Ch 17.1 (Investments in Debt Securities) Flashcards
FASB Standard for reporting loans
Can report loans at amortized cost
FASB Standard for reporting equity investment
Can report equity investments at fair value
Motivations for investing in debt/equity securities (issued by other companies)
- To earn a high rate of return.
- To secure certain operating or financing arrangements with another company ( equity securities)
Debt/Equity security and the company’s intent w.r.t the investment
- Debt; No plans to sell; amortized cost
- Debt; plan to sell; fair value
- Equity - plan to sell; fair value
Debt Securities
Represent a creditor relationship with another entity.
Debt securities include U.S. government securities, municipal securities, corporate bonds, convertible debt, and commercial paper.
Three separate categories for investments in debt securities - Held to maturity, Trading, Available-for-sale
Amortized Cost
The acquisition cost adjusted for the amortization of discount or premium, if appropriate.
Fair Value
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Held to maturity Debt Securities
Accounted for at amortized cost.
These securities do not increase the volatility of either reported earnings or reported capital.
To compute interest revenue, companies compute the effective-interest rate or yield at the time of investment and apply that rate to the beginning carrying amount (book value) for each interest period.
Available-for-sale securities
Report these securities at fair value.
Records the unrealized gains and losses related to changes in the fair value (other comprehensive income).
Companies report available-for-sale securities at fair value on the balance sheet but do not report changes in fair value as part of net income until after selling the security.
eg. if there is a loss, then debit unrealized holding gain or loss and credit fair value adjustment
Companies exclude from net income any unrealized holding gains and losses related to available-for-sale securities.
Available-for-sale securities (selling example)
If a company sells bonds carried as investments in available-for-sale securities before the maturity date, it must make entries to remove from the Debt Investments account the amortized cost of bonds sold.
Gain/loss on sale is reported in the “Other expenses and losses” section of the income statement.
Net income v Capital ( Available-for-sale securities)
Companies do not include in net income unrealized gains and losses.
Volatility of net income is avoided, but volatility of capital still results.
Trading Securities
Companies intend to sell security within a short period of time.
Frequent buying and selling of trading securities.
Purpose: to generate profits from short-term differences in price.
Generally held for less than 3 months.
Companies report trading securities at fair value, with unrealized holding gains and losses reported as part of net income. ( use fair value adjustment & unrealized holding gain or loss accounts)
Companies are required to amortize any discount or premium.
Holding gain or loss
Net change in the fair value of a security from one period to another, exclusive of dividend or interest revenue recognized but not received.
Trading securities (When sold)
When a trading investment is sold, the Debt Investments account is reduced by the amount of the amortized cost of the bonds.
Any realized gain or loss is recorded in the “Other revenues and gains” or the “Other expenses and losses” section of the income statement.
The Unrealized Holding Gain or Loss—Income account is reported in the income statement under “Other revenues and gains” or “Other expenses or losses.”
The Fair Value Adjustment account is then adjusted at year-end for the unrealized gains or losses on the remaining securities in the trading investment portfolio.
