
Securities

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.

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.

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:

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;

Investments 99
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).

Investments 100
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.

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).

Investments 102
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.

Investments 103
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.

Investments 104
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.

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.

Investments 106
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

Investments 107
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).

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 %

Investments 109
Procedures (contd.):
Adjustments include:
a. elimination of intercompany
transaction impact
b. the depreciation of investee’s
depreciable assets step-up

Investments 110
Investment
Cost
Share of Income
Share of dividends
Share of depre. on
assets step-up

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:

Investments 112
Example:(contd.)
B/S Book Value Fair Market Value
Depreciable assets
(remaining life, 10 year) $400,000 $ 450,000
Other nondepreciatble assets
(e.g., land) $190,000 $ 226,000
Total $ 590,000 $ 676,000
Liabilities $ 200,000 $ 200,000
Common Stock $ 250,000
Retained Earnings $ 140,000
$ 590,000

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:

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%) 5,000

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%

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
a.[(450,000 - 4000,000) x 25%] / 10

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

Investments 118
Investment (12/31/x5)
Cost
125,000 Share of
Income 20,250 5,000 Dividends
1,250 Incremental Depr.
Balance 139,000

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) $125,000
Add: 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) $5,000
Depreciation on Excess Market Value
of Acquired Assets 1,250
($6,250)
Carrying Value $139,000

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 $18,750
Less: Depreciation on Excess M.V. of
Acquired Assets ($1,250)
Ordinary Investment Income $17,500
Plus: Share of extraordinary Income $1,500
Net Investment Income $19,000

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

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
Investments 122

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

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 statement
Investments 124

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

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

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

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.

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.

Investments 130
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:

Investments 131
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.

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.

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.

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.

Investments 135
Additional Issues
A. 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.

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.

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:

Investments 138
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:

Investments 139
Example:(contd.)
Cash 12,500
Unrealized Gain and Loss
in Value of SAS 1,500
Investment in SAS
11,500
Gain 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

Investments 140
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.

Investments 141
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.

Investments 142
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.

Investments 143
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.

Investments 144
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:

Investments 145
Example:
Prepaid Insurance 5,500
Cash 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:

Investments 146
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.

Investments 147
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.

Investments 148
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.

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.

Troubled Debt Restructuring (contd.)
J.E. ($ in millions)
Land
20 Loss on T/D
restructuring 13
Interest receivable 3
Note receivable 30
Investments 150

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

Investments 152
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

Investments 153
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

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

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

About Wayne Lippman
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Wayne Lippman has forty years of
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including twenty years with Price
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Oakland offices. He was previously
Managing Tax Partner of the Walnut
Creek office of Price Waterhouse.
http://Waynelippman.wordpress.com

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