Chapter 16: Investments Flashcards
Comprehensive Income
A company’s change in total stockholders’ equity from all sources other than owners’ investments and dividends
- unrealized gains or losses from available-for-sale debt investments
- foreign currency transaction adjustments
- gains or losses on post retirement benefit plans
- deferred gains or losses from derivatives
Consolidation Accounting
Wat to combine the financial statements of two or more companies that have the same owners
Controlling interest
Holdings over 50%
When one corporation requires a voting interest of more than 50% in another corp.
- investor = parent
- investee = subsidiary
- investment in subsidiary is reported on the parent’s books as a LONG-TERM investment
- Parent generally prepares a Consolidated Financial Statement
Classifications of Debit and Stock Investments
Debit Investments:
- Trading
- Available-for-sale
- Held-To-Maturity
Equity Investments: - Trading - Held to Maturity or - No Significant Influence - Significant Influence -Controlling Interest
Available-For-Sale securities
(as of 2016- Available-for-sale classification only for debt securities, not equity)
- Securities held with the intent of selling sometime in the future
- classified as current assets or long-term assets depending on intent
- reported at Fair Market Value and report changes from cost as part of the stockholders equity section
Held-To-Maturity Securities
(Debt Investments)
- Investments the company intends to hold + has the ability to hold until they mature
current or long term assets depending on the maturity date
Trading Securities
Trading debt investments
- Securities held with the intention of selling them in a short period
(Trading = frequent buying and selling)
Trading securities reported at Fair Market Value and report changes in value from cost as part of net income
Always short term assets
Marketable Securities
AKA short-term investments
Securities held by a company that are:
- readily marketable
- intended to be converted into cash within the next year (or operating cycle, whichever is longer)
if investments do not meet both of these requirements they are long-term investments
reported at Fair Value as current asset or balance sheet (just after cash)
Risks to investments in bonds
Guaranteed return of principal + interest BUT
- when interest rates rise value of bonds fall (their lower rates are less attractive)
- credit risk that the company cannot pay back what it borrowed
Reasons corporations invest
1) they have excess cash
2) to generate earnings from investment income
3) for “strategic reasons”
(investing in a key vendor to strengthen relationships)
Security
A share or interest representing financial value
Stock Investment
Accounting depends on investor’s influence over operating and financial affairs of issuing corporation
Equity security
Ownership share in another company that sometimes pays cash or issues stock dividends
Debt Investments
Include government and corporate bonds or notes
Accounting for Value of Financial Instruments
As of 2010 FASB still considering how best to handle
Fair Value (amount the instrument could currently be sold for) possibly difficult to accurate estimate
Adjusting value of trading securities
Debit Security Fair Value Adjustment - Trading
Credit Unrealized Gain - Income
or
Debit Unrealized Loss - Income
Credit Security Fair Value Adjustment - Trading
(Unrealized gain or loss shows in income statement other other income and expense)
Equity method journaling
Purchase:
Debit Stock Investments
Credit Cash
Recognizing Revenue:
Debit Stock Investments (net income reported x ownership percentage)
Credit Revenue from Investments
Receiving Dividends:
Debit Cash
Credit Stock Investments
(dividends are equity no longer held in the company)
Disposing of Equity Investment with Gain or Loss on Disposal
Credit loss on disposal
or
Debit gain on disposal
Both temporary accounts (closed out)
Report in other income/ expenses section of the income statement
Adjusting Value of Available-For-Sale Securities
Gain:
Debit Security Fair Value Adjustment - Available for sale (or “Market Adjustment)
Credit Unrealized Gain - Equity
Loss:
Debit Unrealized Loss- Equity
Credit Security Fair Value Adjustment - Available For Sale
Gain or loss is then reported on the stockholders equity section of the balance sheet (not on income statement)
Recording Acquisition of bonds (Debt Securities)
Include all expenditures (costs) necessary to acquire these investments
- price paid
- brokerage fees
Debit Investment (asset) account
Credit Cash
Recording Bond Investment Interest
Calculate Interest Revenue based on:
Carrying Value (BV) of Bond x Interest Rate x portion of the year the bond is outstanding
Debit Cash received
Credit Interest Revenue (or Interest receivable if already accrued)
Recording Sale of Bonds
Credit Investment (asset) account for the cost of bonds Record gain or loss (any difference between net proceeds of sale (sale price less brokerage fees) and cost of bonds)
Debit Cash
(Debit Loss if applicable)
Credit Investment (asset)
(Credit Gain on sale of bonds if applicable)
Valuing Stock Investments
Percent of ownership of issuing corporation | Investor Influence | Valuation Method
0-20% owned | No significant influence | Cost Method
20-50% owned | Significant Influence | Equity Method
50-100% owned | Control Exists | Cost or Equity. investment eliminated in consolidation
Cost method of recording stock investments
Used for holdings of less than 20%
- investments recording at cost (when bought and sold)
- revenue only recognized when cash dividends are received (no dividends receivable)
- Cost includes all expenditures necessary to acquire investments (price + brokerage fees/ comissions)
Debit Equity Investment (cost)
Credit Cash
Equity Method of Recording stock investments
Used for Holdings between 20%-50%
- Record investment at cost and adjust the amount each period for:
- investors proportionate share of earnings (net income or net loss)
- Dividends received
If investors share of investees losses exceeds Book (carrying) value of investment investor should stop using the equity method
Consolidated Financial Statements
Indicate the magnitude and scope of operations of the companies under common control
Realized/ Unrealized Gain or Loss on Balance Sheet
Other Revenues and Gains:
- Interest Revenue
- Dividend revenue
- Gain on Sale of Investments
- Unrealized Gain - Income
Other Expenses and Losses:
- Loss on Sale of Investments
- Unrealized Loss - Income
Unrealized Gain or Loss on Available-For-Sale securities
Goes on balance sheet
- separate component of stockholders equity
“other comprehensive income or loss”
Stockholders’ equity
Common Stock
Retained Earnings
= Total Paid-In-Capital and retained earnings
Less: unrealized loss on Available-for-sale securities
(or Plus unrealized gain)
= Total stockholders’ equity
Rate of Return on total assets
AKA Return on Assets
= (net income + interest expense)/ average total assets
measures the success a company has in using its assets to earn income
Parent and subsidiary companies under IFRS
Investor and associate (subsidiary) company should following the same accounting practices
- adjustments are made to associate’s policies to conform to investor’s books
NOT a requirement in GAAP
Measurement of Financial Assets under IFRS
IFRS criteria to determine how to measure financial assets:
- company’s business model for managing financial assets
- contractual cash flow characteristics of the asset
eg: if the business model is to hold assets in order to collect contractual cash flows and contractual terms give specified dates to cash flows that are solely payments of principal + interest on principal outstanding = use cost method.
Inventories under IFRS
NOT considered a financial cost
When to use equity method under IFRS
Investor has significant influence (20-50% of investee’s common stock)
Same as GAAP
Reporting unrealized loss on trading investments IFRS
Unrealized gains and losses related to available-for-sale / non-trading equity investments are reported under other comprehensive income in both GAAP and IFRS .
Reported on income statement - reducing net income
Legal vs Economic entities
Parent and subsidiary companies are separate legal entities but are considered a single economic entity
