3.3 Investments in Debt Securities Flashcards
Three categories of debt securities
Trading Securities
Held-to-maturity securities
Available-for-sale securities
Debt securities that the reporting entity has the positive intent and ability to hold to maturity
Held-to-maturity
Debt securities intended to be sold in the near term
Trading
Debt securities not classified as held-to-maturity or trading
Available-for-sale
Available-for-sale debt securities should be measured at _________ in the _____________
at fair value in the balance sheet
Available-for-sale debt securities should be measured at fair value in the balance sheet
On July 2, Year 4, Wynn, Inc. purchased as a short-term investment a $1 million face-value Kean Co. 8% bond for $910,000 plus accrued interest to yield 10%. The bonds mature on January 1, Year 11, and pay interest annually on January 1. On December 31, year 4, the bonds had a fair value of $945,000. On February 13, Year 5, Wynn sold the bonds for $920,000. In its December 31, Year 4, balance sheet, what amount should Wynn report for the bond if it is classified as an available-for-sale security?
$945,000
Available-for-sale debt securities should be measured at fair value in the balance sheet. Thus, the bond should be reported at its fair value of $945,000 to reflect the unrealized holding gain (change in fair value).
The following information pertains to Lark Corp’s available-for-sale debt securities:
December 31
Year 2
Cost: $100,000
Fair Value: $90,000
Year 3
Cost $100,000
Fair Value: $120,000
Differences between cost and fair values are considered to be temporary. The decline in fair value was properly accounted for at December 31, Year 2. Ignoring tax effects, by what amount should other comprehensive income (OCI) be credited at December 31, Year 3?
$30,000
Unrealized holding gains and losses on available-for-sale debt securities, including those classified as current assets, are not included in earnings but ordinarily are reported in OCI, net of tax effects (ignored in this question).
At December 31, Year 2, OCI should have been debited for $10,000 unrealized holding loss. At December 31, Year 3, OCI should be credited to reflect $30,000 unrealized holding gains ($120,000 fair value at 12/31/Yr 3 - $90,000 fair value at 12/31/Year 2)
Debt securities held primarily for sale in the near term to generate income on short-term price difference are known as
A. Available-for-sale securities
B. Trading securities
C. Held-to-maturity securities
D. Discontinued operations
B. Trading securities
Trading securities are initially recorded at cost but are remeasured at fair value at each balance sheet date, with the unrealized holding gains or losses recognized in earnings.
On January 1 of the current year, Barton Co. paid $900,000 to purchase two-year, 8%, $1,000,000 face value bonds that were issued by another publicly-traded corporation. Barton plans to sell the bonds in the first quarter of the following year. The fair value of the bonds at the end of the current year was $1,020,000. At what amount should Barton report the bonds in its balance sheet at the end of the current year?
A. 900,000
B. 950,000
C. 1,000,000
D. 1,020,000
D. 1,020,000
Because Barton intends to sell the investment during the first quarter, the investment should be reclassified as a trading debt securities. Trading debt securities are measured at fair value.
When the fair value of an investment in securities exceeds its carrying amount, how should each of the following assets be reported at the end of the year?
- Held-to-maturity
- Available-for-sale Securities
- Held-to-maturity: carrying amount
- Available-for-sale Securities: fair value
When fair value exceeds the carrying amount of held-to-maturity securities, GAAP do not permit recognition of the unrealized holding gain. Accordingly, these debt securities should be reported at their carrying amount (amortized cost). However, fair value accounting applies to available-for-sale and trading securities.
At year end, Rim Co. held several investments with the intent of selling them in the near term. The investments consisted of $100,000, 8%, 5-year bonds, purchased for $92,000, and short-term notes purchased for $35,000. At year end, the bonds were selling on the open market for $105,000, and the short-term notes had a market value of $50,000. What amount should Rim report as trading securities in its year-end balance sheet?
A. $155,000
B. $127,000
C. $50,000
D. $142,000
A. $155,000
Debt securities that are bought and held primarily for sale in the near term are classified as trading securities.
Consequently, the bonds and the short-term notes are trading securities. They are initially recorded at cost but are subsequently measured at fair value at each balance sheet date. Quoted market prices in active markets are the best evidence of fair value. Based on market quotes at year end, the bonds had a fair value of $105,000, and the short-term notes had a fair value of $50,000. The total is $155,000.
For available-for-sale debt securities included in noncurrent assets, which of the following amounts should be included in the period’s net income?
I. Unrealized holding losses during the period
II. Realized gains during the period
III. Changes in fair value during the period
II only.
The temporary decline below cost of the fair value of available-for-sale debt securities is recorded in OCI, assuming they are not designated as being hedged in a fair value hedge. Thus, temporary changes in the valuation of these securities do not flow through net income. A realized gain occurs when securities are sold at an amount greater than their cost basis. Realized gains are included in net income regardless of the classification of the securities.
Which one of the following statements with regard to marketable securities is incorrect?
A. In the available-for-sale portfolio of marketable debt securities, unrealized gains and losses are recorded on the income statement.
B. Debt securities may be transferred from the held-to-maturity to the available-for-sale portfolio
C. In the trading portfolio of marketable equity securities, unrealized gains and losses are recorded on the income statement.
D. The held-to-maturity portfolio consists only of debt securities.
A. In the available-for-sale portfolio of marketable debt securities, unrealized gains and losses are recorded on the income statement.
Assuming the fair value option has not been elected, unrealized holding gains and losses on available-for-sale debt securities are reported in other comprehensive income.
